FAR- Chapter 1

Explain the role of the auditor in the financial reporting process

Auditors are independent, professional accountants who examine financial statements to express an opinion. The opinion reflects the auditors' assessment of the statements' fairness, which is determined by the extent to which they are prepared in compliance with GAAP. The auditor adds credibility to the financial statements, which increases the confidence of capital market participants relying on that information.

What is the function and primary focus of financial accounting?

Financial accounting is concerned with providing relevant financial information about various kinds of organizations to different types of external users. The primary focus of financial accounting is on the financial information provided by profit-oriented companies to their present and potential investors and creditors.

What is meant by GAAP? Why should all companies follow GAAP in reporting to external users?

GAAP (generally accepted accounting principles) are a dynamic set of both broad and specific guidelines that a company should follow in measuring and reporting the information in their financial statements and related notes. It is important that all companies follow GAAP so that investors can compare financial information across companies to make their resource allocation decisions.

Explain the roles of the SEC and the FASB in the setting of accounting standards.

In 1934, Congress created the SEC and gave it the job of setting accounting and reporting standards for companies whose securities are publicly traded. The SEC has retained the power, but has delegated the task to private sector bodies. The current private sector body responsible for setting accounting standards is the FASB.

What must a company do in the long run to be able to provide a return to investors and creditors?

In the long run, a company will be able to provide investors and creditors with a rate of return only if it can generate a profit. That is, it must be able to use the resources provided to it to generate cash receipts from selling a product or service that exceed the cash disbursements necessary to provide that product or service.

Define net operating cash flows. Briefly explain why periodic net operating cash flows may not be a good indicator of future operating cash flows.

Net operating cash flows are the difference between cash receipts and cash disbursements during a period of time from transactions related to providing goods and services to customers. Net operating cash flows may not be a good indicator of future cash flows because, by ignoring uncompleted transactions, they may not match the accomplishments and sacrifices of the period.

What is meant by the phrase efficient allocation of resources? What mechanism fosters the efficient allocation os resources in the United Stated?

Resources are efficiently allocated if they are given to enterprises that will use them to provide goods and services desired by society and not to enterprises that will waste them. The capital markets are the mechanism that fosters this efficient allocation of resources.

What is the primary objective of financial accounting?

The primary objective of financial accounting is to provide investors and creditors with information that will help them make investment and credit decisions

Identify two important variables to be considered when making an investment decision.

Two extremely important variables that must be considered in any investment decision are the expected rate of return and the uncertainty or risk of that expected return.