Financial Accounting

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CHAPTER 1
Financial Accounting and Accounting Standards
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What is the value of A-1 Industries?
Assets 1,200,000 Liabilities 850,000 Net
Assets 350,000
Net annual cash flows (next 50 years) 50,000
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Accounting provides Information
Assets Liabilities
Future Cash Flows
Investors Creditors Government Agencies
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Assets 1,200,000 Liabilities 850,000 Net
Assets 350,000
Net assets might not reflect firm value

• Most assets are recorded at historical cost.
• Intangible assets are frequently not recognized.

Net annual cash flows (next 50 years) 50,000
A 500,000 investment would yield a 10 return.
A 1,000,000 investment would yield a 5 return.
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Future Cash Flows

• Characteristics
• amount
• timing
• uncertainty

• Important to investors creditors

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• Projecting future cash flows
• requires more than just current cash flows
• financial reporting provides information

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amazon.com
4th quarter 1999 Operating loss 185
million Net loss 323 million
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Possible explanations
Current financial reporting is irrelevant!

• backward looking
• neglects intangibles
• rules have changed

Market was overpriced! (A bubble)
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Objectives of Financial Reporting

• Information to stockholders and creditors
• Future cash flows
• Assets and liabilities

Challenges of Financial Reporting

• Non-financial measurements
• Forward-looking information
• Intangible assets
• Timeliness

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• Federal agency
• Requirements for all companies that issue stock

SEC

• Accounting must conform to GAAP

CAP 39 59
APB 59 73
FASB 73 present

• Private organizations
• Set accounting standards

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FASB
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• The FASB is committed to rendering its final
  decision without regard to any of the social,
  economic, or public policy considerations.
  (J.Carter Beese, SEC)

• Truth in accounting means telling it like it is,
  without bias or intent to encourage any
  particular mode of behavior. (Dennis Beresford,
  FASB)
• Other post-employment benefits (OPEB), stock
  options, derivatives, etc.

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• Detect fraud?
• Verify that financial reporting rules have been
  followed (i.e. proper form)?

• Ensure that the accounting reflects the substance
  of the economic event?
• Auditor independence
• Expectations gap