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Chapter 1
Introduction to Financial Reporting
Development of Generally Accepted Accounting Principles (GAAP)
¢ Generally accepted accounting principles provide a common source of authority for preparation of financial statements
£ History of GAAP in the United States
o Prior to Securities Acts of 1933 and 1934, New York Stock Exchange established reporting requirements for publicly traded companies
o 1934 Act established the SEC; The SEC is given the authority to determine GAAP
£ Sources of GAAP
o 1939–1959: AICPA’s Committee on Accounting Procedures issued Accounting Research Bulletins (ARBs)
o 1959–1973: AICPA’s Accounting Principles Board issued Opinions (APBOs)
o 1973 to present: Financial Accounting Standards Board (FASB) issues:
Statements of Financial Accounting Standards (SFASs)
Interpretations
Technical bulletins
Statement of Financial Accounting Concepts (SFACs)
¢ FASB Conceptual Framework
£ Provides the Board with a common foundation and basic reasons for considering the merits of various alternative accounting principles
£ Statements of Financial Accounting Concepts
o Do not establish GAAP
o Provide a framework for evaluating promulgated accounting principles
o #1 identifies the objectives of for-profit financial reporting
o #2 identifies the qualities and characteristics of financial reporting
o #6 (replaced #3) defines the elements of financial performance and status
Assets
Liabilities
Equity
Investments by owners
Distribution to owners
Comprehensive income
Revenues
Expenses
Gains
Losses
o #4 identifies the objectives of financial reporting by nonbusiness organizations
o #5 addresses recognition and measurement in financial statements of business enterprises
Should meet four criteria:
¨ Definition
¨ Measurability
¨ Relevance
¨ Reliability
Identifies five different measurement attributes currently used in practice:
¨ Historical cost (historical proceeds)
¨ Current cost
¨ Current market value
¨ Net realizable (settlement) value
¨ Present (or discounted) value of future cash flows
Additional Input—American Institute of Certified Public Accountants (AICPA)
¢ Although the AICPA’s primary role in the development of GAAP ended in 1973, various AICPA subdivisions continue to participate in the development of professional literature
£ Accounting Standards Executive Committee (AcSEC)
o Serves as the official voice of the AICPA in matters relating to financial accounting and reporting
£ Accounting Standards Division
o Published numerous documents considered as sources of GAAP
Emerging Issues Task Force (EITF)
¢ Established by the FASB
¢ Responsible for identifying emerging issues affecting reporting or problematic GAAP implementation issues
¢ Its statements contribute to GAAP but at a lower level than the FASB’s statements
A New Reality
¢ Enron bankruptcy
¢ WorldCom bankruptcy
¢ Sarbanes-Oxley Act of 2002
£ Requires companies to maintain adequate internal controls, and to assess the effectiveness of those controls
£ The independent auditor is required to report on management’s internal control assertions and on the effectiveness of those controls
£ Created the Public Company Accounting Oversight Board (PCAOB)
o Registers public accounting firms that audit SEC registrants
o Has authority to promulgate auditing standards to be used by registered firms in the audit of SEC registrants
o Annual certification of corporate financial statements by CEOs and CFOs are filed with the PCAOB
Traditional Assumptions of the Accounting Model
¢ Business Entity
£ The business is a separate entity from its owners
¢ Going Concern or Continuity
£ The entity will remain in business for an indefinite period of time
£ Ignores the possibility of liquidation or bankruptcy
Trump Hotels and Casino Resorts, Inc. “Accounting Impact of Chapter 11 Filing”
¢ Time Period
£ Finite reporting periods are applied to the presumed infinite life of a business
¢ Monetary Unit
£ U.S. dollar is used by domestic entities; inflation information is not presented
¢ Historical Cost
£ Unless another measure is required by specific accounting standards, assets are reported at their acquisition price
¢ Conservatism
£ Selection from various alternative reporting values is made so that the least impact on net income is achieved in the current period
¢ Realization
£ Revenue is recognized when it can be reasonably and objectively determined; depending on circumstances, this can be:
o Point of sale
o End of production
o Receipt of cash
o During production
o Cost recovery
¢ Matching
£ Revenue and costs associated with the generation of that revenue are matched (recorded in the same fiscal period)
£ Costs with no particular association to the revenue are recorded in the period they are incurred
¢ Consistency
£ The same accounting treatment is given to comparable transactions from period to period
¢ Full Disclosure
£ All facts that may influence the judgment of an informed reader must be presented in the financial statements or the accompanying notes
¢ Materiality
£ The relative size and importance of an item to the business entity
£ Does the information influence an informed reader?
¢ Industry Practices
£ Accounting and/or reporting does not conform to GAAP
£ Driven by governmental regulation and/or industry peculiarities
n Transaction Approach
£ Transactions are recorded if they
o Affect the financial position of the entity
o Can be reasonably determined in monetary terms
n Cash Basis
£ Usually not GAAP
£ Does not provide reasonable information about the earning capability of the entity in the short run
o Recognize revenue when cash is collected
o Recognize expense when cash is paid
n Accrual Basis
£ Supports the time period assumption
£ The result is more representational
o Revenue recognized when realized
o Expenses recognized when incurred
£ More complex than cash basis; numerous year-end adjustments required