Chapter 1
The Environment of
Financial Reporting
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
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Objectives
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.
1.
4
Objectives
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.
5.
5
More Accountants Needed
New accounting rules pose
challenges for financial
accounting and projections point
to increased hiring of accounting
graduates.
6
Estimated Hiring Increase
Accounting firms of all sizes plan to increase
future hiring.
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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
9
…or by borrowing from lenders
Bank
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Capital Markets
Corporations
Sell stocks
and bonds
Primary Market
(e.g., individuals,Investors
banks)
Borrow
money
Financial Institutions
Buy and
sell stocks
and bonds
Secondary
Market (e.g., New
York Stock Investors
Exchange)
Buy and
sell stocks
and bonds
Buy and sell
stocks and
bonds
Investors
Accounting Information
Economic Activities and
Decision Making
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Impact
External
User
Company’s
Economic
Activities
Accumulate
Accounting
Information
Communicate
Internal
User
Impact
Externa
l
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
15
Comparison of Financial and
Managerial Accounting
Scope
Financial Accounting
Total company
&
Segment reporting
Managerial Accounting
Individual departments,
divisions, and total company
16
Comparison of Financial and
Managerial Accounting
Type of Information
Financial Accounting
Managerial Accounting
Primarily quantitative
Qualitative as well as
quantitative
17
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
18
Comparison of Financial and
Managerial Accounting
Decision Focus
Financial Accounting
External
Managerial Accounting
Internal
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The company’s
accountants prepare both
the financial and the
managerial accounting
reports…
…and the information
comes from the same
information system.
20
Financial Reporting
Financial reporting is the
process of communicating
financial accounting
information about a
company to external users.
21
Financial Reporting
Companies present at least three major financial
statements:
1. The balance sheet (or statement of financial
position) which summarizes a company’s
financial position at a given date.
2. The income statement which summarizes
the results of a company’s income producing
activities for a period of time.
3. 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
A statement of
changes in
stockholders’ equity
also is included by
many companies.
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Financial Reporting
This statement
summarizes the
changes in each item
of stockholders’
equity for 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.
25
Hierarchy of Sources of
GAAP
Categories
Authoritative Sources
A. FASB Statements of Financial Accounting
Standards and Interpretations, FASB Staff
Positions, FASB Statement 133
Implementation Issues, APB Opinions, and
CAP (AICPA) Accounting Research Bulletins,
(as well as SEC releases such as regulation SX, Financial Reporting releases, and Staff
Accounting Bulletins for companies that file
with the SEC)
Continued
26
Hierarchy of Sources of
GAAP
Categories
Authoritative Sources
B. FASB Technical Bulletins, and, if cleared by
the FASB, AICPA Industry Audit and
Accounting Guides, and AICPA Statements of
Position
C. FASB Emerging Issues Task Force Consensus
Positions and if cleared by the FASB, AICPA
Practice Bulletins
Continued
27
Hierarchy of Sources of
GAAP
Categories
Authoritative Sources
D. FASB Q’s and A’s (Implementation Guides),
AICPA Accounting Interpretations, and practices
that are widely recognized and prevalent either
generally or in the industry (e.g., AICPA
Accounting Trends and Techniques)
There are electronic databases such as the FASB
Financial Accounting Research System (FARS)
that include most accounting standards
28
History of GAAP in Private
Sector
1938
1959
1973
CAP
formed
APB
formed
FASB
formed
CAP
issued
51 ARBs
APB
issued 31
Opinions
Present
FASB
issued 154
Statements
of Standards
as of 10/05
29
Committee on Accounting
Procedure (CAP)
In 1938, the AICPA formed the Committee on
Accounting Procedure. This group issued
pronouncements known as Accounting Research
Bulletins (ARB), but the CAP did not have
authority to enforce its pronouncements and
application was optional. The CAP was criticized
because its members were all CPAs and
application was optional, so the AICPA formed the
Accounting Principles Board in 1959 to replace
the Committee on Accounting Procedure.
30
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.
31
Criticisms of the APB
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.
1.
32
Structure of 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
33
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
34
Types of Pronouncements
Issued by the FASB
Statements of Financial Accounting
Standards
Interpretations
Technical Bulletins
Statements of Financial Accounting
Concepts
Other Pronouncements
35
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
36
FASB Operating Procedures
Hold
Public
Hearings
Modify
Exposure
Drafts
From
previous
page
Issue
Exposure
Draft
Vote
(simple
majority)
Issue
Statement
37
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
38
Other Organizations
Impacting GAAP
 International Accounting Standards Board
(IASB)
 Governmental Accounting Standards Board
(GASB)
 Financial Executives International (FEI)
 Institution of Management Accountants
(IMA)
 Public Company Accounting Oversight Board
 CFA Institute (Chartered Financial Analyst)
39
Participants in the Development
of GAAP
EITF
FEI
CASB
IMA
GASB
FASB
AICPA
PCAOB
SEC
CFAI
AAA
IASB
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.
41
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.
42
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.
43
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.
44
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.
45
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.
46
An Ethicist’s Basic Approaches
to Moral Reasoning
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.
1.
47
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
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