Financial Accounting Rules

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Financial Accounting Rules

• Financial Accounting
• Measures financial activities and summarizes them
  into reports and financial statements
• Objective and Consistent Rules and Conventions
• Generally Accepted Accounting Principles (GAAP)
• Basic Assumptions of Accounting
• Specific Rules of Accounting
• Understand the Compromises and Conventions

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Basic Assumptions of Accounting (Riggs)

• Expression in Monetary Terms
• Separate Entity
• Going-Concern
• Conservatism
• Realization
• Consistency
• Materiality

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Basic Assumptions of Accounting

• Expression in Monetary Terms
• Only events that can be expressed in monetary
  terms will be recorded
• This ensures consistency in reporting financial
  activities
• Not all important business events can be
  expressed in monetary terms.
• The monetary unit must be a stable currency and
  account for the effects of inflation
• Separate Entity
• The finances of the owners and the business must
  not co-mingle
• The specific business entity must be clearly
  delineated.

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Basic Assumptions of Accounting

• Going-Concern
• The business entity will have an indefinite life
  and it is not expected to terminate operation in
  the foreseeable future.
• Assets are valued on their present use and future
  revenues.
• This assumption is not longer valid if the
  business ceases operation.
• Conservatism
• When there is reasonable doubt in valuing assets
  and liabilities, be conservative.
• The lower value for assets the higher value for
  liabilities.
• Revenues will not be recorded until they are
  earned.

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Basic Assumptions of Accounting

• Realization
• Determination if a cash basis or accrual method
  is used to recognize revenues and expenses.
• Must be applied consistently in all transactions
  and financial statements
• The method used to realize revenues and
  liabilities must be clearly footnoted on the
  financial statements.

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Basic Assumptions of Accounting

• Consistency
• Accounting transactions must be recorded in the
  same manner from period to period.
• Any changes in accounting procedures must be
  identified in footnotes on financial statements
  and their impact must be estimated.
• Materiality
• It is only important to record transactions if
  they are large enough to affect the quality of
  the information provided outside the organization
• Estimates can be used when appropriate.

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Specific Rules of Accounting

• Important Institutions
• Professional accounting associations
• Securities and Exchange Commission (SEC)
• Internal Revenue Service (IRS)

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Professional Accounting Associations

• Financial Accounting Standards Board (FASB)
• Seven member board
• Publishes
• Statement of Financial Standards and
• Financial Accounting Concepts.
• Accounting Principles Board (APB)
• The APB was superseded in 1973 by the Financial
  Accounting Standards Board
• Published
• Opinions and Statements of the Accounting
  Principles Board
• Accounting Research Bulletins,
• Accounting Terminology Bulletins and
• Code of Professional Ethics and Accounting
  Interpretations.

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Professional Accounting Associations

• American Institute of Certified Public
  Accountants (AICPA)
• Association of professional Certified Public
  Accountants (CPA)
• Publications include
• Accounting Research Bulletins (ARB),
• Industry Audit and Accounting Guides,
• Statements of Position,
• Practice Bulletins
• Accounting Interpretations
• Issues Papers
• Technical Practice Aids

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GAAP Hierarchy
Generally Accepted Accounting Principles
(GAAP)
Level A
FASB Statements of Financial Standards
FASB Interpretations
APB Opinions and AICPA Accounting Research
Bulletins
Level B
FASB Technical Bulletins
AICPA Industry Audit and Accounting Guides
AICPA Statements of Position
Level C
AICPA Accounting Interpretations
Questions and answers published by the FASB staff
Industry practices widely recognized and prevalent
Accounting literature from a variety of sources
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Government Regulatory Agencies

• Securities and Exchange Commission (SEC)
• responsibility to establish, monitor, and enforce
  accounting rules for publicly traded investment
  securities, which includes stocks and bonds
• establishes standardized procedures and rules for
  preparing and issuing financial statements to
  public shareholders
• Internal Revenue Service (IRS)
• administers the Internal Revenue Code
• responsible to collect income taxes from business
  and individuals
• establishes guidelines and rules regarding the
  treatment of financial statements that affect
  taxable income

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Role of the Auditor

• Verify that
• General and specific accounting rules are
  followed
• Random sample of transactions and accounting
  operations
• Test the accounting system for reliability
• Check unusual transactions
• An other checks that seem prudent
• Financial statements fairly represents the
  companys position and condition.
• The auditor is
• Independent of their client while providing a
  service.
• Obligation to investors, creditor and regulatory
  agencies

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How Good Are The Concepts and Rules

• Financial statements reflect best-estimates of
  the financial picture of an organization.
• Be skeptical financial statements cannot reflect
  the absolute truth.

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Source Documents

• Types of Source Documents
• Sale of a product or service
• An expense is incurred
• A cash receipt
• A cash disbursement
• There are checks-and-balances for source
  documents designed into the accounting system
• Source documents must be matched before payments
  are made.
• Checks are sequentially numbers with an attached
  register.

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Source Documents

• Sale of a product or service
• Invoice
• An expense is incurred
• Purchase Order
• Invoice
• Time Card

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Source Documents

• A cash receipt
• Checks
• Cash register receipts
• A cash disbursement
• Checks
• Petty cash receipt

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The Journal (Register)

• Smaller business will use a single journal while
  larger ones have multiple, specialized journals.
• Payroll - Sales - Cash Receipts
• Expense - Cash Disbursement

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The Ledger (T-account)

• Smaller business will use a single Ledger while
  larger ones have multiple, Subsidiary Ledgers.
• Journal entries are commonly posted to the
  Ledger monthly.
• Entries to the Ledger include a reference to the
  Journal.
• Error are never erased they are reversed.

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Preparing the Financial Statements

• Prepare a Trial Balance
• Adjustments to the Trial Balance
• Prepare the Financial Statements
• Balance Sheet
• Income Statement
• Cash Flow Statement
• Close the books

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The Trial Balance

• The trial balance sequence
• List all ledger accounts and their balances in
  numeric order (from Chart of Accounts)
• Sum all the debits and credits
• The sum of Debits must equal the sum of Credits
  If they do not add up, find the errors.
• Update accounts that have changed value
  (adjusting entries)

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Preparing a Trial Balance
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Adjustment Entries

• One-time entries to appropriate accounts that
  brings accounts up to date
• Three Generic Adjusting Entries
• Corrections
• Prepaid (Cash flows occur BEFORE the revenue or
  expense is recognized)
• Accrual (Cash flows occur AFTER the revenue or
  expense is recognized)
• They match Revenues and Expenses to the period
  they actually occurred
• These are Internal accounting events.

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Adjusting Entries
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Closing the Temporary Accounts

• Performed after the financial reports are
  completed
• Temporary Accounts are defined as all Revenue and
  Expense Accounts.
• Sequence for Closing
• Add debits and credits to Revenue and Expense
  accounts to bring their balance to zero.
• Add corresponding debit and credit entries to the
  Retained Earnings account.
• Revenues and Expenses are zeroed start fresh
  for next accounting period

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Closing Entries