FASB, SEC, GAAP and Audit reports

Environmental Factors

• Several entities provide input to the Financial Accounting Standards Board (FASB).
• The Generally Accepted Accounting Principles (GAAP) are then set by the FASB

Securities and Exchange Commission (SEC)

• The Securities and Exchange Commission (SEC) is an independent, quasi-judicial government agency.
• The SEC administers securities regulations and disclosures.
• The SEC can modify and set GAAP, if necessary.
• The SEC rarely directly challenges FASB.
• The SEC is a major player in global accounting.

Managers of Companies

• Managers of companies have the primary responsibility for fair and accurate reports.
• Managers apply accounting to reflect business activities.
• Managerial discretion is necessary in accounting.
• Managers are major lobbyists on GAAP.

Auditing

• The SEC requires an Audit Report.
• An audit opinion can be clean (fairly presented), qualified (except for), or a disclaimer (no opinion).
• Auditor quality and independence should be checked.
• Auditing identifies errors and irregularities that would materially affect the fairness of statements presentation or conformity with GAAP.
• Types of Audit qualification are "Except for” Qualification, Adverse opinion, or Disclaimer of opinion

Corporate Governance

• Corporate governance involves board of directors oversight.
• An audit committee of the board should oversee the accounting process, internal control, and internal/external audit.
• Internal auditors are another important factor of corporate governance

Users of Financial Information

• Internal users include Managers, Officers, Internal Auditors, Sales Managers, Budget Officers, and Controllers.
• External users include Lenders, Shareholders, Governments, Labor Unions, External Auditors, and Customers.

Alternative Information Sources

• Economic, Industry, and Company News impact current and future financial condition and performance.
• Voluntary Disclosure motivation includes Legal liability, Expectations Adjustment, Signaling, and Managing expectations
• Information Intermediaries are an industry devoted to collecting, processing, interpreting, and disseminating company information.
• Information Intermediaries include analysts, advisers, debt raters, buy- and sell-side analysts, and forecasters
• Major determinant of GAAP

Desirable Qualities of Accounting Information

• Relevance refers to the capacity of information to affect a decision.
• Reliability requires information to be verifiable, representationally faithful, and neutral.
• Verifiability suggests the information is confirmable.
• Faithfulness suggests the information reflects reality
• Neutrality suggests the information is truthful and unbiased

Accounting Information Limitations

• Timeliness refers to periodic disclosure, not a real-time basis.
• Frequency is quarterly and annually.
• Information has limited prospective capacity.

Important Accounting Principles

• The historical cost is fair & objective, values from arm's-length bargaining.
• Accrual Accounting recognizes revenues when earned and expenses when incurred.
• Materiality is a threshold when information impacts decision-making.
• Conservatism is reporting or disclosing the least optimistic information about uncertain events and transactions.

Accounting Concept of Income

• The accounting concept of income is based on the concept of accrual accounting.
• The main purpose of the accounting concept of income is income measurement.
• Two main processes of the accounting concept of income are revenue recognition and expense matching.
• Net Income = Operating Cash Flow + Accruals

Accrual Accounting Foundations

• Revenue Recognition should recognize revenues when earned, realized, or realizable.
• Expense Matching should match with corresponding revenues including product and period costs.

Accruals Illustrated - Case Facts

• A company is established and invests $700 equity.
• Plain T-shirts are purchased for $5 each.
• The fixed screen cost is $100.
• Variable print cost is $0.75 per T-shirt.
• 25 T-shirts are sold at $10 each for cash and on credit.

Case Illustration – Cash Accounting

• In the example, T-Shirt sales are $250.
• Payments for T-Shirt purchases are $500, Screen Purchase $100, and Printing charges $75.
• Total assets (cash) amount to $275 on a cash basis, but equity comes in at ($425) using cash outflow

Case Illustration – Accrual Accounting

• In the example, T-Shirt sales are $500.
• Expenses for T-Shirts costs are $250, Screen depreciation $50, and Printing charges $37.50.
• The net income, and total liabilities & equity on an accrual basis are $162.50 and $862.50 respectively

Accounting Analysis: Process

• Two broad areas of accounting analysis are involved:
• Evaluating Earning Quality:
  • Identify and assess key accounting policies.
  • Evaluate the extent of accounting flexibility.
  • Determine the reporting strategy.
  • Identify and assess red flags.
• Adjusting Financial Statements:
  • Identify, measure, and make necessary adjustments to financial statements to better serve one's analysis objectives;
  • Adjusting (recasting) the statements.