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Chapter 1

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Chapter 1

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  1. Chapter 1 The Conceptual Framework and Objectives of Financial Reporting

  2. What is Accounting Used For? • Decision Making • Evaluation of past performance • Expectations of future performance • Allocation of Resources

  3. Free enterprise principle Resources will flow to the segments of the economy that will use them most efficiently in the creation of new wealth

  4. Role of Accounting Accounting Information Investors

  5. Chapter 1 -- Learning Objective 2. Trace the evolution of generally accepted accounting principles GAAP

  6. GAAP A consensus The conventions, rules, and procedures necessary to define accepted accounting practice

  7. Sources of GAAP • Committee on Accounting Procedures • Accounting Principles Board • Financial Accounting Principles Board

  8. Committee on Accounting Procedure CAP1939 - 1959 • First private body concerned with writing accounting rules • Issued 51 Accounting Research Bulletins • Members were practicing CPAs • An “ad hoc” approach

  9. Accounting Principles Board APB1959 - 1973 • Appointed by the AICPA • Primarily from public accounting • Issued 31 APB Opinions • Criticized for failing to deal with problems on a timely basis • Many saw a need for independence

  10. Financial Accounting Foundation FAFEstablished 1973 • Appoints members of Financial Accounting Standards Board (FASB) • Appoints members of Financial Accounting Standards Advisory Committee (FASAC) • Provides financial support to FASB • Contributions from industry & CPA firms

  11. Financial Accounting Standards Board FASBEstablished 1973 • 7 members • Members are full time, well paid • Responsible only to FAF • Passage of standards requires 5 out of 7 votes

  12. Securities and Exchange Commission • Appointed by President • Reports to Congress • Final authority on reporting by public companies

  13. International Accounting Standards • International Accounting Standards Committee • Standards less specific • “Principle Based” • Not allowed by SEC

  14. Accounting Standard Setting • A political process

  15. Chapter 1 -- Learning Objective 3. Relate the objectives of financial reporting as stated in the conceptual framework to the accounting process

  16. Conceptual Framework • Statements of Financial Accounting Concepts (SFACs) • Purpose: Establish the objectives and concepts to be used by the FASB in developing standards for financial reporting

  17. Conceptual FrameworkSFACs • Objectives of Financial Reporting • Qualitative Characteristics • Objectives for Nonbusiness Organizations • Recognition & Measurement • Elements of Financial Statements

  18. Objectives of Financial ReportingSFAC No. 1 To provide information: 1. Useful in investment and credit decisions 2. Useful in assessing future cash flows 3. About enterprise resources, claims and changes

  19. Chapter 1 -- Learning Objective 4. Interpret the meaning of the qualitative characteristics of accounting information enumerated in the conceptual framework

  20. Objectives • Useful for decision making • Information about future cash flows • Information about resources, claims to resources, changes in resources • Liquidity • Solvency • Flexibility • Profitability

  21. Qualitative CharacteristicsSFAC No. 2 • Primary Qualities • Understandability • Relevance • Reliability • Secondary Qualities • Comparability • Consistency

  22. Relevance The capacity for information to make a difference Predictive Value Feedback Value Timeliness

  23. Reliability User has confidence in the information: Verifiability Representational Faithfulness Neutrality

  24. Secondary Qualities • Comparability—With other enterprises • Consistency—Period to Period • Changes in accounting must be to Better principles

  25. Constraints Measurement and reporting practices are affected by: Cost/benefits Materiality Industry practices

  26. Chapter 1 -- Learning Objective 5. Understand the assumptions and conventions underlying the recognition and measurement of accounting data for financial reporting

  27. Recognition and MeasurementSFAC No. 5 • Recognition • Reporting an item in the financial statements • Measurement • The amount reported for an item in financial statements

  28. Recognition Criteria • Definition • Must meet definition of an element of financial statements found in SFAC No. 6 • Measurability • Must be measurable with sufficient reliability • Relevance • Must be capable of making a difference • Reliability • Must be representationally faithful, verifiable & neutral

  29. Basic Accounting Assumptions: Economic entity Going concern (Continuity) Periodicity Monetary unit

  30. Basic Conventions and Practices Cost or other measurement attributes Revenue recognition Matching Conservatism Full disclosure

  31. Chapter 1 -- Learning Objective 6. Distinguish among the elements of the financial statements

  32. Elements of Financial StatementsSFAC No. 6 Basic Building Blocks

  33. Elements of Financial Statements Balance Sheet • Assets • Liabilities • Equity • Investments by owners • Distributions to owners • Comprehensive Income • Revenues • Expenses • Gains • Losses Income Statement

  34. Chapter 1 -- Learning Objective 7. Understand how accounting information is used in investment decision models

  35. Income Statement Growth potential Balance Sheet Investment Decision Model Factors Operating efficiency Capital generation Asset productivity Financial leverage Goal

  36. Chapter 1 -- Learning Objective 8. Develop an appreciation of ethical and moral considerations in business

  37. Decision Model • Determine the Facts • Define the ethical issues • Identify major values • Specify the Alternatives • Compare values and alternatives • Assess consequences • Decide

  38. Decision Model forEthical Dilemmas 1. Determine the facts 2. Define the ethical issue 3. Identify major values 4. Specify the alternatives 5. Compare values and alternatives 6. Assess the consequences 7. Make the decision