FINANCIAL ACCOUNTING

RICHARD G. SCHROEDER

MYRTLE W. CLARK

JACK M. CATHEY

THEORY AND ANALYSIS:

TEXT AND CASES11TH EDITION

CHAPTER 1

THE DEVELOPMENT OF ACCOUNTING THEORY

Introduction

What is theory?

Webster defines theory as: “Systematically organized knowledge, applicable in a relatively wide variety of circumstances, a system of assumptions, accepted principles and rules of procedure to analyze, predict or otherwise explain the nature of behavior of a specified set of phenomena.”

Normative theoryPositive theory

Why is the development of a general theory of accounting important? Allocating scare resources

What is the relationship of accounting research to accounting theory? Various theories of accounting will be discussed in

Chapter 4

THE EARLY HISTORY OF ACCOUNTING

Denise Schmandt-Besserat Origins of writing are actually found in counting. Pieces of fired clay in Middle Eastern archeological sites. Tokens comprised an elaborate system of accounting that was used

throughout the Middle East from approximately 8000 to 3000 B. C. Each token stood for a specific item

Used to take inventory and keep accounts

Other accounting records dating back several thousand years have been found in various parts of the world. These records indicate that at all levels of development, people desire

information about their efforts and accomplishments.

THE EARLY HISTORY OF ACCOUNTING For example the Zenon Papyri

Who was Zenon? Information about the construction projects, agricultural

activities, and business operations of the private estate of Apollonius for a period of about thirty years during the third century B.C.

Renaissance Italians pursuing trade and commerce needed records Fra Luca Pacioli

THE EARLY HISTORY OF ACCOUNTING

The evolution of joint ventures into ongoing businesses Caused need for external financial reporting

The impact of the industrial revolution and the progressive movement Widespread speculation in the securities markets, watered

stocks, and large monopolies that controlled segments of the U.S. economy.

1900 report suggested that independent public accounting profession should be established to curtail observed corporate abuses.

THE EARLY HISTORY OF ACCOUNTING

The concept of capital maintenance Viewed as a way to curb corporate abuses

The accountant as a protector of business interests American Institute of Accountants (AIA) American Association of the University Instructors in

Accounting

ACCOUNTING IN THE UNITED STATES SINCE 1930 Because of fear of government intervention

Meetings between NYSE and AIA AAA SEC

What caused formation of SEC? Securities Act of 1933 Securities Exchange Act of 1934

Difference between public and private sector formulation of accounting principles

ACCOUNTING IN THE UNITED STATES SINCE 1930

1936 - 1938 SEC: internal debate about whether it

should develop accounting standards. 1938

Accounting Series Release (ASR No. 4) SEC allowed private sector to set accounting principles Reports filed with SEC must be prepared in accordance with accounting principles

that have “substantial authoritative support{.

A Statement of Accounting Principles Sanders, Hatfield & Moore Because accounting profession did not think it had time to develop

theoretical framework of accounting “Do what you think is best.”

American Institute of Certified Public Accountants(AICPA) Formed in 1936 Influence on development of accounting theory

Committee on Accounting Procedure Accounting Principles Board Financial Accounting Standards Board

Each has issued pronouncements Have become primary source of today’s generally

accepted accounting principles

Committee on Accounting Procedure (CAP) Formed in 1936

Professional accountants Accounting Research Bulletins (ARBs)

Pronouncements Did not dictate mandatory practice Received authority only from general acceptance

ARBs consolidated in 1953 Accounting Terminology Bulletin NO. 1, “Review and Resume”

and ARB No. 43 ARB 44-53 published 1953 – 1959 FASB Accounting Standards Codification (Discussed later in the

chapter) includes recommendations of these bulletins that have not been superseded

THE ACCOUNTING PRINCIPLES BOARD (APB)

CAP criticized Methods of formulating accounting principles didn’t arise from

research based on theory Acting in piecemeal fashion & Issuing inconsistent standards

Resulted in APB Formation and structure Types of pronouncements

APB Opinions

Accounting for the investment tax credit (1961) APB Opinions 2 & 4 Rule 203

THE ACCOUNTING PRINCIPLES BOARD (APB)

Criticism of the APB Independence of members

Members had full-time responsibilities elsewhere that could influence views

Structure “Big 8” automatically awarded 1 member Usually 5 or 6 other public accountants on board

Response time Part-time members not able to investigate

and resolve emergency issues in timelymanner

THE FINANCIAL ACCOUNTING STANDARDS BOARD

Because of growing criticism of APB 1971: Board of Directors of AICPA

appointed 2 committees: The Wheat Committee

How to establish accounting principles The Trueblood Committee

Objectives of financial statements

The FASB was established

Structure of the FASB

FinancialAccountingFoundation

Board ofTrustees

AppointElectors

GovernAppoint and fund

FinancialAccountingStandardsAdvisory

Committee(approx.

20 members)

Financial Accounting Standards

Board( 7 members)

Task Forces of the Standards Board

Appoint

Admin. Staff

Research Staff

|||

- - - - - - -

Appoint andfund

FASB Mission – establish standards

Types of pronouncements

Statements of Financial Accounting Concepts

Statements of Financial Accounting Standards

Interpretations

Technical Bulletins

FASB

Emerging Issues Lack of timely guidance

Standards Overload Too many standards

Standard setting as a political process Some users found that best way to influence

formulation of accounting standards is to attempt to influence standard setters

Example: SFAS No. 123 and 123R Economic Consequences

GAAP Evolution of phrase:

Changed wording of auditor’s certificate brought about by meetings between NYSE and AIA

The APB’s definition “present fairly…in conformity with generally accepted accounting

principles: The Auditing Standards Executive Committee’s definition

No singular reference source exists for all principles Makes general acceptance of a specific principle

difficult

SAS 69: determining acceptance of a specific principle is difficult

SFAS No. 162 Hierarchy of GAAP

Four levels FASB codification project reduced

this to 2 levels: Authoritative Not authoritative

A

B

C

D

The FASB’s Accounting Standards Codification

Hundreds of accounting standards promulgated by several different accounting standard setters.

Accounting standards had evolved to the point that professionals could not keep up.

September, 2004: the FAF Trustees approved funding for the FASB’s codification and retrieval project

The FASB’s Accounting Standards Codification

June 2009 FASB announced Codification

would be single source of all nongovernmental US GAAP effective 9/15/09.

Involved following steps:1. Restructure all U.S. GAAP literature by

topic into a single authoritative codification.

2. Modify the standard-setting process to focus on updating the codification.

The FASB’s Accounting Standards Codification

Reasons for codification Researching multiple authoritative sources

complicated research process FASB, EITF, AICPA & SEC literature

FASB ASC contains all current authoritative accounting literature If guidance is not specified, first source to

consider is accounting principles for similar issue with a source of authoritative GAAP

Nonauthoritative guidance from other sources may be considered if similar transactions aren’t discovered in GAAP.

THE ROLE OF ETHICS IN ACCOUNTING The public accountant as a

watchdog What is basic conflict of interest

facing public accountants?

Accounting in Crisis – The Events of the Early 2000s Enron and the Accounting Scandals

“Special-purpose entities” (SPEs) Now termed variable interest entities (VIEs) Purpose:

Access capital Hedge risk

Allowed company to increase financial leverage and return on assets without reporting debt on balance sheet

Losses were kept off Enron’s books Enron filed for bankruptcy and stock became

virtually worthless.

Accounting in Crisis – The Events of the Early 2000s

Two major changes in the accounting profession have taken place in the wake of the accounting scandals:

1. Arthur Andersen

formerly one the Big 5 audit firms has gone out of business

2. Sarbanes-Oxley Act

President Bush signed into law July 2002 imposes a number of corporate governance rules on publicly traded

companies (Discussed in chapter 17)

International Accounting Standards

The concept of harmonization The IASB The IASB’s objectives:

1. To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance

2. To work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements.

41 Statements of Accounting Standards and 13 Statements of Financial Reporting Standards to date

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Prepared by Kathryn Yarbrough, MBA

End of Chapter 1