Chapter 14 lecture notes
In this chapter you will learn how generally accepted accounting principles (GAAP) are developed, about the various agencies involved, the users and uses of financial statements, and FASB’s conceptual framework. If you go to you can browse through current news releases as well as the publications.
The Securities and Exchange Commission (SEC) is the legal rule-making body of the public sector (government) and the Financial Accounting Standards Board (FASB) is the principle representative of the private sector (business). Although the SEC does have the statutory power to establish accounting rules for publicly held companies, they have recognized FASB as the authoritative principle setter in the private sector.
FASB pronouncements are known as Statements of Financial Accounting Standards, which are based on a conceptual framework – the foundation for all generally accepted accounting principles and reporting practices. Important topics in the framework include qualitative features of financial statements, basic assumptions underlying the statements, basic accounting principles, and modifying constraints. The concentration of the financial reporting rules is on providing useful information to current and potential investors and creditors to aid in making investment and credit decisions.
The qualities that make accounting information useful in the decision making process for statement users are the qualitative characteristics. These include usefulness and understandability, relevance, reliability, neutrality, comparability and consistency. It is assumed that statement users will possess a basic knowledge of business and economics and will spend sufficient time analyzing the statements.
The four underlying assumptions which financial statement users should be able to assume the preparers of the statements have made are: the separate economic entity assumption (assumes that the business is separate from its owners), the going concern assumption (the business will continue to operate), the monetary unit assumption (intangible assets and potential liabilities will be given values, and the assumption that the value of the monetary unit is stable), and the periodicity of income assumption (activities can be divided into periods).
The four basic principles which act as guidelines in financial statement preparation are: the historical cost basis principle (long term assets are recorded at cost), the revenue recognition principle (revenues are recognized when earned and realized), the matching principle (revenues and expenses should be matched in the appropriate financial period), and the full disclosure principle (all information that could affect the user’s interpretation should be reported).
Modifying constraints are practical considerations which constrain or modify the general principles. These are materiality, cost benefit test, conservatism, and industry practice. Be sure to note the managerial implications associated with these.