Chapters 1 & 2

Financial Accounting and Accounting Standardsand Conceptual Framework for Financial Reporting

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1. Basic DefinitionsWhat is accounting?

◦the identification, measurement, and communication of financial information

◦about economic entities◦to interested parties

What are objectives of financial reporting?◦To provide relevant and reliable information:

useful for investor & creditor decisions that helps predict cash flows about economic resources, claims to resources, and

changes in resources and claimsACCT-3030 2

1. Basic DefinitionsWho provides accounting information?Who uses accounting information?Should there be a primary user group

identified?Financial statements v. financial reportingWhat are capital markets?

◦Does accounting information help them?Financial accounting v. managerial

accountingACCT-3030 3

2. Financial ReportingWhat are the basic financial statements?What parties are involved in the financial

reporting process?What level of knowledge is expected

from users?What is the time orientation of financial

statements?What are the limitations of accounting?

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3. Accounting StandardsWhat are GAAP?Who sets accounting standards?Who should set accounting standards?Are there political considerations in

accounting standard setting?Do accounting standards have economic

consequences?Principles-based v. rules-based standardsIs accounting governed by rules?

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4. History of Accounting Standard Setting CAP 1939-1959 ARBs Bulletins (51) APB 1959-1973 APBs Opinions (31) FASB 1973-now SFASs Standards (168) Accounting standards updates Role of the SEC Enforcement of standards EITF Conceptual framework Hierarchy Codification IASB

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The Conceptual Framework

The Conceptual Framework is like a constitution—a coherent system of interrelated objectives and

fundamentals that lead to consistent accounting standards.

Why is a conceptual framework needed?

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The Conceptual Framework

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The FASB has issued seven Statements of Financial Accounting Concepts

SFAC No.1 - Objectives of Financial Reporting (superseded by SFAC No. 8)

SFAC No.2 - Qualitative Characteristics of Accounting Information. (superseded by SFAC No. 8)

SFAC No.3 - Elements of Financial Statements. (superseded by SFAC No. 6)

SFAC No.5 - Recognition and Measurement in Financial Statements.

SFAC No.6 - Elements of Financial Statements (replaces SFAC No. 3).

SFAC No.7 - Using Cash Flow Information and Present Value in Accounting Measurements.

SFAC No.8 - The Objective of General Purpose Financial Reporting and Qualitative Characteristics of Useful Financial Information (replaces SFAC No. 1 and No. 2)

The Conceptual FrameworkFASB and IASB Joint Conceptual Framework Project

Eight Phases:A. Objective and Qualitative CharacteristicsB. Elements and RecognitionC. MeasurementD. Reporting EntityE. Presentation and DisclosureF. Framework for a GAAP HierarchyG.Applicability to the Not-For-Profit SectorH. Remaining Issues

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ObjectiveTo provide financial information that is useful to capital providers.

ElementsRecognition and

MeasurementConcepts

ConstraintsFinancial

Statements

The Conceptual Framework

Fundamental and EnhancingQualitative

Characteristics

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LO 4

Illustration 2-7 Conceptual Framework for Financial Reporting

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Practical Boundaries (Constraints) to Achieving Desired Qualitative Characteristics

CostEffectiveness

CostEffectiveness

IndustryPracticeIndustryPractice

Elements of Financial StatementsAssets Probable future economic benefits obtained or

controlled by a particular entity as a result of past transactions.

Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions.

Equity (or net assets)

Shareholders' equity or stockholders' equity for a corporation is the residual interest in the assets of an entity that remains after deducting its liabilities.

Investments by owners

Increases in equity of a particular business enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests in it.

Distributions to owners

Decreases in equity of a particular enterprise resulting from transfers to owners.

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Elements of Financial StatementsComprehensive income

The change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Revenues Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

Expenses Outflows or other using up of assets or incurrences of liabilities during a period from delivering goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

Gains Increases in equity from peripheral or incidental transactions of an entity.

Losses Decreases in equity arising from peripheral or incidental transactions of an entity.ACCT-3030 15

Recognition and Measurement ConceptsAssumptions DescriptionEconomic entity All economic events identified with a particular

economic entity.

Going concern Business entity will continue to operate indefinitely.

Periodicity Life of company is divided into time periods to provide timely information.

Monetary unit Financial statements are measured in U. S. Dollars.

PrinciplesHistorical cost Measurement based on exchange transaction amounts.

Realization Revenue recognized when earnings process is complete and reasonable certainty of collection exists.

Matching Expenses recognized in same period as related revenue.

Full disclosure Information that could change user decisions should be included.

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•The Asset/Liability Approach

The focus on assets and liabilities has lead to

increased interest on fair value measurement

•The Revenue/Expense Approach

Measure assets and liabilities that exist at a balance sheet date.

Recognize revenues, expenses, gains, and losses needed to account for the changes in assets and liabilities from the previous balance sheet date.

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The Move Toward Fair Value

Fair value is the price that would be received to sell assets or paid to transfer a liability in

an orderly transaction between market participants at the measurement date.

Market Approaches

Income Approaches

CostApproaches

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Fair Value HierarchyLevel Inputs

1 Most Desirable

Quoted market prices in active markets for identical assets or liabilities

2 Inputs other than quoted prices that are observable for the asset or liability. These inputs include quoted prices for similar assets or liabilities in active or inactive markets and inputs that are derived principally from or corroborated by observable related market data.

3 Least Desirable

Unobservable inputs that reflect the entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed on the best information available on the circumstances.

SFAS No. 159 gives companies the option to report some or all of their financial assets and liabilities at fair value.

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