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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Environmental and Theoretical Structure
of Financial Accounting
1Insert Book Cover
Picture
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Learning Objectives
Describe the function and primaryfocus of financial accounting.
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Financial Accounting Environment
Profit-orientedcompanies
Not-for-profitentities
Households
Providers ofFinancial Information
ExternalUser 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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1-5The Economic Environment and Financial Reporting
A sole proprietorshipis owned by a
single individual.
A sole proprietorshipis owned by a
single individual.
A partnership isowned by two ormore individuals.
A partnership isowned by two ormore individuals.
A corporation is ownedby stockholders,
frequently numberingin the tens of thousands
in large corporations.
A corporation is ownedby stockholders,
frequently numberingin the tens of thousands
in large corporations.
A highly-developed system of financial reporting is necessary to communicate financial information from a corporation
to its many shareholders.
A highly-developed system of financial reporting is necessary to communicate financial information from a corporation
to its many shareholders.
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Investment-Credit DecisionsA Cash Flow Perspective
Corporate shareholders receive cash from their investments through . . . Periodic dividend distributions from the
corporation. The ultimate sale of the ownership shares of
stock.
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Accounting information should help investors evaluate the amount, timing,
and uncertainty of the enterprise’sfuture cash flows.
Investment-Credit DecisionsA Cash Flow Perspective
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Learning Objectives
Explain the difference betweencash and accrual accounting.
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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.
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Cash Versus Accrual Accounting
Accrual AccountingRevenue is recognized when earned.
Expenses are recognized when incurred.
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Learning Objectives
Define generally accepted accounting principles (GAAP) and discuss the historical
development of accounting standards.
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The Development of Financial Accounting and Reporting Standards
Concepts, principles, and
procedures weredeveloped to meet the
needs of external users (GAAP).
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Historical Perspective and Standards
Securities and Exchange Commission 1934 – present
Evolution of Standard-Setting Process 1938 – 1959:
Committee on Accounting Procedures (CAP)
1959 – 1973:Accounting Principles Board (APB)
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Current Standard Setting - FASBwww.fasb.org Supported by the Financial Accounting
Foundation. Seven full-time, independent voting members
serving for 10 years. Answerable only to the Financial Accounting
Foundation. Members not required to be CPAs.
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Learning Objectives
Explain why the establishment ofaccounting standards is characterized
as a political process.
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Establishment of Accounting StandardsA Political Process
GAAP
Internal RevenueService
www.irs.gov
American Instituteof CPAs
www.aicpa.org
Securities andExchange
Commissionwww.sec.gov
AmericanAccountingAssociation
www.aaa-edu.org
GovernmentalAccounting
Standards Boardwww.gasb.org
Financial ExecutivesInternationalwww.fei.org
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FASB’s Standard-Setting Process
Identification of problem. The task force. Research and analysis. Discussion memorandum. Public response. Exposure draft. Public response. Statement issued.
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Role of the Auditor
Independent intermediary to help insure that management has in fact appropriately
applied GAAP.
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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, commonly referred to as the
Sarbanes-Oxley Act for the two congressmen who sponsored the bill.
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Learning Objectives
Explain the purpose of theFASB’s conceptual framework.
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The Conceptual Framework
Maintain consistency among standards. Resolve new accounting problems. Provide user benefits.
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Learning Objectives
Identify the objectives of financial reporting, the qualitative characteristics of accounting
information, and the elements of financial statements.
Describe the four basicassumptions underlying GAAP
Describe the four basic accountingprinciples that guide accounting practice.
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The Conceptual Framework
Recognition and Measurement Criteria (SFAC No. 5)
Environment Implementation Implementationassumptions principles constraints
Objectives of Financial Reporting(SFAC No. 1)
Qualitative Characteristicsof Accounting Information
(SFAC No. 2)
Elements ofFinancial Statements
(SFAC No. 6)
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ObjectivesTo provide information:
Useful for investor and creditor decisions.That helps predict cash flows.About economic resources, claims to resources, and changes in resources and claims.
ElementsRecognition and
MeasurementConcepts
Constraints
Conceptual Framework
QualitativeCharacteristics
FinancialStatements
Continued
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ElementsAssets
LiabilitiesEquity
Investments by OwnersDistributions to owners
RevenuesExpenses
GainsLosses
Comprehensive Income
Recognition andMeasurement
Concepts
AssumptionsEconomic entityGoing concern
PeriodicityMonetary unit
PrinciplesHistorical cost
RealizationMatching
Full Disclosure
Objectives
Financial StatementsBalance sheet
Income statementStatement of cash flows
Statement of shareholders’ equityRelated disclosures
ConstraintsCost effectiveness
MaterialityConservatism
QualitativeCharacteristics
Understandability
PrimaryRelevanceReliability
SecondaryComparabilityConsistency
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Relevance Reliability
PredictiveValue
FeedbackValue
Timeliness NeutralityVerifiabilityRepresentational
Faithfulness
Comparability Consistency
Qualitative Characteristics ofAccounting Information
Decision Usefulness
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1-27Practical Constraints to Achieving Desired Qualitative Characteristics
CostEffectiveness
CostEffectiveness MaterialityMateriality
ConservatismConservatism
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SFAC No. 6Assets and Liabilities
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer or provide services to other entities in the future as a result of past transactions or events.
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SFAC No. 6Equity
Equity, or net assets, called shareholders’ equity or stockholders’ equity for a
corporation, is the residual interest in the assets of an entity that remains after
deducting liabilities.
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SFAC No. 6Investments and Distributions
Investments by owners are increases in equity resulting from transfers of resources (usually cash) to a company in exchange for ownership interest.
Distributions to owners are decreases in equity resulting from transfers to the owners.
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SFAC No. 6Revenues
Revenues are inflows or other enhancements of assets or settlements of
liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s
ongoing major, or central, operations.
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SFAC No. 6Expenses
Expenses are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major, or
central, operations.
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SFAC No. 6Gains and Losses
Gains are increases in equity peripheral, or incidental, transactions of an entity.
Losses represent decreases in equity arising from peripheral, or incidental, transactions of an entity.
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SFAC No. 6Comprehensive Income
Comprehensive income is the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. It
includes all changes in equity during a period except those resulting from investments from
owners and distributions to owners.
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Recognition and Measurement Concepts
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Question
The function of financial accounting is to identify, measure and communicate financial information about economic entities to interested parties.
a. True
b. False
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Question
The function of financial accounting is to identify, measure and communicate financial information about economic entities to interested parties.
a. True
b. False
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Question
Accrual accounting provides a better indication of ability to generate cash flows than does information limited to the financial effects of cash receipts and cash payments.
a. True
b. False
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Question
Accrual accounting provides a better indication of ability to generate cash flows than does information limited to the financial effects of cash receipts and cash payments.
a. True
b. False
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Question
The primary objective of accrual basis accounting is the measurement of income.
a. True
b. False
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Question
The primary objective of accrual basis accounting is the measurement of income.
a. True
b. False
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Question
Generally accepted accounting principles include both standards set by various rule making bodies and certain accounting practices that have evolved over time.
a. True
b. False
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Question
Generally accepted accounting principles include both standards set by various rule making bodies and certain accounting practices that have evolved over time.
a. True
b. False
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Question
The major financial accounting standard setting body is the
a. Accounting Principles Board
b. Securities and Exchange Commission
c. Financial Accounting Standards Board
d. American Institute of CPAs
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Question
The major financial accounting standard setting body is the
a. Accounting Principles Board
b. Securities and Exchange Commission
c. Financial Accounting Standards Board
d. American Institute of CPAs
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Question
The FASB issues which of the following types of pronouncements?
a. Standards
b. Interpretations
c. Financial Accounting Concepts
d. Technical Bulletins
e. All of the above
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Question
The FASB issues which of the following types of pronouncements?
a. Standards
b. Interpretations
c. Financial Accounting Concepts
d. Technical Bulletins
e. All of the above
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Question
The Financial Accounting Standards Board develops accounting and reporting standards independent of public, business and political pressures.
a. True
b. False
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Question
The Financial Accounting Standards Board develops accounting and reporting standards independent of public, business and political pressures.
a. True
b. False
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Ethics in Accounting
To be useful, accounting information must be objective and reliable.
Management may be under pressure to report desired results and ignore or bend existing rules.
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End of Chapter 1