Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Environmental and Theoretical Structure of Financial Accounting 1 Insert Book Cover Picture 1-2 Learning Objectives Describe the function and primary focus of financial accounting. 1-3 Financial Accounting Environment Profit-oriented companies Not-for-profit entities Households Providers of Financial Information External User Groups Investors Creditors Employees Labor unions Customers Suppliers Government agencies Financial intermediaries Relevant Financial Information 1-4 Financial Accounting Environment Relevant financial information is provided primarily through financial statements and related disclosure notes.  Balance Sheet  Income Statement  Statement of Cash Flows  Statement of Shareholders’ Equity 1-5 The Economic Environment and Financial Reporting A sole proprietorship is owned by a single individual. A sole proprietorship is owned by a single individual. A partnership is owned by two or more individuals. A partnership is owned by two or more individuals. A corporation is owned by stockholders, frequently numbering in the tens of thousands in large corporations. A corporation is owned by stockholders, frequently numbering in the tens of thousands in large corporations. A highly-developed system of financial reporting is necessary to communicate financial information from a corporation to its many shareholders. A highly-developed system of financial reporting is necessary to communicate financial information from a corporation to its many shareholders. 1-6 Investment-Credit Decisions A Cash Flow Perspective Corporate shareholders receive cash from their investments through . . .  Periodic dividend distributions from the corporation.  The ultimate sale of the ownership shares of stock. 1-7 Accounting information should help investors evaluate the amount, timing, and uncertainty of the enterprise’s future cash flows. Investment-Credit Decisions A Cash Flow Perspective 1-8 Learning Objectives Explain the difference between cash and accrual accounting. 1-9 Cash Versus Accrual Accounting Cash Basis Accounting Revenue is recognized when cash is received. Expenses are recognized when cash is paid. 1-10 Cash Versus Accrual Accounting Cash Basis Accounting Carter Company has sales on account totaling $100,000 per year for three years. Carter collected $50,000 in the first year and $125,000 in the second and third years. The company prepaid $60,000 for three years’ rent in the first year. Utilities are $10,000 per year, but in the first year only $5,000 was paid. Payments to employees are $50,000 per year. Let’s look at the cash flows. [...]... 1-1 1 Cash Versus Accrual Accounting Cash Basis Accounting 1-1 2 Cash Versus Accrual Accounting Cash Basis Accounting Cash flows in any one year may not be a predictor of future cash flows  1-1 3 Cash Versus Accrual Accounting Accrual Accounting Revenue is recognized when earned Expenses are recognized when incurred Let’s reconsider the Carter Company information  1-1 4 Cash Versus Accrual Accounting. .. needs of external users (GAAP) 1-1 6 1-1 7 Historical Perspective and Standards Securities and Exchange Commission  1934 – present Evolution of Standard-Setting Process  1938 – 1959: Committee on Accounting Procedures (CAP)  1959 – 1973: Accounting Principles Board (APB) Current Standard Setting - FASB www.fasb.org Supported by the Financial Accounting Foundation  Seven full-time, independent voting members... Executives International www.fei.org GAAP Governmental Accounting Standards Board www.gasb.org American Accounting Association www.aaa-edu.org 1-2 0 1-2 1 FASB’s Standard-Setting Process         Identification of problem The task force Research and analysis Discussion memorandum Public response Exposure draft Public response Statement issued International Accounting Standards Board (IASB) Established... differences in accounting standards  Increase in international trade has motivated the IASB to attempt to eliminate alternative accounting treatments  1-2 2 1-2 3 Role of the Auditor Independent intermediary to help insure that management has in fact appropriately applied GAAP  1-2 4 Financial Reporting Reform As a result of numerous financial scandals, Congress passed the Public Company Accounting Reform... 2002 Sarbanes-Oxley Act for the two congressmen who sponsored the bill  1-2 5 Learning Objectives Explain the purpose of the FASB’s conceptual framework  1-2 6 The Conceptual Framework Maintain consistency among standards  Resolve new accounting problems  Provide user benefits  1-2 7 Learning Objectives Identify the objectives of financial reporting, the qualitative characteristics of accounting information,... Seven full-time, independent voting members serving for 10 years  Answerable only to the Financial Accounting Foundation  Members not required to be CPAs  1-1 8 1-1 9 Learning Objectives Explain why the establishment of accounting standards is characterized as a political process Establishment of Accounting Standards A Political Process Internal Revenue Service www.irs.gov American Institute of CPAs... information  1-1 4 Cash Versus Accrual Accounting Accrual Accounting Revenue is recognized when earned Expenses are recognized when incurred Let’s reconsider the Carter Company information  1-1 5 Learning Objectives Define generally accepted accounting principles (GAAP) and discuss the historical development of accounting standards The Development of Financial Accounting and Reporting Standards Concepts, principles,... Describe the four basic accounting principles that guide accounting practice  1-2 8 The Conceptual Framework Objectives of Financial Reporting (SFAC No 1) Qualitative Characteristics of Accounting Information Elements of Financial Statements (SFAC No 2) (SFAC No 6) Recognition and Measurement Criteria (SFAC No 5) Environment assumptions Implementation principles Implementation constraints 1-2 9 Conceptual Framework... Disclosure 1-3 1 Qualitative Characteristics of Accounting Information Decision Usefulness Relevance Predictive Value Feedback Value Comparability Reliability Timeliness Verifiability Neutrality Consistency Representational Faithfulness Practical Constraints to Achieving Desired Qualitative Characteristics Conservatism Conservatism Cost Cost Effectiveness Effectiveness Materiality Materiality 1-3 2 SFAC... or provide services to other entities in the future as a result of past transactions or events 1-3 3 SFAC No 6 Equity Equity, or net assets, called shareholders’ equity or stockholders’ equity for a corporation, is the residual interest in the assets of an entity that remains after deducting liabilities 1-3 4 SFAC No 6 Investments and Distributions Investments by owners are increases in equity resulting . function and primary focus of financial accounting. 1-3 Financial Accounting Environment Profit-oriented companies Not-for-profit entities Households Providers. Perspective 1-8 Learning Objectives Explain the difference between cash and accrual accounting. 1-9 Cash Versus Accrual Accounting Cash Basis Accounting