SU 1: The Financial Reporting Environment

Accounting Principles Rules in the sections of the AICPA's Code of Professional Conduct GAAP include principles issued by the bodies designated by the AICPA Council to establish professional standards.

-Financial Accounting Standards Boards (FASB) -International Accounting Standards Board (IASB) -Governmental Accounting Standards Board (GASB) -Federal Accounting Standards Advisory Board (FASAB)

Relevance

-Predictive Value -Confirmatory Value -Materiality

SEC

-delegated the authority to establish principles for financial reporting to the FASB -The SEC makes sure that the issuers meet certain periodic reporting requirements. -In addition to overseeing financial reporting requirements, the SEC's divison of enforcement investigates possible violations of securities laws and prosecutes them in federal courts

FASB

-the FASB follows a due process procedure before issuing final pronouncements. -After discussing the issues and considering input from interested parties (ex business, academia, and the accounting profession) the FASB votes on a final draft proposal. If a majority of the board members approves, an Accounting Standards Update (ASU) is issued. -When an ASU has been incorporated into the FASB's Accounting Standards Codification (ASC), it has the status of U.S. GAAP.

Changes in Assets and Liabilities with No Change in Equity

1) Asset Exchanges 2) Liability Exchanges 3) Receipt of goods or services with incurrence of payables 4) Settlement of payables with assets

Assumptions of financial accounting

1) Economic-Entity Assumption 2) Going Concern Assumption 3) Monetary-Unit Assumption 4) Periodicity Assumption

Key stakeholders in not-for-profit entities

1) Resource Providers 2) Constituents 3) Governing and oversight bodies 4) Managers

Principles of financial accounting

1) Revenue Recognition 2) Matching Principles 3) Historical Cost Principle 4) Full-Disclosure Principle

Recognition Criteria of when items are incorporated into the financial statements

1) The item must meet the definition of an element of the f.s. 2) it must have a relevant attribute measurable with sufficient reliability 3) The information must be relevant. It must be capable of making a difference in user decisions 4) The information must be reliable. It must be representationally faithful, verifiable, and neutral.

Three primary characteristics of the governmental environment that distinguish it from the business and not-for-profit environments

1) The representative form of government and the separation of powers 2) the federal system of government, with its hierarchy of national, state, county, and city governments and the significant flow of revenues among them c) the expectations of taxpayers who provide government with revenue, about the services they receive

OBJECTIVES OF FINANCIAL REPORTING not-for-profit entities

1) Useful in making resource allocation decisions 2) Useful in assessing services and ability to provide services 3) Useful in assessing management stewardship and performance 4) About economic resources, obligations, net resources, and changes in them, including -performance of an organization during a period -nature of and relation between resource inflows and outflows -service efforts and accomplishments -factors that may affect an organizations liquidity 5) About manager's explanations and interpretations to help users understand financial information

Faithful representation

1) completeness (containing what is needed for user understanding) 2) Neutrality (unbiased in its selection and presentation) 3) Freedom from error

A full set of financial statements should report the following

1) financial position at the end of the period 2) Earnings for the period 3) Comprehensive income for the period 4) Cash flows during the period 5) Investments by and distributions to owners during the period

Financial Statements additional information is provided by:

1) financial statement notes 2) supplementary information 3) other disclosures

Business-Type Activities of a government differ from its governmental activities they

1) involve a direct exchange of money in return for goods delivered or services rendered 2) have large investments in revenue-producing capital assets (ex toll roads, manufacturing facilities for prison industries) 3) often perform only a single function 4) may still be influenced by the political process 5) are less likely to use legally adopted budgets.

Information about cash flows is helpful in

1) understanding operations 2) Evaluating financing and investing activities, liquidity and solvency. 3) Interpreting other financial information and 4) Assessing the potential for net cash inflows

Accountability and Interperiod Equity in Government

1)Accountability- is the essence of governmental financial reporting. Accountability requires that a government provide information to explain its actions and help evaluate whether its operations were within legal constraints 2) Interperiod Equity- current year revenues should suffice to pay for current-year services and current citizens should not shift the tax burden for those services to future citizens

FAF Financial Accounting Foundation, oversees two other bodies

1. The FASB establishes GAAP for nongovernmental U.S. entities 2. The Financial Accounting Standards Advisory Council (FASAC) advises the FASB on priorities and proposed standards and evaluates its performance

Primary Users cannot obtain all necessary information from general-purpose financial reports because

1. are insufficient to determine the value of the entity 2. Based significantly on estimates, judgments, and models.

in 2002 the FASB and IASB pledged

1. make their existing financial reporting standards fully compatible as soon as is practicable and 2. to coordinate their future work programs to ensure that once achieved, compatibility is maintained.

Monetary-Unit (unit-of-money) Assumption

Accounting records are kept in terms of money. The changing purchasing power of the monetary unit is assumed not be significant.

IFRS elemnts of financial statements

Assets Liabilities Equity Income (including revenues and gains) Expenses (including losses)

Statement of Financial Position (Balance Sheet)

Assets Liabilities Equity Investment by Owners Distributions to owners

Expense Recognition Principles

Associating cause and effect (matching) Systematic and Rational Allocation immediate recognition

Enhancing Characteristics

Comparability Verifiability Timeliness Understandability

Constraints

Cost Constraint Industry Practice Constraint Conservatism Constraint

Changes in Equity with No Change in Assets or Liabilities

Declaration and distribution of stock dividends Conversion of preferred stock

Recognition Criteria

Definiton Measurable Relevant Reliable

Periodicity (Time Period) Assumption

Economic activity can be divided into distinct time periods. This assumption requires reporting estimated in the financial statements. It sacrifices some degree of faithful representation of information for increased relevance.

Industry Practices Constraint

GAAP may not be followed in certain industries to avoid reporting misleading or unnecessary information

Statement of Investments by and Distributions to Owners

Investment by owners Distribution to owners

Objectives of financial reporting for governmental activities and business-type activities are essentially the same

Public Accountability 1) The government should provide information a) about whether current-year revenues were sufficient to pay for current year services b) about whether it complied with the legally enacted budget and other finance-related requirements c) for assessing service efforts, costs, and accomplishments Evaluating Operating Results 2) The government should provide information a) about sources and uses of financial resources b) about how its activities were finances and its cash requirements were met c) to determine whether its financial condition improved or declined Assessing Services Provided 3) The government should provide information about a) about its financial position and condition b) about its noncurrent nonfinancial resources c) that discloses legal or contractual restriction and potential risks.

Qualitative Characteristics

Relevance Faithful representation

Changes in Assets and Liabilities with a Change in Equity

Revenues Expenses Gains Losses Investments by Owners Distributions to Owners

Statement of Earnings (Net Income)

Revenues Gains Expenses Losses

Revenue Recognition

Revenues and gains generally are measured by the exchange prices of the assets or liabilities involved. According to the revenue recognition principle, revenues, and gains are recognized when 1) realized or realizable 2) earned

Elements of financial statements of State and Local Governments

Statement of Net Position Resource Flows Statement

2 sources of authoritative financial accounting guidance for nongovernmental entities in the US

The Codification. SEC pronouncements.

Economic-Entity Assumption

The reporting entity is separately identified for the purpose of economic and financial accountability. Thus, the economic affairs of owners and managers are kept separate from those of the reporting entity. Also, the legal entity and the economic entity are not necessarily the same. ex a parent and its subsidiary.

Cost Constraint

This constraint limits reporting

The objective to report financial information that is

USEFUL, in making decisions about providing resources to the reporting entity

Qualitative Characteristics of State and Local Governmental Reporting

Understandability Reliability Relevance Timeliness Comparability Cost-Benefit Limitations

Going-Concern (business continuity) Assumption

Unless stated otherwise, every business is assumed to be a going concern that will continue operating indefinitely. As a result, the liquidation basis of accounting is not used. It is assumed that the entity will not be liquidated in the near future

Amortization

a form of allocation. It decreases an amount by periodic payments or write-downs.

Users of financial reporting for governmental-type activities

a) citizens (those to whom the governmental body is directly accountable) b) legislative and oversight bodies (those who represent the citizenry) c) investors and creditors (those who provide financing)

Uses of Governmental Reporting

a) comparing actual results with budgeted amounts b) assessing financial condition and operating results c) determining compliance with laws, rules, and regulations d) evaluating efficiency and effectiveness

Nature of Financial Accounting

a. Financial accounting produces information about an entity's assets, liabilities, revenues, expenses, and other elements of financial statements b. For general-purpose financial statements to be useful to external parties, they must be prepared in conformity with U.S. GAAP. c. Management accounting assists management decision making, planning, and control. Management accounting information therefore is directed primaRily to specific internal users, and is ordinarily need not follow GAAP

Convergence project

an effort to harmonize U.S. GAAP and IFRS

Financial Reporting Releases (FRRs)

announce accounting and auditing matters of general interest

accruals

anticipate future cash flows. example sales or purchases on account, interest, and taxes are common accruals

The smaller reporting company system

applies to small business issuers and nonaccelerated filers. IT reduces the disclosure requirements for smaller companies that file periodic reports and registration statements with the SEC

Assets

are "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." Valuation allowances, such as premiums on notes receivable, are part of the related assets and are not assets or liabilities

Losses

are decreases in equity (net assets) other than from expenses or distributions to owners.

Distributions to owners

are decreases in equity. They result from transferring assets, providing services, or incurring liabilities. A distribution to owners decreases ownership interests.

Gains

are increases in equity (net assets) other than from revenues or investments by owners

Investments by Owners

are increases in equity of a business entity. They result from transfers by other entities of something of value to increase ownership interests. Assets are the most commonly transferred item, but services also can be exchanged for equity interests

Revenues

are inflows or other enhancements of assets or settlements of liabilities (or both) from a) delivering or producing goods b) providing services c) other activities that qualify as ongoing major or central operations

Staff Accounting Bulletins (SABs)

are issued as interpretations to be followed by the SEC staff in administering disclosure requirements *Because they are the views of the staff, SABs are not legally required to be followed by registrants, but an entity should have a good reason not to comply.

Expenses

are outflows or other uses of assets or incurrences of liabilities (or both) from a) delivering or producing goods b) providing services or c) other activities that qualify as ongoing major or central operations

IFRS

are principle-based. They tend to be less detailed than U.S. GAAP -requires more professional judgement

Liabilities

are probable future sacrifices of economic benefits. They are existing obligations of a specific entity to transfer assets or provide services to other entities as a result of previous transactions or events. Valuation allowances, such as discounts on bonds payable, are part of the related liability are not liabilities or assets

IFRS revenue recognition is different from GAAP

bottom of page 27

FASAB

establishes accounting principles for the federal government and issues Statements of Federal Accounting Standards

Expense Recognition

expenses and losses are recognized when a consumption of economic benefits occurs in connection with the entity's primary activities or the ability of existing assets to provide future benefits is impaired.

Full-Disclosure Principle

financial statement users should be able to assume that financial information that could influence users' judgment is reported in the f.s.

Regulation S-X

governs the reporting of financial statements, including notes and schedules

Relevance

information is relevant if it can make a difference in user decisions. To do so, it must have predictive value, confirmatory value or both. *Information has predictive value if it can be used as an input in a predictive process *Information has confirmatory value with respect to prior evaluations if it provides feedback that confirms or changes (corrects) them. *Information is material if its omission or misstatement can influence user decisions based on a specific entity's financial information. Thus, it is an entity-specific aspect of relevance

Timeliness

information is timely when it is available in time to influence decisions

Verifiability

information is verifiable (directly or indirectly) if knowledgeable and independent observers can reach a consensus (not necessarily unanimity) that it is faithfully represented.

Comparability

information should be comparable with similar information for 1) other entities 2) the same entity for another period or date *Consistency is a means of achieving comparability.

IASB

is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements.

systematic and rational allocation

is the assignment or distribution of an amount according to a plan or formula. Examples are 1) the apportionment of a lump-sum purchase price among the assets acquired and 2) the assignment of manufacturing costs to products

Statement of Comprehensive Income

is the periodic change in equity of a business entity from nonowner sources. It includes earnings (net income) but excludes the effects of investments by owners and distributions to owners.

GASB

is the primary standards setter for state and local governmental entities.

Equity (net assets of a not-for-profit entity)

is the residual interest in the assets of an entity after subtracting liabilities

IFRS for Small and Medium Sized Entities (SMES)

it is not necessary for a jurisdiction to adopt full IFRS for it to adopt IFRS SMEs. However issuers and financial institutions must not use it

Primary Users

of financial information are current or prospective investors and creditors who cannot obtain it directly.

Regulation S-K

provides disclosure standards, including many that are nonfinancial. Regulation S-K also covers certain aspects of corporate annual reports to shareholder

deferrals

reflect past cash flows. example: prepaid insurance

The accrual basis of accounting

reports the effects of transactions and other events and circumstances on the entity's resources and claims when they occur, not necessarily when the cash flows occur. Thus, the accrual basis is preferable to the cash basis for evaluating past performance and predicting future performance

US GAAP is criticized for

stressing the letter of accounting rules rather than the economic substance of transactions.

Conservatism Constraint

the conservatism constraint is a response to uncertainty. When alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable.

Cost Constraint

the costs of all financial reporting should be justified by the benefits

Capital Maintenance Concept

the full set of financial statements, including comprehensive income, is based on this.

Historical Cost Principle

transactions are recorded initially at cost because it is the most objective determination of fair value. However, the trend is toward more extensive reporting of fair value information

Understandability

understandable information is clearly and concisely classified, characterized, and presented.