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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in hole or in part, e!cept "oruse as per#itted in a license distributed ith a certain product or service or otherise on a passord$protected ebsite "orclassroo# use.

Chapter 1

%ntroduction to &inancialReporting

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in hole or in part, e!cept "or use as per#itted in a license distributed ith a certainproduct or service or otherise on a passord$protected ebsite "or classroo# use.

• ecurities Act o" 133 – -o regulate the initial o""erings and sale o" securities

in interstate co##erce

• ecurities /!change Act o" 134 – Regulate securities traded on national e!changes

– Created the ecurities and /!change Co##ission)/C*

• /C has the authority to deter#ine 'AA(• /C issues Regulation $5, hich describes disclosure

re6uire#ents "or co#panies

evelop#ent o" 'AA( in the nitedtates7Continued

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• +as the authority to deter#ine 'AA( and toregulate the accounting pro"ession

• %ssues Regulation $5, hich describes

disclosure re6uire#ents "or co#panies• %ssues &inancial Reporting Releases )&RRs*

that pertain to "inancial reporting re6uire#ents

ecurities and /!change Co##ission)/C*

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• %s a pro"essional accounting organi8ation hose#e#bers are certi"ied public accountants)C(As*

• /stablished to standing co##ittees in 13 – Co##ittee on Accounting (rocedures

– Co##ittee on Accounting -er#inology

• A%C(A replaced the to co##ittees in 19ith: – Accounting (rinciples oard )A(*

– Accounting Research ivision

A#erican %nstitute o" Certi"ied (ublic Accountants )A%C(A*

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Organization(s) Period Issued

Co##ittee on Accounting (rocedures

; Co##ittee on Accounting -er#inology

13s* and 4

tate#ents )A(s*

Accounting Researchivision

19

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• %ssues "our types o" pronounce#ents – tate#ents o" &inancial Accounting tandards

)&As*

–

%nterpretations o" &As, A(>s, and ARs – -echnical ulletins

– tate#ent o" &inancial Accounting Concepts )&ACs*• >utput o" the &A?s Conceptual &ra#eor@ proect

•

ot a part o" 'AA(

&inancial Accounting tandards oard)&A*

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/!hibit 1$17tructure o" -he &A

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• -opic is added to the technical agenda

• (ublic co##ents solicited – iscussion Me#orandu#

– %nvitation to Co##ent – +olds hearing to revie co##ents

• %ssues /!posure ra"t )/*

>perating (rocedure "or &A

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• A syste# o" interrelated obectives andunderlying concepts

• erves as the basis "or evaluating e!isting

standards o" "inancial accounting and reporting• tate#ents o" &inancial Accounting Concepts

)&ACs* – (rovide the oard ith co##on "oundation "or

considering #erits o" alternative accounting principles

• &A intends to evaluate current principles inter#s o" the concepts established

&A Conceptual &ra#eor@

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• (rovide in"or#ation use"ul in #a@ing businessand econo#ic decisions

• %n"or#ation is co#prehensible to those having a

reasonable understanding o" business andecono#ic activities

• +elps users to assess "uture cash "los

•

(ri#ary "ocus is on earnings and its co#ponents• %n"or#ation is provided about econo#ic

resources and the clai#s against thoseresources

&AC 1: >bectives o" &inancialReporting

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/!hibit 1$27A +ierarchy o" AccountingBualities

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• Assets – (robable "uture econo#ic bene"its obtained or

controlled as a result o" past business transactions

•Liabilities – >bligations to trans"er assets or provide services in

the "uture as a result o" past business transactions

• /6uity – -he residual interest in the assets a"ter deducting

liabilities

&AC : /le#ents o" &inancialtate#ents

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• %nvest#ents by oners – %ncreases in the e6uity due to trans"ers o" value to

obtain or increase onership interests )or e6uity* in it

•istribution to oners – ecrease in e6uity resulting "ro# trans"erring assets,

rendering services, or incurrence o" liabilities by theenterprise to oners

• Co#prehensive inco#e – -he change in e6uity during a period due to

transactions, events, and circu#stances "ro#nononer sources

&AC : /le#ents o" &inancialtate#ents7Continued

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• Revenues – %n"los and other enhance#ents o" assets or

settle#ents o" liabilities "ro# delivering or providing

goods, rendering services, or carrying out otheractivities related to the central operations

• /!penses – >ut"los or consu#ption o" assets or incurrence o"

liabilities "ro# delivering or providing goods, renderingservices, or carrying out other activities related to thecentral operations


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• 'ains – %ncreases in e6uity "ro# peripheral or incidental

transactions o" an entity

•

Losses – ecreases in e6uity "ro# peripheral or incidental

transactions o" an entity


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• -o be recogni8ed, an ite# should #eet the"olloing criteria – &its in to a de"inition o" ele#ents

–Measurable ith su""icient reliability

– %n"or#ation should be relevant

– %n"or#ation should be reliable

&AC 9: Recognition and Measure#ent

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• -he "ive di""erent #easure#ent attributes usedare – +istorical cost )historical proceeds*

–Current cost

– Current #ar@et value

– et reali8able )settle#ent* value

– (resent )or discounted* value o" "uture cash "los

&AC 9: Recognition and Measure#ent7Continued

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• A "ull set o" "inancial state#ents "or a periodshould sho the "olloing – &inancial position at the end o" the period

–/arnings )net inco#e*

– Co#prehensive inco#e )total nononer change ine6uity*

– Cash "los during the period

– %nvest#ents by and distributions to oners during theperiod

&AC 9: Recognition and Measure#ent7Continued

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• Accounting tandards /!ecutive Co##ittee)Ac/C* serves as the o""icial voice o" the

A%C(A

• Accounting tandards ivision publishednu#erous docu#ents – %ndustry Audit 'uides

– %ndustry Accounting 'uides

– tate#ents o" (osition )>(s*

Additional %nput "ro# A%C(A

ources o" 'AA(

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• /stablished by the &A in Duly 1E4

• %denti"ies – /#erging issues a""ecting reporting

– (roble#s in i#ple#enting authoritativepronounce#ents

• Capable o" revieing a nu#ber o" issues ithina relatively short ti#e

• %ssues state#ents that are part o" 'AA(

/#erging %ssues -as@ &orce )/%-&*

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• Maor "inancial "rauds – /nron

– ForldCo#

• uch "rauds led to the legislation calledarbanes$>!ley Act o" 2002 – ection 404 re6uires co#panies to docu#ent

ade6uate internal controls and procedures

– Must be able to assess the e""ectiveness o" theinternal controls and "inancial reporting

A e Reality

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• Re6uired by the /C to include the "olloing: – A state#ent o" #anage#ent?s responsibilities "or

establishing and #aintaining an ade6uate syste#

–

%denti"ication o" the "ra#eor@ used to evaluate theinternal controls

– A state#ent as to hether or not the internal controlsyste# is e""ective as o" year$end

–

-he disclosure o" any #aterial ea@nesses – A state#ent that the co#pany?s auditors have issued

an audit report on #anage#ent?s assess#ent

Annual Report on %nternal Controlyste#s

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• Created by the arbanes$>!ley Act

• Consists o" 9 #e#bers72 C(As, 3 non$C(As

• (ro#ulgates auditing standards "or co#panies

subect to the arbanes$>!ley Act – %#pact on the A%C(A?s role in setting auditing

standards

• &ee$based "inancial support

• C/>s and C&>s #ust certi"y the "inancialstate#ent disclosures

-he (ublic Co#pany Accounting>versight oard )(CA>*

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• (rovides a single source o" authoritative ..'AA(

• 200 Codi"ication is organi8ed in a tiered

structure – >rgani8ed into eight areas "ro# industry$speci"ic to

general "inancial state#ent #atters

– (rovides electronic real ti#e updates

&A Accounting tandardsCodi"icationG

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-raditional Assu#ptionso" the Accounting Model

• usiness /ntity

• 'oing Concern orContinuity

• -i#e (eriod• Monetary nit

• +istorical Cost

•

Conservatis#• Reali8ation

• Matching

• Consistency

• &ull isclosure

• Materiality• %ndustry (ractices

• -ransaction Approach

• Cash asis• Accrual asis

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• -he business entity is separate and distinct "ro#the oners o" the entity

• -he entity is an econo#ic unit that stands on its

on

usiness /ntity

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• -he entity ill re#ain in business "or aninde"inite period o" ti#e

• isregards possibility o" ban@ruptcy or

li6uidation• %#pacts ho assets and liabilities are #easured

and reported

•

%n case o" a threat o" li6uidation or ban@ruptcy,"inancial state#ents #ust disclose that thepresu#ption o" continuity is not applicable

'oing Concern or Continuity

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• &inite reporting periods applied to the presu#edinde"inite li"e o" a business – atural business year

–

Calendar year – &iscal year

• Allos #easure#ent o" the results o" operationsprior to the li6uidation o" a business entity?s li"e

-i#e (eriod

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• tandard o" #easure "or "inancial transactions

• .. dollar "or do#estic entities

• %n"lation: -he loss in value o" #oney

• &or countries ith signi"icant in"lation, "inancialstate#ents are adusted by an in"lation "actor

Monetary nit

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• >"ten used because it is obective anddeter#inable

• Acceptable deviations

– Fhen it beco#es apparent that the historical costcannot be recovered )usti"ied by the conservatis#concept*

– Fhere speci"ic standards call "or another

#easure#ent attribute such as current #ar@et value,net reali8able value, or present value

+istorical Cost

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• elect "ro# various #easures o" value, eachhaving reasonable support

• Conservatis# guides selection o" the alternative

that has the – Least "avorable i#pact on net inco#e and "inancial

position

Conservatis#

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• %n general, the point o" recognition o" revenueshould be the point in ti#e hen revenue can bereasonably and obectively deter#ined

• (oint o" sale – /arning process is virtually co#plete, and the

e!change value is deter#ined

• /nd o" production – Recognition o" revenue is acceptable hen the price

o" ite# is @non and a ready #ar@et e!ists

Reali8ation

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• Receipt o" cash – %t is used hen collection cannot be reasonably

esti#ated

•

uring production – Revenue is recogni8ed proportional to e""ort

• Cost recovery – Acceptable "or highly speculative transactions

• -here are #any other acceptable #ethods o"recogni8ing revenue that are usually industry$speci"ic

Reali8ation7Continued

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• Match revenue recogni8ed ith costs associated

• irect association )i.e., inventory sales and costo" the inventory*

• Costs that have no direct connection ithrevenue – yste#atic recognition, usually in the period incurred

Matching

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• a#e accounting treat#ent should be given toco#parable transactions "ro# period to period

• +elps #a@e "inancial reports co#parable

• upports trend analysis• %" a change is #ade

– Dusti"ication o" change is disclosed

–

%#pact o" the change on the "inancial #ust bee!plained

Consistency

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• Accounting reports #ust disclose all the "actsthat #ay in"luence the udg#ent o" an in"or#edreader

•Methods o" disclosure – (arenthetical e!planations

– upporting schedules

– Cross$re"erences

– otes

• Reasonable su##ari8ation o" signi"icant"inancial in"or#ation is re6uired

&ull isclosure

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• Considers the relative si8e and i#portance o" anite# to the business entity

• %##aterial ite#s not subect to concepts and

principles – +andle in #ost econo#ical and e!pedient #anner

• oes the in"or#ation in"luence an in"or#edreader o" the "inancial state#entsH – Ies, i" it is #aterial

– o, i" it is i##aterial

Materiality

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• %ndustry$speci"ic reports

• o not con"or# to general accounting guidelines – 'overn#ent regulation

– ni6ue needs or peculiarities o" an industry• /""ort to #ini#i8e but ill probably never be

co#pletely eli#inated

%ndustry (ractices

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• Record transactions that – A""ect the "inancial position o" the entity

– Can be reasonably deter#ined in #onetary ter#s

•Many transactions are non#onetary in nature – ot recorded

– May be disclosed in co#pliance ith J"ull disclosureKassu#ption

-ransaction Approach

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• Recogni8e revenue hen cash is received

• Recogni8e e!pense hen cash is paid

• sually does not provide reasonable in"or#ation

about the earning capability o" the entity in theshort run

• Acceptability – sually not accepted by 'AA(

– May be used i" di""erence beteen cash basis andaccrual basis is not #aterial

Cash asis

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• Revenue recogni8ed hen reali8ed )reali8ationconcept*

• /!penses recogni8ed hen incurred )#atching

concept*• u#erous year$end adust#ents re6uired

• More co#ple! than cash basis

•

Result is #ore representational o" "inancialcondition

• upports the ti#e period assu#ption

Accrual asis

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• old inventory "or 29,000 on credit, hich cost12,900

• (urchase inventory o" 30,000 on credit

• (aid suppliers 1E,000 "or inventory this year • Collected 19,000 "ro# previous sales

Accrual vs. Cash asis Accounting)/!a#ple*

Accrual Basis Cash Basis

ales 29,000 Receipts 19,000Cost o" ales )12,900* /!penditures )1E,000*

%nco#e 12,900 Loss )3,000*

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• o#estic accounting standards have developedto #eet the needs o" do#estic environ#ents

• %ncreased interest in the har#oni8ation due to

e!pansion o" international business and globalcapital #ar@ets

+ar#oni8ation o" %nternational Accounting tandards

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• -he nited ations )* appointed a group tostudy har#oni8ation in 1=3 – -o "acilitate develop#ent o" standards

•

>ther organi8ations – &A

– /uropean /cono#ic Co##unity )//C*

– >rgani8ation "or /cono#ic Cooperation and

evelop#ent )>/C* – %nternational &ederation o" Accountants )%&AC*

– %nternational Accounting tandards Co##ittee )%AC*

>rgani8ations %nvolved in +ar#oni8ation

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• Replaced the %AC in 2001

• tandards have been adopted in hole or in partby appro!i#ately 100 countries

– ut does not have authority to en"orce its standards• %ssues %nternational &inancial Reporting

tandards )%&Rs* – %&Rs no re"ers to the entire body o" international

standards

• /#ploys a due$process procedure si#ilar to thato" the &A to issue standards

%nternational Accounting tandardsoard )%A*

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• -he &A and the %A #et ointly in oral@,Connecticut, 2002 – Co##it to the develop#ent o" high$6uality,

co#patible accounting standards• >ther oint #eetings rea""ir#ed their

co##it#ent and agreed to the convergence o".. 'AA( and %&R

• 200= agree#ent beteen and /uropeannion alloed co#panies to drop 'AA( i""inancial state#ents ere prepared by %&R

Convergence

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• %A published an %&R "or #all and Mediu#$i8ed /ntities )M/s* in 200

• A blue ribbon panel on (rivate Co#pany

&inancial Reporting as appointed in 2010 – -he panel #ade reco##endations to the &inancial

Accounting &oundation )&A&*• &or a ne, separate board ith standard setting authority

under the oversight o" the &A&• Changes and #odi"ications to 'AA( recogni8ing the uni6ue

needs o" users o" private co#pany "inancial state#ents

&inancial Reporting tandards "or M/s

AGibson_13E_Ch01

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