A Review of the Accounting Cycle

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chapter 1
FINANCIAL REPORTING
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Learning Objectives

• 1. Describe the purpose of financial reporting
  and identify the primary financial statements.
• 2. Explain the function of accounting standards
  and describe the role of the FASB in setting
  these standards in the United States.
• 3. Recognize the importance to financial
  reporting of the SEC, AICPA, AAA, and IRS.

Continued
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Learning Objectives

• 4. See the growing importance and relevance of
  international accounting issues to the practice
  of accounting in the United States and understand
  the role of the ISAC in international accounting
  standard setting.
• 5. Understand the significance of the FASBs
  conceptual framework in outlining the qualities
  of good accounting information, defining terms
  such as asset and revenue, and providing guidance
  about appropriate recognition, measurement, and
  reporting.

Continued
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Learning Objectives
6. Identify career opportunities related to
accounting and financial reporting in the fields
of public accounting, corporate accounting,
financial analysis, banking, and consulting.
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Definition for Accounting

• Accounting is a service activity. Its function
  is to provide quantitative information, primarily
  financial in nature, about economic entities that
  is intended to be useful in making economic
  decisionsin making reasoned choices among
  alternative courses of action. (Statement of the
  Accounting Principles Board No. 4, p. 40)

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Definition for Accounting
Key features of this definition

• Accounting provides a vital service in todays
  business environment.
• Accounting is concerned primarily with
  quantitative financial information that is used
  in conjunction with qualitative evaluations in
  making judgments.

Continued
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Definition for Accounting
Key features of this definition

• Accounting information is used in making
  decisions about how to allocate scarce resources.

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Definition for Accounting
Key features of this definition

• Although accountants place much emphasis on
  reporting what has already occurred, this past
  information is intended to be useful in making
  economic decisions about the future.

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Users of Accounting Information
All parties interested in the financial health of
a company are called stakeholders.
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Users of Accounting Information
Two major classifications of stakeholders
Internal users, who make decisions directly
affecting the internal operations of the
enterprise.
External users, who make decisions concerning
their relationship to the enterprise.
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Major Internal and External Stakeholder Groups
Investors
Government
Community
Board of Directors Management Employees
Suppliers
Analysts
Employees
Customers
Creditors
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Financial Reporting
The balance sheet reports, as of a certain point
in time, the resources of a company (the assets),
the companys obligations (the liabilities), and
the equity of the owners.
The income statement reports, for a specified
interval, the net assets generated through
business operations (revenues), the net assets
consumed (the expenses), and the net income.
The statement of cash flows reports, for a
specified time period, the amount of cash
generated and consumed by a company through
operating, financing, and investing activities.
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Financial Reporting
Accounting estimates and judgments are outlined
in the notes to financial statements.
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Financial Statement Relationships
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Auditors
Auditors issue an auditors opinion about the
fairness of the statements and their adherence to
proper accounting principles.
Auditors working independently of a companys
management and internal accountants examine the
financial statements.
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Auditors Opinion

• Unqualified opinionIn the opinion of the
  auditor, the financial statements are presented
  in accordance with GAAP.
• Qualified opinionIn the opinion of the auditor,
  except for the effects of the qualified item, the
  financial statement are presented in conformity
  with GAAP.
• No opinionThe auditor does not express an
  opinion about the financial statements.
• AdverseIn the opinion of the auditor, the
  financial statements do not present information
  in conformity with GAAP.

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Relative Frequency of Audit Opinions (2000)
Companies
Unqualified 5,651 Unqualified With Explanatory
Language 1,506 Qualified 4 No opinion 2 Adverse 1
Total 7,164
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Accounting StandardSetting Organizations
FAF
SEC
AICPA
Other
FASAC
FASB
AcSEC
IAPC
GASAC
GASB
U.S. Gov't
IASC
EITF
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Financial Accounting Standards Board
Committee on Accounting Procedures (CAP)
Born 1939 Died 1959
Pronouncements Accounting Research Bulletins
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Financial Accounting Standards Board
Accounting Principles Board (APB)
Born 1959 Died 1973
Pronouncements APB Opinions
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Financial Accounting Standards Board
Financial Accounting Standards Board (FASB)
Born 1973 Died
Pronouncements Statements of Financial
Accounting Standards
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Financial Accounting Standards Board

• 1) Seven full-time members comprise this
  independent body.
• 2) Issues Statements of Financial Accounting
  Standards.
• 3) Determines GAAP by due process.
• 4) Works within the Conceptual Framework.

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FASB Authority SourcesOverview
FASB
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FASB Authority SourcesSEC
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FASB Authority Sources -- AICPA

• Provides authority to the FASB through its Code
  of Professional Conduct Rule 203.
• AICPA members must show that client financial
  statements comply with FASB pronouncements
  (GAAP).
• AICPA grants continuing membership to its members
  who comply with Rule 203.

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FASB Due Process

• 1) Topic or project added to agenda.
• 2) Task force assembled to study topic.
• 3) Research and analysis performed by FASB
  technical staff.
• 4) Discussion Memorandum (DM) drafted and
  released.
• 5) Public hearing, usually 60 days later, is held.

Continued
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FASB Due Process

• 6) Board analyzes and evaluates public
  response.
• 7) Exposure Draft (ED) prepared and released.
• 8) Sixty-day exposure period allows for public
  comment.
• 9) Committee studies public response to
  exposure draft and prepares final draft.

Continued
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FASB Due Process
10) Board votes on final draft leads to either
the issuance of a Statement of Financial
Accounting Standard, a revised Exposure Draft, or
abandonment of the project.
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Emerging Issue Task Force
In an effort to overcome the slow process of
standard setting, in 1984 the FASB established
the Emerging Issues Task Force (EITF) to assist
the FASB in identifying the emerging issues that
affect financial reporting.
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Accounting StandardSetting Organizations
FAF
SEC
AICPA
Other
FASAC
FASB
AcSEC
IAPC
GASAC
GASB
U.S. Gov't
IASC
EITF
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Securities Exchange Commission (1933-present)

• 1929 stock market crash blamed on nonstandard
  accounting.
• 1933 Securities Act established SEC to
  standardize accounting.
• Created to protect the interests of investors by
  ensuring full and fair disclosure.
• Granted legal authority to dictate GAAP.
• Has tended to defer setting GAAP to the
  accounting profession.

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Securities and Exchange Commission
SEC official statements are referred to as
Financial Reporting Releases which are accounting
interpretations and policies the SEC uses in
evaluating firms disclosure policies.
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Securities and Exchange Commission
Other Authoritative Literature

• Staff Accounting Bulletins
• Accounting and Auditing Enforcement Releases
• Accounting Series Releases

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American Institute of Certified Public Accountants
The American Institute of Certified Public
Accountants (AICPA) is the professional
organization of practicing CPAs in the United
States.
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American Accounting Association
The American Accounting Association (AAA) is
primarily an organization for accounting
professors.
What are assets ?
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Internal Revenue Service
The Internal Revenue Service (IRS) has the
primary goal of equitable collecting revenue.
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What is GAAP?
A B C D
Higher Authority
Lower Authority
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What is GAAP?

• FASB Statements and Interpretations
• APB Opinions
• CAP Accounting Research Bulletins

A
Highest Authority
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What is GAAP?

• FASB Technical Bulletins
• AICPA Industry Audit and Accounting Guides
• AICPA Statements of Position

B
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What is GAAP?

• Consensus Positions of EITF
• AICPA Practice Bulletins

C
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What is GAAP?

• AICPA Accounting Interpretations
• FASB Question and Answer guides
• Other widely recognized industry practices

D
Lowest Authority
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International Accounting Standards Committee
The accounting standards produced by the
International Accounting Standards Committee are
referred to as International Accounting Standards
or IAS.
The International Accounting Standards Committee
(ISAC) was formed in 1973 to develop worldwide
accounting standards.
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Conceptual Framework of Accounting
Objectives of Financial Reporting
Qualitative Characteristics of Information Account
ing
Elements of Financial Statements
Recognition and Measurement Concepts
Assumptions
Principles
Constraints
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Objectives of Financial Reporting
The overall objective of financial reporting is
to provide information useful for decision making.
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Objectives of Financial Reporting

• Usefulness.
• Understandability.
• Target audience investors and creditors.
• Assessing future cash flows.
• Evaluating economic resources.
• Primary focus on earnings.

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Objectives of Financial Reporting
Usefulness
Financial reporting should provide information
that is useful to present and potential investors
and creditors and other users in making rational
investment, credit, and similar decisions.
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Objectives of Financial Reporting
Understandability
Financial reporting should provide information
that is understandable to one who has a
reasonable knowledge of accounting and business
and who is willing to study and analyze the
information presented.
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Objectives of Financial Reporting
Target Audience
While there are many potential users of financial
reports, the objectives are directed primarily
toward investors and creditors.
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Objectives of Financial Reporting
Assessing Future Cash Flows
Financial reporting should provide information
that is useful in assessing amounts, timing, and
uncertainty (risk) of prospective cash flows.
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Objectives of Financial Reporting
Evaluating Economic Resources
Financial reporting should also provide
information about an enterprises assets,
liabilities, and owners equity to help
investors, creditors, and others evaluate the
financial strengths and weaknesses of the
enterprise and its liquidity and solvency.
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Objectives of Financial Reporting
Primary Focus on Earnings
Information about enterprise earnings, measured
by accrual accounting, generally provides a
better basis for forecasting future performance
than does information about current cash receipts
and disbursements.
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Qualitative Characteristics of Accounting
Information
Benefits gt Cost
Understandability
Decision
Usefulness
Relevance
Reliability
Predictive
Feedback
Timeliness
Verifiability
Representational
Value
Value
Faithfulness
Neutrality
Comparability (including Consistency)
Materiality
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What About Conservatism?
The concept of conservatism can be summarized as
follows When in doubt, recognize all losses but
dont recognize any gains.
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Elements of Financial Statements

• Assets
• Liabilities
• Equity, or Net Assets
• Investments by Owners
• Distributions to Owners
• Comprehensive Income
• Revenues
• Expenses
• Gains
• Losses

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Recognition, Measurement, and Reporting
Boiling down all the estimates and judgments into
one number and then using that one number to make
a journal entry is called recognition.
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Recognition, Measurement, and Reporting
Skipping the journal entry and just relying on
the note to convey the information to users is
called disclosure.
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Recognition, Measurement, and Reporting
Measurement
1. Historical cost 2. Current replacement
cost 3. Current market value 4. Net realizable
value 5. Present (or discounted) value
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Recognition, Measurement, and Reporting
Reporting

• Financial position at the end of the period
• Earnings (net income) for the period
• Cash flows during the period
• Investments by and distributions to owners during
  the period
• Comprehensive income for the period

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Traditional Assumptions of the Accounting Model

• Economic entity.
• Going concern.
• Arms-length transactions.
• Stable monetary unit.
• Accounting period.

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Careers in Financial Accounting

• Public accounting.
• Company accounting.
• User (analyst, banker, consultant).