1. RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY
FINANCIAL ACCOUNTING
THEORY AND ANALYSIS: TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY 4

2. THE DEVELOPMENT OF ACCOUNTING THEORY
CHAPTER 1
THE DEVELOPMENT OF ACCOUNTING THEORY

3. Introduction What is theory?
Webster defines theory as:
“Systematically organized knowledge, applicable in a relatively wide variety of circumstances, a system of assumptions, accepted principles and rules of procedure to analyze, predict or otherwise explain the nature of behavior of a specified set of phenomena.”
Normative theory
Positive theory
Why is the development of a general theory of accounting important?
Allocating scare resources
What is the relationship of accounting research to accounting theory?
Various theories of accounting will be discussed in Chapter 4 5

4. THE EARLY HISTORY OF ACCOUNTING
Denise Schmandt-Besserat
Origins of writing are actually found in counting.
Pieces of fired clay in Middle Eastern archeological sites.
Tokens comprised an elaborate system of accounting that was used throughout the Middle East from approximately 8000 to 3000 B. C.
Each token stood for a specific item
Used to take inventory and keep accounts
Other accounting records dating back several thousand years have been found in various parts of the world.
These records indicate that at all levels of development, people desire information about their efforts and accomplishments. 6

5. THE EARLY HISTORY OF ACCOUNTING
For example the Zenon Papyri
Who was Zenon?
Information about the construction projects, agricultural activities, and business operations of the private estate of Apollonius for a period of about thirty years during the third century B.C.
Renaissance
Italians pursuing trade and commerce needed records
Fra Luca Pacioli 6

6. THE EARLY HISTORY OF ACCOUNTING
The evolution of joint ventures into ongoing businesses
Caused need for external financial reporting
The impact of the industrial revolution and the progressive movement
Widespread speculation in the securities markets, watered stocks, and large monopolies that controlled segments of the U.S. economy.
1900 report suggested that independent public accounting profession should be established to curtail observed corporate abuses. 6

7. THE EARLY HISTORY OF ACCOUNTING
The concept of capital maintenance
Viewed as a way to curb corporate abuses
The accountant as a protector of business interests
American Institute of Accountants (AIA)
American Association of the University Instructors in Accounting 6

8. ACCOUNTING IN THE UNITED STATES SINCE 1930
Because of fear of government intervention
Meetings between NYSE and AIA
AAA
SEC
What caused formation of SEC?
Securities Act of 1933
Securities Exchange Act of 1934
Difference between public and private sector formulation of accounting principles 7

9. ACCOUNTING IN THE UNITED STATES SINCE 1930
SEC: internal debate about whether it should develop accounting standards.
1938
Accounting Series Release (ASR No. 4)
SEC allowed private sector to set accounting principles
Reports filed with SEC must be prepared in accordance with accounting principles that have “substantial authoritative support{.
A Statement of Accounting Principles
Sanders, Hatfield & Moore
Because accounting profession did not think it had time to develop theoretical framework of accounting
“Do what you think is best.” 7

10. American Institute of Certified Public Accountants (AICPA)
Formed in 1936
Influence on development of accounting theory
Committee on Accounting Procedure
Accounting Principles Board
Financial Accounting Standards Board
Each has issued pronouncements
Have become primary source of today’s generally accepted accounting principles 8

11. Committee on Accounting Procedure (CAP)
Formed in 1936
Professional accountants
Accounting Research Bulletins (ARBs)
Pronouncements
Did not dictate mandatory practice
Received authority only from general acceptance
ARBs consolidated in 1953
Accounting Terminology Bulletin NO. 1, “Review and Resume” and ARB No. 43
ARB published 1953 – 1959
FASB Accounting Standards Codification (Discussed later in the chapter) includes recommendations of these bulletins that have not been superseded 8

12. THE ACCOUNTING PRINCIPLES BOARD (APB)
CAP criticized
Methods of formulating accounting principles didn’t arise from research based on theory
Acting in piecemeal fashion & Issuing inconsistent standards
Resulted in APB
Formation and structure
Types of pronouncements
APB Opinions
Accounting for the investment tax credit (1961)
APB Opinions 2 & 4
Rule 203 8

13. THE ACCOUNTING PRINCIPLES BOARD (APB)
Criticism of the APB
Independence of members
Members had full-time responsibilities elsewhere that could influence views
Structure
“Big 8” automatically awarded 1 member
Usually 5 or 6 other public accountants on board
Response time
Part-time members not able to investigate and resolve emergency issues in timely manner 8

14. THE FINANCIAL ACCOUNTING STANDARDS BOARD
Because of growing criticism of APB
1971: Board of Directors of AICPA appointed 2 committees:
The Wheat Committee
How to establish accounting principles
The Trueblood Committee
Objectives of financial statements
The FASB was established 9

15. Structure of the FASB Financial Accounting Foundation Board of
Trustees
Electors
Appoint and
fund
Govern
Appoint |
Appoint and
fund
Financial
Accounting
Standards
Advisory
Committee
(approx.
20 members)
Financial
Accounting
Standards
Board
( 7 members)
Task Forces
of the
Standards
Board
Appoint
Admin Staff
Research Staff 10

16. FASB Mission – establish standards Types of pronouncements
Statements of Financial Accounting Concepts
Statements of Financial Accounting Standards
Interpretations
Technical Bulletins 11

17. FASB Emerging Issues Standards Overload
Lack of timely guidance
Standards Overload
Too many standards
Standard setting as a political process
Some users found that best way to influence formulation of accounting standards is to attempt to influence standard setters
Example: SFAS No. 123 and 123R
Economic Consequences 12

18. GAAP Evolution of phrase:
Changed wording of auditor’s certificate brought about by meetings between NYSE and AIA
The APB’s definition
“present fairly…in conformity with generally accepted accounting principles:
The Auditing Standards Executive Committee’s definition
No singular reference source exists for all principles
Makes general acceptance of a specific principle difficult
SAS 69: determining acceptance of a specific principle is difficult 13

19. SFAS No. 162 Hierarchy of GAAP
Four levels
FASB codification project reduced this to 2 levels:
Authoritative
Not authoritative A B C D 13

20. The FASB’s Accounting Standards Codification
Hundreds of accounting standards promulgated by several different accounting standard setters.
Accounting standards had evolved to the point that professionals could not keep up.
September, 2004: the FAF Trustees approved funding for the FASB’s codification and retrieval project

21. The FASB’s Accounting Standards Codification
June 2009
FASB announced Codification would be single source of all nongovernmental US GAAP effective 9/15/09.
Involved following steps:
Restructure all U.S. GAAP literature by topic into a single authoritative codification.
Modify the standard-setting process to focus on updating the codification.

22. The FASB’s Accounting Standards Codification
Reasons for codification
Researching multiple authoritative sources complicated research process
FASB, EITF, AICPA & SEC literature
FASB ASC contains all current authoritative accounting literature
If guidance is not specified, first source to consider is accounting principles for similar issue with a source of authoritative GAAP
Nonauthoritative guidance from other sources may be considered if similar transactions aren’t discovered in GAAP.

23. THE ROLE OF ETHICS IN ACCOUNTING
The public accountant as a watchdog
What is basic conflict of interest facing public accountants? 20

24. Accounting in Crisis – The Events of the Early 2000s
Enron and the Accounting Scandals
“Special-purpose entities” (SPEs)
Now termed variable interest entities (VIEs)
Purpose:
Access capital
Hedge risk
Allowed company to increase financial leverage and return on assets without reporting debt on balance sheet
Losses were kept off Enron’s books
Enron filed for bankruptcy and stock became virtually worthless.

25. Accounting in Crisis – The Events of the Early 2000s
Two major changes in the accounting profession have taken place in the wake of the accounting scandals:
Arthur Andersen
formerly one the Big 5 audit firms
has gone out of business
Sarbanes-Oxley Act
President Bush signed into law July 2002
imposes a number of corporate governance rules on publicly traded companies (Discussed in chapter 17)

26. International Accounting Standards
The concept of harmonization
The IASB
The IASB’s objectives:
To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance
To work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements.
41 Statements of Accounting Standards and 13 Statements of Financial Reporting Standards to date

27. Prepared by Kathryn Yarbrough, MBA
End of Chapter 1
Prepared by Kathryn Yarbrough, MBA
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