Chapter 1: Financial Accounting Environment The primary focus of nancial accounting accounting is to provide information information to external users (investors and creditors) creditors) This is done ith fnancial reporting primarily through nancial statements and related disclosure notes !alance "heet ("tatement of Financial #osition) o $ncome "tatement ("tatement of %perations) o "tatement of Cash Flos o o "tatement of "hareholder&s E'uity o "tatement of %ther Comprehensive $ncome Economic Environment Financial eporting Capital Markets: provide a mechanism to help our economy allocate resources e*ciently "ole proprietorships and partnerships outnum+er corporations +ut corporations are the dominant form of +usiness organi,ation Corporation: ac'uire capital from investors in exchange for onership interest and from creditors form +orroing Initial Market Transactions: issuance of stoc-s and +onds +eteen individuals and institutions Secondary Market Transactions: transfer of stoc-s and +onds +eteen individuals and organi,ations Corporations should provide information to investors.creditors that evaluates the amounts/ timing/ and uncertainty of future cash receipts and dis+urstments Rate o Return: (dividends 0 share price appreciation).initial o investment Cash Accounting: revenue is recogni,ed hen its received received and expenses are recogni,ed recogni,ed hen cash is paid o Net Operating Cash Flo o "hortrun operating cash 2os might not +e indicative of long run cashgenerating a+ility Accrual Accounting: revenue is recogni,ed hen earned and expenses are recogni,ed hen incurred Net Inco!e"#oss o 3sed +y most protoriented companies many nonprots o The 4evelopment of Financial Financial Accounting eporting eporting "tandards $enerally Accepted Accounting %rinciples &$AA%': set of guidelines companies follo hen measuring and reporting the information in nancial statements and related notes The Securities ( )*change Co!!ission &S)C' as created +y congress to set accounting and reporting reporting standards for pu+licly traded companies5they gave it o6 to the private sector The rst +ody to assume the tas- as the committee committee on accounting procedure (CA#) •
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The Accounting #rinciples !oard (A#!) replaced CA# $n 1789 the Financial Accounting Standards +oard &FAS+' as created 8 full time mem+ers from various constituencies o o "upported +y Financial Accounting Foundation (FAF) o The )!erging Issues Task Force as created to improve nancial reporting +y dening issues ithin AA# o The Codifcation created a conceptual frameor- for the underlying accounting standards;
accounting standards (Statements of Financial Accounting Standards) International Accounting Standards +oard &IAS+': dedicated to developing a single set of glo+al accounting standards o International Financial Reporting Standards &IFRSs' o >?: sign the @oral- Agreement o @ov ?>>: "EC issues roadmap ith milestones o Bay ?>11: "EC issues discussion paper condorsemntD o o @o ?>11: "EC issues ? studies comparing AA# $F" There is an ela+orate process hen developing accounting standards o !oards receives re'uests for proects and reconsideration of standards from various sources FA"! Chairman decides to add to technical agenda or not o !oard deli+erates at pu+lic meetings o o !oard issues an Exposure 4raft o !oard holds a pu+lic round ta+le meeting on Exposure 4raft "ta6 analy,es comments and suggestions/ discussed provisions o at pu+lic meetings !oard issues Accounting "tandards 3pdate descri+ing o amendments to the Accounting "tandards Codication Encouraging >? &Sar,anse-O*ley Act': applies to pu+lic securitiesissuing entities; #rovides regulation of auditors increasing accounta+ility of corporate executives and provides sti6 criminal penalties %versight !oard o o 3nlaful for auditors to provide nonaudit services o Bust -eep or- papers for 8 years o Auitor rotation • •
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Cannot have con2ict of interest Audiors must +e hired +y +oard not company management Section ./.: re'uires management document internal controls and report on their ade'uacy
A Bove Aay from ules!ased "tandards There has +een a de+ate to move to #rinciples +ased o+ectives over ules +ased5stressed professional udgment instead of folloing a list of rules )thics: code or moral system that provides criteria from evaluating right or rong o Expected for professionals to engage in The Conceptual FrameorConceptual ra!eork: Accounting ConstitutionD provides the underlying foundation for 3" accounting standards "hon in FA"!&s "tatements of Financial Accounting Concepts %+ectives of Financial eporting ("FAC 1/ replaced +y "FAC ) o #rovide nancial reporting to companies that is useful for capital providers in decision ma-ing ualitative Characteristics ("FAC ?/ replaced +y "FAC ) 0ecision 1seulness: main purposeG su+divided into5 o Rele2ance o %redicti2e 3alue.Confr!atory 3alue: a+ility of reported earning to predict a company&s future earnings Material: if omitting.misstating could a6ect users& decisions Faithul Representation: agreement +eteen a measure o and the phenomenon it purports to represent Completeness @eutrality Free from Error Bany accountants employ conservatism o Enhancing ualitative Characteristics Compara+ility Consistency: among di6erent reporting periods Heria+ility Timeliness 3nderstanda+ility: if users can comprehend it Iey constraint is cost e6ectiveness: the +enets of nancial o -noledge must exceed the cost of getting it Elements of Financial "tatements ("FAC 9/ replaced +y "FAC =) Assets: pro+a+le future economic +enets o o+tained.controlled •
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#ia,ilities: pro+a+le future sacrices of economic +enets arising from present o+ligations o )4uity: shareholders.stoc-holders e'uityG residual interest in the assets of an entity after deducting its lia+ilities In2est!ents ,y oners: increased in e'uity o 0istri,utions to oners: decreases in e'uityG transfer to o oners o Co!prehensi2e inco!e: change in e'uity during a period Re2enues: in2os of assets.settlements of lia+ilities o )*penses: out2os.using up of assets o $ains: increases in e'uity from transactions of an entity o o #osses: decreases in e'uity from transactions of an entity Financial eporting for @onprot %rgani,ations ("FAC J) ecognition Beasurement ("FAC K "FAC 8) o Recognition: the process of admitting information into the nancial statements 4enition: item meets denition of element in nancial statement Beasura+ility: item has relevant attri+ute measura+le ith su*cient relia+ility elevance: information is capa+le of ma-ing a di6erence in decisions elia+ility: information represented faithful/ veria+le/ neutral Reali5ation principle: ? criteria must +e met +efore revenue can +e recogni,ed: earning process is udged to +e completed there is reasona+le certainty to the collecta+ility of the asset Allo for accrual accounting #ointofsale: triggers recognition of revenue Matching %rinciple: expenses should +e recogni,ed in the period in hich they produced revenues: +ased on causee6ect relationship % associating an expense ith revenues recogni,ed % a systematic rational allocation % in period incurred/ regardless of related revenues Measure!ent: process of association numerical amounts o ith the elements
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AA# gives a company the option to value nancial assets.lia+ilities at their fair value Fair Halue
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Chapter ?: evie of the Accounting #rocess The !asic Bodel )cono!ic )2ents: cause changes in the nancial position of the company )*ternal )2ents: involve an exchange +eteen the company and another entity Internal )2ents: do not involve an exchange transaction +ut do a6ect the company&s nancial position The Accounting )4uation: Assets6#ia,ilities7 Oner8s )4uity o #ortrays e'uality +eteen the total economic resources of an entity and its total claims Each event (transaction) ill have a dual e6ect +ecause o resources must alays e'ual the claims •
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Assets M
Nia+ilities
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0 "hareholderOs E'uity
Expenses.Noss es
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)evenues.:ain s
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%er!anent Accounts: represents +asic nancial position elements of the accounting e'uation (assets/ lia+ilities/ shareholders e'uity) Te!porary Accounts: represents changes in the retained earnings component of shareholder&s e'uity (revenue/ expenses/ gain and losses) The Accounting #rocessing Cycle 1; %+tain information a+out transactions from source documents ?; Analy,e the transaction (transaction analysis) 9; ecord the transactions in the ournal J; #ost from the ournal to the general ledger accounts ( posting ) $; %erpetual In2entory Syste!: cost of merchandise is recorded in the inventory and hen inventory is sold the inventory account is decreased +y the cost of the item sold $$; %eriodic In2entory Syste!: Cost of merchandise is recorded in a temporary #urchases account; Cost of goods sold is determined at the end of the period and inventory account is then adusted (+eginning inventory 0 purchases P ending inventory M cost of goods sold) •
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i; C%" xx $nventory x #urchases xxx #repare an unadusted trial +alance ecord adusting entries $; #repayments: cash 2os proceed either expense or revenue recognition 4epreciation Expense 1> Accumulated 4epreciation 1> 3nearned ent evenue 1> ent evenue 1> $$; Accruals: occur hen the cash 2o comes after either expense or revenue recognition salaries expense 1> salaries paya+le 1> $$$; Estimates #repare an Adusted Trial !alance #reparation of Financial "tatements
$; Inco!e State!ent: a change statement that summari,es the prot generating transactions that caused stoc-holder&s e'uity to change during the period (evenuesExpensesM@et $ncome) $$; State!ent o Co!prehensi2e Inco!e: reports the changes in stoc-holder&s e'uity that ere not a result of transactions ith oners $$$; The +alance Sheet: a position statement that presents an organi,ed list of assets/ lia+ilities/ and e'uity at a particular point in time i9 Current assets"lia,ilities: can +e converted into cash.ill +e satised ithin 1 year or the operating cycle (hichever is longer) I39The State!ent o Cash Flos: a change statement that summari,es the transactions that caused cash to change during the period i9 Operating Acti2ities: in2os and out2os of cash related to transactions entering into the determination of net income ii9 In2esting Acti2ities: involve the ac'uisition sale of longterm assets used and nonoperation investments assets iii9 Financing Acti2ities: nancing activities involving cash in2os and out2os from transactions ith creditors and oners 39 The State!ent o Shareholder8s )4uity: a change statement that discloses the sources of changes in the permanent shareholder&s e'uity accounts i9 Add paid-in capital/ deduct dividends 9 Close the Temporary Accounts to $ncome "ummary and then into etained Earnings "ales evenue 1> $ncome "ummary 1> $ncome "ummary 1> Expense Accounts 1> $ncome "ummary ?> etained Earnings ?> 1>; #ostClosing Trial !alance (at year end only)
