chapter 7
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TRANSCRIPT
Chapter 7-1
Accounting PrinciplesAccounting Principles
Financial Accounting, Sixth Edition
Chapter Chapter 77Chapter Chapter 77
Chapter 7-2
1. Explain the meaning of GAAP and identify the key items of the conceptual framework.
2. Describe the basic objectives of financial reporting.
3. Discuss the qualitative characteristics of accounting information and elements of financial statements.
4. Identify the basic assumptions used by accountants.
5. Identify the basic principles of accounting.
6. Identify the two constraints in accounting.
7. Understand and analyze classified financial statements.
8. Explain the accounting principles used in international operations.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives
Chapter 7-3
Accounting PrinciplesAccounting PrinciplesAccounting PrinciplesAccounting Principles
Monetary unitMonetary unit
Economic Economic entityentity
Time periodTime period
Going Going concernconcern
TheTheConceptualConceptual
Framework ofFramework ofAccountingAccounting
TheTheConceptualConceptual
Framework ofFramework ofAccountingAccounting
AssumptionsAssumptionsAssumptionsAssumptions PrinciplesPrinciplesPrinciplesPrinciplesConstraints Constraints
in in
AccountingAccounting
Constraints Constraints
in in
AccountingAccounting
Statement Statement
Presentation Presentation
and Analysisand Analysis
Statement Statement
Presentation Presentation
and Analysisand Analysis
Objectives of Objectives of reporting reporting
Qualitative Qualitative characteristicscharacteristics
Elements of Elements of financial financial statements statements
Operating Operating guidelinesguidelines
Revenue Revenue recognition recognition
MatchingMatching
Full Full disclosuredisclosure
CostCost
MaterialityMateriality
ConservatismConservatism
Summary of Summary of conceptual conceptual frameworkframework
Classified Classified balance sheetbalance sheet
Classified Classified income income statement statement
Analyzing Analyzing financial financial statements statements
An international An international perspectiveperspective
Chapter 7-4
Various users need financial information
Various users need financial information
The accounting profession has
attempted to develop a set of standards that are generally accepted and universally practiced.
Financial StatementsBalance SheetIncome StatementStatement of Retained EarningsStatement of Cash FlowsNote Disclosure
Financial StatementsBalance SheetIncome StatementStatement of Retained EarningsStatement of Cash FlowsNote Disclosure
Generally Generally Accepted Accepted
Accounting Accounting Principles Principles
(GAAP)(GAAP)
Generally Generally Accepted Accepted
Accounting Accounting Principles Principles
(GAAP)(GAAP)
The Conceptual Framework of The Conceptual Framework of AccountingAccountingThe Conceptual Framework of The Conceptual Framework of AccountingAccounting
SO 1 Explain the meaning of GAAP and identify SO 1 Explain the meaning of GAAP and identify the key items of the conceptual the key items of the conceptual framework.framework.
Chapter 7-5
Securities and Exchange Commission (SEC)
http://www.fasb.org/
http://www.sec.gov/
The Conceptual Framework of The Conceptual Framework of AccountingAccountingThe Conceptual Framework of The Conceptual Framework of AccountingAccountingOrganizations Involved in Standard Setting:
Financial Accounting Standards Board (FASB)
SO 1 Explain the meaning of GAAP and identify SO 1 Explain the meaning of GAAP and identify the key items of the conceptual the key items of the conceptual framework.framework.
Chapter 7-6
Conceptual Framework - “…a constitution, a coherent system of interrelated objectives and fundamentals.”
FASB’s conceptual framework consists of the following:
1. Objectives of financial reporting.
2. Qualitative characteristics of accounting information.
3. Elements of financial statements.
4. Operating guidelines (assumptions, principles, and constraints).
The Conceptual Framework of The Conceptual Framework of AccountingAccountingThe Conceptual Framework of The Conceptual Framework of AccountingAccounting
SO 1 Explain the meaning of GAAP and identify SO 1 Explain the meaning of GAAP and identify the key items of the conceptual the key items of the conceptual framework.framework.
Chapter 7-7
a)a) To provide information that is useful to those making To provide information that is useful to those making investment and credit decisions.investment and credit decisions.
a)a) To provide information that is useful to those making To provide information that is useful to those making investment and credit decisions.investment and credit decisions.
b)b) Helpful in assessing future cash flows.Helpful in assessing future cash flows.b)b) Helpful in assessing future cash flows.Helpful in assessing future cash flows.
c)c) Identify the economic resources (assets), the claims to Identify the economic resources (assets), the claims to those resources (liabilities), and the changes in those those resources (liabilities), and the changes in those resources and claims.resources and claims.
c)c) Identify the economic resources (assets), the claims to Identify the economic resources (assets), the claims to those resources (liabilities), and the changes in those those resources (liabilities), and the changes in those resources and claims.resources and claims.
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
Objectives of Financial Reporting
SO 2 Describe the basic objectives of financial SO 2 Describe the basic objectives of financial reporting.reporting.
Chapter 7-8
According to the FASB conceptual framework, the According to the FASB conceptual framework, the objectives of financial reporting for business objectives of financial reporting for business enterprises are based on?enterprises are based on?
a.a. Generally accepted accounting principlesGenerally accepted accounting principles
b.b. Reporting on management’s stewardship.Reporting on management’s stewardship.
c.c. The need for conservatism.The need for conservatism.
d.d. The needs of the users of the information.The needs of the users of the information.
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
(CPA adapted)(CPA adapted)
Review:Review:
SO 2 Describe the basic objectives of financial SO 2 Describe the basic objectives of financial reporting.reporting.
Chapter 7-9
Question:How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it?
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Answer:
By determining which alternative provides the most useful information for decision-making purposes (decision usefulness).
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
Chapter 7-10
Relevance – making a difference in a decision.
Predictive valueFeedback valueTimeliness
ReliabilityVerifiableRepresentational faithfulnessNeutral - free of error and bias
Qualitative Characteristics
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Chapter 7-11
Comparability – Information that is measured and reported in a similar manner for different companies is considered comparable.
Consistency - When a company applies the same accounting treatment to similar events from period to period.
Qualitative Characteristics
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Chapter 7-12
RevenueRevenue
ExpensesExpenses
GainsGains
LossesLosses
AssetsAssets
LiabilitiesLiabilities
EquityEquity
“Moment in Time” “Period of Time”
Elements of Financial Statements
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Chapter 7-13
Illustration: Identify the element or elements associated with items below.
(a) Obligation to transfer (a) Obligation to transfer resources arising from a resources arising from a past transaction.past transaction.
(b)(b) Items characterized by Items characterized by future economic benefit.future economic benefit.
(c)(c) Arises from income Arises from income statement activities that statement activities that constitute the entity’s constitute the entity’s ongoing major or central ongoing major or central operations.operations.
Elements
(a)AssetsAssets
LiabilitiesLiabilities
Equity Equity
RevenueRevenue
ExpensesExpenses
(b)
(c)
(c)
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Chapter 7-14
AssetsAssets
LiabilitiesLiabilities
Equity Equity
RevenueRevenue
ExpensesExpenses
(d) (d) Residual interest Residual interest in the net assets of the in the net assets of the enterprise.enterprise.
(e) (e) Increases assets Increases assets through sale of product.through sale of product.
Elements
(a)
(b)
(c)
(c)
(d)
(e)
Illustration: Identify the element or elements associated with items below.
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
SO 3 Discuss the qualitative characteristics of SO 3 Discuss the qualitative characteristics of accounting accounting information and elements of information and elements of financial statements.financial statements.
Chapter 7-15
Operating Guidelines
Conceptual FrameworkConceptual FrameworkConceptual FrameworkConceptual Framework
Chapter 7-16
Assumptions provide a foundation for the accounting process.
Monetary Unit
Economic Entity
Periodicity
Going Concern
SO 4 Identify the basic assumptions used by SO 4 Identify the basic assumptions used by accountants.accountants.
AssumptionsAssumptionsAssumptionsAssumptions
Chapter 7-17
Only transaction data capable of being expressed in terms of money should be included in the accounting records of the economic entity.
SO 4 Identify the basic assumptions used by SO 4 Identify the basic assumptions used by accountants.accountants.
AssumptionsAssumptionsAssumptionsAssumptions
Monetary Unit
Chapter 7-18
Economic events can be identified witha particular unit of accountability.
SO 4 Identify the basic assumptions used by SO 4 Identify the basic assumptions used by accountants.accountants.
AssumptionsAssumptionsAssumptionsAssumptions
Economic Entity
Chapter 7-19 SO 4 Identify the basic assumptions used by SO 4 Identify the basic assumptions used by
accountants.accountants.
AssumptionsAssumptionsAssumptionsAssumptions
Time Period
The economic life of a business can be divided into artificial time periods.
Chapter 7-20 SO 4 Identify the basic assumptions used by SO 4 Identify the basic assumptions used by
accountants.accountants.
AssumptionsAssumptionsAssumptionsAssumptions
Going Concern
The enterprise will continue in operation long enough to carry out its existing objectives.
Chapter 7-21
Accounting principles dictate how economic events should be recorded and reported.
Revenue Recognition
Matching (Expense Recognition)
Full Disclosure
Cost
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Chapter 7-22
Revenue Recognition - companies should recognize revenue in the accounting period in which it is earned.
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Chapter 7-23
Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.”
Illustration 7-4Illustration 7-4 Expense Recognition
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Chapter 7-24
Illustration 7-5Illustration 7-5 Basic Principles
Matching
Principle
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Chapter 7-25
Full Disclosure – Provided through financial statements, notes to the financial statements, and supplementary information.
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Illustration 7-5Illustration 7-5 Basic Principles
Chapter 7-26
Cost Principle – the price, established by the exchange transaction, is the “cost”.
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Illustration 7-5Illustration 7-5 Basic Principles
Chapter 7-27
Illustration: Identify which basic principle of accounting is best described in each item below.
(a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected.
(b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.
(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.
(d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater.
Revenue Revenue RecognitionRecognition
MatchingMatching
Full Full DisclosureDisclosure
CostCost
SO 5 Identify the basic principles of accounting.SO 5 Identify the basic principles of accounting.
PrinciplesPrinciplesPrinciplesPrinciples
Chapter 7-28
Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information.
Materiality
Conservatism
Constraints in AccountingConstraints in AccountingConstraints in AccountingConstraints in Accounting
SO 6 Identify the two constraints in accounting.SO 6 Identify the two constraints in accounting.
Chapter 7-29
Materiality - an item is material if its inclusion or omission would influence or change the judgment of a reasonable person.
Illustration 7-6Illustration 7-6 Constraints
Constraints in AccountingConstraints in AccountingConstraints in AccountingConstraints in Accounting
SO 6 Identify the two constraints in accounting.SO 6 Identify the two constraints in accounting.
Chapter 7-30
Conservatism - When in doubt, choose the method that will be least likely to overstate assets and income.
Illustration 7-6Illustration 7-6 Constraints
Constraints in AccountingConstraints in AccountingConstraints in AccountingConstraints in Accounting
SO 6 Identify the two constraints in accounting.SO 6 Identify the two constraints in accounting.
Chapter 7-31
Illustration What accounting constraints are illustrated by the items below?
(a) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000.
(b) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired.
ConservatismConservatism
MaterialityMateriality
Constraints in AccountingConstraints in AccountingConstraints in AccountingConstraints in Accounting
SO 6 Identify the two constraints in accounting.SO 6 Identify the two constraints in accounting.
Chapter 7-32
Summary of Conceptual FrameworkSummary of Conceptual FrameworkSummary of Conceptual FrameworkSummary of Conceptual Framework
Chapter 7-33
Classified Balance Sheet
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Illustration 7-8Illustration 7-8 Standard classification
Chapter 7-34
Classified Balance Sheet
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Illustration 7-9Illustration 7-9 Proprietorship balance sheet
A proprietorship, the balance sheet uses the term“Owner’s equity” instead of “Stockholders’ equity”
Chapter 7-35
Classified Balance Sheet
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Illustration 7-10Illustration 7-10 Partnership balance sheet
In a partnership, each partner has a separate capitalaccount.
Chapter 7-36
Classified Income Statement
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
A multiple-step income statement generally includes the following.
Sales revenue Cost of goodsOperating Other revenues and gainsOther expenses and losses
Two additional items are income tax expense and earnings per share.
Chapter 7-37
Classified Income Statement
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Illustration 7-11Illustration 7-11 Income taxes
Chapter 7-38
Classified Income Statement
Net IncomeEarnings Per Share
= Number of Common Shares
Outstanding
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
Indicates the net income earned by each share of outstanding common stock.
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Chapter 7-39
Analyzing Financial Statements
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Three major characteristics are generally used:
Liquidity,
Profitability, and
Solvency.
Chapter 7-40
Liquidity
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
This ratio means that current assets are more than two times greater than current liabilities.
Chapter 7-41
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Working capital provides some indication of the company’sability to meet its existing current obligations.
Liquidity
Chapter 7-42
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Profitability
Chapter 7-43
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Profit Margin Percentage measures the percentage of each dollar of sales that results in net income.
Profitability
Profitability ratios measure the income or operating success of a company for a given period of time.
Chapter 7-44
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Return on Assets is an overall measure of profitability.
Profitability
Return on Common Equity shows the percentage of net income earned for each dollar of owners’ investment.
Chapter 7-45
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 7 Understand and analyze classified financial SO 7 Understand and analyze classified financial statements.statements.
Debt to Total Assets measures the percentage of total assets that creditors, as opposed to stockholders, provide.
Solvency
Solvency measures the ability of an enterprise to survive over a long period of time.
Chapter 7-46
Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis
SO 8 Explain the accounting principles used in international SO 8 Explain the accounting principles used in international operations.operations.
An International Perspective
There are few recognized worldwide accounting standards. The International Accounting Standards Board (IASB), of which the United States is a member, is working to obtain conformity in international accounting practices.
Chapter 7-47
Scandals and bankruptcies at Enron, WorldCom, and other companies brought many changes to the way America does business.
Many companies have developed a code of ethics to:
deter wrongdoing
promote honest and ethical conduct
indicate that management takes ethics seriously.
Corporations Have Governance Structures—Do You?Corporations Have Governance Structures—Do You?
All About YouAll About YouAll About YouAll About You
Chapter 7-48
Some Facts:
Under Sarbanes-Oxley, a company must disclose whether it has a code of ethics.
Enron had a code of ethics. Enron’s board of directors knowingly waived requirements of the code so that the CFO could set up and run special purpose entities.
In a recent survey of 1,436 workers, 34% said that they have seen unethical activities at their workplace, but only 47% said they are likely to report these activities.
All About YouAll About YouAll About YouAll About You
Corporations Have Governance Structures—Do You?Corporations Have Governance Structures—Do You?
Chapter 7-49
Stockholders often lose money as a result of unethical behavior by management and they often file lawsuits against the company in an effort to recoup these losses.
All About YouAll About YouAll About YouAll About You
Source: Elaine Buckberg, Todd Foster, and Ronald I. Miller, “Recent Trends in Shareholder Class Action Litigation: Are WorldCom and Enron the New Standard?” NERA Economic Consulting, www.nera.com (accessed June 26, 2006).
Chapter 7-50
What Do You Think?What Do You Think?
Many universities have become concerned about student cheating. Many schools now have student ethics codes. Do you think that these ethics codes serve a useful purpose?
All About YouAll About YouAll About YouAll About You
YES: Anything that will reduce unethical behavior is a good thing.
NO: The existence of an ethics code won’t affect student behavior.
Chapter 7-51
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