Spiceland and Sepe

Spiceland and Sepe Intermediate Accounting

Environment and Theoretical Structure of Financial Accounting CHAPTER 1

Financial Accounting Environment Providers of Financial Information External User Groups Profit-oriented companies Not-for-profit entities Households Investors Creditors Employees Labor unions Customers Suppliers Government agencies Financial intermediaries Relevant Financial Information

Financial Accounting Environment Relevant financial information is provided primarily through financial statements and related disclosure notes. • Balance Sheet • Income Statement • Statement of Cash Flows • Statement of Shareholders’ Equity

Investment-Credit DecisionsA Cash Flow Perspective Corporate shareholders will receive cash from their investments through . . . • Periodic dividend distributions from the corporation. • The ultimate sale of the ownership shares of stock.

Investment-Credit DecisionsA Cash Flow Perspective Accounting information should help investors evaluate the amount, timing, and uncertainty of the enterprise’s future cash flows.

Cash Versus Accrual Accounting Cash Basis Accounting • Revenue is recognized when cash is received. • Expenses are recognized when cash is paid.

Cash Versus Accrual Accounting Cash Basis Accounting Carter Company has sales on account totaling $100,000 per year, and collected as shown on the following slide. The company prepaid $60,000 for three years’ rent in the first year. Utilities are $10,000 per year, but in the first year only $5,000 was paid. Payments to employees are $50,000 per year.Let’s look at the cash flows.

Cash Versus Accrual Accounting Cash Basis Accounting

Cash Versus Accrual Accounting Cash Basis Accounting Cash flows in any one year may not be a predictor of future cash flows.

Cash Versus Accrual Accounting Accrual Accounting • Revenue is recognized when earned. • Expenses are recognized when incurred. Let’s reconsider the Carter Company information.

Cash Versus Accrual Accounting Accrual Accounting • Revenue is recognized when earned. • Expenses are recognized when incurred. Lets reconsider the Carter Company information.

Development of Financial Accounting Concepts, principles, and procedures were developed to meet the needs of external users (GAAP).

Early Standard Setting Evolution of Standard-Setting Process 1938 - 1959: • Committee on Accounting Procedures (CAP) 1959 - 1973: • Accounting Principles Board (APB)

Current Standard Setting - FASBwww.fasb.org • Supported by the Financial Accounting Foundation. • Seven full-time, independent voting members serving for 10 years. • Answerable only to the Financial Accounting Foundation. • Members not required to be CPAs.

Establishment of Accounting StandardsA Political Process Internal Revenue Servicewww.irs.gov Financial Executives Institutewww.fei.org GAAP Governmental Accounting Standards Boardwww.gasb.org American Institute of CPAswww.aicpa.org Securities and Exchange Commissionwww.sec.gov American Accounting Associationwww.aaa-edu.org

International Accounting Standards Committee (IASC) • Established in 1973 to narrow the range of differences in accounting standards. • Increase in international trade has motivated the IASC to attempt to eliminate alternative accounting treatments.

Role of the Auditor Independent intermediary to help insure that management has in fact appropriately applied GAAP.

The Conceptual Framework • Accounting standards consistency. • Resolve new accounting problems. • Provide user benefits.

The Conceptual Framework Objectives of Financial Reporting (SFAC No. 1) Qualitative Characteristics of Accounting Information (SFAC No. 2) Elements of Financial Statements (SFAC No. 6) Recognition and Measurement Criteria (SFAC No. 5) Environment Implementation Implementation assumptions principles constraints

Conceptual Framework Objectives • To provide information: • Useful for decisions. • That helps predict cash flows. • About economic resources, claims to resources, and changes in resources and claims. Recognition andMeasurementConcepts Elements QualitativeCharacteristics FinancialStatements Constraints Continued

Objectives Recognition andMeasurementConcepts AssumptionsEconomic entity Going concern Periodicity Monetary unit Principles Historical cost Realization Matching Full Disclosure Elements Assets Liabilities Equity Investments by Owners Distributions to owners Revenues Expenses Gains Losses Comprehensive Income QualitativeCharacteristics Understandability Primary Relevance Reliability Secondary Comparability Consistency Financial Statements Balance sheet Income statement Statement of cash flows Statement of shareholders’ equity Related disclosures Constraints Cost effectiveness Materiality Conservatism

Qualitative CharacteristicsUnderstandability Decision Usefulness Relevance Reliability PredictiveValue Feedback Value Timeliness Verifiability Neutrality RepresentationalFaithfulness Comparability Consistency

The Realization Principle Two conditions must be met if the realization principle is to be satisfied. Reasonable Assurance of Collection Substantial Completion of Transaction

Recognition and Measurement Concepts

SFAC No. 6Revenues “Inflows of assetsor settlements of liabilities during a particular accounting period. Such inflows or settlements stem from delivery or production of goods or rendering of services.”

SFAC No. 6Expenses “Outflows of assetsor incurrences of liabilities during a particular accounting period. Such outflows are necessary to delivery or production of goods or rendering of services.”

SFAC No. 6Gains and Losses Gains: “Increases in equity resulting from incidental transactions not associated with the company’s major business.” Losses: “Decreases in equity resulting from incidental transactions not associated with the company’s major business.”

SFAC No. 6Assets and Liabilities Assets: “Business resources that have probable future economic benefits.” Liabilities: “Probable future sacrifices of economic benefits.”

SFAC No. 6Equity Residual interestin the assets of a business entity is also known as net assets.

SFAC No. 6Investments and Distributions Investments by owners: “Increases in equity resulting from asset contribution by other entities (owners/stockholders).” Distribution to owners: “Decreases in equity resulting from the distribution of assets to other entities.”

SFAC No. 6Comprehensive Income “The change in equity resulting from the aggregate of all transactions reported in a particular accounting period, except forinvestments by and distributions to owners.”

Question The function of financial accounting is to identify, measure and communicate financial information about economic entities to interested parties. a. True b. False

Question Accrual accounting provides a better indication of ability to generate cash flows than does information limited to the financial effects of cash receipts and cash payments. a. True b. False

Question The primary objective of accrual basis accounting is the measurement of income. a. True b. False

Question Generally accepted accounting principles include both standards set by various rule making bodies and certain accounting practices that have evolved over time. a. True b. False

Question The major financial accounting standard setting body is the a. Accounting Principles Board b. Securities and Exchange Commission c. Financial Accounting Standards Board d. American Institute of CPAs

Question The FASB issues which of the following types of pronouncements? a. Standards b. Interpretations c. Financial Accounting Concepts d. Technical Bulletins e. All of the above

Question The Financial Accounting Standards Board develops accounting and reporting standards independent of public, business and political pressures. a. True b. False

Ethics in Accounting • To be useful, accounting information must be objective and reliable. • Management may be under pressure to report desired results and ignore or bend existing rules.

Model for Ethical Decisions • Determine the facts of the situation. • Identify the ethical issue and the stakeholders. • Identify the values related to the situation. • Specify the alternative courses of action. • Evaluate the courses of action. • Identify the consequences of each course of action. • Make your decision and take any indicated action.

End of Chapter 1

Spiceland and Sepe