Introduction to Intermediate Accounting

Key Things To Know

 

The Purpose of Financial Accounting:

Financial accounting is a system that records, summarizes, and reports “quantitative information” about an economic entity’s transactions to external users

Transactions:
• An exchange of one thing for another thing
•  Measured in dollars

Financial accounting provides the information investors and creditors (the capital markets) need to make decisions about allocating capital.

 

Objectives of accounting and financial reporting:

Provide useful information to investors and creditors:

1) useful in making rational investment and credit decisions
(understandable by those who have a reasonable understanding of business/economics that are willing to study the information)

2) useful to assess amounts, timing, uncertainty of cash flows

3) about the economic resources (assets) and claims to resources (liabilities): effects of transactions, events, circumstances that may change the economic resources of the company.

 

Cash versus Accrual:

Cash Method:
Record revenues and expenses when cash is received or paid

Provides “net operating cash flow”:
cash receipts less cash disbursements

Does not report earnings over a short period of time

Accrual Method:
Report activity: revenues and expenses when earned and incurred
When cash is received or paid does not matter

Revenues:
Earned and believe you will receive the cash, an exchange occurs

Expenses:
Incurred (receive the benefit) in support of the revenue process

Net Income/Earnings:
The result of the economic activity during the period

The accrual method is required under GAAP

The History of Accounting Guidance:

Accounting guidance was first provided by
The Committee on Accounting Procedure (CAP):

A committee of the American Institute of Accountants (AIA) which was subsequently renamed the American Institute of Certified Public Accountants (AICPA).

The CAP issued 51 Accounting Research Bulletins (ARBs) between 1938 and 1958 that provided guidance for specific accounting and reporting issues.

The AICPA is the current national professional organization of accountants.

 

The Accounting Principles Board (APB) replaced the CAP in 1959.

Members of the Accounting Principles Board were voluntary, part-time and lacked complete independence and the time to devote to issuing timely guidance.

The APB issued 31 Accounting Principles Board Opinions (Opinions) between 1959 and 1973.

The Financial Accounting Standards Board (FASB) established in 1973

Replaced the APB to provide unbiased and dedicated effort to addressing financial accounting and reporting issues.

FASB is the current independent non-governmental organization that provides accounting and reporting guidance in the United States.

FASB consists of seven full-time voting board members and a large staff of accountants to research accounting issues.
• supported by the Financial Accounting Foundation (“FAF”)

Audit partners, corporate accountants, educators, financial analysts, and capital investment advisors (among others) serve as FASB voting members.

The goal of the FASB is to provide accounting guidance that improves the usefulness of financial information.
• New business transactions require new accounting guidance.
• Guidance that has been followed for many years often needs revision to report the current economic impact of transactions.

FASB is an independent private sector group

FASBs Conceptual Framework:
See Accounting Concepts

FASB issues accounting standards after consulting accounting and finance professionals. A formal process occurs as follows:

• A reporting issue is identified by the investment or accounting community and a request for consideration of the issue is presented          to the FASB.

• The FASB Chairman adds the issue to the agenda.

• FASB staff research the issue and identify associated issues.

• The Board deliberates the various issues identified at one or more public meetings.

• The Board issues a Discussion Draft or an Exposure Draft to the business community for comments.

• Comments are received and incorporated into a revised draft, if necessary.

• The process of comments and revision continues until proposed guidance is generally accepted by most users of financial statements involved in the process.

• New guidance is voted on and approved by the FASB before it is issued.

• The Board issues an Accounting Standards Update and a new Financial Accounting Standard describing the amendment to GAAP.

A detail discussion of the issues and projects currently being addressed by FASB is available on their website at www.fasb.org.

Generally Accepted Accounting Principles (GAAP).
The total body of guidance accountants follow when preparing financial information.

Current GAAP is organized and numbered in the Accounting Standard Codification (ASC) as follows:

 

Topic	Numbered
General Principles	100 – 199
Presentation	200 – 299
Assets	300 – 399
Liabilities	400 – 499
Equity	500 – 599
Revenues	600 – 699
Expenses	700 – 799
Broad Transactions	800 – 899
800 – 899	800 – 899

 

The Securities Exchange Commission (SEC)

The government entity that regulates the information public companies are required to provide to investors and creditors.

The SEC was established just after the stock market crash of 1929 to ensure public companies to provide reliable financial information.

The SEC has delegated the authority to issue accounting guidance to the FASB; however, the SEC also issues accounting guidance when necessary (called Staff Accounting Bulletins and Financial Reporting Releases).

Violation of SEC reporting requirements is a violation of law for public companies.

Privately held companies are not legally required to follow GAAP.
However, privately held companies that do not follow GAAP find it very difficult to obtain money from outsiders.

Investors and lenders with excess money generally do not have confidence in financial information that is not prepared in accordance with GAAP.

Public Accounting Firms (the Auditor)

Public accounting firms (auditors) review and issue an opinion on financial statements and footnotes before the financial information is provided to the general public (audit).

The auditor’s report states whether or not the financial statements are fairly presented in accordance with GAAP.

Fairly presented means a user of the financial information would not be misled when relying on the information to make a financial decision.

Fairly presented does not mean the financial information is 100% accurate.

Financial statements may contain minor errors that do not significantly change the interpretation of the financial information provided.

All public companies must provide audited financial information.

Investors and creditors often require private companies to be audited in order to have a higher level of confidence in the information provided by the financial statements and footnotes.

The Public Company Accounting Oversight Board (PCAOB)

Established by Congress as part of Public Company Accounting Reform and Investor Protection Act of 2002, commonly referred to as Sarbanes Oxley (SOX).

SOX requires company management to establish and document internal controls.
Internal controls are procedures followed to ensure the completeness and integrity of financial data.

Managers of public companies are required to sign off on the adequacy of accounting internal controls.

Auditors are required to review and report on the adequacy of accounting internal controls.

The PCAOB establishes standards that auditors must follow and conducts reviews to “audit the auditors” procedures.

The PCAOB was established to bring consistency and credibility to the audit process after several instances of erroneous financial statements were issued with an opinion stating the financial statements were presented in accordance with GAAP.

International Financial Reporting Standards

Accounting principles and guidelines around the world differ.

Many countries have their own financial accounting guidelines provided by an organization similar to FASB.

Other countries follow accounting guidance provided by the International Accounting Standards Board (IASB), an organization that is attempting to standardize accounting guidance around the world.

The IASB has issued over 40 International Financial Reporting Standards (IFRS.)

Many argue that one set of financial accounting standards used world-wide would improve comparability and facilitate access to global capital markets.

Others argue that the U.S. needs accounting standards that specifically address the economic issues of the U.S. business environment.

Those opposed to a common set of standards argue that differences in enforcement could make the financial statements appear more comparable than they really are.

Goals of IASB:

1. Develop a single set of high quality, understandable global accounting standards
2. Promote the use of those standards
3. Converge national accounting standards and international accounting standards