Financial Accounting Topic 1 PDF

**Topic 1** **Financial Accounting** **I. [What is Financial Accounting?]** A. **Financial Accounting is the:** 1\. identification 2\. measure­ment, and 3\. communication of financial information 4\. about the business activities of economic entities 5\. to its stakeholders 6\. to aid in th...

**Topic 1** **Financial Accounting** **I. [What is Financial Accounting?]** A. **Financial Accounting is the:** 1\. identification 2\. measure­ment, and 3\. communication of financial information 4\. about the business activities of economic entities 5\. to its stakeholders 6\. to aid in the decision-making process. B. **What are the business activities?** 1\. Financing Activities a\. Raising equity capital by attracting investment from business owners, such as common shareholders. b\. Acquiring resources from lenders or by the issuance of bonds. 2\. Investing Activities a\. Acquiring productive resources such as property, plant, equipment, technology, legal rights, and other assets necessary to operate the business. 3\. Operating Activities a\. Utilization of resources in day-to-day activities to produce goods and/or services. b\. Selling of goods and services to customers. C. **Who are the stakeholders?** 1\. Anyone that has some type of interest in the company. 2\. Most companies have many different stakeholders. The users may be internal or external. 3\. Stakeholders include: stockholders, banks, creditors, governmental agencies, management, employees, customers, suppliers, and others. D. **What do stakeholders need to know?** 1\. Investors a\. The business model, strategies, and competitive advantages of the company. b\. Resources the company owns and the debt it owes. c\. The net income or net loss, cash flows, and whether profits and cash flows are growing over time. 2\. Creditors a\. The amount of equity capital in place b\. Resources the company owns and the debt it owes c\. Cash flows and the company's ability to meet interest and principal payments when due. E. **Financial statements** are the principal means through which a company communicates its financial information to external stakeholders. The financial statements most frequently provided are: - **the balance sheet,** - **the income statement**, - **the statement of cash flows**, and - **the statement of owners' or stockholders' equity.** 1\. Balance Sheet (Statement of Financial Position) a\. Presents, as of a specific date: i\. a snapshot of the resources of a entity (assets) and ii\. the claims on the entity (liabilities and shareholders' equity). b\. Assets = Liabilities + Shareholders' Equity 2\. Income Statement (Profit and Loss Statement) a\. Measures and reports the financial results of an entity's performance for a period of time. b\. Net Income (loss) = Revenues - Expenses + Gains - Losses 3\. Statement of Cash Flows a\. Reports for a period of time the net cash flows from operating, investing, and financing activities. b\. Provides useful information about how an entity is generating and using cash. c\. Is useful to creditors and other stakeholders to help evaluate the entity's cash- generating ability. 4\. Statement of Shareholders' Equity a\. Provides information about the common shareholders' equity claims on the company and how those claims changed during the year. b\. Contributed Capital - Amounts contributed by shareholders for an interest in the entity (common stock, additional paid-in capital). c\. Earned Capital i\. Cumulative net income in excess of dividends declared (retained earnings). ii\. Stockholders' equity effects from the recognition or valuation of certain assets or liabilities (Accumulated Other Comprehensive Income). 5\. Other means of communicating financial information include: a\. Financial Statement Notes i\. Companies must provide notes as additional information with the financial statements. ii\. Financial notes explain how the accounts and amounts have been determined. iii\. Provides important details about the accounting principles, methods, and estimates the company has used to measure values of assets, liabilities, equity, revenues, expenses, gains and losses. b\. Management Discussion and Analysis i\. Is an extensive narrative discussion and quantitative analysis from the company's managers. ii\. Provides managers' insight into: strategies, evaluation of performance, exposure to business risk factors, and expectations about the future. c\. Managers' and Independent Auditors'' Attestations i\. The Sarbanes-Oxley Act of 2002 imposed responsibilities on managers and auditors. ii\. Management is responsible for the financial statements and the underlying accounting and control system that generates the financial statements. iii\. Independent auditors are responsible for assessing a company's internal control system, designing audit tests, and forming an opinion about the fairness of the amounts reported in the financial statements.. **II. [The Need to Develop Standards]** A. The accounting profession has developed a common set of standards and procedures known as **generally accepted accounting principles (GAAP).** B. These prin­ciples serve as a general guide to the accounting practitioner in accumulating and reporting the financial information of a business enterprise. The main controversy in setting accounting standards is, "Whose rules should we play by, and what should they be?" C. Users of financial accounting standards have both coinciding and conflicting need for information of various types. To meet these needs, companies prepare a set of **general purpose financial statements**. Users expect these statements to **present fairly, clearly, and completely the company's financial position**. **III. [Parties Involved in the Standard Setting Process]** A. What prompted the standard setting process? 1\. **After the stock market crash in 1929 and the Great Depression,** there were calls for increased government regulation and supervision---especially of financial institutions and the stock market. 2\. As a result, the federal government established **the Securities and Exchange Commission (SEC)** to help develop and standardize financial information presented to stockholders. a\. The SEC is a federal agency and administers **the Securities Act of 1933** and **the Securities Exchange Act of 1934** and several other acts. b\. Most companies that issue securities to the public or are listed on a stock exchange are required to file audited financial statements with the SEC. c\. In addition, the SEC has the legal authority to prescribe the accounting practices and standards to be employed by companies that fall within its jurisdiction. 3\. At the time the SEC was created, it encouraged the creation of a private standards- setting body. As a result, accounting standards have generally been developed in the private sector either through **the American Institute of Certified Public Accountants (AICPA)** or **the** **Financial Accounting Standards Board (FASB).** a\. The SEC has affirmed its support for the FASB by indicating that financial statements conforming to standards set by the FASB will be presumed to have substantial authoritative support. b\. Over its history, the SEC's involvement in the development of accounting standards has varied. In some cases, the private sector has attempted to establish a standard, but the SEC has refused to accept it. In other cases, the SEC has prodded the private sector into taking quicker action on setting standards. **IV. [AICPA -- American Institute of Certified Public Accountants - 1887]** A. The first group appointed by the AICPA to address the issue of uniformity in accounting practice was the **Committee on Accounting Procedure (CAP).** 1\. This group served the accounting profession from 1939 to 1959. 2\. During that period, it issued 51 **Accounting Research Bulletins (ARBs)** that narrowed the wide range of alternative accounting practices then in existence. B. In 1959, the AICPA created the **Accounting Principles Board (APB).** a\. The major purposes of this group were 1\. to advance the written expression of accounting principles, 2\. to deter-mine appropriate practices, and 3\. to narrow the areas of difference and inconsistency in practice. b\. The APB was designated as the AICPA's sole authority for public pronouncements on accounting principles. c\. Its pronouncements, known as **APB Opinions,** were intended to be based mainly on research studies and be supported by reason and analysis. C. In 1971, a committee, known as the **Study Group on Establishment of Accounting Principles (Wheat Committee),** was set up to study the APB and recommend changes in its structure and operation. The result of the Study Group's findings was the demise of the APB and the creation of the **Financial Accounting Standards Board (FASB**) in 1973. D. **FASB -- Financial Accounting Standards Board** 1\. The FASB represents the current rule-making body within the accounting profession. 2\. The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of financial information. 3\. The FASB differs from the predecessor APB in the following ways: a\. Smaller membership (7 versus 18 on the APB). b\. Full-time remunerated membership (APB members were unpaid and part- time). c\. Greater autonomy (APB was a senior committee of the AICPA). d\. Increased independence (FASB members must sever all ties with firms, companies, or institutions). e\. Broader representation (it is not necessary to be a CPA to be a member of the FASB). 4\. Two basic premises of the FASB are that in establishing financial accounting standards: a\. it should be responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession, and b\. it should operate in full view of the public through a "due process" system that gives interested persons ample opportunity to make their views known. **V. [Due Process]** A. The **FASB** issues two major types of pronouncements: 1, **Accounting Standards Updates.** The Updates amend the Accounting Standards Codification, which represents the source of authoritative accounting standards, other than standards issued by the SEC. a\. Each Update explains how the Codification has been amended and also includes information to help the reader understand the changes and when those changes will be effective. b\. They are considered GAAP and must be followed in practice. **2. Financial Accounting Concepts**. The SFACs represent an attempt to move away from the problem-by-problem approach to standard setting that has been characteristic of the accounting profession. a\. The Concept Statements are intended to form a cohesive set of interrelated concepts, a conceptual framework, which will serve as tools for solving existing and emerging problems in a consistent manner. b\. Unlike FASB statements, the Concept Statements do not establish GAAP. B. A second type of **update** is a consensus of the EITF. 1\. In 1984, the FASB created the **Emerging Issues Task Force (EITF).** 2\. The purpose of the Task Force is to reach a consensus on how to account for new and unusual financial transactions that have the potential for creating differing financial reporting practices. 3\. The EITF can deal with short-term accounting issues by reaching a consensus and thus avoiding the need for deliberation by the FASB and the issuance of an FASB Statement. **VI. [GAAP -- Generally Accepted Accounting Principles]** A. Generally accepted accounting principles (GAAP) are those principles that have **substantial authoritative support.** 1\. Accounting principles that have substantial authoritative support are those found in FASB Statements, Interpretations, and Staff Positions; APB Opinions; and Accounting Research Bulletins (ARBs). 2\. If an accounting transaction is not covered in any of these documents, the accountant may look to other authoritative accounting literature for guidance. B. FASB Accounting Standards Codification (ASC) 1\. The Codification is an electronic database that integrates and topically organizes U.S. GAAP into one coherent body of literature.  2\. The Codification became effective on July 1, 2009.  3\. The FASB developed the Codification to achieve three goals: a\. Simplify user access by organizing and categorizing all authoritative U.S. GAAP in one database. b\. Ensure the codified content accurately represented all U.S. GAAP. c\. Create a codification research system that is up to date, including the most recently released standards. 4\. The Codification is now the *[only]* source of authoritative GAAP for U.S. companies to determine how to record their transactions, events, or circumstances, and how to report the results in their financial statements. 5\. The Codification did not change GAAP, only repackaged it. **VII. [International Accounting Standards]** A. The IASB and IFRs 1\. The IASB is the international accounting standard setter, establishing IFRS which are required or permitted in roughly 130 countries. 2\. As the parent organization of the IASB, the IFRS Foundation consists of a group of Trustees that is responsible for fund-raising, appointing IASB members, and overseeing the effectiveness of the IASB. 3\. The IASB includes 16 members from various countries. 4\. Following a similar process as the FASB, the IASB studies the topic, issues a discussion paper, issues an Exposure Draft, evaluates comments, and drafts the proposed standard. 5\. If approved by 10 of the 16 members, the proposed standard becomes an International Financial Reporting Standard (IFRS). B. Convergence of FASB and IASB Accounting Standards 1\. The SEC mandates corporations are subject to U.S. GAAP or IFRS. 2\. International convergence of accounting standards refers to both a goal and the path chosen to reach it. 3\. The ultimate goal of convergence is a single set of high-quality, international accounting standards that companies worldwide would use for both domestic and cross-border financial reporting. 4\. The path toward that goal has been the collaborative efforts of the FASB and the IASB to both improve U.S. GAAP and IFRS and eliminate or minimize the differences between them. 5\. Major projects have been completed to achieve convergence of accounting standards for: consolidated financial statements, fair value measurement, financial statement presentation and revenue recognition. C. The SEC and International Convergence 1\. In 2007 the SEC decided to allow foreign companies to use IFRS rather than U.S. GAAP, agreed to accept IFRS-based filings (in Form 20-F), and decided that these companies do not need to reconcile how differences between IFRS and U.S. GAAP affect their reported financial statements. 2\. Professional accountants must be fluent in U.S. GAAP and IFRS and well informed about their differences. **VIII. [Ethics in the Accounting Profession]** A. Accountants serve the greater good of society and owe a responsibility of ethics and fairness to all stakeholders, whose interests are sometime conflicting. B. Accountants face ethical dilemmas, situations in which an accountant must make a decision about what is the "right" (ethical) action to take in given circumstances. C. Professional accounting organizations have established codes of ethics for their members. D. The AICPA has adopted the Code of Professional Conduct (CPC). E. The CPC includes six principles that express the basic tenets of ethical and professional conduct and call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage. **Principles of the AICAP Code of Professional Ethics**