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FFINANCIAL INANCIAL
RREPORTINGEPORTING
chapter chapter 11
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Learning Objectives
1. Describe the purpose of financial reporting and identify the primary financial statements.
2. Explain the function of accounting standards and describe the role of the FASB in setting these standards in the United States.
3. Recognize the importance to financial reporting of the SEC, AICPA, AAA, and IRS.
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Learning Objectives
4. See the growing importance and relevance of international accounting issues to the practice of accounting in the United States and understand the role of the ISAC in international accounting standard setting.
5. Understand the significance of the FASB’s conceptual framework in outlining the qualities of good accounting information, defining terms such as asset and revenue, and providing guidance about appropriate recognition, measurement, and reporting.
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Learning Objectives
6. Identify career opportunities related to accounting and financial reporting in the fields of public accounting, corporate accounting, financial analysis, banking, and consulting.
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Definition for Accounting
“Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions—in making reasoned choices among alternative courses of action.” (Statement of the Accounting Principles Board No. 4, p. 40)
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• Accounting provides a vital service in today’s business environment.
• Accounting is concerned primarily with quantitative financial information that is used in conjunction with qualitative evaluations in making judgments.
Definition for Accounting
Key features of this definition:
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• Accounting information is used in making decisions about how to allocate scarce resources.
Definition for Accounting
Key features of this definition:
Economists and environmentalists
remind us constantly that we live in a world with limited resources.
Economists and environmentalists
remind us constantly that we live in a world with limited resources.
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• Although accountants place much emphasis on reporting what has already occurred, this past information is intended to be useful in making economic decisions about the future.
Definition for Accounting
Key features of this definition:
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Users of Accounting Information
All parties interested in the financial health of a
company are called stakeholders.
All parties interested in the financial health of a
company are called stakeholders.
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Users of Accounting Information
Internal users, Internal users, who who make decisions make decisions
directly affecting the directly affecting the internal operations internal operations of the enterprise.of the enterprise.
Internal users, Internal users, who who make decisions make decisions
directly affecting the directly affecting the internal operations internal operations of the enterprise.of the enterprise.
External users, External users, who make decisions who make decisions
concerning their concerning their relationship to the relationship to the
enterprise.enterprise.
External users, External users, who make decisions who make decisions
concerning their concerning their relationship to the relationship to the
enterprise.enterprise.
Two major classifications of stakeholders
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InvestorsCommunity
Board of DirectorsManagement
EmployeesSuppliers
Employees
CreditorsCustomers
Analysts
Government
Major Internal and External Stakeholder Groups
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Financial Reporting
The balance sheet reports, as of a certain
point in time, the resources of a
company (the assets), the company’s obligations (the
liabilities), and the equity of the owners.
The balance sheet reports, as of a certain
point in time, the resources of a
company (the assets), the company’s obligations (the
liabilities), and the equity of the owners.
The income statement reports, for a specified interval, the net assets
generated through business operations (revenues), the net
assets consumed (the expenses), and the net
income.
The income statement reports, for a specified interval, the net assets
generated through business operations (revenues), the net
assets consumed (the expenses), and the net
income.
The statement of cash flows reports, for a
specified time period, the amount of cash generated
and consumed by a company through
operating, financing, and investing activities.
The statement of cash flows reports, for a
specified time period, the amount of cash generated
and consumed by a company through
operating, financing, and investing activities.
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Accounting estimates and judgments are
outlined in the notes to financial statements.
Accounting estimates and judgments are
outlined in the notes to financial statements.
Financial Reporting
14Financial Statement Relationships
Balance Sheet 12/31/04
Cash $ 80,000Other 4,550,000Total $4,630,000
Liabilities $2,970,000Stock 900,000R/E 760,000Total $4,630,000
Statement of Cash Flows 2005
Cash From Op $ 973,000Cash From Inv (1,188,000)Cash From Fin 245,000Net Increase $ 30,000Beg. Cash 80,000End. Cash $ 110,000
Statement ofRetained Earnings
R/E 12/31/04 $ 760,000Net Income 864,600Dividends (400,000)R/E 12/31/05 $1,224,600
Revenues $12,443,000Expenses 11,578,400Net Income $ 864,600
Income Statement
Cash $ 110,000Other 4,975,000Total $5,085,000
Liabilities $2,860,400Stock 1,000,000R/E 1,224,600Total $5,085,000
Balance Sheet 12/31/05
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Auditors
Auditors working independently of
a company’s management and
internal accountants examine the
financial statements.
Auditors working independently of
a company’s management and
internal accountants examine the
financial statements.
Auditors issue an auditor’s opinion about the fairness of the statements
and their adherence to
proper accounting principles.
Auditors issue an auditor’s opinion about the fairness of the statements
and their adherence to
proper accounting principles.
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Auditor’s Opinion Unqualified opinion—In the opinion of the auditor, the
financial statements are presented in accordance with GAAP.
Qualified opinion—In the opinion of the auditor, except for the effects of the qualified item, the financial statement are presented in conformity with GAAP.
No opinion—The auditor does not express an opinion about the financial statements.
Adverse—In the opinion of the auditor, the financial statements do not present information in conformity with GAAP.
17Relative Frequency of Audit Opinions (2000)
Companies
Unqualified 5,651
Unqualified With Explanatory Language 1,506
Qualified 4
No opinion 2
Adverse 1
TotalTotal 7,1647,164
18Accounting Standard–Setting Organizations
FASAC FASB
FAF SEC
AcSEC
AICPA
IASC
IAPC
Other
EITF
GASAC GASB U.S. Gov't
19 Financial Accounting Standards Board
Committee on Accounting Procedures
(CAP)Born: 1939Died: 1959
Pronouncements: Accounting Research Bulletins
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Accounting Principles
Board(APB)
Born: 1959Died: 1973
Pronouncements: APB Opinions
Financial Accounting Standards Board
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Financial Accounting
Standards Board(FASB)
Born: 1973Died:
Pronouncements: Statements of Financial Accounting Standards
Financial Accounting Standards Board
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1) Seven full-time members comprise this independent body.
2) Issues Statements of Financial Accounting Standards.3) Determines GAAP by “due process.”4) Works within the Conceptual Framework.
Financial Accounting Standards Board
Statement PreparersStatement Preparers• Financial ExecutivesFinancial Executives
InstituteInstitute• IMAIMA• Individual CorpsIndividual Corps
FASB
FASB Authority Sources—Overview
Gov’t RegulatorsGov’t Regulators• SECSEC• State Boards State Boards
of Public Acct.of Public Acct.
• American Acct.American Acct.InstructorsInstructors
AssociationAssociation
AuditorsAuditors• AICPAAICPA• State societies of State societies of
CPAsCPAs• Major audit firmsMajor audit firms
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Congress
FASB Authority Sources—SEC
SEC
FASB
Registrant Companies
25FASB Authority Sources -- AICPA
Provides authority to the FASB through its Code of Professional Conduct Rule 203.
AICPA members must show that client financial statements comply with FASB pronouncements (GAAP).
AICPA grants continuing membership to its members who comply with Rule 203.
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FASB “Due Process”
1) Topic or project added to agenda.2) Task force assembled to study topic.3) Research and analysis performed by FASB
technical staff.4) Discussion Memorandum (DM) drafted and
released.5) Public hearing, usually 60 days later, is held.
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6) Board analyzes and evaluates public response.
7) Exposure Draft (ED) prepared and released. 8) Sixty-day exposure period allows for public
comment. 9) Committee studies public response to
exposure draft and prepares final draft.
FASB “Due Process”
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10) Board votes on final draft leads to either the issuance of a Statement of Financial Accounting Standard, a revised Exposure Draft, or abandonment of the project.
FASB “Due Process”
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Emerging Issue Task Force
In an effort to overcome the slow process of standard setting, in 1984 the FASB established the Emerging Issues Task Force (EITF) to assist the FASB in identifying the emerging
issues that affect financial reporting.
In an effort to overcome the slow process of standard setting, in 1984 the FASB established the Emerging Issues Task Force (EITF) to assist the FASB in identifying the emerging
issues that affect financial reporting.
30Accounting Standard–Setting Organizations
FASAC FASB
FAF SEC
AcSEC
AICPA
IASC
IAPC
Other
EITF
GASAC GASB U.S. Gov't
31Securities Exchange Commission (1933-present)
1929 stock market crash blamed on nonstandard accounting.
1933 Securities Act established SEC to standardize accounting.
Created to protect the interests of investors by ensuring full and fair disclosure.
Granted legal authority to dictate GAAP.Has tended to defer setting GAAP to the
accounting profession.
32Securities and Exchange Commission
SEC official statements are referred to as Financial Reporting Releases
which are accounting interpretations and policies the SEC uses in
evaluating firms’ disclosure policies.
SEC official statements are referred to as Financial Reporting Releases
which are accounting interpretations and policies the SEC uses in
evaluating firms’ disclosure policies.
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Staff Accounting Bulletins Accounting and Auditing
Enforcement Releases Accounting Series Releases
Securities and Exchange Commission
Other Authoritative LiteratureOther Authoritative LiteratureOther Authoritative LiteratureOther Authoritative Literature
34American Institute of Certified Public Accountants
The American Institute of Certified Public Accountants
(AICPA) is the professional
organization of practicing CPAs in the
United States.
35American Accounting Association
What are assets ?
The American Accounting
Association (AAA) is primarily an
organization for accounting professors.
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Internal Revenue Service
The Internal Revenue Service (IRS) has the
primary goal of equitable collecting
revenue.
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What is GAAP?
A B C D
Higher Authority
Lower Authority
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What is GAAP?
– FASB Statements and Interpretations
– APB Opinions
– CAP Accounting Research Bulletins
AHighest AuthorityHighest AuthorityHighest AuthorityHighest Authority
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What is GAAP?
– FASB Technical Bulletins
– AICPA Industry Audit and Accounting Guides
– AICPA Statements of Position
B
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What is GAAP?
– Consensus Positions of EITF
– AICPA Practice Bulletins C
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What is GAAP?
– AICPA Accounting Interpretations
– FASB “Question and Answer” guides
– Other widely recognized industry practices
DLowest AuthorityLowest AuthorityLowest AuthorityLowest Authority
42International Accounting Standards Committee
The International Accounting Standards Committee (ISAC) was formed in 1973 to develop
worldwide accounting standards.
The International Accounting Standards Committee (ISAC) was formed in 1973 to develop
worldwide accounting standards.
The accounting standards produced by the International
Accounting Standards Committee are referred to as International Accounting Standards or IAS.
The accounting standards produced by the International
Accounting Standards Committee are referred to as International Accounting Standards or IAS.
43Conceptual Framework of Accounting
Objectivesof FinancialReporting
QualitativeCharacteristicsof Information
Accounting
Elementsof FinancialStatements
Recognition and Measurement Concepts
Assumptions Principles Constraints
44Objectives of Financial Reporting
The overall objective of financial reporting is to
provide information useful for decision making.
The overall objective of financial reporting is to
provide information useful for decision making.
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Usefulness.
Understandability.
Target audience: investors and creditors.
Assessing future cash flows.
Evaluating economic resources.
Primary focus on earnings.
Objectives of Financial Reporting
46Objectives of Financial Reporting
UsefulnessUsefulnessUsefulnessUsefulness
Financial reporting should provide information that is useful to present and
potential investors and creditors and other users in making rational
investment, credit, and similar decisions.
47Objectives of Financial Reporting
UnderstandabilityUnderstandabilityUnderstandabilityUnderstandability
Financial reporting should provide information that is understandable to one
who has a reasonable knowledge of accounting and business and who is
willing to study and analyze the information presented.
48Objectives of Financial Reporting
Target AudienceTarget AudienceTarget AudienceTarget Audience
While there are many potential users of financial reports, the objectives are directed
primarily toward investors and creditors.
49Objectives of Financial Reporting
Assessing Future Cash FlowsAssessing Future Cash FlowsAssessing Future Cash FlowsAssessing Future Cash Flows
Financial reporting should provide information that is useful in assessing
amounts, timing, and uncertainty (risk) of prospective cash flows.
50Objectives of Financial Reporting
Evaluating Economic ResourcesEvaluating Economic ResourcesEvaluating Economic ResourcesEvaluating Economic Resources
Financial reporting should also provide information about an enterprise’s assets,
liabilities, and owners’ equity to help investors, creditors, and others evaluate the financial strengths and weaknesses of the enterprise and its liquidity and solvency.
51Objectives of Financial Reporting
Primary Focus on EarningsPrimary Focus on EarningsPrimary Focus on EarningsPrimary Focus on Earnings
Information about enterprise earnings, measured by accrual accounting, generally
provides a better basis for forecasting future performance than does information
about current cash receipts and disbursements.
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PredictiveValue
FeedbackValue
Timeliness
Relevance
Verifiability
Neutrality
RepresentationalFaithfulness
Reliability
DecisionUsefulness
Understandability
Decision Makers
Qualitative Characteristics of Accounting Information
Materiality
Benefits > Cost
Comparability (including
Consistency)
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What About Conservatism?
The concept of conservatism can be summarized as follows: When in doubt, recognize all losses but
don’t recognize any gains.
The concept of conservatism can be summarized as follows: When in doubt, recognize all losses but
don’t recognize any gains.
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Elements of Financial Statements
• Assets• Liabilities• Equity, or Net Assets• Investments by Owners• Distributions to Owners• Comprehensive Income• Revenues• Expenses• Gains• Losses
55 Recognition, Measurement, and Reporting
Boiling down all the estimates and judgments into one number and then using that one number to make a journal entry is called recognition.
56 Recognition, Measurement, and Reporting
Skipping the journal entry and just relying on the note to
convey the information to users is called disclosure.
Skipping the journal entry and just relying on the note to
convey the information to users is called disclosure.
57 Recognition, Measurement, and Reporting
MeasurementMeasurementMeasurementMeasurement
1. Historical cost
2. Current replacement cost
3. Current market value
4. Net realizable value
5. Present (or discounted) value
58 Recognition, Measurement, and Reporting
ReportingReportingReportingReporting
Financial position at the end of the period Earnings (net income) for the period Cash flows during the period Investments by and distributions to owners
during the period Comprehensive income for the period
59Traditional Assumptions of the Accounting Model
• Economic entity.
• Going concern.
• Arm’s-length transactions.
• Stable monetary unit.
• Accounting period.
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• Public accounting.
• Company accounting.
• User (analyst, banker, consultant).