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Chapter 1

Chapter 1. Financial Accounting and Accounting Standards. What is the Purpose of Financial Accounting?. Identify, measure, and communicate financial information to allocate resources.

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Chapter 1

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  1. Chapter 1 Financial Accounting and Accounting Standards

  2. What is the Purpose of Financial Accounting? • Identify, measure, and communicate financial information to allocate resources. • Capture business economics of the firm (e.g., relationship to industry, competitive strategy, business model). How does firm create value?

  3. Challenges of Financial Accounting • Nonfinancial measures; e.g., performance measures such as customer satisfaction. • Forward-looking Information; e.g., forecasts and projections. • Soft assets; e.g., intangibles, employee expertise. • Timeliness: information available quarterly.

  4. Objectives of Financial Reporting • Financial reporting should provide information useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions • to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts • about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

  5. Accounting Regulators • Securities & Exchange Commission (SEC)--regulates securities markets and financial reporting (10-K, 10-Q, 8-K) • Financial Accounting Standards Board (FASB)--promulgates GAAP • International Accounting Standards Board (IASB)—issuing International Financial Reporting Standards (IFRS)

  6. SEC Regulation • Mission: Protect investors & maintain integrity of the securities markets • Established following the Great Market Crash (SEC Act of 1934) • SEC requires public registration, proxy statements & annual (10-K) and quarterly (10-Q) reports, 8-K for specific events • Update: Sarbanes-Oxley Act of 2002 & Public Company Accounting Oversight Board; Dodd-Frank, 2010

  7. U.S. Standard Setters: 1938-Present • Committee on Accounting Procedures (CAP) issued 51 Accounting Research Bulletins (ARBs)--1938-59 • Accounting Principles Board (APB) issued 31 Opinions--1959-73 • Financial Accounting Standards Board (FASB) has issued 168 Statements through 2009 (SFASs) plus other standards—now Standards Codification in 4 volumes, by topic

  8. The FASB • Seven member board, full time, appointed by FAF, presumed independent • Extensive due process: agenda items, discussion memoranda (DM), exposure drafts (ED), pronouncements, public exposure with written & oral comments • Super-majority (5-2 vote) [simple majority used 1977-90] • Standard setting a political process

  9. The FASB Structure

  10. FASB Due Process • Step 1 = Topic placed on agenda • Step 2 = Research conducted and Discussion Memorandum issued. • Step 3 = Public hearing • Step 4 = Board evaluates research, public response and issues Exposure Draft • Step 5 = Board evaluates responses and issues final Statement of Financial Accounting Standard

  11. Generally Accepted Accounting Principles (GAAP) • Those principles that have substantial authoritative support. • Major sources of GAAP are: • FASB Standards, Interpretations, and Staff Positions • APB Opinions • AICPA Accounting Research Bulletins

  12. GAAP Hierarchy • Category A (most authoritative): FASB statements, interpretations, & staff positions; APB opinions; CAP ARBs. • Category B: FASB technical bulletins; AICPA industry audit & industry guides; AICPA statements of position. • Category C: FASB emerging issues task force; AICPA AcSEC practice bulletins. • Category D (least authoritative): AICPA accounting interpretations; FASB implementation guides; recognized industry practices.

  13. Expectations Gap and Accounting Scandals • McKesson & Robbins (1938) • Savings & Loan Crisis of the 1980s • Sunbeam, 1998 • Enron, 2001 • WorldCom, 2002 • Lehman Brothers, 2008 • MS Global, 2011

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