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Chapter 1: Financial Accounting and Accounting Standards
Definitions:
Accounting:
Financial Accounting:
Financial Statements: The principal way to communicate financial information to outside
parties. Typically include:
1.
2.
3.
4.
- Footnotes (FN) are important, too!
Note: This text focuses on (1) the basic financial statements and (2) related disclosures
Accounting and Capital Allocation (see Illustration 1-1 on page 3 of textbook.)

Financial Reporting:

Financial Statement Users:

Capital Allocation:
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The Challenges Facing Financial Accounting

Non-financial Measurements: Important measurements used to assess a company’s
future stability that are often provided on an ad hoc basis by management (e.g., customer
satisfaction, backlog info, etc.)

Forward-looking Information: Financial statements do not provide forward-looking
information that would be helpful for financial statement users. While this information
would be relevant, reliability would be questionable.

Soft Assets: Include so called “unrecorded assets” such as knowledge, market
dominance, employees, brand names, etc.

Timeliness: Financial Statements are provided quarterly and (audited) annually.
Objectives of Financial Reporting
(Found in Statement of Financial Accounting Concept No. 1 – SFAC1.)
1)
2)
3)
Homework: Q2, 5, 6
Parties Involved in Standards Setting
1) Securities and Exchange Commission (SEC)
2) American Institute of Certified Public Accountants (AICPA)
3) Financial Accounting Standards Board (FASB) – 1973-present
4) Governmental Accounting Standards Board (GASB)
5) Previous Major Organizations
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a
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Committee on Accounting Procedure (CAP) – 1939-1959; published 51 Accounting
Research Bulletins (ARB)
b Accounting Principles Board (APB) – 1959-1973; Issued 31 Opinions and 4 statements
Securities and Exchange Commission (SEC) – Standard setting in the public sector
1) SEC developed in response to the stock market crash of 1929 and the Great Depression.
Public wanted increased government regulation and oversight of businesses, financial
institutions, and stock market.
2) SEC administers the Securities Exchange Act of 1934 and several other acts. SEC requires
companies who issue securities to the public or are listed on securities exchanges to file
audited financial statements.
a
Form 10K:
b Form 10Q:
c
Form 8K:
3) SEC requires registrants follow GAAP.
4) Although the SEC is ultimately in control of establishing accounting principles, it generally
relies on FASB to develop accounting standards.
American Institute of Certified Public Accountants (AICPA): national professional
organization of practicing Certified Public Accountants (CPAs). Provides educational and
lobbying services on members’ behalf and promulgates auditing standards.
1) Committee on Accounting Procedure - CAP (1939-1959)
a
First rule-making body of AICPA
b Formed due to criticism of lack of uniformity of accounting information.
c
Advisory role (not authoritative)
d Published 51 Accounting Research Bulletins
e
Failed because it dealt with specific problems. It did not formulate a conceptual
framework.
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2) Accounting Principles Board – APB (1959-1973)
a Issued 31 Opinions and 4 statements
b 18 to 21 part-time members
c
Failed because of lack of coordination between research and specific issues.
d Rule 203 (part of AICPA’s Code of Professional Conduct): Gave more authority to APB
Opinions.
Homework: Q8
Financial Accounting Standards Board (FASB) (1973-present): Establish and improve
standards of financial accounting and reporting for guidance and education of public.
1) Smaller membership – 7-member board (full-time; paid; exclusive authority as a rule-making
body.) Renewable 5 year term.
2) Independent Board members.
3) Not necessary to be a CPA to be a member.
FASB should:
1)
2)
Due Process enables interested parties to express views on issues under consideration.
Types of FASB Pronouncements
Standards: Issued by FASB after following due process. Considered GAAP. Note: The SEC
continues to play an active role in influencing standards.
Interpretations: represent modifications or extensions of existing standards. Provide
clarification of previously issued statements. Have same authority as standards. Does not
require same Due Process as standards.
Staff Positions: now used in lieu of technical bulletins. Provide timely interpretive guidance on
certain issues and minor amendments to standards and interpretations.
Financial Accounting Concepts: Intended to form a cohesive set of interrelated concepts, a
conceptual framework, which will serve as tools for solving existing and emerging problems in a
consistent manner. Does not establish GAAP.
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Emerging Issues Task Force Statements (EITF):
1) EITF created by FASB in 1984. Includes 13 members.
2) Purpose is to reach a consensus on how to account for new and unusual financial transactions
that have potential for creating differing financial reporting practices.
Governmental Accounting Standards Board (GASB): Created in 1984 to address state and
local government reporting issues. Operates under the oversight of FASB.
Changing Role of the AICPA:
1) Once FASB was created, the AICPA became a major voice on accounting and reporting
issues. It created the Accounting Standards Division and the Accounting Standards
Executive Committee (AcSEC) within the Division. This group issues:
a
Audit and Accounting Guidelines
b Statements of Position (SOP)
c
Practice Bulletins
2) After a transition period, the AICPA will no longer issue authoritative guidance for
companies.
3) In the past, the AICPA’s Auditing Standards Board developed auditing standards. After
Sarbanes-Oxley Act of 2002, Public Company Accounting Oversight Board oversees the
development of future auditing standards.
The need to develop standards led to GAAP.
Generally Accepted Accounting Principles (GAAP):
1. Principles (standards) established by an authoritative rule-making body.
2. General acceptance over time of accounting practices that have received widespread
application.
GAAP
1) Principles that have “substantial authoritative support.”
2) Rule 203: See explanation in book on page 12.
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3) GAAP covered by Rule 203 are construed to be FASB Standards and Interpretations, APB
Opinions, and AICPA Accounting Research Bulletins. Often, specific accounting
transactions occur that are not covered by these documents. In this case, other authoritative
literature is used.
Hierarchy of Sources of GAAP
Where there is a conflict between accounting principles relevant to the circumstances, the
treatment in the higher category should prevail.
(Note: Official Accounting Pronouncements are listed in the back of textbook.)
1) Category A
a
FASB Statements of Financial Accounting Standards
b FASB Interpretations and Staff Positions
c
Accounting Principles Board Opinions
d AICPA Accounting Research Bulletins
2) Category B
a
FASB Technical Bulletins (no longer issued)
b AICPA Industry Audit Guides (if cleared by the FASB)
c
AICPA Industry Accounting Guides (if cleared by the FASB)
d AICPA Statements of Position
3) Category C
a
AICPA Accounting Standards Executive Committee (AcSEC) Practice Bulletins
b Consensus positions of the FASB Emerging Issues Task Force (EITF)
4) Category D
a
AICPA Accounting Interpretations
b FASB implementation guides (Q&A)
c
Practices that are widely recognized and prevalent either generally or in the industry
Homework: Q11, 12, 14, 15, 17, 20, 24
Issues in Financial Reporting
1) Standards Setting in a Political Environment
a
Accounting standards are as much a product of political action as they are of careful logic
or empirical findings.
b User groups influence the formulation of accounting standards. (See chart on page 14.)
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2) The Expectations Gap:
Although the profession can argue rightfully that they cannot be responsible for every
financial catastrophe, it must continue to strive to meet the needs of society. Developing
highly transparent, clear, and reliable system will require considerable resources.
Key changes due to Sarbanes-Oxley 2002
a An accounting oversight board is being established. It will have oversight and
enforcement authority and will establish auditing, quality control, and independence
standards and rules.
b Stronger independence rules for auditors are now in place. Audit partners, for example,
will be required to rotate every five years.
c
CEOs and CFOs must forfeit bonuses and profits when there is an accounting
restatement.
d CEOs and CFOs are required to certify that the financial statements and company
disclosures are accurate and complete.
e
Audit committees will need independent members and members with financial expertise.
f
Codes of ethics must be in place for senior financial officers.
Homework: Q27, 28
3) International Accounting Standards:
a International Accounting Standards Committee (IASC) was formed in 1973 to
attempt to narrow the areas of divergence between standards of different countries.
Objective was “to work generally for the improvement and harmonization of regulations,
accounting standards and procedures relating to the presentation of financial statements.”
This was later restructured and renamed the IASB.
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b International Accounting Standards Board (IASB): IASB issues International
Financial Reporting Standards (IFRS). Work toward the development of a single set of
high-quality global standards. The United States has a major voice in how international
standards are being developed.
c
The SEC has indicated that foreign companies will be allowed to use IASB standards in
security offerings in the US if the financial information is reconciled to U.S. GAAP.
4) Ethics in the Environment of Financial Accounting
a
Basic questions to ask:
i) Is this way of communicating financial information good or bad?
ii) Is it right or wrong?
iii) What should I do in the circumstance?
b Steps to take in resolving an ethical dilemma:
i) Recognize an ethical dilemma exists.
ii) Identify and analyze the elements of the dilemma.
iii) Identify and analyze the alternatives available.
iv) Select the best or most ethical alternative.
c
It is important to be aware of ethical considerations.
Homework: Q30
Conclusion: What will happen to the accounting practice in the face of all of the recent scandals
and allegations? The next few years will be interesting!