CHAPTER
Financial Accounting
and
Accounting
Standards
……..…………………………………………………………...
What is the value of A-1 Industries?
Assets
Liabilities
Net Assets
$1,200,000
850,000
$ 350,000
Net annual cash flows (next 50 years)
$ 50,000
1
Accounting
provides
Information
Assets &
Liabilities
Investors
Creditors
Government Agencies
Future
Cash Flows
Assets
Liabilities
Net Assets
$1,200,000
850,000
$ 350,000
Net assets might not reflect firm value:

Most assets are recorded at historical cost.

Intangible assets are frequently not recognized.
Net annual cash flows (next 50 years)
$ 50,000
A $500,000 investment would yield a 10% return.
A $1,000,000 investment would yield a 5% return.
Future Cash Flows
 Characteristics
 amount
 timing
2003 2004 2005
 uncertainty
 Important to investors & creditors
 Projecting future cash flows
 requires more than just current cash flows
 financial reporting provides information
equipment /
depreciation
sales
gains /
losses
stock
options
inventories
pension
obligations
amazon.com
?
4th quarter 1999
Operating loss
Net loss
$185 million
$323 million
March 2000
Market value
$25.6 billion
?
Possible explanations
Current financial reporting
is irrelevant!
 backward looking
 neglects intangibles
 “rules” have changed
Market was overpriced!
(A bubble)
Objectives of Financial Reporting
 Information to stockholders and creditors
 Future cash flows
 Assets and liabilities
Challenges of Financial Reporting
 Non-financial measurements
 Forward-looking information
 Intangible assets
 Timeliness
PARTIES INVOLVED IN STANDARD SETTING
 Federal agency
 Requirements for
all companies that
issue stock
CAP
’39 – ‘59
SEC
 Accounting must
conform to GAAP
APB
’59 – ‘73
FASB
’73 – present
 Private organizations
 Set accounting standards
FAF
AICPA
CAP
’39 – ‘59
FASB
ASB
APB
’59 – ‘73
 Concepts
 Standards
 Rsrch Bulletins
 APB Opinions
 Auditing
Stnds
 Interpretations
 Guidelines
 Technical Bulletins
 Stmnts of Position
 Emerging Issues
 Practice Bulletins
ISSUES IN FINANCIAL REPORTING
The Political Environment
 “The FASB is committed to rendering its
final decision without regard to any of the
social, economic, or public policy
considerations.” (J.Carter Beese, SEC)
 “Truth in accounting means telling it like it is, without
bias or intent to encourage any particular mode of
behavior.” (Dennis Beresford, FASB)
 Other post-employment benefits (OPEB), stock
options, derivatives, etc.
Responsibilities of Accountants
 Detect fraud?
 Verify that financial reporting
rules have been followed (i.e.
proper form)?
 Ensure that the accounting reflects the
substance of the economic event?
 Auditor independence
 Expectations gap