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Chapter 1. The Conceptual Framework and Objectives of Financial Reporting. What is Accounting Used For? . Decision Making Evaluation of past performance Expectations of future performance Allocation of Resources. Free enterprise principle. Resources will flow to the segments of the economy

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Chapter 1

The Conceptual Framework and Objectives of Financial Reporting


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What is Accounting Used For?

  • Decision Making

    • Evaluation of past performance

    • Expectations of future performance

  • Allocation of Resources


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Free enterprise principle

Resources will flow to the segments of the economy

that will use them most efficiently in the creation of new wealth


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Role of Accounting

Accounting Information

Investors


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Chapter 1 -- Learning Objective

2. Trace the evolution of generally accepted accounting principles

GAAP


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GAAP

A consensus

The conventions, rules, and procedures necessary to define accepted accounting practice


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Sources of GAAP

  • Committee on Accounting Procedures

  • Accounting Principles Board

  • Financial Accounting Principles Board


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Committee on Accounting Procedure CAP1939 - 1959

  • First private body concerned with writing accounting rules

  • Issued 51 Accounting Research Bulletins

  • Members were practicing CPAs

  • An “ad hoc” approach


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Accounting Principles Board APB1959 - 1973

  • Appointed by the AICPA

  • Primarily from public accounting

  • Issued 31 APB Opinions

  • Criticized for failing to deal with problems on a timely basis

  • Many saw a need for independence


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Financial Accounting Foundation FAFEstablished 1973

  • Appoints members of Financial Accounting Standards Board (FASB)

  • Appoints members of Financial Accounting Standards Advisory Committee (FASAC)

  • Provides financial support to FASB

  • Contributions from industry & CPA firms


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Financial Accounting Standards Board FASBEstablished 1973

  • 7 members

  • Members are full time, well paid

  • Responsible only to FAF

  • Passage of standards requires 5 out of 7 votes


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Securities and Exchange Commission

  • Appointed by President

  • Reports to Congress

  • Final authority on reporting by public companies


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International Accounting Standards

  • International Accounting Standards Committee

  • Standards less specific

  • “Principle Based”

  • Not allowed by SEC


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Accounting Standard Setting

  • A political process


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Chapter 1 -- Learning Objective

3. Relate the objectives of financial reporting as stated in the conceptual framework to the accounting process


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Conceptual Framework

  • Statements of Financial Accounting Concepts (SFACs)

  • Purpose:

    Establish the objectives and concepts to be used by the FASB in developing standards for financial reporting


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Conceptual FrameworkSFACs

  • Objectives of Financial Reporting

  • Qualitative Characteristics

  • Objectives for Nonbusiness Organizations

  • Recognition & Measurement

  • Elements of Financial Statements


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Objectives of Financial ReportingSFAC No. 1

To provide information:

1. Useful in investment and credit decisions

2. Useful in assessing future cash flows

3. About enterprise resources, claims and changes


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Chapter 1 -- Learning Objective

4. Interpret the meaning of the qualitative characteristics of accounting information enumerated in the conceptual framework


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Objectives

  • Useful for decision making

  • Information about future cash flows

  • Information about resources, claims to resources, changes in resources

    • Liquidity

    • Solvency

    • Flexibility

    • Profitability


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Qualitative CharacteristicsSFAC No. 2

  • Primary Qualities

    • Understandability

    • Relevance

    • Reliability

  • Secondary Qualities

    • Comparability

    • Consistency


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Relevance

The capacity for information to make a difference

Predictive Value

Feedback Value

Timeliness


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Reliability

User has confidence in the information:

Verifiability

Representational Faithfulness

Neutrality


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Secondary Qualities

  • Comparability—With other enterprises

  • Consistency—Period to Period

    • Changes in accounting must be to Better principles


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Constraints

Measurement and reporting practices are affected by:

Cost/benefits

Materiality

Industry practices


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Chapter 1 -- Learning Objective

5. Understand the assumptions and conventions underlying the recognition and measurement of accounting data for financial reporting


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Recognition and MeasurementSFAC No. 5

  • Recognition

    • Reporting an item in the financial statements

  • Measurement

    • The amount reported for an item in financial statements


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Recognition Criteria

  • Definition

    • Must meet definition of an element of financial statements found in SFAC No. 6

  • Measurability

    • Must be measurable with sufficient reliability

  • Relevance

    • Must be capable of making a difference

  • Reliability

    • Must be representationally faithful, verifiable & neutral


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Basic Accounting Assumptions:

Economic entity

Going concern (Continuity)

Periodicity

Monetary unit


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Basic Conventions and Practices

Cost or other measurement attributes

Revenue recognition

Matching

Conservatism

Full disclosure


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Chapter 1 -- Learning Objective

6. Distinguish among the elements of the financial statements


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Elements of Financial StatementsSFAC No. 6

Basic Building Blocks


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Elements of Financial Statements

Balance Sheet

  • Assets

  • Liabilities

  • Equity

  • Investments by owners

  • Distributions to owners

  • Comprehensive Income

  • Revenues

  • Expenses

  • Gains

  • Losses

Income Statement


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Chapter 1 -- Learning Objective

7. Understand how accounting information is used in investment decision models


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Income Statement

Growth potential

Balance Sheet

Investment Decision Model

Factors

Operating efficiency

Capital generation

Asset productivity

Financial leverage

Goal


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Chapter 1 -- Learning Objective

8. Develop an appreciation of ethical and moral considerations in business


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Decision Model

  • Determine the Facts

  • Define the ethical issues

  • Identify major values

  • Specify the Alternatives

  • Compare values and alternatives

  • Assess consequences

  • Decide


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Decision Model forEthical Dilemmas

1. Determine the facts

2. Define the ethical issue

3. Identify major values

4. Specify the alternatives

5. Compare values and alternatives

6. Assess the consequences

7. Make the decision


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