Intermediate Accounting
Spiceland / Sepe / Tomassini
Third Edition
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Chapter 1
Environment and Theoretical
Structure of Financial Accounting
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Financial Accounting
Environment
Providers of
Financial Information
Profit-oriented
companies
Not-for-profit
entities
Households
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External
User Groups
Relevant
Financial
Information
Investors
Creditors
Employees
Labor unions
Customers
Suppliers
Government
agencies
Financial
intermediaries
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Financial Accounting
Environment
Relevant financial information is provided
primarily through financial statements and
related disclosure notes.
 Balance Sheet
 Income Statement
 Statement of Cash Flows
 Statement of Shareholders’ Equity
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Investment-Credit Decisions
A Cash Flow Perspective
Corporate shareholders will receive cash from
their investments through . . .
 Periodic
dividend distributions from the
corporation.
 The ultimate sale of the ownership shares of
stock.
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Investment-Credit Decisions
A Cash Flow Perspective
Accounting information should help investors
evaluate the amount, timing, and
uncertainty of the enterprise’s future cash
flows.
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Cash Versus Accrual Accounting
Cash Basis Accounting
 Revenue is recognized when cash is received.
 Expenses are recognized when cash is paid.
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Cash Versus Accrual Accounting
Cash Basis Accounting
Carter Company has sales on account totaling
$100,000 per year, and collected as shown on the
following slide. The company prepaid $60,000 for
three years’ rent in the first year. Utilities are
$10,000 per year, but in the first year only $5,000
was paid. Payments to employees are $50,000 per
year.
Let’s look at the cash flows.
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Cash Versus Accrual Accounting
Cash Basis Accounting
Year 1
Cash receipts from
customers
$ 50,000
Summary of Cash Flows
Year 2
Year 3
$ 125,000
$ 125,000
Total
$ 300,000
Payment of 3
years' rent
(60,000)
-
-
(60,000)
Salaries to
employees
(50,000)
(50,000)
(50,000)
(150,000)
(5,000)
$ (65,000)
(15,000)
$ 60,000
(10,000)
$ 65,000
(30,000)
$ 60,000
Payments for
utilities
Net cash flow
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Cash Versus Accrual Accounting
Cash Basis Accounting
Year 1
Cash receipts from
customers
$ 50,000
Payment of 3
years' rent
(60,000)
Summary of Cash Flows
Year 2
Year 3
$ 125,000
-
$ 125,000
-
Total
$ 300,000
(60,000)
Salaries to
Cash flows
in any one
year may(50,000)
not be a (150,000)
employees
(50,000)
(50,000)
Payments for
utilities
Net cash flow
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predictor of future cash flows.
(5,000)
$ (65,000)
(15,000)
$ 60,000
(10,000)
$ 65,000
(30,000)
$ 60,000
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Cash Versus Accrual Accounting
Accrual Accounting
 Revenue
is recognized when earned.
 Expenses are recognized when incurred.
Let’s reconsider the Carter Company
information.
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Cash Versus Accrual Accounting
Accrual Accounting
 Revenue
Summary
of Operations
is recognized
when earned.
Year 1
Year 2
Year 3
 Expenses are recognized when incurred.
Revenue
$ 100,000
$ 100,000
$ 100,000
Total
$ 300,000
Let’s reconsider the Carter Company
Rent expense
(20,000)information.
(20,000)
(20,000)
Salary expense
Utility expense
Income
McGraw-Hill/Irwin
(60,000)
(50,000)
(50,000)
(50,000)
(150,000)
(10,000)
$ 20,000
(10,000)
$ 20,000
(10,000)
$ 20,000
(30,000)
$ 60,000
© 2004 The McGraw-Hill Companies, Inc.
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The Development of Financial
Accounting and Reporting Standards
Concepts,
principles, and
procedures were
developed to meet the
needs of external
users (GAAP).
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Early Standard Setting
Evolution of Standard-Setting Process
 1938
- 1959:
Committee on Accounting Procedures (CAP)
 1959
- 1973:
Accounting Principles Board (APB)
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Current Standard Setting - FASB
www.fasb.org
 Supported by the Financial Accounting Foundation.
 Seven full-time, independent voting members serving
for 10 years.
 Answerable only to the Financial Accounting
Foundation.
 Members not required to be CPAs.
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Establishment of Accounting Standards
A Political Process
Internal Revenue
Service
www.irs.gov
American Institute
of CPAs
www.aicpa.org
Securities and
Exchange
Commission
www.sec.gov
McGraw-Hill/Irwin
Financial Executives
Institute
www.fei.org
GAAP
Governmental
Accounting
Standards Board
www.gasb.org
American
Accounting
Association
www.aaa-edu.org
© 2004 The McGraw-Hill Companies, Inc.
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FASB’s Standard-Setting Process








Identification of problem.
The task force.
Research and Analysis.
Discussion memorandum.
Public response.
Exposure draft.
Public response.
Statement issued.
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International Accounting Standards
Committee (IASC)
 Established in 1973 to narrow the
range of differences in accounting
standards.
 Increase in international trade has
motivated the IASC to attempt to
eliminate alternative accounting
treatments.
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Role of the Auditor
Independent intermediary to help insure that
management has in fact appropriately
applied GAAP.
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The Conceptual Framework
 Maintain consistency among standards.
 Resolve new accounting problems.
 Provide user benefits.
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The Conceptual Framework
Objectives of Financial Reporting
(SFAC No. 1)
Qualitative Characteristics
of Accounting Information
Elements of
Financial Statements
(SFAC No. 2)
(SFAC No. 6)
Recognition and Measurement Criteria
(SFAC No. 5)
Environment
assumptions
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Implementation
principles
Implementation
constraints
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Conceptual Framework Objectives
To provide information:
Useful for decisions.
That helps predict cash flows.
About economic resources, claims to resources,
and changes in resources and claims.
Qualitative
Characteristics
Constraints
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Elements
Financial
Statements
Recognition and
Measurement
Concepts
Continued
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Objectives
Qualitative
Characteristics
Understandability
Primary
Relevance
Reliability
Secondary
Comparability
Consistency
Recognition and
Measurement
Concepts
Elements
Assets
Liabilities
Equity
Investments by Owners
Distributions to owners
Revenues
Expenses
Gains
Losses
Comprehensive Income
Assumptions
Economic entity
Going concern
Periodicity
Monetary unit
Principles
Historical cost
Realization
Matching
Full Disclosure
Financial Statements
Constraints
Cost effectiveness
Materiality
Conservatism
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Balance sheet
Income statement
Statement of cash flows
Statement of shareholders’ equity
Related disclosures
© 2004 The McGraw-Hill Companies, Inc.
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Qualitative Characteristics Understandability
Decision Usefulness
Relevance
Predictive
Value
Feedback
Value
Comparability
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Reliability
Timeliness
Verifiability
Neutrality
Representational
Faithfulness
Consistency
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Practical Constraints to Achieving
Desired Qualitative Characteristics
Conservatism
Cost
Effectiveness
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Materiality
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SFAC No. 6
Revenues
“Inflows of assets or settlements of liabilities
during a particular accounting period. Such
inflows or settlements stem from delivery or
production of goods or rendering of
services.”
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SFAC No. 6
Expenses
“Outflows of assets or incurrences of
liabilities during a particular accounting
period. Such outflows are necessary for
delivery or production of goods or rendering
of services.”
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SFAC No. 6
Gains and Losses
Gains: “Increases in equity resulting from
incidental transactions not associated with
the company’s major business.”
Losses: “Decreases in equity resulting from
incidental transactions not associated with
the company’s major business.”
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SFAC No. 6
Assets and Liabilities
Assets: “Business resources that have
probable future economic benefits.”
Liabilities: “Probable future sacrifices of
economic benefits.”
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SFAC No. 6
Equity
Residual interest in the assets of a business
entity is also known as net assets.
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SFAC No. 6
Investments and Distributions
Investments by owners: “Increases in equity
resulting from asset contribution by other
entities (owners/stockholders).”
Distribution to owners: “Decreases in equity
resulting from the distribution of assets to
other entities.”
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SFAC No. 6
Comprehensive Income
“The change in equity resulting from the
aggregate of all transactions reported in a
particular accounting period, except for
investments by and distributions to
owners.”
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Recognition and Measurement Concepts
Assumptions
Economic entity
Description
All economic events identified with a particular
economic entity.
Going concern
Business entity will continue to operate indefinitely.
Perodicity
Life of company is divided into time periods to provide
timely information.
Monetary unit
Financial statements are measured in U. S. Dollars.
Principles
Historical cost
Measurement based on exchange transaction amounts.
Realization
Revenue recognized when earnings process is complete
and reasonable certainty of collection exists.
Matching
Expenses recognized in same period as related revenue.
Full disclosure
Information that could change user decisions should be
included.
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The Realization Principle
Two conditions must be met if the
realization principle is to be satisfied.
Reasonable
Assurance of
Collection
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Substantial
Completion of
Transaction
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Question
The function of financial accounting is to
identify, measure and communicate financial
information about economic entities to
interested parties.
a. True
b. False
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Question
The function of financial accounting is to
identify, measure and communicate financial
information about economic entities to
interested parties.
a. True
b. False
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Question
Accrual accounting provides a better indication
of ability to generate cash flows than does
information limited to the financial effects of
cash receipts and cash payments.
a. True
b. False
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Question
Accrual accounting provides a better indication
of ability to generate cash flows than does
information limited to the financial effects of
cash receipts and cash payments.
a. True
b. False
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Question
The primary objective of accrual basis
accounting is the measurement of income.
a. True
b. False
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1-40
Question
The primary objective of accrual basis
accounting is the measurement of income.
a. True
b. False
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1-41
Question
Generally accepted accounting principles
include both standards set by various rule
making bodies and certain accounting practices
that have evolved over time.
a. True
b. False
McGraw-Hill/Irwin
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Question
Generally accepted accounting principles
include both standards set by various rule
making bodies and certain accounting practices
that have evolved over time.
a. True
b. False
McGraw-Hill/Irwin
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Question
The major financial accounting standard setting
body is the
a.
b.
c.
d.
McGraw-Hill/Irwin
Accounting Principles Board
Securities and Exchange Commission
Financial Accounting Standards Board
American Institute of CPAs
© 2004 The McGraw-Hill Companies, Inc.
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Question
The major financial accounting standard setting
body is the
a.
b.
c.
d.
McGraw-Hill/Irwin
Accounting Principles Board
Securities and Exchange Commission
Financial Accounting Standards Board
American Institute of CPAs
© 2004 The McGraw-Hill Companies, Inc.
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Question
The FASB issues which of the following
types of pronouncements?
a. Standards
b. Interpretations
c. Financial Accounting Concepts
d. Technical Bulletins
e. All of the above
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Question
The FASB issues which of the following
types of pronouncements?
a. Standards
b. Interpretations
c. Financial Accounting Concepts
d. Technical Bulletins
e. All of the above
McGraw-Hill/Irwin
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Question
The Financial Accounting Standards Board
develops accounting and reporting standards
independent of public, business and political
pressures.
a. True
b. False
McGraw-Hill/Irwin
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Question
The Financial Accounting Standards Board
develops accounting and reporting standards
independent of public, business and political
pressures.
a. True
b. False
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Ethics in Accounting
 To be useful, accounting information must
be objective and reliable.
 Management may be under pressure to
report desired results and ignore or bend
existing rules.
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Model for Ethical Decisions
 Determine the facts of the situation.
 Identify the ethical issue and the stakeholders.
 Identify the values related to the situation.
 Specify the alternative courses of action.
 Evaluate the courses of action.
 Identify the consequences of each course of action.
 Make your decision and take any indicated action.
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End of Chapter 1
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