chapter 1

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C H A P T E R 1

FINANCIAL REPORTING AND ACCOUNTING STANDARDS

Intermediate AccountingIFRS Edition

Kieso, Weygandt, and Warfield

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1. Identify the major financial statements and other means of financial reporting.

2. Explain how accounting assists in the efficient use of scarce resources.

3. Explain the need for high-quality standards.

4. Identify the objective of financial reporting.

5. Identify the major policy-setting bodies and their role in the standard-setting process.

6. Explain the meaning of IFRS.

7. Describe the challenges facing financial reporting.

Learning ObjectivesLearning Objectives

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General-purpose financial statements

Capital providers

Entity perspective

Decision-usefulness

Global MarketsObjective of

Financial Reporting

Standard-Setting Organizations

Financial Reporting

Challenges

Financial statements and financial reporting

Accounting and capital allocation

High-quality standards

IOSCO

IASB

Hierarchy of IFRS

Political environment

Expectations gap

Significant financial reporting issues

Ethics

International convergence

Financial Reporting and Accounting StandardsFinancial Reporting and Accounting Standards

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What is accounting?What is accounting?

Accounting:

Broadly, is an information system that is meant to provide a fair and balanced reporting and measurement of financial performance for a given economic entity donated in monetary terms.

Why do we need this information? … who uses this information? And what do they use it for?

You have to keep this question in mind as you study to become a professional accountant

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Objective of Financial AccountingObjective of Financial Accounting

Objective: Provide financial information about the

reporting entity that is useful to…

present and potential equity investors,

lenders, and

other creditors

in making decisions in their capacity as capital

providers.

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Capital Providers (Investors)

Investors are the primary user group.


General-Purpose Financial Statements

Provide financial reporting information to a wide variety

of users.

Provide the most useful information possible at the

least cost. (costs vs. benefits)

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Decision-Usefulness


Investors are interested in assessing the company’s

1. ability to generate net cash inflows and

2. management’s ability to protect and enhance the

capital providers’ investments (i.e. stewardship)

Entity Perspective

As we provide information about an entity, we have to view the

entity (company) as a separate and distinct being from its

owners.

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How Do We Prepare Accounting Information?How Do We Prepare Accounting Information?

Follow a set of standards we can all accept and agree on:

1. Can be local for a specific country. (U.S. GAAP, Saudi

GAAP, Chinese GAAP)

2. Can be common for a group of countries (IFRS).

We need to use a common method?... Otherwise!

Question: do we really need international standards? Or, is

having local accounting standards for your country enough?

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The Case for IFRSThe Case for IFRS

1. World economies have become greatly intertwined in a

globalized world economy.

2. Investors have become international in their investment

strategies.

3. The rise of multinational corporations.

4. Companies list their shares in global exchange markets and

seek to raise capital from different countries.

5. It is costly to have more than one set of standards.

Why use IFRS instead of Custom Standards?

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Global MarketsGlobal Markets

World markets are becoming increasingly intertwined.

Top 20 Global Companies In Terms Of Sales

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Significant number of foreign companies are found on

national exchanges.

By 2013, 213 of the largest 500 global companies in the world will be using IFRS.

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Characteristics of Accounting InformationCharacteristics of Accounting Information

Financial Statements and Financial Reporting

Characteristics of accounting are:

(1) the identification, measurement, and communication of financial information about

(2) economic entities to

(3) interested parties.

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Financial Information

Accounting?

Identify

and

Measure

and

Communicate

Financial Information

Accounting?

Identify

and

Measure

and

Communicate

Statement of Financial Position

Income Statement or Statement of Comprehensive

Income

Statement of Cash Flows

Statement of Changes in Equity

Note Disclosures

Statement of Financial Position

Income Statement or Statement of Comprehensive

Income

Statement of Cash Flows

Statement of Changes in Equity

Note Disclosures

President’s letter

Prospectuses

Reports filed with governmental

agencies

News releases

Forecasts

Environmental impact statements

Etc.

President’s letter

Prospectuses

Reports filed with governmental

agencies

News releases

Forecasts

Environmental impact statements

Etc.

Financial StatementsFinancial Statements Additional InformationAdditional InformationEconomic EntityEconomic Entity

Accounting Information FormsAccounting Information Forms

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Resources are limited. Efficient use of resources often determines whether a business thrives.Resources are limited. Efficient use of resources often determines whether a business thrives.

Accounting and Capital Allocation

What is the role of accounting in society?What is the role of accounting in society?

Accountants must measure performance accurately and fairly, so that the right managers and companies are able to attract investment capital.

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High Quality Standards

Elements of Global Accounting StandardsElements of Global Accounting Standards

Globalization demands a single set of high-quality

international accounting standards.

How? Some elements needed for success:

1. Single set of high-quality accounting standards established by

a single standard-setting body.

2. Consistency in application and interpretation.

3. Common disclosures.

4. Common high-quality auditing standards and practices.

5. Common approach to regulatory review and enforcement.

6. Education and training of market participants.(Continued)

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High Quality Standards


Globalization demands a single set of high-quality

international accounting standards. Some elements:

7. Common delivery systems (e.g., eXtensible Business

Reporting Language—XBRL).

8. Common approach to corporate governance and legal

frameworks around the world.

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The objective of financial reporting places the most

emphasis on:

a. reporting to capital providers.

b. reporting on stewardship.

c. providing specific guidance related to specific needs.

d. providing information to individuals who are experts in

the field.

Review Question


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General-purpose financial statements are prepared

primarily for:

a. internal users.

b. external users.

c. auditors.

d. government regulators.

Review Question


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Two Major Organizations:

International Accounting Standards Board (IASB)

Issues International Financial Reporting Standards

(IFRS).

Standards used on most foreign exchanges.

Standards used by foreign companies listing on U.S.

securities exchanges.

IFRS used in over 115 countries.

To be implemented in Saudi Arabia in 2014!

Standard-Setting OrganizationsStandard-Setting Organizations

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Two Major Organizations:

Financial Accounting Standards Board (FASB)

Issues Statements of Financial Accounting

Standards (SFAS).

Required for all U.S.-based companies.

FASB standards are more detailed and outnumber

current IASB standards.


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International Organization of Securities Commissions (IOSCO)

Does not set accounting standards.

Dedicated to ensuring that global

markets can operate in an efficient

and effective basis.

Is the equivalent of the SEC

(securities and exchange

commission) in the U.S. and CMA

(Capital Markets Authority) in Saudi

Arabia.

http://www.iosco.org/

http://www.cma.gov.sa/




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Composed of four organizations—

International Accounting Standards Committee Foundation

(IASCF)


Standards Advisory Council

International Financial Reporting Interpretations

Committee (IFRIC)

http://www.iasb.org

http://www.iasb.org/

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The major key players on the international side

(outside the United States) are the:

a. IASB and FASB.

b. SEC and FASB.

c. IOSCO and the SEC.

d. IASB and IOSCO.

Review Question


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Which body from the U.S. side is similar to the IASB?

a. SEC.

b. FASB.

c. FASC.

d. FAF.

Review Question


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Due ProcessDue Process

The IASB due process has the following elements:

1. Independent standard-setting board;

2. Thorough and systematic process for developing

standards;

3. Engagement with investors, regulators, business

leaders, and the global accountancy profession at

every stage of the process; and

4. Collaborative efforts with the worldwide standard-

setting community.

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The IASB characteristics are as follows:

• Membership: 14 members from different countries (2-part-

time);

• Autonomy: The IASB is NOT part of any other professional

organization, only follows IASC.

• Independence: Full-time IASB members must sever all

ties to any past employer.

• Voting: 9 out of 14 votes are required to approve a

standard.

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Issued by the IASB:

Types of PronouncementsTypes of Pronouncements

International Financial Reporting Standards.

Framework for financial reporting.

International financial reporting interpretations.

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Types of PronouncementsTypes of Pronouncements

Hierarchy of IFRS

Companies first look to:

1. International Financial Reporting Standards (IFRS);

2. International Accounting Standards (IAS) (i.e. old

standards); and

3. Interpretations originated by the International

Financial Reporting Interpretations Committee (IFRIC)

or the former Standing Interpretations Committee (SIC).

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Financial Reporting ChallengesFinancial Reporting Challenges

IFRS in a Political Environment

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The independence of the IASB:

IASC is funded primarily by the private sector

(including U.S. big accounting firms).

IASC has been seeking joint government funding to

become more independent financially.

The SEC has still NOT issued guidelines for U.S.

companies to use IFRS. Currently, foreign companies

listed in the U.S. are allowed to use IFRS instead of

U.S. GAAP.

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Accounting standard-setters use the following process

in establishing international standards:

a. Research, exposure draft, discussion paper, standard.

b. Discussion paper, research, exposure draft, standard.

c. Research, preliminary views, discussion paper,

standard.

d. Research, discussion paper, exposure draft, standard.

Review Question


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What the public thinks accountants should do VS. what

accountants think they can do.


The Expectations Gap

Significant Financial Reporting Issues

Non-financial measurements

Forward-looking information

Soft assets

Timeliness

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Ethics in the Environment of Financial Accounting

Companies that concentrate on “maximizing the bottom

line,” “facing the challenges of competition,” and

“stressing short-term results” place accountants in an

environment of conflict and pressure.

IFRS does not always provide an answer.

This is why your job is interesting!

Doing the right thing is not always easy or obvious.


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International Convergence

In 2002, the IASB and the FASB formalized their commitment

to the convergence of U.S. GAAP and international

standards. The two Boards agreed to:

1. Make their existing financial reporting standards fully

converged as soon as practicable, and

2. Coordinate their future work programs to ensure that

once achieved, convergence is maintained.


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The fact that there are differences between IFRS and U.S. GAAP should not be surprising because standard-setters have developed standards in response to different user needs.

IFRS tends to be simpler and more flexible in its accounting and disclosure requirements.

The U.S. SEC recently eliminated the need for foreign companies that trade shares in U.S. markets to reconcile their accounting with U.S. GAAP.

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The expectations gap is:

a. what financial information management provides and what users want.

b. what the public thinks accountants should do and what accountants think they can do.

c. what the governmental agencies want from standard-setting and what the standard-setters provide.

d. what the users of financial statements want from the government and what is provided.

Review Question


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Appendix 1A THE U.S. STANDARD-SETTING ENVIRONMENT

Organizations responsible for developing financial

accounting standards (GAAP) in the United States:

1. Securities and Exchange Commission (SEC).

2. Financial Accounting Standards Board (FASB).

http://www.sec.gov/

http://www.fasb.org/

http://www.sec.gov/

http://www.fasb.org/

http://www.sec.gov/

http://www.sec.gov/

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Securities Act of 1933

Securities Act of 1934

Securities and Exchange CommissionSecurities and Exchange Commission

Established by federal government Accounting and reporting for public companies

Encouraged private standard-setting body SEC requires public companies to adhere to GAAP SEC provides oversight & enforcement

authority.

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Financial Accounting Standards BoardFinancial Accounting Standards Board

Wheat Committee’s recommendations resulted in the creation of a the Financial Accounting Standards Board (FASB) in 1973.

Financial Accounting Foundation

Selects members of the FASB Funds their activities Exercises general oversight.

Financial Accounting

Standards Board

Financial Accounting Standards Advisory

Council

Mission to establish and improve standards of financial accounting and reporting.

Consult on major policy issues.

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Mission is to establish and improve standards of financial accounting and reporting. Differences between FASB and APB include:


Smaller Membership

Full-time, Remunerated Membership

Greater Autonomy

Increased Independence

Broader Representation

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FASB relies on two basic premises:

(1) Responsive to entire economic community

(2) Operate in full view of the public


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

Due Process

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Standards, Interpretations, and Staff Positions.

Financial Accounting Concepts

Emerging Issues Task Force Statements

Types of Pronouncements

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Hierarchy of U.S. GAAPHierarchy of U.S. GAAP

FASB Statements of Financial Accounting Standards, FASB Interpretations, SEC rules and interpretivereleases, AICPA Accounting Research Bulletins,

Accounting Principles Board Opinions

FASB Technical Bulletins, AICPA Industry Audit and Accounting Guides and Statements of Position

AICPA Accounting Standards Executive Committee Practice Bulletins

FASB Implementation Guides, AICPA Accounting Interpretations, and widely recognized general or industry

practices.

Most Authoritative

Least Authoritative

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Establishment of Accounting StandardsA Political Process

Establishment of Accounting StandardsA Political Process

GAAP

Internal RevenueService

www.irs.gov

American Instituteof CPAs

www.aicpa.org

Securities andExchange

Commissionwww.sec.gov

AmericanAccountingAssociation

www.aaa-edu.org

GovernmentalAccounting

Standards Boardwww.gasb.org

Financial ExecutivesInternationalwww.fei.org

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Sarbanes-Oxley Act of 2002Sarbanes-Oxley Act of 2002

Became law in 2002 after numerous accounting scandals. Established the Public Company Accounting Oversight Board. Implements stronger independence rules for auditors. Requires CEOs and CFOs to personally certify that financial

reports are complete and accurate. Requires CEOs and CFOs to forfeit bonuses when there are

accounting restatements. Requires audit committee members to be independent have

financial expertise. Requires codes of ethics for senior financial officers. Requires public companies to attest to the effectiveness of their

internal controls.

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Principles that have substantial authoritative support.

Major sources of GAAP:

FASB Standards, Interpretations, and Staff Positions

APB Opinions

AICPA Accounting Research Bulletins

U.S. Generally Accepted Accounting Principles


When the Board approves a new standard, staff position, etc., the results are included in the Codification through an Accounting Standards Update.

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IASB and FASB have set up an extensive work plan to achieve one set of international standards.

Improvements in Accounting Standards

International Accounting ConvergenceInternational Accounting Convergence

Illustration 1A-3IFRS Adoption Timeline

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SEC Work Plan

International Accounting ConvergenceInternational Accounting Convergence

Sufficient development and application of IFRS.

Independent standard-setting for the benefit of investors.

Investor understanding and education.

Regulatory environment.

Impact on large and small financial statement preparers.

Human capital readiness.

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End of Chapter 1End of Chapter 1