100 chap 15
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Chapter 15
Accounting Principles
ACCT 100
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Objectives of the Chapter
1. Define the generally acceptedaccounting principles (GAAP).
2. Study the conceptual frameworkunderlying financial reports.
3. Study the accounting standardcompliance system in the United
States.4. Discuss the need for a set of global
accounting standards.
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Objectives of the Chapter (contd.)
5. Multiple-step income statement vs.single-step income statement.
6. Analyzing Financial Statements
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Environment and Theoretical Structure of Financial Acounting 4
1. General Accepted Accounting Principles(GAAP)
Accounting methods having substantialauthoritative support and used bybusiness entities in preparing financial
statements.
The support is from the Securities andExchange Commission (SEC).
The SEC is a government agency whichwas created by the Securities ExchangeAct of 1934.
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The Authorities Prescribe theAccounting Standards
Prior to 1973, two committees under theAICPA (American Institute of Certified PublicAccountants) were the authorities in the
private sector to be in charge of prescribingaccounting standards.
Since 1973, the financial accounting
standards board (FASB) became theauthority in the private sector to prescribeaccounting standards.
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Environment and Theoretical Structure of Financial Accounting 6
1934 CongressSEC Regulation S-X
ASR and FRRStaff Accounting Bulletins1938 Accounting Profession
AICPA
1938-1959 CAP ARBs (51)1959-1973 APB APB Opinions (31)1973 FASB . 1. Statement of Financial
Accounting Standards
2. Interpretations3. Concepts of FinancialAccounting
4. Technique Bulletins
5. Statements issued byEITF
Year Authority Official Release
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Problems Associated with AccountingStandards Developed Prior to 1973
Under CAP (Committees on AccountingProcedures) and APB (AccountingPrinciples Board), accounting standardswere developed on a problem-by-problem basis.
Accounting rule-making bodies (i.e.,CAP and APB) solved specificproblems.
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Problems Associated with AccountingStandards Developed Prior to 1973 (Contd.)
The problem-by-problem approachresulted in inconsistent accountingstandards.
The FASB developed a conceptualframework to serve as the foundation to
develop accounting standards.
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2. Conceptual Framework ofFinancial Reporting
Conceptual Framework of FinancialReporting: a system of interactiveobjectives and fundamentals which canlead to a set of consistent standards inpreparing financial reports.
The current accounting standard settingauthority (FASB) relies on thisframework to prescribe a set of
consistent accounting standards.
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Financial Reporting: A Theoretical StructureA Conceptual Framework for Financial Reporting
AssumptionsEntityGoing-Concern
Monetary unit
Periodicity
ConstraintsCost/BenefitMaterialityIndustryPractice
Conservatism
Objectives
Qualitative
Characteristicof AccountingInformation
Elements(SFAC No. 6)
Recognition andMeasurement Concepts
PrinciplesHistorical CostRevenueMatchingFull Disclosure
SFAC N0. 1
SFAC No. 8
SFAC No.5
First Level
Second Level
Third level
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SFAC No. 1(Level One of the Conceptual Framework)
Objectives of financial reporting:
Providing information
1. useful in making investment andcredit decisions;
2. useful in assessing future cash flows;
3. about entity resources, claims to theresources and changes of theseresources.
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SFAC No. 8 (Chapter 3: Qualitative Characteristics of UsefulFinancial Information ) (Level Two of The Framework)
Qualitative Characteristics of AccountingInformation
I. Primary Qualities1) Relevance
a) Predictive value
b) Confirmatory valuec) Materiality
2) Faithful Representationa) Complete
b) Neutralc) Free from error
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SFAC No. 8 (contd.)
II. Enhancing Qualitative Characteristics
1) Comparability(including consistency)
2) Verifiability
3) Timeliness4) Understandability
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SFAC No. 5 (Operating Guidelines)(Level Three of The Conceptual Framework)
Measurement and Recognition Concepts
I. Assumptions
1) Economic Entity
2) Going-concern (continuity)
3) Monetary unit
4) Periodicity (Period of time)
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SFAC No. 5 (contd.)
II. Principles1) Historical cost (exception: LCM of
inventory)2) Revenue recognition (exceptions:3) Matching4) Full Disclosure (footnote disclosure)
III. Constraints1) Cost-Benefit2) Materiality3) Industry Practice4) Conservatism
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3. The Accounting StandardCompliance System in the US
The interrelationship of the SEC andthe FASB:
FASB: the current rule making body.SEC: the enforcing agency of
securities laws and accounting
standards; regulating the stockmarket.
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4. The Need for International AccountingStandards
Companies doing business in more thanone nations found that it is hard tocomply with more than one set of
accounting standards established byauthorities in different nations.
In response to this problem,
International Accounting StandardsCommittee (IASC) was formed in 1973to develop a single set of globalaccounting standards.
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The Popularity of the InternationalAccounting Standards
IASC created International AccountingStandards Board (IASB) in 2001 to be incharge of prescribing the standards.
Since 2005, over 7,000 companies listedin the European Union used IASBstandards.
Many other countries now also use IASBstandards.
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Th C f th U S A ti
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The Convergence of the U.S. AccountingStandards and the International AccountingStandards To increase the international
comparability and the quality of USaccounting standards, the FASB has
been engaged in activities to increasethe convergence of the accountingstandards.
The FASB is working closely with theIASB toward the convergence ofaccounting standards (i.e., to develop asingle set of global standards).
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Short-Term International Convergence(source: FASB Project Updates)
The IASB and the FASB acknowledgedthat convergence of IASB standards andU.S. GAAP is a primary objective of both
Boards. To achieve this objective and to improve
the financial reporting in the US, the
FASB started a short term project,conducted jointly with the IASB, toeliminate narrow differences betweenUS GAAP and IASB standards in 2002.
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Current Compliances in the US
The U.S. firms filing reports with theSEC must use U.S. GAAP.
Foreign issuers filing reports with the
SEC can use U.S. GAAP or theinternational standards.
The SEC abolished a requirement that
non-US companies with US listingsreconcile their financial reports to USGAAP in 2007.
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Accrual Accounting and the Financial Statements 22
5. Income Statement Formats
Net sales revenue $150,000Cost of good sold (80,000)Gross margin 70,000
Operating expensesSelling, Administration and Depreciation (40,000)
Income form operations 30,000Other icome (expense):
Interest revenue $2,000
Interest expense (9,000)Gain on sale of equipment 3,000 (4,000)
Income before income tax 26,000Income tax expense (10,000)
Net income $16,000
Multiple -Step Income Statement (see
illustration 5-11 of textbook for an Example) :
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Income Statement Formats (contd.)
Single-Step Income Statement (See Illus.5-12 oftextbook)
Revenues:Net sales $150,000
Interest revenue 2,000Gain on sale of equipment 3,000
Total revenue $155,000Expenses:Cost of goods sold 80.000
Selling, administrative and depr. 40,000Interest expense 9,000Income tax expense 10,000
Total expenses 139,000Net Income $ 16,000
Accounting for Merchandising Operations 23
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Income Statement Formats (Contd.)
CGS=Beg. Inv.+Net Pur. End. Inv.
Net Pur. =Pur.PRPD + Freight-In
Selling expenses include: salariesexpense (sales related), advertisingexpense, freight-out.
Administrative expenses include:salaries expense (administrationrelated), utility expense, insurance
expense. Accounting for Merchandising Operations 24
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Financial Statement Analysis 25
6. Analyzing Financial Statements
Liquidity
Measuring a companys ability to pay
current liabilities.
Current ratio = Current Assets
Current LiabilitiesWorking Capital = Current assetsCurrent
Liabilities
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Financial Statement Analysis 27
Profitability
Indicators of how effective a company
has been in meeting its overall profit
objectives, particularly in relation to theresources invested.
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Profitability (contd.)
a. Profit margin percentage (rate of return onsales)
= Net Income
Net Sales b. Return on assets
= Net Income
Average Total Assets c. Return on comm. stockholders equity
= Net Income - Preferred Dividends
Average Stockholders Equity