Acc301 Ch1
general-purpose financial statements.
A type of financial accounting report that is distributed to external users.
All ARBs and APB Opinions implemented by 1973 (when the FASB formed) continue to be effective until
amended or superseded by FASB pronouncements.
As we indicated earlier, companies listed on a stock exchange must
submit their financial statements to the SEC. If the SEC believes that an accounting or disclosure irregularity exists regarding the form or content of the financial statements, it sends a deficiency letter to the company. Companies usually resolve these deficiency letters quickly. If disagreement continues, the SEC may issue a "stop order," which prevents the registrant from issuing or trading securities on the exchanges. The Department of Justice may also file criminal charges for violations of certain laws. The SEC process, private sector initiatives, and civil and criminal litigation help to ensure the integrity of financial reporting for public companies.
The emphasis on "assessing cash flow prospects" does not mean
that the cash basis is preferred over the accrual basis of accounting
Auditing Standards Board
the Sarbanes-Oxley Act requires the Public Company Accounting Oversight Board to oversee the development of auditing standards. The AICPA continues to develop and grade the CPA examination, which is administered in all 50 states
Efficient use of resources often determines whether a business
thrives
However, when the private sector fails to address accounting problems as quickly as the SEC would like
the partnership between the SEC and the private sector can be strained. This occurred in the deliberations on the accounting for business combinations and intangible assets. It is also highlighted by concerns over the accounting for off-balance-sheet, special-purpose entities.
Financial accounting
the process that culminates in the preparation of financial reports on the enterprise for use by both internal and external parties. Users of these financial reports include investors, creditors, managers, unions, and government agencies.
n establishing financial accounting standards, the FASB relies on two basic premises.
(1) The FASB should be responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession. (2) It should operate in full view of the public through a "due process" system that gives interested persons ample opportunity to make their views known. To ensure the achievement of these goals, the FASB follows specific steps to develop a typical FASB pronouncement,
Bob Herz, a former FASB chair, believes that there are three fundamental considerations the FASB must keep in mind in its rule-making activities:
(1) improvement in financial reporting, (2) simplification of the accounting literature and the rule-making process, and (3) international convergence.
The financial statements most frequently provided are
(1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners' or stockholders' equity
As indicated earlier, when making these decisions, investors are interested in assessing
(1) the company's ability to generate net cash inflows and (2) management's ability to protect and enhance the capital providers' investments. Financial reporting should therefore help investors assess the amounts, timing, and uncertainty of prospective cash inflows from dividends or interest, and the proceeds from the sale, redemption, or maturity of securities or loans.
The essential characteristics of accounting are
(1) the identification, measurement, and communication of financial information about (2) economic entities to (3) interested parties.
The expectations of success and support for the new FASB relied on several significant differences between it and its predecessor, the APB:
1. Smaller membership. The FASB consists of seven members, replacing the relatively large 18-member APB. 2. Full-time, remunerated membership. FASB members are well-paid, full-time members appointed for renewable 5-year terms. The APB members volunteered their part-time work. 3. Greater autonomy. The APB was a senior committee of the AICPA. The FASB is not part of any single professional organization. It is appointed by and answerable only to the Financial Accounting Foundation. 4. Increased independence. APB members retained their private positions with firms, companies, or institutions. FASB members must sever all such ties. 5. Broader representation. All APB members were required to be CPAs and members of the AICPA. Currently, it is not necessary to be a CPA to be a member of the FASB.
The FASB issues two major types of pronouncements
1.Accounting Standards Updates 2.Financial Accounting Concepts
SEC requires registrants to adhere to GAAP
GAAP
he FASB issues accounting pronouncements through
Accounting Standards Updates
As a result, accounting standards have developed in the private sector either through the
American Institute of Certified Public Accountants (AICPA) or the Financial Accounting Standards Board (FASB).
Financial Accounting Standards Board Codification Research System (CRS)
CRS is an online, real-time database that provides easy access to the Codification.
The Wheat Committee's recommendations resulted in the creation of a new standard-setting structure composed of three organizations—the
Financial Accounting Foundation (FAF), the Financial Accounting Standards Board (FASB), and the Financial Accounting Standards Advisory Council (FASAC).
In addition to research help from its own staff, the FASB relies on the expertise of various task force groups formed for various projects and on the
Financial Accounting Standards Advisory Council (FASAC).
The major operating organization in this three-part structure is the
Financial Accounting Standards Board (FASB).
Presently, there are two sets of rules accepted for international use
GAAP and International Financial Reporting Standards (IFRS), issued by the London-based International Accounting Standards Board (IASB). U.S. companies that list overseas are still permitted to use GAAP, and foreign companies listed on U.S. exchanges are permitted to use IFRS. As you will learn, there are many similarities between GAAP and IFRS
The SEC's involvement in the development of accounting standards varies.
In some cases, the SEC rejects a standard proposed by the private sector. In other cases, the SEC prods the private sector into taking quicker action on certain reporting problems, such as accounting for investments in debt and equity securities and the reporting of derivative instruments.
What happens if the Codification does not cover a certain type of transaction or event?
In that case, other accounting literature should be considered, such as FASB Concept Statements, international financial reporting standards, and other professional literature. This will happen only rarely.
decision-usefulness approach
Investors are interested in financial reporting because it provides information that is useful for making decisions
accrual-basis accounting
It ensures that a company records events that change its financial statements in the periods in which the events occur, rather than only in the periods in which it receives or pays cash. Using the accrual basis to determine net income means that a company recognizes revenues when it provides the goods or services rather than when it receives cash.
What is GAAP
It is composed of a mixture of over 2,000 documents that have been developed over the last 70 years or so. It includes APB Opinions, FASB Standards, and AICPA Research Bulletins. In addition, the FASB has issued interpretations and FASB Staff Positions that modified or extended existing standards. The APB also issued interpretations of APB Opinions. Both types of interpretations are considered authoritative for purposes of determining GAAP.
Financial Reporting Issues
Nonfinancial measurements. • Forward-looking information. • Soft assets • Timeliness • Understandability.
What is the objective (or purpose) of financial reporting?
The objective of general-purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in decisions about providing resources to the entity. Those decisions involve buying, selling, or holding equity and debt instruments, and providing or settling loans and other forms of credit
Statements of Financial Accounting Concepts
The series sets forth fundamental objectives and concepts that the Board uses in developing future standards of financial accounting and reporting. The Board intends to develop a cohesive set of interrelated concepts—a conceptual framework—that will serve as tools for solving existing and emerging problems in a consistent manner. Unlike an Accounting Standards Update, a Statement of Financial Accounting Concepts does not establish GAAP.
generally accepted accounting principles (GAAP)
The term "generally accepted" means either that an authoritative accounting rule-making body has established a principle of reporting in a given area or that over time a given practice has been accepted as appropriate because of its universal application
Internal controls
are a system of checks and balances designed to prevent and detect fraud and errors. Most companies have these systems in place, but many have never completely documented them. Companies are finding that it is a costly process but perhaps badly needed.
These Updates amend the Accounting Standards Codification, which represents the source of
authoritative accounting standards, other than standards issued by the SEC
FASB pronouncements are considered GAAP and thereby
binding in practice
In recognition of possible misconceptions of the term "principles," the FASB uses the term
financial accounting standards in its pronouncements
GAAP is as much a product of political action as it is of
careful logic or empirical findings
Committee on Accounting Procedure (CAP)
composed of practicing CPAs, issued 51 Accounting Research Bulletins during the years 1939 to 1959. These bulletins dealt with a variety of accounting problems. But this problem-by-problem approach failed to provide the needed structured body of accounting principles. In response, in 1959 the AICPA created the Accounting Principles Board.
Generally, the SEC relies on the FASB to
develop accounting standards.
The role of the AICPA in standard-setting is now
diminished
As part of the objective of general-purpose financial reporting, an
entity perspective is adopted. Companies are viewed as separate and distinct from their owners (present shareholders) using this perspective.
The SEC's mandate is to
establish accounting principals
Some financial information is better provided, or can be provided only, by means of
financial reporting other than formal financial statements. Examples include the president's letter or supplementary schedules in the corporate annual report, prospectuses, reports filed with government agencies, news releases, management's forecasts, and social or environmental impact statements.
The passage of new FASB guidance in the form of an Accounting Standards Update requires the support of
four of the seven Board member
Financial Accounting Standards Board Accounting Standards Codification (or more simply, "the Codification").
he FASB's primary goal in developing the Codification is to provide in one place all the authoritative literature related to a particular topic. This will simplify user access to all authoritative U.S. generally accepted accounting principles. The Codification establishes the way GAAP is documented, presented, and updated. It explains what GAAP is and eliminates nonessential information such as redundant document summaries, basis for conclusion sections, and historical content. In short, the Codification integrates and synthesizes existing GAAP; it does not create new GAAP. It creates one level of GAAP, which is considered authoritative. All other accounting literature is considered non-authoritative
The objective of financial reporting
identifies investors and creditors as the primary users for general-purpose financial statements
At the time the SEC was created, no group—public or private—
issued accounting standards
Unfortunately, the APB came under fire early, charged with
lack of productivity and failing to act promptly to correct alleged accounting abuses. Later, the APB tackled numerous thorny accounting issues, only to meet a buzz saw of opposition from industry and CPA firms. It also ran into occasional governmental interference. In 1971, the accounting profession's leaders, anxious to avoid governmental rule-making, appointed a Study Group on Establishment of Accounting Principles. Commonly known as the Wheat Committee for its chair Francis Wheat, this group examined the organization and operation of the APB and determined the necessary changes to attain better results. The Study Group submitted its recommendations to the AICPA Council in the spring of 1972, which led to the replacement of the APB with the Financial Accounting Standards Board (FASB) in 1973.
The FASAC consults with the FASB on
major policy and technical issues and also helps select task force members
Financial Accounting Standards Board (FASB).
mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of financial information.
A perspective that financial reporting should be focused only on the needs of shareholders
proprietary perspective
General-purpose financial statements
provide financial reporting information to a wide variety of users. In other words, general-purpose financial statements provide the most useful information possible at the least cost.
Emerging Issues Task Force (EITF)
provides implementation guidance within the framework of the Codification to reduce diversity in practice on a timely basis. The EITF was designed to minimize the need for the FASB to spend time and effort addressing narrow implementation, application, or other emerging issues that can be analyzed within existing GAAP. Examples include accounting for pension plan terminations, revenue from barter transactions by Internet companies, and excessive amounts paid to takeover specialists.
The AICPA does have a Financial Reporting Executive Committee (FinREC), which is authorized to make
public statements on behalf of the AICPA on financial reporting matters. The mission of FinREC is to determine the AICPA's technical policies regarding financial reporting standards, with the ultimate purpose of serving the public interest by improving financial reporting.
Financial Accounting Foundation
selects the members of the FASB and the Advisory Council, funds their activities, and generally oversees the FASB's activities.
Securities and Exchange Commission (SEC)
to help develop and standardize financial information presented to stockholders. The SEC is a federal agency. It administers the Securities Exchange Act of 1934 and several other acts. Most companies that issue securities to the public or are listed on a stock exchange are required to file audited financial statements with the SEC.
The Sarbanes-Oxley Act
was passed in response to a string of accounting scandals at companies like Enron, Cendant, Sunbeam, Rite-Aid, Xerox, and WorldCom. This law increased the resources for the SEC to combat fraud and curb poor reporting practices
APB Opinions
were intended to be based mainly on research studies and be supported by reason and analysis. Between its inception in 1959 and its dissolution in 1973, the APB issued 31 opinions.
The major purposes of the Accounting Principles Board (APB)
were to (1) advance the written expression of accounting principles, (2) determine appropriate practices, and (3) narrow the areas of difference and inconsistency in practice. To achieve these objectives, the APB's mission was twofold: to develop an overall conceptual framework to assist in the resolution of problems as they become evident and to substantively research individual issues before the AICPA issued pronouncements. The Board's 18 to 21 members, selected primarily from public accounting, also included representatives from industry and academia.
expectations gap
what the public thinks accountants should do and what accountants think they can do—is difficult to close. Due to the number of fraudulent reporting cases, some question whether the profession is doing enough.
American Institute of Certified Public Accountants (AICPA)
which is the national professional organization of practicing Certified Public Accountants (CPAs), has been an important contributor to the development of GAAP. Various committees and boards established since the founding of the AICPA have contributed to this effort.
The following are some of the key provisions of the SOX
•Establishes an oversight board, the Public Company Accounting Oversight Board (PCAOB), for accounting practices. The PCAOB has oversight and enforcement authority and establishes auditing, quality control, and independence standards and rules. •Implements stronger independence rules for auditors. Audit partners, for example, are required to rotate every five years, and auditors are prohibited from offering certain types of consulting services to corporate clients. •Requires CEOs and CFOs to personally certify that financial statements and disclosures are accurate and complete, and requires CEOs and CFOs to forfeit bonuses and profits when there is an accounting restatement. •Requires audit committees to be comprised of independent members and members with financial expertise. •Requires codes of ethics for senior financial officers.