1 An electronic presentation by Douglas Cloud by Douglas Cloud Pepperdine University Pepperdine...

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An electronic presentationAn electronic presentation by Douglas Cloudby Douglas Cloud

Pepperdine UniversityPepperdine University

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The Environment The Environment of Financial of Financial ReportingReporting

Chapter1

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1. Understand capital markets and decision making.

2. Know what is included in financial reporting.3. Explain generally accepted accounting

principles (GAAP) and the sources of GAAP.4. Identify the types of pronouncements issued

by the FASB.

Objectives

ContinuedContinued

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5. Understand how the Financial Accounting Standards Board (FASB) operates.

6. Describe the relationship between the Securities and Exchange Commission (SEC) and the FASB.

7. Use ethical models for decision making about ethical dilemmas.

8. Understand creative and critical thinking.

Objectives

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Companies need large amounts of capital for operations.

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Companies may obtain capital by

issuing capital stock...

Stock Exchange

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... or by borrowing from lenders.

Bank

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Capital MarketsCapital Markets

Corporations

Financial InstitutionsInvestors

Borrow money

Sell stocks and bonds

Primary Market (e.g., individuals,

banks)

Secondary Market (e.g., New York

Stock Exchange)

Buy and sell stocks and

bonds

Buy and sell stocks and

bonds

Investors InvestorsBuy and sell stocks and

bonds

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Accounting Information Economic Accounting Information Economic Activities and Decision MakingActivities and Decision Making

Accumu-late

AccountingInformation

Communi-cate

External User

Internal User

External Decisio

n Making

Internal Decisio

n Making

Company’s Economic Activities

Impact

Impact

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External and Internal UsersExternal and Internal Users

1. Buy. A potential investor decides to purchase a particular security on the basis of communicated accounting information.

2. Hold. An actual investor decides to retain a particular security on the basis of communicated accounting information.

3. Sell. An actual investor decides to dispose of a particular security on the basis of communicated accounting information.

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Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

Sources of Authority

Internal needs

Managerial Accounting Financial Accounting

GAAP

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Time Frame of Reported Information

Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

Present and future

Managerial Accounting

Primarily historical

Financial Accounting

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Scope

Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

Mainly total company

Financial Accounting

Individual departments, divisions, and total company

Managerial Accounting

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Type of Information

Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

Primarily quantitative

Sales$275,240

Cost180,120

Gross mar. 95,120

Expenses 80,120

Net inc. $15,000

Financial Accounting

Qualitative as well as quantitative

Materials usage is

unfavorable by $8,400.

Managerial Accounting

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Statement Format

Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

Prescribed by GAAP; oriented toward investment

and credit decisions

Financial Accounting

Determined by company; focused upon specific decisions being made

Managerial Accounting

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Decision Focus

Comparison of Financial and Comparison of Financial and Managerial AccountingManagerial Accounting

External

Financial Accounting

Internal

Managerial Accounting

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The company’s accountants prepare both the financial

and the managerial accounting reports…

…and the information comes from the same information system.

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Financial ReportingFinancial ReportingFinancial reporting is the

process of communicating financial accounting information about a

company to external users.

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The balance sheet (or statement of financial position) which summarizes a company’s financial position at a given date.

The income statement which summarizes the results of a company’s income producing activities for a period of time.

The statement of cash flows which summarizes a company’s cash inflows and outflows for a period of time.

Companies present at least three major financial statements:

Financial ReportingFinancial Reporting

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A statement of changes in stockholders’ equity

also is included by many companies.

This statement summarizes the

changes in each item of stockholders’

equity for a period.

Financial ReportingFinancial Reporting

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Generally Accepted AccountingGenerally Accepted AccountingPrinciples (GAAP)Principles (GAAP)

GAAP are the guidelines, procedures, and practices that a company is required

to use in recording and reporting the accounting information in its audited

financial statements.

They are like laws and are the rules that must be followed in financial reporting.

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Hierarchy of Sources of GAAPHierarchy of Sources of GAAP

A. Pronouncements of authoritative bodies (FASB, APB, CAP, SEC).

B. Pronouncements of bodies of expert accountants that have been exposed for public comment.

C. Pronouncements of bodies of expert accountants that have not been exposed for public comment.

ContinuedContinued

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D. Widely accepted practices and pronouncements representing prevalent practice in a particular industry or applications to specific circumstances.

E. Other accounting literature.

Hierarchy of Sources of GAAPHierarchy of Sources of GAAP

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History of GAAP in History of GAAP in the Private Sectorthe Private Sector

1938

CAP formed

CAP issued 51

ARBs

APB issued 31 Opinions

1959

APB formed

1973

FASB formed

Present

FASB issued 145

Statements of Standards as

of 5/02

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Reasons for Forming APBReasons for Forming APB

1. To alleviate criticism about the process of formulating accounting principles, which included wider representation.

2. To create a policy-making body whose rules would be binding on companies rather than optional.

The APB was comprised 17 to 21 The APB was comprised 17 to 21 members, selected primarily from members, selected primarily from

the accounting profession.the accounting profession.

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Criticisms of the APBCriticisms of the APB1. Independence. The members of the APB were part-

time volunteers whose major responsibilities were to the business, governmental, or academic organization employing them.

2. Representation. The public accounting firms and the AICPA were too closely associated with the development of accounting standards.

3. Response time. Emerging problems were not solved quickly enough by the part-time members of the APB.

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Structure of the FASBStructure of the FASB

Financial Accounting Standards Advisory Council

(approximately 30 members)

Financial Accounting Standards Board

(7 members)

Appoint, fund, and oversee

Advise

Financial Accounting Foundation (16-member board of trustees)

ContinuedContinued

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Financial Accounting Standards Board

(7 members)

Task Forces of the Standards Board

(including Emerging Issues Task Force)

Appoint

Consult

Support

Administrative Administrative StaffStaff

Research and Research and Technical StaffTechnical Staff Consult

Structure of the FASBStructure of the FASB

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Types of Pronouncements Types of Pronouncements Issued by the FASBIssued by the FASB

• Statements of Financial Accounting Standards

• Interpretations• Technical Bulletins• Statements of Financial Accounting

Concepts• Other Pronouncements

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FASB Operating ProceduresFASB Operating Procedures

Identify Topic

Appoint Task Force

Conduct Research

Issue Discussion

Memorandum or Invitation to

Comment

Issue Exposure

Draft

ContinuedContinued

Deliberate on Findings

Hold Public Hearings

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Modify Exposure

Drafts

Vote (super-

majority)

Issue Exposure

Draft

Hold Public Hearings

FASB Operating ProceduresFASB Operating Procedures

From previous

page

Issue Statement

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Securities and Exchange Commission (SEC) American Institute of Certified Public

Accountants (AICPA) FASB Emerging Issues Task Force (EITF) Cost Accounting Standards Board (CASB) Internal Revenue Service (IRS) American Accounting Association (AAA)

Other Organizations Other Organizations Impacting GAAPImpacting GAAP

ContinuedContinued

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International Accounting Standards Committee (IASC)

Governmental Accounting Standards Board (GASB)

Financial Executives International (FEI) Institution of Management Accountants (IMA) Association for Investment Management and

Research (AIMR)

Other Organizations Other Organizations Impacting GAAPImpacting GAAP

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Participants in the Participants in the Development of GAAPDevelopment of GAAP

EITF

CASB

GASB

IMA

IRSIASC

AAAAIMR

FEI

G4+1

FASBFASB

SECSEC AICPAAICPA

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Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

Responsibilities

In carrying out their responsibilities as

professionals, members should exercise sensitive

professional judgment in all their activities.

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The Public Interest

Members should accept the obligation to act in a way that will serve the public interest,

honor the public trust, and demonstrate commitment to

professionalism.

Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

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Integrity

To maintain and broaden public confidence,

members should perform all professional

responsibilities with the highest sense of integrity.

Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

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Objectivity and Independence

A member should maintain objectivity and be free from

conflicts of interest in discharging professional responsibilities. A

member in public practice should be independent in fact and

appearance.

Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

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Due Care

A member should observe the profession’s technical and ethical

standards, strive continually to improve competence and the

quality of services, and discharge the professional responsibility to the best of the member’s ability.

Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

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Scope and Nature of Service

A member in public practice should observe the Principles of the CPC in determining the scope and nature of services

to be provided.

Principles of the AICPA Code Principles of the AICPA Code of Professional Conductof Professional Conduct

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An Ethicist’s Basic Approaches An Ethicist’s Basic Approaches to Moral Reasoningto Moral Reasoning

(1) The utilitarian model, which evaluations actions based on the greatest good for the greatest number.

(2) The rights model, which embraces actions that protect individual moral rights.

(3) The justice model, which emphasizes a fair distribution of benefits and burdens.

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Creative and Critical Thinking Creative and Critical Thinking Impact on Problem SolvingImpact on Problem Solving

Recognize Problem

Identify Alternatives

Evaluate Alternatives

Select Solution

Implement Solution

Creative Thinking

Critical Thinking

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Chapter1

The EndThe End

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