Chapter 1. Learning Objective 1, 2. Capital Allocation. Efficient Capital Allocation. Financial Accounting and Accounting Standards

Transcription

1 Chapter 1 Financial Accounting and Accounting Standards Learning Objective 1, 2 Identify the major financial statements and other means of financial reporting Explain how accounting assists in the efficient use of scare resources Capital Allocation Free market, capitalist economy Business separate entity, cash needed Loans from lenders Investments from owners Lenders and investors need information to allocate resources efficiently Which company to lend to? Which company to invent in? Efficient Capital Allocation Apple Market Value 1

2 Efficient Capital Allocation Efficient Capital Allocation General Motors Stock Price Capital Allocation Efficient process of capital allocation Increases employment, wages Promotes productivity, innovation Increases wealth of nation: Adam Smith Focus on information needs of Investors Lenders Process Of Accounting Identify Measure Communicate 2

3 Financial Accounting Financial, Managerial Identify, measure, communicate financial information About economic entities Publically traded corporations To interested parties Lenders Investors Financial Accounting For decision makers outside the business Investors Creditors Managers Government regulators Tax authorities News reporting Managerial Accounting For decision makers inside the business Budgets Forecasts Cost to produce Buy or lease Sell or process further Internal rate of return Four Financial Statements Income statement Statement of stockholders equity Balance sheet Statement of cash flows History measured in money terms Financial Statements Financial information provided by Financial statements Disclosure notes Note disclosures are an integral part of each financial statement Learning Objective 3 Objectives of Financial Reporting Objective of Financial Reporting Provide financial information about the reporting entity that is useful to present and potential Equity investors Lenders and other creditors To help them make better decisions in their capacity as capital providers 3

4 General-Purpose Financial Statements Provide financial reporting information to a wide variety of users Provide the most useful information possible at the least cost Entity Perspective Business is a separate entity Separate from owners (stockholders) Separate from other businesses Separate from vendors Separate from customers Accounting records of business record assets, liabilities, equity of business only Decision-Usefulness Management s ability to protect and enhance capital providers investments Will business succeed and be able to Pay principal and interest on time (lender) Increase stock price, dividend (investor) Decision-Usefulness Predict future net cash inflows Amount Timing Uncertainty (risk) In long run most important information: cash inflows and cash outflows Accrual Accounting Accrual accounting better predictor of future cash flows than cash basis Separate recognition of revenues and expenses from movement of cash Record revenues when earned, not when cash collected Record expenses when incurred, not paid Learning Objective 4, 5 Need for Accounting Standards Parties in Standard Setting Process 4

5 Sources of GAAP 1. Authoritative group pronounced a rule 2. Over time practice accepted because of universal application Who Writes GAAP? SEC Securities and Exchange Commission AICPA American Institute of CPAs Predecessor organizations (AIA) FASB Financial Accounting Standards Board Historical Perspective Securities and Exchange Commission SEC created by congress in 1934 Authority to set accounting standards Delegated responsibility to actg profession AIA / AICPA / FASB SEC can and does issue rules Financial reporting releases (FRRs) Securities and Exchange Commission Rarely writes rules itself May request or reject proposed rule Requires public companies, accounting professionals, to follow to GAAP Publically traded companies submit financial statements to SEC SEC action: deficiency letter, stop order Historical Perspective Committee on Accounting Procedures (CAP) Committee of AIA (Amer Inst Accountants) 51 Accounting Research Bulletins (ARB) Case-by-case basis No framework Historical Perspective Accounting Principles Board (APB) Committee of AICPA 31 Board Opinions (APBOs) Case-by-case basis Attempted to create framework, failed Wheat Committee recommendations adopted in 1973, created FASB 5

6 Historical Perspective Financial Accounting Standards Board (FASB) 1973 Present Currently sets accounting standards Independent from AICPA Financial Accounting Standards Board Differences: FASB and CAP, APB Smaller membership (7) Full-time, paid members Greater autonomy (not part of AICPA) Increased independence (FASB work only) Broader representation (diverse groups) Financial Accounting Standards Board Establish and improve standards of financial accounting and reporting For guidance and education of Public Issuers Auditors Users FASB Due Process Responsive to needs and viewpoint of entire economic community Lenders, investors, regulators, preparers, CFOs, auditors, news organizations, public Operate in full view of public Three Part Structure FAF (Financial Accounting Foundation) Selects members of FASB, FASAC Provides funding, oversight FASB FASAC (Fin Acc Standards Adv Coun) Advise FASB on policy, technical issues, priorities, management of task forces Steps to Pronouncement 1. Topic placed on agenda 2. Research conducted and Discussion Memorandum issued 3. Public hearing For information on FAF, FASAC go to fasb.org/facts 6

7 Steps to Pronouncement 4. Board evaluates research, public response and issues Exposure Draft 5. Board evaluates responses and issues Statement of Financial Accounting Standard FASB Pronouncements Accounting Standards Updates Modify Codification (new rule or change) Emerging Issues Task Force Statements Financial Accounting Concepts Emerging Issues Task Force Address new or unusual issues If possible reach decision quickly Months rather than years EITF decisions approved by FASB Avoid long FASB deliberation process Financial Accounting Concepts Objectives and concepts used to develop future rules Guide for solving problems in a consistent manner Conceptual framework Not GAAP AICPA AICPA no longer issues GAAP AICPA publishes best practices Accounting Guides, Practice Bulletins Statements of Position (SOP) Develops, grades CPA examination Not problem-by-problem approach to standard setting used in past 7

8 Learning Objective 6 Generally Accepted Accounting Principles GAAP Authoritative Support AICPA Code of Professional Conduct requires CPAs to prepare financial statements in accordance with GAAP SEC requires all publically traded companies to file financial statements based on GAAP each quarter Major Sources of GAAP GAAP Documents All official pronouncements since 1939 FASB Standards, Interpretations APB Opinions Accounting Research Bulletins And more SEC authoritative pronouncements Accepted industry practices Codification GAAP on a website Codification only authoritative source No more hierarchy of GAAP Free access using Basic View See WebAccess for login ID and password Codification login 8

9 Learning Objective 7 Role of user groups in developing GAAP Political Environment Accounting standards developed by Careful logic Empirical findings Lobbying by Corporations Regulators Consumer groups Elected representatives (Congressmen) Political Environment Political Process Accounting rules create winners, losers FASB considers potential economic consequences of accounting standards Political Process Controversial issues in recent years Employee stock options Employee postretirement benefits Business combinations FASB undertakes a series of information gathering steps before issuing a new standard Political Process Employee stock options Technology firms pay key employees with stock options; no expense on I/S because value of options when granted is $0 Employee postretirement benefits Unions want B/S liability to be smaller Business combinations How much is recorded as Goodwill and how much is recorded as expense 9

10 Role of Auditor Independent judge Ensure management has properly applied GAAP Issue opinion on financial statements Sarbanes-Oxley act changed auditing Sarbanes-Oxley Act In 2002, Enron, Tyco and Worldcom Congress passed Sarbanes-Oxley (Sarbox or SOX) Created Public Company Accounting Oversight Board (PCAOB) PCAOB oversees the development of auditing standards Sarbanes-Oxley Act Stronger independence for auditors Audit partners rotate every five years Auditors prohibited from offering certain types of consulting services CEOs, CFOs Personally certify financial statements Forfeit bonuses, profits when there is accounting restatement Sarbanes-Oxley Act Audit committees must be independent members with financial expertise Requires codes of ethics for senior financial officers Section 404 Internal controls are a system of procedures designed to prevent and detect fraud and errors Section 404 requires public companies to document effectiveness of controls Compliance very expense in early years Learning Objective 8 Challenges facing accounting 10

11 Challenges Facing Accounting Nonfinancial measurements Forward-looking information Soft assets Timeliness GAAP only looks backwards at what it can measure Nonfinancial Measurements Important information that will effect future profits not measured by GAAP Customer satisfaction Employee morale Consumer trends Actions by competitors Forward-looking Information Management may give guidance Not permitted in financial statements or notes prepared using GAAP GAAP presents accumulation of past Soft Assets Financial reports focused on hard assets (inventory, plant assets) Important factors not quantifiable Microsoft's market dominance Dell's marketing structure IBM s well-trained employees J. Crew's brand image Timeliness Financial statements quarterly Audited financials annually No real-time information available Learning Objective International Financial Reporting Standards 11

12 International Standards Global companies, capital markets Two standards commonly used USA: GAAP, issued by FASB Outside USA: International Financial Reporting Standards (IFRS), issued by International Accounting Standards Board (IASB) International Accounting Standards Board Develop a single set of high quality, understandable global accounting standards Promote use of those standards Bring about the convergence of national accounting standards and international accounting standard International Standards Past: SEC required non-us companies with shares on US exchanges to prepare GAAP financial statements Now: SEC accepts IFRS financial statements for non-us corporations IFRS, GAAP Differences GAAP: Rules-based IFRS: Principles-based (also called objectives-oriented) Principles approach sets broad objectives (record revenue when earned) and relies on professional judgment, not list of rules Principles vs. Rules Problems with rules Possible to follow letter but not spirit of rule Need rule for every issue Many complex rules accumulate Problems with principles Different judgments for similar situations Less comparability between companies Discretion can be abused Problems with IFRS in US GAAP imbedded in US laws Loan agreements based upon GAAP Protecting home industries, carve outs Different agendas (social good vs profit) Lawsuits in US, not other countries 12

13 Convergence Timeline issued by the SEC in 2008 FASB committed to convergence One set of rules OR Narrow differences between IFRS, GAAP Most accounting guidelines now same See WebAccess (EY, PWC reports) GAAP vs IFRS comparison In 2014 SEC declared US will continue to follow GAAP When possible, new standards will be issued jointly When agreement not reached, IFRS and GAAP will differ Learning Objective 9 Ethical issues Ethics in Accounting Doing the right thing is not always easy or obvious Management may be under pressure to report desired results and bend rules A high standard of ethical behavior is expected of the accounting profession Ethics in Accounting Beliefs that lead to unethical actions No one will know No one will be harmed Everyone else is doing it I will not get caught I deserve this Ethics in Accounting Test for unethical action I am changing my opinion due to pressure Find mentor outside of organization to discuss ethical issues 13

14 End of Chapter 14