Chap001 jpm-f2011

Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.1 - 2

Environment and Theoretical Structure of Financial Accounting

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Financial Accounting Environment

Profit-orientedcompanies

Not-for-profitentities

Households

Providers ofFinancial

InformationExternal

User Groups

Investors

Creditors

Employees

Labor unions

Customers

Suppliers

Governmentagencies

Financialintermediaries

Relevant

FinancialInformation

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Financial Accounting Environment

Relevant financial information is provided primarily through financial statements and related disclosure notes. Balance Sheet Income Statement Statement of Cash Flows Statement of Shareholders’ Equity

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Investment-Credit Decisions ─ A Cash Flow Perspective

Shareholders Receive

Cash

1. Dividends2. Sale of Stock

Creditors Receive

Cash

1. Interest2. Loan Repayment

Accounting information should help investors and creditors evaluate the amount, timing, and uncertainty of the enterprise’s future

cash flows.

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Cash versus Accrual Accounting

Cash Basis Accounting Revenue is recognized when cash is received. Expenses are recognized when cash is paid.

OROROR

OR

Accrual AccountingRevenue is recognized when earned.

Expenses are recognized when incurred.

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Cash versus Accrual Accounting

Cash Basis Accounting• Carter Company has sales on account totaling $100,000 per

year for three years. • Carter collected $50,000 in the first year and $125,000 in the

second and third years. • Carter prepaid $60,000 for three years’ rent in the first year. • Utilities are $10,000 per year, but in the first year only

$5,000 was paid. • Payments to employees are $50,000 per year.

Let’s look at the cash flows.

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Cash versus Accrual (page 7)

Cash Basis Accounting

Cash flows in any one year may notbe a predictor of future cash flows.

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Accrual Accounting (page 8)

Net Income is considered a better indicator of future cash flows.

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Historical Perspective and Standards

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Current Standard Setting

• Supported by the Financial Accounting Foundation

• How many full-time, independent voting members?

• Answerable only to the Financial Accounting Foundation

• Members not required to be CPAs

Financial Accounting Standards Board

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FASB Accounting Standards Codification

The objective of the codification project was to integrate and organize by topics all relevant accounting pronouncements

into a searchable, online database.

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Toward Global Accounting Standards

The main objective of the International Accounting Standards Board (IASB) is to

develop a single set of high quality, understandable and enforceable global

accounting standards to help participants in the world’s capital markets and other users

make economic decisions.

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Role of the Auditor

Auditors serve as independent intermediaries to help insure that

management has appropriately applied GAAP in preparing the company’s

financial statements.

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Financial Reporting Reform

As a result of numerous financial scandals, Congress passed the Public Company Public Company

Accounting Reform and Investor Protection Accounting Reform and Investor Protection Act of 2002Act of 2002, (Sarbanes-Oxley Act). The goal

was to restore credibility and investor confidence in the financial reporting process.

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Ethics in Accounting

• For financial information to be useful, it should possess the fundamental decision-specific qualities of relevance and faithful representation.

• Management may be under pressure to report desired results and ignore or bend existing rules.

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The Conceptual Framework

The Conceptual Framework has been described as a constitution, a coherent system of

interrelated objectives and fundamental that lead to consistent accounting standards.

FASB Conceptual Framework(Statements of Financial Accounting Concepts)

Objectives of Financial Reporting (SFAC No. 1)Qualitative Characteristics (SFAC No. 2)Elements of Financial Statements (SFAC No. 6)Recognition and Measurement (SFAC No. 5 and SFAC No. 7)

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ObjectiveTo provide financial information that is useful to capital providers.

(2) Elements(3) Recognition &

MeasurementConcepts

(4) ConstraintsFinancial

Statements

The Conceptual Framework

(1) Qualitative Characteristics

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Relevance Faithful representation

Predictivevalue

Confirmatory value

NeutralityCompletenessFree from

material error

(1) Qualitative Characteristics ofAccounting Information (page 23)

Comparability(Consistency)

UnderstandabilityVerifiability Timeliness

Decision usefulness

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(2a) Elements of Financial Statements (page 27)

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(2b) Elements of Financial Statements (page 27)

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(3a) Recognition & Measurement Concepts

RecognitionProcess of admitting

information into the basic financial statements

1. Definition2. Measurability3. Relevance4. Reliability

Measurement involves both the choice of a unit of measure and the choice of an attribute to be

measured.

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(3b) Recognition & Measurement Concepts (page 32)

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(4) Constraints (pages 25-26)

• Cost effectiveness

• Materiality

• Conservatism?

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Evolution of Accounting Principles The Move Toward Fair Value

Fair value is the price that would be received to sell assets or paid to transfer a liability in

an orderly transaction between market participants at the measurement date.

Market Approaches

Income Approaches

CostApproaches

End of Chapter 1