Lecture on Accounting Principles Framework AssignmentPoint

1. Lecture on Accounting Principles Framework www.AssignmentPoint.com

2. Study Objectives • Explain the meaning of GAAP and identify the key items of the conceptual framework. • Describe the basic objectives of financial reporting. • Discuss the qualitative characteristics of accounting information and elements of financial statements. • Identify the basic assumptions used by accountants. • Identify the basic principles of accounting. • Identify the two constraints in accounting. • Understand and analyze classified financial statements. • Explain the accounting principles used in international operations.

3. Accounting Principles The Conceptual Framework of Accounting Assumptions Principles Constraints in Accounting Statement Presentation and Analysis Objectives of reporting Qualitative characteristics Elements of financial statements Operating guidelines Monetary unit Economic entity Time period Going concern Revenue recognition Matching Full disclosure Cost Materiality Conservatism Summary of conceptual framework Classified balance sheet Classified income statement Analyzing financial statements An international perspective

4. The Conceptual Framework of Accounting • Financial Statements • Balance Sheet • Income Statement • Statement of Retained Earnings • Statement of Cash Flows • Note Disclosure Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Generally Accepted Accounting Principles (GAAP) SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.

5. The Conceptual Framework of Accounting Organizations Involved in Standard Setting: • Securities and Exchange Commission (SEC) http://www.sec.gov/ • Financial Accounting Standards Board (FASB) http://www.fasb.org/ SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.

6. The Conceptual Framework of Accounting • Conceptual Framework - “…a constitution, a coherent system of interrelated objectives and fundamentals.” • FASB’s conceptual framework consists of the following: • Objectives of financial reporting. • Qualitative characteristics of accounting information. • Elements of financial statements. • Operating guidelines (assumptions, principles, and constraints). SO 1 Explain the meaning of GAAP and identify the key items of the conceptual framework.

7. Conceptual Framework Objectives of Financial Reporting To provide information that is useful to those making investment and credit decisions. Helpful in assessing future cash flows. Identify the economic resources (assets), the claims to those resources (liabilities), and the changes in those resources and claims. SO 2 Describe the basic objectives of financial reporting.

8. Conceptual Framework According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on? • Generally accepted accounting principles • Reporting on management’s stewardship. • The need for conservatism. • The needs of the users of the information. Review: (CPA adapted) SO 2 Describe the basic objectives of financial reporting.

9. Conceptual Framework Question: How does a company choose an acceptable accounting method, the amount and types of information to disclose, and the format in which to present it? Answer: By determining which alternative provides the most useful information for decision-making purposes (decision usefulness). SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

10. Conceptual Framework Qualitative Characteristics • Relevance– making a difference in a decision. • Predictive value • Feedback value • Timeliness • Reliability • Verifiable • Representational faithfulness • Neutral - free of error and bias SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

11. Conceptual Framework Qualitative Characteristics Comparability– Information that is measured and reported in a similar manner for different companies is considered comparable. Consistency - When a company applies the same accounting treatment to similar events from period to period. SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

12. Conceptual Framework Elements of Financial Statements “Moment in Time” “Period of Time” • Assets • Liabilities • Equity • Revenue • Expenses • Gains • Losses SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

13. Conceptual Framework Illustration: Identify the element or elements associated with items below. Elements • Assets • Liabilities • Equity • Revenue • Expenses • (a) Obligation to transfer resources arising from a past transaction. • (b) Items characterized by future economic benefit. • (c) Arises from income statement activities that constitute the entity’s ongoing major or central operations. (b) (a) (c) (c) SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

14. Conceptual Framework Illustration: Identify the element or elements associated with items below. Elements • Assets • Liabilities • Equity • Revenue • Expenses • (d) Residual interest in the net assets of the enterprise. • (e) Increases assets through sale of product. (b) (a) (d) (e) (c) (c) SO 3 Discuss the qualitative characteristics of accounting information and elements of financial statements.

15. Conceptual Framework Operating Guidelines

16. Assumptions • Assumptions provide a foundation for the accounting process. • Monetary Unit • Economic Entity • Periodicity • Going Concern SO 4 Identify the basic assumptions used by accountants.

17. Assumptions Monetary Unit Only transaction data capable of being expressed in terms of money should be included in the accounting records of the economic entity. SO 4 Identify the basic assumptions used by accountants.

18. Assumptions Economic Entity Economic events can be identified with a particular unit of accountability. SO 4 Identify the basic assumptions used by accountants.

19. Assumptions Time Period The economic life of a business can be divided into artificial time periods. SO 4 Identify the basic assumptions used by accountants.

20. Assumptions Going Concern The enterprise will continue in operation long enough to carry out its existing objectives. SO 4 Identify the basic assumptions used by accountants.

21. Principles • Accounting principles dictate how economic events should be recorded and reported. • Revenue Recognition • Matching (Expense Recognition) • Full Disclosure • Cost SO 5 Identify the basic principles of accounting.

22. Principles Revenue Recognition- companies should recognize revenue in the accounting period in which it is earned. SO 5 Identify the basic principles of accounting.

23. Principles Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. “Let the expense follow the revenues.” Illustration 7-4Expense Recognition SO 5 Identify the basic principles of accounting.

24. Principles Matching Principle Illustration 7-5Basic Principles SO 5 Identify the basic principles of accounting.

25. Principles Full Disclosure – Provided through financial statements, notes to the financial statements, and supplementary information. Illustration 7-5Basic Principles SO 5 Identify the basic principles of accounting.

26. Principles Cost Principle– the price, established by the exchange transaction, is the “cost”. Illustration 7-5Basic Principles SO 5 Identify the basic principles of accounting.

27. Principles Illustration: Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. Revenue Recognition Matching Full Disclosure Cost SO 5 Identify the basic principles of accounting.

28. Constraints in Accounting • Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information. • Materiality • Conservatism SO 6 Identify the two constraints in accounting.

29. Constraints in Accounting Materiality- an item is material if its inclusion or omission would influence or change the judgment of a reasonable person. Illustration 7-6Constraints SO 6 Identify the two constraints in accounting.

30. Constraints in Accounting Conservatism- When in doubt, choose the method that will be least likely to overstate assets and income. Illustration 7-6Constraints SO 6 Identify the two constraints in accounting.

31. Constraints in Accounting Illustration What accounting constraints are illustrated by the items below? (a) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (b) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. Conservatism Materiality SO 6 Identify the two constraints in accounting.

32. Summary of Conceptual Framework

33. Statement Presentation and Analysis Classified Balance Sheet Illustration 7-8Standard classification SO 7 Understand and analyze classified financial statements.

34. Statement Presentation and Analysis Classified Balance Sheet Illustration 7-9Proprietorship balance sheet A proprietorship, the balance sheet uses the term “Owner’s equity” instead of “Stockholders’ equity” SO 7 Understand and analyze classified financial statements.

35. Statement Presentation and Analysis Illustration 7-10Partnership balance sheet Classified Balance Sheet In a partnership, each partner has a separate capital account. SO 7 Understand and analyze classified financial statements.

36. Statement Presentation and Analysis Classified Income Statement • A multiple-step income statement generally includes the following. • Sales revenue • Cost of goods • Operating • Other revenues and gains • Other expenses and losses • Two additional items are income tax expense and earnings per share. SO 7 Understand and analyze classified financial statements.

37. Statement Presentation and Analysis Classified Income Statement Illustration 7-11Income taxes SO 7 Understand and analyze classified financial statements.

38. Statement Presentation and Analysis Classified Income Statement Net Income Earnings Per Share = Number of Common Shares Outstanding Indicates the net income earned by each share of outstanding common stock. SO 7 Understand and analyze classified financial statements.

39. Statement Presentation and Analysis Analyzing Financial Statements • Three major characteristics are generally used: • Liquidity, • Profitability, and • Solvency. SO 7 Understand and analyze classified financial statements.

40. Statement Presentation and Analysis Liquidity This ratio means that current assets are more than two times greater than current liabilities. SO 7 Understand and analyze classified financial statements.

41. Statement Presentation and Analysis Liquidity Working capital provides some indication of the company’s ability to meet its existing current obligations. SO 7 Understand and analyze classified financial statements.

42. Statement Presentation and Analysis Profitability SO 7 Understand and analyze classified financial statements.

43. Statement Presentation and Analysis Profitability Profitability ratios measure the income or operating success of a company for a given period of time. Profit Margin Percentage measures the percentage of each dollar of sales that results in net income. SO 7 Understand and analyze classified financial statements.

44. Statement Presentation and Analysis Profitability Return on Assets is an overall measure of profitability. Return on Common Equity shows the percentage of net income earned for each dollar of owners’ investment. SO 7 Understand and analyze classified financial statements.

45. Statement Presentation and Analysis Solvency Solvency measures the ability of an enterprise to survive over a long period of time. Debt to Total Assets measures the percentage of total assets that creditors, as opposed to stockholders, provide. SO 7 Understand and analyze classified financial statements.

46. Statement Presentation and Analysis An International Perspective There are few recognized worldwide accounting standards. The International Accounting Standards Board (IASB), of which the United States is a member, is working to obtain conformity in international accounting practices. SO 8 Explain the accounting principles used in international operations.

47. All About You Corporations Have Governance Structures—Do You? • Scandals and bankruptcies at Enron, WorldCom, and other companies brought many changes to the way America does business. • Many companies have developed a code of ethics to: • deter wrongdoing • promote honest and ethical conduct • indicate that management takes ethics seriously.

48. All About You Corporations Have Governance Structures—Do You? • Some Facts: • Under Sarbanes-Oxley, a company must disclose whether it has a code of ethics. • Enron had a code of ethics. Enron’s board of directors knowingly waived requirements of the code so that the CFO could set up and run special purpose entities. • In a recent survey of 1,436 workers, 34% said that they have seen unethical activities at their workplace, but only 47% said they are likely to report these activities.

49. All About You Stockholders often lose money as a result of unethical behavior by management and they often file lawsuits against the company in an effort to recoup these losses. Source: Elaine Buckberg, Todd Foster, and Ronald I. Miller, “Recent Trends in Shareholder Class Action Litigation: Are WorldCom and Enron the New Standard?” NERA Economic Consulting, www.nera.com (accessed June 26, 2006).