Finance and Accounting Overview Quiz

Chapter 1: Environment and Theoretical Structure of Financial Accounting

• Financial accounting provides useful information about economic activity to help make good decisions and foster a prosperous society.
• Accounting judgments have shades of gray.
• The main focus of financial accounting is providing information to external users, including investors, creditors, and other stakeholders.
• Financial information is conveyed through financial statements and related disclosure notes.
• Financial statements include the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity.
• Financial reporting is the process of providing financial information to external users.

Visualizing the Important Role of Accounting

• Accounting is crucial for making good decisions.
• Accounting helps analyze economic activity and influences decisions by conveying information about it.
• Critical thinking is essential for productive accounting and society's prosperity.

Primary Focus of Financial Accounting

• Financial accounting primarily focuses on providing information to external users (investors, creditors, etc.).
• This information is essential for predicting risk and potential returns of investments and loans.
• Financial information is a vital component of financial reporting.

Financial Accounting

• Financial information is communicated through financial statements and related disclosure notes.
• These notes include the balance sheet, income statement, statement of comprehensive income, and others.

Financial Information Providers and External User Groups

• Profit-oriented companies are providers of financial information in the market.
• Not-for-profit entities (government, charitable organizations, schools) provide information as well.
• Households are also a source of financial information in the market.

The Economic Environment and Financial Reporting

• Capital markets are essential for effective resource allocation.
• Corporations acquire capital from investors (ownership interest) and creditors (borrowing, debt such as bonds).

The Investment-Credit Decision—A Cash Flow Perspective

• Investors and creditors provide capital to earn a fair return.
• Important considerations for investment decisions include the rate of return, and uncertainty or risk.
• Dividends constitute a component of shareholder return.

Rate of Return

• Investors can assess rate of return directly by calculating it based on historical measures.
• Share value appreciation and dividend earnings contribute to the rate of return.

Concept Check: Rate of Return

• The rate of return calculation is an example illustrating the method of calculating the rate of return.

Example of Uncertainty

• The choice between a risk-free investment (savings account) and a riskier, but potentially higher-return, investment (profit-oriented company) illustrates the tradeoff between risk and return.

Objective of Financial Accounting

• The primary objective of financial accounting is providing useful information for decision-making to investors and creditors.
• The information focuses on understanding the future cash inflows and outflows of an enterprise.

Cash versus Accrual Accounting

• Cash basis accounting measures cash receipts as well as cash payments.
• Accrual basis accounting measures revenues and expenses regardless of when cash changes hands.
• Accrual basis accounting produces net income or loss.

Cash Basis Example

• Demonstrates how cash basis accounting tracks cash flows from transactions.

Accrual Basis Example

• Shows how accrual accounting records expenses and revenues over anticipated accounting periods.

Concept Check: Accrual Accounting

• Accrual accounting is an important financial reporting methodology because it spreads out the influence of one-time events, captures long-run performance, and recognizes assets and liabilities associated with receivables and payables.

The Development of Financial Accounting and Reporting Standards

• Generally Accepted Accounting Principles (GAAP) provides guidelines for financial reporting.
• GAAP standardizes the reporting procedures followed by companies.
• Comparability arises from the use of GAAP.

Accounting Standard Setting

• Hierarchy of standard-setting authority: Congress, SEC, Private Sector (CAP, APB, FASB)
• Different bodies were responsible for financial accounting and reporting standards in different time periods.

Historical Perspective and Standards

• The Securities and Exchange Commission (SEC) was created in response to the 1929 stock market crash.
• The SEC's goal is to restore investor confidence and oversight of financial reporting practices.
• The Securities Act of 1933 and the Securities Exchange Act of 1934 regulate financial markets.

Early U.S. Standard Setting

• The Committee on Accounting Procedure (CAP), established in 1938, was the initial private-sector accounting standard-setting body.
• Subsequent bodies included the Accounting Principles Board (APB).

Financial Accounting Standards Board (FASB)

• The FASB was created in 1973 to set U.S. accounting standards and has been supported by the Financial Accounting Foundation.
• The Emerging Issues Task Force (EITF) identifies and resolves financial reporting issues and assists in the processing of accounting standards.
• The Government Accounting Standards Board(GASB) develops accounting standards for governmental units, such as states and cities.

Concept Check: Accounting Standard Setting

• The FASB is the primary standard-setting body in the U.S. accounting system.

Codification

• FASB Accounting Standards Codification is the authoritative source for nongovernmental U.S. GAAP; it organizes GAAP topics.
• The Accounting Standards Update (ASU) houses new accounting standards issued by FASB.

FASB Accounting Standards Codification Topics

• Breakdown of how financial reporting areas are organized in the codification.

International Standard Setting

• The International Accounting Standards Committee (IASC) formed to create global accounting standards.
• The International Accounting Standards Board (IASB) was created to set global accounting standards.

Comparison of Organizations of U.S. and International Standard Setters

• Comparison of U.S. GAAP and IFRS regulatory oversight, organizations, advisory councils, and bodies that address emerging issues.

International Financial Reporting Standards (IFRS)

• International financial reporting standards (IFRS), initially known as IAS, have been the basis of financial reporting for many countries around the world.

Efforts to Converge U.S. and International Standards

• The FASB and IASB have been developing consistent international standards.
• Convergence of U.S. and IFRS accounting standards are ongoing efforts.

The FASB's Standard-Setting Process

• The FASB's standard-setting process involves multiple steps to address accounting issues based on stakeholder requests.

Politics in Standard Setting

• Political pressure has influenced aspects of accounting standards development regarding employee stock options and fair value accounting.

Encouraging High-Quality Financial Reporting

• Auditors offer credibility to financial statements and provide opinions on the compliance of financial statements with accounting standards (GAAP).
• Certified public accountants (CPAs) have the state license to offer and provide audit services to states.

Financial Reporting Reform

• Accounting scandals, like those of Enron, WorldCom, Xerox, and Merck, have prompted reforms that protect investors and promote credibility in financial reporting practices.

A Move Away from Rules-Based Standards

• Transitioning from rules-based to principles-based accounting standards emphasizes professional judgment over rigid rules.
• Principles-based standards rely on the professional judgment of accountants, while rules-based standards rely on strict rules.

Ethics and Professionalism

• Ethics are the values and principles used to distinguish right and wrong.
• Codes of ethics, issued by organizations such as the AICPA, provide guidance on ethical standards.

Analytical Model for Ethical Decisions

• The analytical process steps involve identifying the ethical issue, stakeholders, issues, possible courses of action, their consequences, and the impact on various stakeholders.

Concept Check: High-Quality Financial Reporting

• Several factors contribute to high-quality financial reporting: comparability, materially misstated financial statements corrected by auditors, and reforms like Sarbanes-Oxley.

The Conceptual Framework

• The conceptual framework provides the underlying foundation for U.S. accounting standards.
• The framework structures how accounting events and their relevant information are collected, summarized, and communicated, providing guidance for financial reporting.
• The framework, through Statements of Financial Accounting Concepts (SFACs), disseminates financial reporting principles..

The Conceptual Framework (concluded)

• The objective drives the recognition and measurement concepts; it leads to reliable financial statement preparation.
• Important characteristics like qualitative characteristics (relevance, faithful representation), and constraints, are included in financial statement preparation.

International Financial Reporting Standards: Role of the Conceptual Framework

• Conceptual frameworks are similar in U.S. GAAP and IFRS, with areas of ongoing convergence.
• The conceptual framework acts as support for the development of quality standards for both U.S. and international accounting standards.

Qualitative Characteristics of Financial Reporting Information

• Qualitative characteristics such as relevance, faithful representation, materiality, and completeness ensure financial reports are useful and reliable.
• Constraints in the reporting framework are a component that ensures reporting practices are not too burdensome for companies to comply with.

Hierarchy of Qualitative Characteristics of Financial Information

• Financial reporting information is categorized into hierarchical units, based on its elements and importance to financial decision-making.
• Hierarchy based on decision usefulness based on its predictive and confirmatory value, comparability, verifiability, timeliness, understandability, and free from error.

Concept Check: FASB Conceptual Framework-Relevance and Faithful Representation

• Components of relevance include predictive, confirmatory value, and materiality; components of faithful representation include free from error, neutrality, and completeness.

The Conceptual Framework: Elements

• The framework diagram outlines the components, including elements (assets, liabilities, equity, revenues, expenses), recognition and measurement, qualitative characteristics, and constraints.

Elements of Financial Statements

• Financial statement elements include assets, liabilities, equity, investments, distributions, comprehensive income, revenues, expenses, gains, and losses.

Underlying Assumptions

• Four fundamental GAAP assumptions are the economic entity, going concern, periodicity, and monetary unit assumptions.

The Conceptual Framework: Recognition, Measurement, and Disclosure Concepts

• The conceptual framework provides a structured approach to the accounting process, encompassing recognition, measurement, and disclosure.

Recognition, Measurement, and Disclosure Concepts

• Recognition is the process of including information in financial statements; measurement involves assigning numerical amounts to accounting elements, while disclosure provides additional information.

Revenue Recognition

• Revenue is recognized when the earnings process is complete or virtually complete, with reasonable certainty of collectibility.
• The revenue recognition principle provides the basis for when to recognize income.

Expense Recognition

• Expenses are recognized using cause-and-effect relationships or by associating them with the time period in which revenues are recognized or by a rational allocation to time periods.

Measurement

• GAAP uses a mixed attribute measurement model, encompassing attributes such as historical cost, net realizable value, current cost, present value, and fair value.

Historical Cost

• Historical cost is the original transaction value adjusted for depreciation or amortization.
• Accounting is centered around value at initial acquisition; this is the most common and basic way of measuring value.

Net Realization Value, Current Cost, Present Value

• Net realizable value estimates the expected selling price less completion costs.
• Current cost is the expense for purchasing or reproducing an asset.
• Present value estimates future cash flows.

Fair Value

• Fair value is the price paid in exchange for an asset, or the price received when exchanging a liability.
• The fair value amounts are measured using market, income, or cost approaches

Concept Check: FASB Framework-Measurement Attributes

• The list price is not a standard measurement attribute according to the conceptual framework.

Fair Value Hierarchy

• The fair value hierarchy provides different levels for inputs in measuring fair value, with Level 1 (most desirable) characterized by quoted market prices and Level 3 (least desirable) by unobservable inputs.

Fair Value Option

• The fair value option is an option under GAAP that gives companies the choice to account for specified financial assets and liabilities at fair value.
• Fair value option provides a pathway for companies to adapt to accounting standards without complicated hedge accounting requirements.

Disclosure

• The full disclosure principle requires companies to include any information potentially affecting user decisions.

Summary of Recognition, Measurement, and Disclosure Concepts

• Recognition, measurement, and disclosure concepts are defined and summarized in several aspects of accounting and financial reporting.

Evolving GAAP

• GAAP approaches (revenue/expense and asset/liability) help clarify how revenues and expenses are captured as activities relate to the balance sheet and income statement.

Accounting Concepts Development: GAAP vs. IFRS

• The FASB's conceptual framework is focusing on revising the definitions of assets, liabilities, and revenues.

Test your knowledge on the foundations of finance, including the creation of the Securities and Exchange Commission and significant Acts like the 1933 Securities Act. Explore the evolution of accounting standards and the roles of important regulatory bodies. This quiz covers key concepts in capital markets and investor relations.