Introduction to Intermediate Accounting
Key Things to Know
Financial Accounting and its purpose:
A system to provide “quantitative information” about economic entities
to external users
Record / Classify / Summarize financial information
Consist of transactions: everything the business does - measured in money
(Millions of transactions – the accountant keeps track of and summarizes)
Financial accounting provides the information investors and creditors need to know in
order to make decisions about allocating capital.
Capital Markets: Assist with the allocation of resources – investors and creditors
Provide cash / expect to receive more cash in the future
Objectives of accounting and financial reporting: Provide info to investors and creditors:
1. useful in making rational investment and credit
decisions
(understandable by those who have a reasonable understanding of
business/economics that are willing to study the information)
2. assess amounts, timing, uncertainty of
cash flows
3. about the
economic resources (assets) and claims to resources
(liabilities): effects of transactions, events, circumstances that may
change the economic resources of the company.
Cash versus Accrual:
Cash Method: Record revenues and expenses when cash is received or paid
Provides “net operating cash flow”: cash receipts less cash disbursements
Does not match revenues and expenses over a short period of time
Accrual Method: Record revenues and expenses when earned and incurred
When cash is received or paid does not matter
Record and recognize in the financial statements:
Revenues: Earned and believe you will receive the cash, an exchange occurs
Expenses: Incurred (receive the benefit) in support of the revenue process
Measures accomplishments (revenues) and resources used (expenses) during a period of time
Net Income: The difference in revenues and expenses during the period
The accrual method is required under GAAP
Accountants have developed accounting rules to achieve financial reporting objectives:
GAAP – (Generally Accepted Accounting Principles)
Provides a means of comparison among companies
Ever changing set of broad principles and guidance that provides a
consensus at a particular time on how business transactions should be
recorded and reported
Evolution of GAAP:
1933 – 1934 Securities Exchange Commission (SEC):
Created by Congress – has the legal authority to establish accounting
standards for public companies but has delegated this responsibility to
the accounting profession (currently FASB)
The SEC also issues its own accounting standards in the form
of “Financial Reporting Releases”
1930s CAP – Committee on Accounting Procedures
Associated with American Institute of Accountants “AIA” which was
renamed American Institute of CPAs “AICPA” in 1959 which is the
national organization of professional public accountants
Published 51 Accounting Research Bulletins (ARBs)
1959 APB – Accounting Principles Board (replaced the CAP) part-time
Published 31 APB Opinions, Interpretations and 4 statements
APB Statement #4 – “Basic Concepts and Accounting Principles
Underlying Financial Statements and Business Enterprises”
was not accepted by the accounting profession
APB had part time members and was criticized for not acting timely
and a perceived lack of independence
1973 – FASB Financial Accounting Standards Board (7 voting members)
Independent private sector body
Supported by the Financial Accounting Foundation (“FAF”)
Full time employees, large research staff
Resolve various accounting issues in the changing business
environment
Issued “Accounting Concepts” – theory / basis for accounting rules
and 150 + Statements that provide guidance on specific issues
EITF – Emerging Issues Task Force; part of FASB.
Formed to provide more timely specific guidance on how to account
for business transactions – “EITF Issues”
Identifies potential problems and issues
FASBs Conceptual Framework:
FASB issued 7 statements of conceptual framework called
Statements of Financial Accounting Concepts (SFACs)
See Accounting Concepts
FASB Standard Setting Process:
1. Identify the problem
2. Establish a task force of approximately 15 knowledgeable people
3. Research and investigate the issue
4. Issue a Discussion Memorandum – analysis and alternative solutions
5. Public Response – hold public hearings, responses sent to FASB
6. Issue Exposure Draft – preliminary proposal of solutions
7. Public Response to the exposure draft
8. Issue a FASB Statement to address the issue
GAAP Hierarchy:
1. ARBs and APB Opinions that are not superseded by FASB
FASB statements, interpretations and staff positions
Also SEC rules and interpretations for public companies
2. FASB technical bulletins and AICAP audit and accounting guides and
Statements of Position
3. AICPA Accounting Standards Executive Committee Practice Bulletins
4. Implementation guides published by FASB staff and AICPA interpretations
and industry practice guides
Global Accounting Standards:
International Accounting Standards Committee (IASC) –
formed in 1973 to develop global accounting standards
International Accounting Standards Board (IASB) –
formed in 2001 to establish international accounting standards
Structure is consistent with FASB in the United States
Goals of IASB:
1. Develop a single set of high quality, understandable global
accounting standards
2. Promote the use of those standards
3. Bring convergence of national accounting standards and
international accounting standards
Currently issuing: International Financial Reporting Standards (IFRSs)
Compliance is voluntary, no authority to enforce
In 2002, FASB and IASB signed the Norwalk Agreement, formalizing a commitment to converge US GAAP and IFRS. Future accounting issues will be resolved working together
The Role of the Auditor:
Make sure that management has appropriately applied GAAP in preparing the
company’s financial statements
Examine the statements and give an “opinion” on whether or not the company
has fairly presented the financial position in accordance with GAAP
and internal controls are adequate to prevent misstatement.
Sarbanes Oxley:
Public Company Accounting Reform and Investor Protection ACT of 2002
Increases accountability of corporate executives and provides stiffer penalties
Regulates auditors and services provided to clients
Addresses conflict of interest; prohibits auditors from providing non audit services
Section 404: Requires documentation and audit/opinion related to adequacy
of internal controls
Established the Public Company Accounting Oversight Board (PCAOB)
Authority to provide auditing standards
Principles Based vs. Rules Based
Principles / Objectives Based: accounting is applied based on profession judgment
to achieve an objective rather than on specific rules
Rules Based: accounting is applied based on following specific rules
