Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Environment and Theoretical Structure of Financial Accounting

Chapter 1

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Financial Accounting Environment

Profit-orientedcompanies

Not-for-profitentities

Households

Providers ofFinancial

InformationExternal

User Groups

Investors

Creditors

Employees

Labor unions

Customers

Suppliers

Governmentagencies

Financialintermediaries

Relevant

FinancialInformation

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Financial Accounting EnvironmentRelevant financial information is provided primarily through

financial statements and related disclosure notes. The following financial statements are the most frequently provided.

1. Balance Sheet2. Income Statement3. Statement of Cash Flows4. Statement of Shareholders’ EquityStarting in 2012, companies must either provide a

Statement of Other Comprehensive Income immediately following the Income Statement, or present a Combined Statement of Comprehensive Income that includes the information normally contained in both the Income Statement and the Statement of Other Comprehensive Income.

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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.

OROROR

OR

Accrual AccountingRevenue is recognized when earned.

Expenses are recognized when incurred.

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The Development of Financial Accounting and Reporting Standards

Concepts, principles, and

proceduresdeveloped to meet the

needs of external users (GAAP).

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Historical Perspective and Standards

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Current U. S. Standard Setting

Supported by the Financial Accounting Foundation

Seven full-time, independent voting members

Members not required to be CPAs

Financial Accounting Standards Board

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International Standard Setting

The main objective of the International Accounting Standards Board (IASB) is to develop a single set of high quality,

understandable, and enforceable global accounting standards to help participants in the world’s capital

markets and other users make economic decisions.

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Efforts to Converge U.S. and International Standards

Issues and Concerns: Desire for a single set of global standards Need for standards that are customized to fit stringent

legal and regulatory requirements of U.S. Possible differences in implementation and enforcement

Progress: September 2002: FASB and IASB sign Norwalk

Agreement. November 2008: SEC issues a Roadmap with

milestones. May 2011: SEC issues discussion paper describing a

“condorsement” approach. November 2011: SEC issues two studies comparing

U.S. GAAP to IFRS and analyzing how IFRS are applied globally.

December 2011: SEC postpones final determination until 2012.

1-10A Move Away from

Rules-Based Standards?

Rules-based accounting standards vs.

Objectives-oriented approach

Objectives-oriented (principles-based) approach stresses

professional judgment

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The Conceptual Framework

The Conceptual Framework has been described as an “Accounting Constitution.” It provides the

underlying foundation for accounting standards.

FASB Conceptual Framework(Statements of Financial Accounting Concepts)

Objectives of Financial Reporting (SFAC 1, replaced by SFAC 8)Qualitative Characteristics (SFAC 2, replaced by SFAC 8)Elements of Financial Statements (SFAC 3, replaced by SFAC 6)Recognition and Measurement (SFAC 5 and SFAC 7)

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ObjectiveTo provide financial information that is useful to capital providers.

ElementsRecognition and

MeasurementConcepts

ConstraintsFinancial

Statements

The Conceptual Framework

Qualitative Characteristics

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NeutralityCompletenessFree from

errorPredictive

valueMateriality

Relevance Faithful representation

Qualitative Characteristics ofAccounting Information

Comparability(Consistency)

UnderstandabilityVerifiability Timeliness

Decision usefulness

Confirmatory value

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Elements of Financial Statements

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Elements of Financial Statements

1-16Recognition, Measurement and

Disclosure ConceptsRecognition

Process of admitting information into the basic

financial statements

Criteria:1. Definition2. Measurability3. Relevance4. Reliability

Measurement Process of associating

numerical amounts with the elements.

Measurement Attributes:

1. Historical cost2. Net realizable

value3. Current cost4. Present value of

future cash flows5. Fair value

Disclosure Process of including

additional supplemental information.

Examples:1. Parenthetical

amounts2. Notes to FS3. Supplemental FS

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Revenue Recognition: Realization

Two Criteria:1.Earnings process is complete or virtually complete.2.Reasonable certainty as to the collectability of the asset to be received (usually cash).

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Expense Recognition: Matching

The matching principle requires that all expenses incurred in generating revenue for a period also be recognized in the same period.

Four Approaches1.Based on exact cause-and-effect relationships.2.By associating an expense with the revenues recognized in a specific time period.3.By a systematic and rational allocation to specific time periods.4.In the period incurred, without regard to related revenues.

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End of Chapter 1