1. Administrative –12 th Edition –FARS access: SBA computer lab –Actg 199 –Intro Questionnaire Due Wednesday 1/10 –Sammy Skateboard Take-home quiz due Wednesday 1/17 –Class website Review syllabus Chapter 1 Agenda

2. How to do Well in this Course Memorize Comprehend and Apply Read ahead - cramming won’t work Seek understanding, not memorization Take notes while reading the text Consider study groups – learn by teaching Assess your time: plan on 4 hrs/week for class and 8 hours prep time (2 nd most difficult SBA course)

3. What do you think accounting is? Is accounting an art or a science? What are accounting disciplines? What is common between all accounting’s disciplines? Overview

4. SenderMessageReceiver ? ? ? Purpose: Rules: As a Macy’s sales manager, what type of information do you want? Managerial Accounting

5. SenderMessageReceiver ? ? ? Purpose: Rules: Tax Accounting

6. SenderMessageReceiver ? ? ? Purpose: For an economic entity to send a financial message to interested parties (stakeholders) Rules: Financial Accounting

7. Accounting identifies, measures and communicates financial information. This information is about economic entities. Information is communicated to interested parties such as investors, creditors, unions and governmental agencies. –Users are assumed to have a reasonable understanding of the business, and to use reasonable diligence SenderMessage Receiver Economic entity Financial statementsStakeholders -LLP -Investors -Partnership -Creditors -Corporation - Employees - SEC - Union Characteristics of Financial Accounting

8. Demand: external parties demand financial accounting information to facilitate their resource allocation decisions –Creditors determine which firms to extend credit and at what interest rate –Investors determine what firm stock to buy and at what price Supply: Firms supply financial accounting information based on the expected economic consequences of doing so –Benefits –Costs Supply and Demand of Financial Accounting Information

9. Does Accounting Matter for Capital Markets? The price of a stock is in theory set at the discounted value of the expected future cash flows to that stock So investors focus on estimating the future net income of the firm, as a measure (“proxy”) of those cash flows What does this mean for managers? If they have some leeway in the net income that the firm reports, they may be able to convince the market of a higher net income that would suddenly make the firm “worth” more

10. To ensure communication between firms and stakeholders, a common understanding is needed – GAAP- the “rules” that define accepted accounting practice GAAP consist of authoritative pronouncements issued by certain accounting bodies GAAP framework is not always rigid and allows flexibility in the manner that firms may record certain transactions - example Generally Accepted Accounting Principles (GAAP)

11. Securities and Exchange Commission (SEC) –Appointed by President, reports to Congress –Final authority on public company reporting American Institute of Certified Public Accountants (AICPA) Financial Accounting Standards Board (FASB) Governmental Accounting Standards Board (GASB) International Accounting Standards Board (IASB) –Principles-Based (not Rules-Based) The Standard Setting Process: Parties Involved

12. Who is responsible? Securities and Exchange Commission (SEC)  Ultimate authority over U.S. financial reporting  Historically delegated its authority to private standard-setting bodies (AICPA and FASB)  SEC requires registrants to adhere to GAAP  Issues Staff Accounting Bulletins (SABs) Financial Accounting Standards in the U.S.

13. Who is responsible? American Institute of Certified Public Accountants (AICPA)  Issued Accounting Research Bulletins (ARBs) from 1939 to 1959.  Issued APB Opinions from 1959-1973.  Today  Provides input into standard setting process and issues various documents generally considered GAAP  Responsible for Auditing Standards until PCAOB created by SOX  Develops and grades uniform CPA exam Financial Accounting Standards in the U.S.

14. Who is responsible? Financial Accounting Standards Board (FASB)  Current private sector organization in charge of accounting standard setting.  Major types of pronouncements issued:  Standards and Interpretations  Financial Accounting Concepts  Technical Bulletins  Emerging Issues Task Force Statements Financial Accounting Standards in the U.S.

15. In establishing financial standards, the FASB follows a due process procedure The due process procedure gives time to interested persons to make their views known to the Board But this means that new standards development takes time, and there is a high degree of lobbying –For example, it took years to remove the pooling method of accounting for acquisitions –SFAS 123 (1995) required stock options to be valued. However, major lobbying efforts essentially allowed the value to be reported only as a footnote disclosure until March 2006, when SFAS 123(R) was released. Operate in the full view of the public FASB Due Process

16. 1.Drafts and releases a discussion memorandum for identified accounting issues: Describes the possible accounting treatments Describes FASB’s preliminary views on the issue 2.Receives public feedback on the discussion memorandum 3.Prepares an exposure draft (proposed new accounting standard) after analyzing and evaluating feedback 4.Accepts public feedback on the exposure draft 5.Decides whether to: Remove the exposure draft from further consideration Revise and reissue the exposure draft Vote upon the current version of the exposure draft (if passed by FASB members, becomes a new accounting standard) FASB Due Process for Standard Setting

17. AGENDA 1 Topics for standard setting are identified Discussion Memorandum 2 The FASB issues initial research and analysis Public Hearing 3 4 A public hearing is conducted FASB Due Process

18. Exposure Draft 4 The FASB issues an exposure draft (tentative standard) Final Standard 5 The FASB evaluates responses and issues the final standard FASB Due Process

19. 1913: 16 th Amendment 1929: Black Friday stock market crash 1933 and 1934 SEC Exchange Acts 1939-1959: CAP (Committee on Accounting Procedure), under AICPA, is first private body to write accounting rules: 51 ARBs (Accounting Research Bulletins) 1959-1973: APB (Accounting Principles Board), under AICPA issued 31 Opinions 1973 - present: FAF (Financial Accounting Foundation) established, in part, to financially support and appoint members to FASB FASB (Financial Accounting Standards Board): –issues SFAS (Statements of Financial Accounting Standards) –Includes 7 full time members 1984: EITF (Emerging Issues Task Force) created by FASB to provide timely guidance regarding new and unusual accounting issues History of Accounting

20. House of GAAP

21. FASB is considering a switch from historical-based accounting to fair value accounting: not yet at exposure draft stage More information needs to be provided regarding soft assets (intangibles) Statements may have to be prepared on a real-time basis (not just quarterly and annually) Providing forward-looking information, in addition to historical information Developing and reporting non-financial measurements Challenges Facing Financial Accounting

22. Pension accounting: many defined benefit plans are underfunded and now firms must put the liability on the books Variable interest firms and Special Purpose Entities (like Enron): had 90% interest in firms, but gave up control and therefore did not consolidate entity with debt Stock options: –Expensing – Senate trying to make applicable only to top 5 executives –Back-dating Controversies in Financial Accounting Now

23. More Recent History and Challenges: SOX The Sarbanes-Oxley Act of 2002 (SOX) was enacted to restore investor confidence following the numerous accounting scandals including Enron and Worldcom SOX has increased the level of corporate governance at publicly traded companies, has increased criminal penalties for corporate executives, and has increased the independence between firms and their auditors, including: –Creation of the Public Company Accounting Oversight Board (PCAOB) that now creates auditing standards and performs CPA firm inspections –CEO and CFO certifications over financial statements and internal controls –SOX Section 404 internal control audits –Audit committee members must be independent, financially literate, must approve all services performed by audit firm, and are responsible for retaining and terminating the auditor. In addition, the firm must disclose financial experts on the audit committee. –Certain non-audit services prohibited by audit firm –Audit partner rotation –Prohibition on loans to executive officers and directors –Prohibition of audit if CEO, controller, CFO, or chief accounting officer was employed by auditor and participated in audit of issuer within prior year

24. Trust drives the accounting profession –SOX, PCAOB, and class action lawsuits are a result of a breach of trust –From a broad perspective, we pay a heavy price for low trust: Waits at airports, audit fees Implications for personal conduct? Trust

25. An expectations gap exists between what the public thinks accountants and auditors should do and what accountants and auditors think they can do –Consider: what is earnings management? Is it unethical? –Do accountants “manage” earnings by recording accruals, adjustments, and depreciation? –Transparency The Expectations Gap

26. The Challenges Ahead Robert Herz, Chairman of FASB: The most pressing challenges to our reporting system are the need to reduce complexity and to improve transparency –The basic principles found in our accounting standards have often been overwhelmed by detailed rules, “bright lines,” and exceptions –The detail and volume of our rules (GAAP) pose a major problem And make it easier for those who attempt to structure “form-over substance” arrangements to manipulate their f/s If Herz is successful: basic principles will be strengthened and clarified, and (just maybe) we will see less complexity on the horizon for accounting –But if the underlying transactions are complex, how can you make the accounting for them simple? –FASB is working on integrating GAAP into one comprehensive volume, similar to the Canadian (CICA) Handbook

27. The objectives are specified in Statement of Financial Accounting Concepts No. 1. The objectives are as follows: Information provided must be useful in investment and credit decisions. Information must be useful in assessing cash flow prospects. Information must be about enterprise resources, claims to those resources and changes therein. Objectives of Financial Reporting by Business Enterprises