Chapter 1
The Environment of
Financial Reporting
Intermediate Accounting 11th edition
Nikolai Bazley Jones
An electronic presentation
By Norman Sunderman
and Kenneth Buchanan
Angelo State University
COPYRIGHT © 2010 South-Western/Cengage Learning
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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 Financial Accounting Standards Board
(FASB).
5. Understand how the FASB operates.
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Objectives
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.
9. Describe the joint convergence project of the
FASB and the IASB (Appendix).
10. Understand SEC reporting under U.S. GAAP
and IFRS (Appendix).
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More Accountants Needed
New accounting rules pose
challenges for financial accounting
and projections point to increased
hiring of accounting graduates.
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Estimated Hiring Increase
Accounting firms of all sizes plan to increase
future hiring.
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Capital Markets
Companies need large amounts of capital for
operations
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Capital Markets
Companies may obtain capital by issuing
capital stock...
Stock Exchange
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Capital Markets
…or by borrowing from lenders
Bank
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Capital Markets
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Accounting Information: Economic Activities and Decision 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
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
Managerial Accounting
Prescribed by GAAP;
oriented toward investment
and credit decisions
Determined by company;
focused upon specific
decisions being made
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Comparison of Financial and Managerial Accounting
Decision Focus
Financial Accounting
Managerial Accounting
External
Internal
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Comparison of Financial and Managerial Accounting
The company’s accountants
prepare both the financial and
the managerial accounting
reports…
…and the information
comes from the same
information system.
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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:
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
is also 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.
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FASB Accounting Standards Codification
Currently, there is no single document that
includes all the accounting standards.
However, the FASB has released its FASB
Accounting Standards Codification for
verification by its constituents. When
finalized, this Codification will be electronic
and will integrate and topically organize U.S.
accounting standards.
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Hierarchy of Sources of GAAP
Categories
A
Authoritative Sources
FASB Statements of Financial Accounting
Standards and Interpretations, FASB Statement
133 Implementation Issues, FASB Staff
Positions, and APB Opinions and CAP
(AICPA) Accounting Research Bulletins not
superceded by actions of the FASB (as well as
SEC releases such as Regulation S-X, Financial
Reporting Releases, and Staff Accounting
Bulletins for companies that file with the SEC)
Continued
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Hierarchy of Sources of GAAP
Categories
B
C
Authoritative Sources
FASB Technical Bulletins, and, if
cleared by the FASB, AICPA
Industry Audit and Accounting
Guides, and AICPA Statements of
Position
FASB Emerging Issues Task
Force Consensus Positions, Topics
discussed in Appendix D of EITF
Abstracts, and, if cleared by the
FASB, AICPA Practice Bulletins
Continued
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Hierarchy of Sources of GAAP
Categories
D
Authoritative Sources
FASB Q’s and A’s (Implementation Guides),
AICPA Accounting Interpretations, AICPA
Industry and Audit Guides, and AICPA
Statements of Position not cleared by the FASB,
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
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FASB Accounting Standards Codification
The Codification does not change GAAP.
Instead, it reorganizes the many
pronouncements on U.S. GAAP into about
90 accounting topics, organized in a
consistent structure.
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FASB Accounting Standards Codification
The FASB expects the Codification to:
 Reduce the amount of time and effort needed
to solve an accounting research issue.
 Improve the usability of the accounting
literature, thereby reducing the chances of not
complying with GAAP.
 Provide real-time updates as new standards are
issued.
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FASB Accounting Standards Codification
The FASB expects to approve the Codification
in 2009. At that time, the Codification will
supercede all then-existing non-SEC
standards. Once the Codification has been
approved, the FASB will not issue separate
new pronouncements. Instead, any new
standards will be structured in a way to
update the Codification.
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History of GAAP in the Private Sector
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Committee on Accounting Procedure (CAP)
In 1938, the AICPA formed the Committee on
Accounting Procedure (CAP). 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 (APB) in 1959 to
replace the Committee on Accounting Procedure.
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Reasons for Forming the 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 organizations
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 FASB
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Types of Pronouncements Issued by the FASB
1.
2.
3.
4.
5.
Statements of Financial Accounting Standards
Interpretations
Staff Positions
Technical Bulletins
Statements of Financial Accounting
Concepts
6. Other Pronouncements
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FASB Operating Procedures
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Other Organizations Impacting GAAP
 Securities and Exchange Commission (SEC) – The SEC
is a governmental agency that has the legal authority to
prescribe accounting principles and reporting practices
for all corporations issuing publicly traded securities.
 American Institute of Certified Public Accountants
(AICPA) – The AICPA is the professional organization
for all certified public accountants in the United States.
To be a member of the AICPA, an individual must have
passed the Uniform CPA Examination, hold a CPA
certificate, agree to abide by its bylaws and Code of
Professional Ethics, and have 150 hours of higher
education.
Continued
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Other Organizations Impacting GAAP
 FASB Emerging Issues Task Force (EITF) – The
primary objectives of the EITF are (1) to identify
significant emerging accounting issues (i.e., unique
transactions and accounting problems) that it feels the
FASB should address and (2) to develop consensus
positions on the implementation issues involving the
application of standards.
 International Accounting Standards Board (IASB) –
The IASB issues International Financial Reporting
Standards (IFRS) and includes 12 full-time members
(and 2 part-time members) from various countries. To
date IASB has issued 49 Standards.
Continued
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Other Organizations Impacting GAAP
 Governmental Accounting Standards Board (GASB) –
The GASB’s responsibility is to establish financial
accounting standards for certain state and local
governmental entities.
 Public Company Accounting Oversight Board
(PCAOB) – The PCAOB is a non-profit corporation
that was created by Congress in the Sarbanes-Oxley Act
of 2002. Its purpose is to protect the interests of
investors by overseeing auditors of public companies in
the preparation of informative, accurate, and
independent audit reports for companies that sell
securities to the public.
Continued
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Other Organizations Impacting GAAP
 Cost Accounting Standards Board (CASB) –
The CASB is responsible only for negotiated
federal contracts and subcontracts exceeding
$500,000.
 Internal Revenue Service (IRS) – The IRS
administers the Internal Revenue Code enacted
by Congress.
 American Accounting Association (AAA) – The
AAA is an organization primarily of academics
and practicing accountants.
Continued
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Other Organizations Impacting GAAP
 Financial Executives International (FEI) – The
FEI consists primarily of high-level financial
executives (such as financial vice-presidents,
treasures, and controllers) of major
corporations. The FEI publishes a monthly
journal called the Financial Executive.
 Institute of Management Accountants (IMA) –
The primary focus of the IMA is on
management accounting and financial
accounting issues. The IMA publishes a
monthly journal called Strategic Finance.
Continued
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Other Organizations Impacting GAAP
 CFA Institute (CFAI) – Members of the CFAI
are financial analysts who use accounting
information in various investment management
and security analysis decisions.
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Participants in the Development of GAAP
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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
and moral judgments 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 evaluates 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
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IFRS and U.S. GAAP
Many companies have become “globalized”. Currently,
U.S. corporations are subject to the accounting standards
established by the FASB, while foreign corporations are
subject to international financial reporting standards
(IFRS) established by the IASB or by accounting
standards set by their national accounting standards
board. These differences in accounting standards have led
to differences among U.S. and foreign corporations’
financial statements. These differences, in turn, have
made it difficult for investors and creditors to make valid
comparisons across corporations and to make effective
buy-sell-hold decisions in the U.S. and foreign capital
markets.
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IFRS and U.S. GAAP
To resolve this issue, FASB and the IASB entered
into an agreement to develop high-quality,
compatible accounting standards that could be
used for both “domestic” and “cross-border”
financial reporting. To achieve this compatibility,
the Boards agreed to work together to achieve
“short-term” convergence on a number of
individual differences between U.S. and
international accounting standards.
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Chapter 1
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