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PREVIEW OF CHAPTER 1

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What is accounting?

Bookkeeping?

Accounting

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Financial Statements and Reporting

Essential 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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Accounting and Photography

Bookkeeping

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Financial Statements and Other Means of Financial Reporting Major financial statements include:

Balance Sheet Income Statement Statement of Cash Flows Statement of Shareholders’ (Owners’) Equity

+ [Note Disclosures]

Other forms of financial reporting include: News releases Management forecasts, etc.

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Financial Reporting Aids Capital Allocation

What’s the role for accounting?• Measure performance and prepare financial statement (accountant)

• Validate (auditor)• Analyze (analysts, both credit and equity)

• Quarterly reports from IBM and Goldman Sachs sent stocks tumbling.

• Google share price rises on better than expected earnings

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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.

Objectives of Financial Reporting

Financial Statements and Reporting

Provide useful information to assist capital allocation

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Decision-Usefulness (i.e., what do investors care about?)

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.

Financial reporting should help investors assess both.

Objective of Financial Accounting

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Various users need financial

information

Various users need financial

information

The accounting profession has

attempted to develop a set of

standards that are generally

accepted and universally

practiced.

Financial StatementsBalance SheetIncome StatementStatement of Stockholders’ EquityStatement of Cash FlowsNote Disclosure

Financial StatementsBalance SheetIncome StatementStatement of Stockholders’ EquityStatement of Cash FlowsNote Disclosure

Generally Accepted Accounting Principles

(GAAP)

Generally Accepted Accounting Principles

(GAAP)

The Need To Develop Standards

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Parties Involved In Standard Setting

Three organizations:

Securities and Exchange Commission (SEC).

• Federal agency;

• Requires registrants to adhere to GAAP.

Two private sector entities that develop accounting

standards:

American Institute of Certified Public Accountants

(AICPA).

Financial Accounting Standards Board (FASB).

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Principles that have substantial authoritative support.

Major sources of GAAP:

FASB Standards, Interpretations, and Staff Positions.

APB Opinions.

APB: Accounting Principle Board, FASB’s predecessor

AICPA Accounting Research Bulletins.

Generally Accepted Accounting Principles

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Goal in developing the Codification is to provide in one place all

the authoritative literature related to a particular topic.

Creates one level of GAAP, which is considered authoritative.

All other accounting literature is considered non-authoritative.

FASB Codification

FASB has developed the Financial Accounting

Standards Board Codification Research System

(CRS). CRS is an online real-time database that

provides easy access to the Codification.

Generally Accepted Accounting Principles

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Issues in Financial Reporting

GAAP is as

much a product

of political

action as they

are of careful

logic or

empirical

findings.

GAAP in a Political EnvironmentIllustration 1-6User Groups that Influence the Formulation of Accounting Standards

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Two sets of standards accepted for international use:

U.S. GAAP, issued by the FASB.

International Financial Reporting Standards (IFRS),

issued by the IASB.

International Accounting Standards

Issues in Financial Reporting

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In accounting, we frequently encounter ethical dilemmas.

GAAP does not always provide an answer.

Doing the right thing is not always easy or obvious.

Ethics in the Environment of Financial Accounting

Issues in Financial Reporting

“The Generally Accepted Accounting Principles weren’t as generally accepted as I thought.“