Intermediate Accounting Chapter 1

Slideshow Highlights

Objectives of Financial Reporting

• Provide info useful to present and potential investors, creditors, and other users in making rational investments, credit, and similar decisions

• Help investors in assessing the amounts, timing, and uncertainty of future cash flows, and management’s ability to protect and enhance the capital providers’ investments

• Details the firm’s resources (assets), claims to those resources (liabilities), and changes in them (equity)

Essential Characteristics of Accounting

Identification, measurement, and communication of financial information about economic entities to interested parties

Financial Statements Order

1. Income Statement

2. Statement of Shareholders’ Equity

3. Balance Sheet

4. Cash Flows

GAAP

Set of guidelines companies follow in measuring and reporting financial information

SEC Role

Authority to set accounting standards for companies, but always delegates responsibility to the accounting profession

• The Financial Accounting Standards Board (FASB) currently sets accounting standards

Exceptions

Rules and interpretive releases of the SEC

FASB Standard Setting Process

1. Identify and study the problem

2. appoint a task force

3. research and analysis

4. issue a discussion memorandum

5. public response (public comment period and public hearing)

6. issue exposure draft

7. public response

8. statement issued (steps repeated if necessary)

FASB Conceptual Framework

Intended to set forth objectives and fundamentals that FASB uses when developing accounting standards.

• The foundation/theory behind accounting rules

Why do we need a conceptual framework

• Enables FASB to provide more useful and consistent pronouncement overtime

• Solve new accounting problems faster by using established concepts

• Increase users’ understanding and confidence in financial reporting

FASB has issued

Seven statements of financial accounting concepts (SFAC)

SFAC reaplaced:

SFAC 1 and SFAC 2

SFAC 8 (Objectives of Financial Reporting)

• Provide info useful to present and potential investors, creditors, etc.

• Help investors in assessing amounts, timing, and uncertainty of future cash flows

• Should provide info about assets, liabilities, and equity and changes to them

SFAC No. 8 Relevance (Fundamental Qualities)

Info helps users make decisions (predict or confirm)

Predictive Value

Confirmatory Value

Materiality

SFAC No. 8 Faithful Representation (Fundamental Qualities)

Info should accurately represent the economic reality

Neutrality

Completeness

Free of Error

Predictive Value (Relevance, SFAC 8)

• Info helps users predict future outcomes, helps users form their own expectations

Materiality (Relevance, SFAC 8)

Information is material if leaving it out or misstating it could influence a user’s decision

• A $1 error might not matter to a huge company, but a $10 million error probably does

Confirmatory Value (Relevance, SFAC 8)

Info helps users confirm or change previous expectations

Faithful Representation

Information should accurately represent the economic reality

• Completeness

• Free of error

• Neutrality

Completeness (Faithful Representation, SFAC 8)

All information that is necessary is provided

Neutrality (Faithful Representation, SFAC 8)

Company cannot select info that is necessary to favor one set of interested parties over another

Free from Error (Faithful Representation, SFAC 8)

Info that is free from error will be a more accurate (faithful) representation of a financial item. Without mistakes.

Comparability (Enhancing Qualities, SFAC 8)

Information measured and reported in a similar manner for different companies

Verifiability (Enhancing Qualities, SFAC 8)

Independent measurers using same methods obtain similar results

Timeliness (Enhancing Qualities, SFAC 8)

Information is available soon enough to affect decisions

Understandability

The quality of information that lets reasonably informed users see its significance

(presented clearly enough for reasonably informed users to understand)

Implementation Constraints (SFAC 8)

Cost effectiveness: the benefit of providing information should justify its cos

Conservatism: A practical approach that may influence certain accounting choices. Delay gains until realized.

Industry Practices: some industries have unique characteristics that may require different accounting treatment

SFAC 6 - Elements of Financial Statements

Defines 10 elements of financial statements: revenues, gains, losses, assets, liabilities, equity, investment by owners, distribution to owners, and comprehensive income

Assets (SFAC 6)

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

• What the company owns/controls that provides future benefit

Liabilities

Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

• What the company owes

Equity (SFAC 6)

Residual interest in assets of an entity that remains after deducting liabilities

• Assets - Liabilities = Equity

Investments by Owners (SFAC 6)

Owners give something of value to the company in exchange for ownership/equity

• Owner contributes $10,000 cash to the business

Distribution to Owners (SFAC 6)

Company gives assets/services/value back to owners

• Dividends

Comprehensive Income

Change in equity (net assets) of an entity during a period of transactions and other events circumstances from nonowner sources.

• Investment by owner → increases equity

• Distribution to owner → Decreases equity

• = Net Income + Other comprehensive income

Revenues

Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that consitute the entity’s ongoing major or central operations

• Inflows/increases from company’s main ongoing operations (Selling products)

Expenses

Outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations

• Salaries, rent, utlities, COGS (resources used to generate revenue)

Gains

Increases in equity from peripheral/secondary transactions. Not normal operations. Affecting the entity during a period except those that result from revenues or investment by owners.

• Selling an old building for more than book value, gaining donations, etc.

Losses

Decreases in equity (net assets) from peripheral or incidental transactions during a period except those that result from expenses or distributions to owners. Decrease in equity from not normal operations.

• Hurricane, selling asset for less than book value, selling stock at lower price

Recognition Assumptions (SFAC 5)

Economic entity - company that keeps its activity separate from its owners and other businesses. Treated as separate from its owners and other businesses.

Going concern - Assume company to last long enough to fulfill objectives and commitments into foreseeable future

Monetary Unit - Money is the common unit used to measure accounting information. Ignore inflation/deflation

Periodicity - A company’s activities can be divided into specific time periods

Measurement Principles (SFAC 5)

Measurement Principles - Accounting measurements commonly use historical cost and fair value

Revenue recognition - recognize revenue when company satisfie its performance obligation, not when cash is received

Expense recognition - let the expense follow the revenues

Full Disclosure -