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An electronic presentation
by Douglas Cloud
Pepperdine University
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Chapter 1
The Environment
of Financial
Reporting
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Objectives
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.
Continued
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Objectives
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.
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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 Markets
Corporations
Sell stocks
and bonds
Borrow
money
Primary Market
(e.g., individuals, Investors
banks)
Financial Institutions
Buy and sell
stocks and
bonds
Secondary Market
(e.g., New York Investors
Stock Exchange)
Buy and sell
stocks and
bonds
Buy and sell
stocks and
bonds
Investors
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Accounting Information Economic
Activities and Decision Making
Impact
External
User
Company’s
Economic
Activities
Accumulate
Accounting
Information
Communicate
Internal
User
Impact
External
Decisio
n
Making
Internal
Decisio
n
Making
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External 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
Managerial Accounting
Sources of Authority
Financial Accounting
Managerial Accounting
Internal needs
GAAP
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Comparison of Financial and
Managerial Accounting
Time Frame of Reported Information
Financial Accounting
Primarily historical
Managerial Accounting
Present and future
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Comparison of Financial and
Managerial Accounting
Scope
Financial Accounting
Mainly total company
Managerial Accounting
Individual departments,
divisions, and total company
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Comparison of Financial and
Managerial Accounting
Type of Information
Financial Accounting
Managerial Accounting
Primarily quantitative
Qualitative as well as
quantitative
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Comparison of Financial and
Managerial Accounting
Statement Format
Financial Accounting
Prescribed by GAAP;
oriented toward investment
and credit decisions
Managerial Accounting
Determined by company;
focused upon specific
decisions being made
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Comparison of Financial and
Managerial Accounting
Decision Focus
Financial Accounting
External
Managerial Accounting
Internal
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The company’s accountants
…and the information comes
prepare both the financial
from the same information
and the managerial
system.
accounting reports…
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Financial Reporting
Financial reporting is the
process of communicating
financial accounting
information about a company
to external users.
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Financial Reporting
Companies present at least three major financial
statements:
 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.
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Financial Reporting
This statement
A statement
of the
changes
summarizes
in stockholders’
equity
changes
in each item
also
is included by
of
stockholders’
manyfor
companies.
equity
a period.
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Generally Accepted Accounting
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 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.
Continued
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Hierarchy of Sources of GAAP
D. Widely accepted practices and
pronouncements representing prevalent
practice in a particular industry or
applications to specific circumstances.
E. Other accounting literature.
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History of GAAP in
the Private Sector
1938
1959
1973
CAP
formed
APB
formed
FASB
formed
CAP
issued 51
ARBs
APB
issued 31
Opinions
Present
FASB
issued 145
Statements of
Standards as
of 5/02
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Reasons 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
members, selected primarily from
the accounting profession.
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Criticisms of the APB
1. 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 FASB
Financial Accounting Foundation
(16-member board of trustees)
Appoint, fund, and oversee
Financial Accounting
Standards Advisory Council
(approximately 30
members)
Advise
Financial Accounting
Standards Board
(7 members)
Continued
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Structure of the FASB
Financial Accounting
Standards Board
(7 members)
Appoint
Consult
Task Forces of the
Standards Board
(including Emerging
Issues Task Force)
Support
Administrative
Staff
Research and
Technical Staff
Consult
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Types of Pronouncements
Issued by the FASB
• Statements of Financial Accounting
Standards
• Interpretations
• Technical Bulletins
• Statements of Financial Accounting
Concepts
• Other Pronouncements
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FASB Operating Procedures
Identify
Topic
Appoint
Task Force
Conduct
Research
Issue
Discussion
Memorandum
or Invitation to
Comment
Hold Public
Hearings
Deliberate
on Findings
Issue
Exposure
Draft
Continued
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FASB Operating Procedures
Hold Public
Hearings
Modify
Exposure
Drafts
From
previous
page
Issue
Exposure
Draft
Vote
(supermajority)
Issue
Statement
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Other Organizations
Impacting GAAP
 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)
Continued
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Other Organizations
Impacting GAAP
 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)
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Participants in the
Development of GAAP
EITF
FEI
CASB
GASB
FASB
IMA
SEC AICPA
AIMR
G4+1
AAA
IASC
IRS
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Principles of the AICPA Code
of Professional Conduct
Responsibilities
In carrying out their
responsibilities as
professionals, members
should exercise sensitive
professional judgment in all
their activities.
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Principles of the AICPA Code
of Professional Conduct
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.
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Principles of the AICPA Code
of Professional Conduct
Integrity
To maintain and broaden
public confidence,
members should perform
all professional
responsibilities with the
highest sense of integrity.
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Principles of the AICPA Code
of Professional Conduct
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.
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Principles of the AICPA Code
of Professional Conduct
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.
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Principles of the AICPA Code
of Professional Conduct
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.
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An Ethicist’s Basic Approaches
to 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
Impact on Problem Solving
Creative Thinking
Recognize
Problem
Identify
Alternatives
Evaluate
Alternatives
Critical Thinking
Select
Solution
Implement
Solution
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Chapter 1
The End
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