Chapter 1: Financial Accounting and Accounting Standards: Questions
Because they are generally shorter, FASB interpretations are subjective to less due process, compared to FASB standards.
True.
The objectives of financial statements emphasize a stewardship approach for reporting financial information.
True.
The primary governmental body that has influence over the FASB is the SEC
True.
If you were given complete authority in the matter, how would you propose that GAAP should be developed and enforced?
(1) The method must be efficient, responsive, and expeditious. (2) The method must be free of bias and be above or insulated from pressure groups. (3) The method must command widespread support if it does not have legislative authority. (4) The method must produce sound yet practical accounting principles or standards.
The Sarbanes-Oxley Act was enacted to combat fraud and curb poor reporting practices. What are some key provisions of this legislation?
1. Establishes an oversight board for accounting practices. The Public Company Accounting Over-sight Board (PCAOB) has oversight and enforcement authority and establishes auditing, quality control, and independence standards and rules. 2. 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. 3. 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. 4. Requires audit committees to be comprised of independent members and members with finan-cial expertise. 5. Requires codes of ethics for senior financial officers. 6. Section 404 of the Sarbanes-Oxley Act requires public companies to attest to the effectiveness of their internal controls over financial reporting.
Of what value is a common set of standards in financial accounting and reporting?
A common set of standards applied by all businesses and entities provides financial statements which are reasonably comparable. Without a common set of standards, each enterprise could, and would, develop its own theory structure and set of practices, resulting in noncomparability among enterprises.
What was the Committee on Accounting Procedure, and what were its accomplishments and failings?
A special committee of the American Institute of CPAs that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with a wide variety of timely accounting problems. These bulletins provided solutions to immediate problems and narrowed the range of alternative practices. But, the Committee's problem-by-problem approach failed to provide a well-defined and well-structured body of accounting theory that was so badly needed. The Committee was replaced in 1959 by the Accounting Principles Board
How are financial accountants challenged in their work to make ethical decisions? Is technical mastery of GAAP not sufficient to the practice of financial accounting?
Accountants must perceive the moral dimensions of some situations because GAAP does not define or cover all specific features that are to be reported in financial statements. In these instances accountants must choose among alternatives. These accounting choices influence whether par ticular stakeholders may be harmed or benefited. Moral decision-making involves awareness of potential harm or benefit and taking responsibility for the choices.
APB
Accounting Principles Board. A committee of public accountants, industry accountants and academicians which issued 31 Opinions between 1959 and 1973. The APB replaced the CAP and was itself replaced by the FASB. Its opinions, unless superseded, remain a primary source of GAAP.
AICPA
American Institute of Certified Public Accountants, a voluntary organization of CPAs that sets professional requirements, conducts research, and publishes materials relevant to accounting, auditing, management consulting services, and taxes
How does accounting help the capital allocation process attract investment capital?
By providing timely, relevant information.
CPA
Certified public accountant. An accountant who has fulfilled certain education and experience requirements and passed a rigorous examination. Most CPAs offer auditing, tax, and management consulting services to the general public.
CAP
Committee on Accounting Procedure
One writer recently noted that 99.4 % of all companies prepare statements that are in accordance with GAAP. Why then is there such a concern about fraudulent financial reporting?
Concern exists about fraudulent financial reporting because it can undermine the entire financial reporting process. Failure to provide information to users that is accurate can lead to inappropriate allocations of resources in our economy. In addition, failure to detect massive fraud can lead to additional governmental oversight of the accounting profession.
EITF
Emerging Issues Task Force; comprised of representatives from CPA firms and financial statement preparers the reach a consensus on how to account for new and unusual financial transactions that may potentially create differing financial reporting practices.
The FASB has a government mandate and therefore does not have to follow due process in issuing a standard
False- in 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 people ample opportunities to make their view known.
Any company claiming compliance with GAAP must comply with most standards and interpretations but does not have to follow the disclosure requirements.
False. Any company claiming compliance with GAAP must comply with all standards and interpretations, including disclosure requirements.
The purpose of the objective of financial reporting is to prepare a balance sheet, an income statement, a statement of cash flows, and a statement of owners' or stockholders' equity.
False. The objective of 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 making decisions in their capacity as capital providers.
FAF
Financial Accounting Foundation. An organization whose purpose is to select members of the FASB and its Advisory Councils, fund their activities, and exercise general oversight.
FASAC
Financial Accounting Standards Advisory Council. An organization whose purpose is to consult with the FASB on issues, project priorities, and select task forces.
FASB
Financial Accounting Standards Board, is the private sector body given the primary responsibility to work out the detailed rules that become GAAP.
Differentiate broadly between financial accounting and managerial accounting
Financial accounting measures, classifies, and summarizes in report form those activities and that information which relate to the enterprise as a whole for use by parties both internal and external to a business enterprise. Managerial accounting also measures, classifies, and summarizes in report form enterprise activities, but the communication is for the use of internal, managerial parties, and relates more to subsystems of the entity. Managerial accounting is management decision oriented and directed more toward product line, division, and profit center reporting.
Differentiate broadly between financial accounting and managerial accounting.
Financial accounting measures, classifies, and summarizes in report form those activities and that information which relate to the enterprise as a whole for use by parties both internal and external to a business enterprise. Managerial accounting also measures, classifies, and summarizes in report form enterprise activities, but the communication is for the use of internal, managerial parties, and relates more to subsystems of the entity. Managerial accounting is management decision oriented and directed more toward product line, division, and profit center reporting.
What is the difference between financial statements and financial reporting?
Financial reporting is the process of providing information about the reporting entity to potential and current investors, lendors, and other creditors. Financial statements are the channel through which this information is relayed.
GAAP
Generally Accepted Accounting Principles. The standards and rules that accountants follow while recording and reporting financial activities.
The objectives of financial reporting uses an entity rather than a proprietary approach in deterring what information to report.
True
IASB
International Accounting Standards Board. An international group, formed in 1973, that is actively developing and issuing accounting standards that will have international appeal and hopefully support.
Briefly explain the meaning of decision-usefulness in the context of financial reporting.
Investors are interested in financial reporting because it provides information that is useful for making decisions (referred to as the decision-usefulness approach). When making these decisions, 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 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. In order for investors to make these assessments, the economic resources of an enterprise, the claims to those resources, and the changes in them must be understood.
In what ways was it felt that the statements issued by the Financial Accounting Standards Board would carry greater weight than the opinions issued by the Accounting Principles Board?
It was believed that FASB Statements would carry greater weight than APB Opinions because of significant differences between the FASB and the APB, namely: (1) The FASB has a smaller membership, (2) full-time compensated members; (3) the FASB has greater autonomy, (4) increased independence; (5) the FASB has broader representation than the APB.
What are some of the major challenges facing the accounting profession?
Nonfinancial measurement—how to report significant key performance measurements such as customer satisfaction indexes, backlog information and reject rates on goods purchased. Forward-looking information—how to report more future oriented information. Soft assets—how to report on intangible assets, such as market know-how, market dominance, and well-trained employees. Timeliness—how to report more real-time information.
What is the objective of financial reporting?
Provide information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors.
Identify the objective of financial reporting
Reporting of financial information other than in 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.
What is Rule 203 of the Code of Professional Conduct?
Rule 203 of the Code of Professional Conduct prohibits a member of the AICPA from expressing an opinion that financial statements conform with GAAP if those statements contain a material departure from an accounting principle promulgated by the FASB, or its predecessors, the APB and the CAP, unless the member can demonstrate that because of unusual circumstances the financial statements would otherwise have been misleading. Failure to follow Rule 203 can lead to a loss of a CPA's license to practice. This rule is extremely important because it requires auditors to follow FASB standards.
SEC
Securities and Exchange Commission, an independent federal agency that oversees the exchange of securities to protect investors.
Distinguish between FASB Accounting Standards Updates and FASB Statements of Financial Accounting Concepts.
Statements of financial accounting standards contained in Accounting Standards updates constitute generally accepted accounting principles and dictate acceptable financial accounting and reporting practices as promulgated by the FASB. The first standards statement was issued by the FASB in 1973. Statements of financial accounting concepts do not establish generally accepted accounting principles. Rather, the concepts statements set forth fundamental objectives and concepts that the FASB intends to use as a basis for developing future standards. The concepts serve as guidelines in solving existing and emerging accounting problems in a consistent, sound manner. Both the standards statements and the concepts statements may develop through the same process from discussion memorandum, to exposure draft, to a final approved statement.
Explain the role of the Emerging Issues Task Force in establishing generally accepted accounting principles.
The Emerging Issues Task Force often arrives at consensus conclusions on certain financial report ing issues. These consensus conclusions are then looked upon as GAAP by practitioners because the SEC has indicated that it will view consensus solutions as preferred accounting and will require persuasive justification for departing from them. Thus, at least for public companies which are subject to SEC oversight, consensus solutions developed by the Emerging Issues Task Force are followed unless subsequently overturned by the FASB. It should be noted that the FASB took greater direct ownership of GAAP established by the EITF by requiring that consensus positions be ratified by the FASB.
What is the difference between Codification and the Codification Research System?
The Financial Accounting Standards Board Accounting Standards Codification (Codification) is a compilation of all GAAP in one place. Its purpose is to integrate and synthesize existing GAAP and not to create new GAAP. It creates one level of GAAP which is considered authoritative. The FASB Codification Research Systems (CRS) is an-on-line real time data base which provides easy access to the Codification. The Codification and the related CRS provide a topically organized structure which is subdivided into topic, subtopics, sections, and paragraphs.
In what way is the Securities and Exchange Commission concerned about and supportive of accounting principles and standards?
The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and principles to be employed by the companies that fall within its jurisdiction. Because the SEC receives audited financial statements from nearly all companies that issue securities to the public or are listed on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the statements. For many years the SEC relied on the AICPA to regulate the profession and develop and enforce accounting principles. Lately, the SEC has assumed a more active role in the develop-ment of accounting standards, especially in the area of disclosure requirements. In December 1973, in ASR No. 150, the SEC said the FASB's statements would be presumed to carry substantial authoritative support and anything contrary to them to lack such support. It thereby supports the development of accounting principles in the private sector.
For what purposes did the AICPA create the Accounting Principles Board?
The creation of the Accounting Principles Board was intended to advance the written expression of accounting principles, to determine appropriate practices, and to narrow the differences and inconsistencies in practice. To achieve its basic objectives, its mission was to develop an overall conceptual framework to assist in the resolution of problems as they became evident and to do substantive research on individual issues before pronouncements were issued.
If you had to explain or define "generally accepted accounting principles or standards," what essential characteristics would you include in your explanation?
The explanation should note that generally accepted accounting principles or standards have "substantial authoritative support." They consist of accounting practices, procedures, theories, concepts, and methods which are recognized by a large majority of practicing accountants as well as other members of the business and financial community. Bulletins issued by the Committee on Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements issued by the Financial Accounting Standards Board constitute "substantial authoritative support."
GAAP is the term used to indicate the whole body of FASB authoritative literature.
True
What are the sources of pressure that change and influence the development of GAAP?
The sources of pressure are innumerable, but the most intense and continuous pressure to change or influence accounting principles or standards come from individual companies, industry associations, governmental agencies, practicing accountants, academicians, professional accounting organizations, and public opinion.
How are FASB preliminary views and FASB exposure drafts related to FASB "statements"?
The technical staff of the FASB conducts research on an identified accounting topic and prepares a "preliminary views" that is released by the Board for public reaction. The Board analyzes and evaluates the public response to the preliminary views, deliberates on the issues, and issues an "exposure draft" for public comment. The preliminary views merely present all facts and alternatives related to a specific topic or problem, whereas the exposure draft is a tentative "statement." After studying the public's reaction to the exposure draft, the Board may reevaluate its position, revise the draft, and vote on the issuance of a final statement.