• Administrative– 12th Edition– FARS access: SBA computer lab– Actg 199– Intro Questionnaire Due Wednesday 1/10– Sammy Skateboard Take-home quiz due Wednesday

1/17– Class website

• Review syllabus• Chapter 1

AgendaAgenda

How to do Well in this CourseHow to do Well in this Course

Memorize Comprehend and Apply

•Read ahead - cramming won’t work

•Seek understanding, not memorization

•Take notes while reading the text

•Consider study groups – learn by teaching

•Assess your time: plan on 4 hrs/week for class and 8 hours prep time (2nd most difficult SBA course)

• What do you think accounting is?

• Is accounting an art or a science?

• What are accounting disciplines?

• What is common between all accounting’s disciplines?

OverviewOverview

Sender Message Receiver

? ? ?

Purpose:

Rules:

As a Macy’s sales manager, what type of information do you want?

Managerial AccountingManagerial Accounting

Sender Message Receiver

? ? ?

Purpose:

Rules:

Tax AccountingTax Accounting

Sender Message Receiver

? ? ?

Purpose: For an economic entity to send a financial message to interested parties (stakeholders)

Rules:

Financial AccountingFinancial Accounting

• Accounting identifies, measures and communicates financial information.

• This information is about economic entities.• Information is communicated to interested parties such as investors,

creditors, unions and governmental agencies.– Users are assumed to have a reasonable understanding of the business,

and to use reasonable diligence

Sender Message ReceiverEconomic entity Financial statements Stakeholders

- LLP -Investors- Partnership -Creditors- Corporation - Employees

- SEC - Union

Characteristics of Financial AccountingCharacteristics of Financial Accounting

• Demand: external parties demand financial accounting information to facilitate their resource allocation decisions– Creditors determine which firms to extend credit and at

what interest rate– Investors determine what firm stock to buy and at what

price • Supply: Firms supply financial accounting

information based on the expected economic consequences of doing so– Benefits– Costs

Supply and Demand of Financial Supply and Demand of Financial Accounting InformationAccounting Information

Does Accounting Matter for Capital Markets?

• The price of a stock is in theory set at the discounted value of the expected future cash flows to that stock

• So investors focus on estimating the future net income of the firm, as a measure (“proxy”) of those cash flows

• What does this mean for managers? If they have some leeway in the net income that the firm reports, they may be able to convince the market of a higher net income that would suddenly make the firm “worth” more

• To ensure communication between firms and stakeholders, a common understanding is needed – GAAP- the “rules” that define accepted accounting practice

• GAAP consist of authoritative pronouncements issued by certain accounting bodies

• GAAP framework is not always rigid and allows flexibility in the manner that firms may record certain transactions - example

Generally Accepted Accounting Generally Accepted Accounting Principles (GAAP)Principles (GAAP)

• Securities and Exchange Commission (SEC)– Appointed by President, reports to Congress

– Final authority on public company reporting

• American Institute of Certified Public Accountants (AICPA)

• Financial Accounting Standards Board (FASB)

• Governmental Accounting Standards Board (GASB)

• International Accounting Standards Board (IASB)– Principles-Based (not Rules-Based)

The Standard Setting Process: The Standard Setting Process: Parties InvolvedParties Involved

Who is responsible?

Securities and Exchange Commission (SEC)

Ultimate authority over U.S. financial reporting

Historically delegated its authority to private standard-setting bodies (AICPA and FASB)

SEC requires registrants to adhere to GAAP

Issues Staff Accounting Bulletins (SABs)

Financial Accounting Standards in the U.S.Financial Accounting Standards in the U.S.

Who is responsible?

American Institute of Certified Public Accountants (AICPA)Issued Accounting Research Bulletins (ARBs) from 1939 to 1959.Issued APB Opinions from 1959-1973.Today

Provides input into standard setting process and issues various documents generally considered GAAP

Responsible for Auditing Standards until PCAOB created by SOX

Develops and grades uniform CPA exam

Financial Accounting Standards in the U.S.Financial Accounting Standards in the U.S.

Who is responsible?

Financial Accounting Standards Board (FASB)

Current private sector organization in charge of accounting standard setting.

Major types of pronouncements issued: Standards and Interpretations

Financial Accounting Concepts

Technical Bulletins

Emerging Issues Task Force Statements

Financial Accounting Standards in the U.S.Financial Accounting Standards in the U.S.

• In establishing financial standards, the FASB follows a due process procedure

• The due process procedure gives time to interested persons to make their views known to the Board

• But this means that new standards development takes time, and there is a high degree of lobbying– For example, it took years to remove the pooling method of

accounting for acquisitions– SFAS 123 (1995) required stock options to be valued. However,

major lobbying efforts essentially allowed the value to be reported only as a footnote disclosure until March 2006, when SFAS 123(R) was released.

• Operate in the full view of the public

FASBFASBDue ProcessDue Process

1. Drafts and releases a discussion memorandum for identified accounting issues:

• Describes the possible accounting treatments• Describes FASB’s preliminary views on the issue

2. Receives public feedback on the discussion memorandum3. Prepares an exposure draft (proposed new accounting

standard) after analyzing and evaluating feedback4. Accepts public feedback on the exposure draft5. Decides whether to:

• Remove the exposure draft from further consideration• Revise and reissue the exposure draft• Vote upon the current version of the exposure draft (if passed by

FASB members, becomes a new accounting standard)

FASB Due Process FASB Due Process for Standard Settingfor Standard Setting

AGENDA

1

Topics for standard setting areidentified

DiscussionMemorandum

2

The FASBissuesinitial

research andanalysis

PublicHearing

34

A publichearing

isconducted

FASBFASBDue ProcessDue Process

ExposureDraft

4

The FASBissues

an exposure draft

(tentativestandard)

Final Standard

5

The FASBevaluates

responses andissues the

finalstandard

FASBFASBDue ProcessDue Process

• 1913: 16th Amendment• 1929: Black Friday stock market crash• 1933 and 1934 SEC Exchange Acts• 1939-1959: CAP (Committee on Accounting Procedure), under AICPA, is

first private body to write accounting rules: 51 ARBs (Accounting Research Bulletins)

• 1959-1973: APB (Accounting Principles Board), under AICPA issued 31 Opinions

• 1973 - present: FAF (Financial Accounting Foundation) established, in part, to financially support and appoint members to FASB

• FASB (Financial Accounting Standards Board):– issues SFAS (Statements of Financial Accounting Standards)– Includes 7 full time members

• 1984: EITF (Emerging Issues Task Force) created by FASB to provide timely guidance regarding new and unusual accounting issues

History of AccountingHistory of Accounting

House of GAAPHouse of GAAP

• FASB is considering a switch from historical-based accounting to fair value accounting: not yet at exposure draft stage

• More information needs to be provided regarding soft assets (intangibles)

• Statements may have to be prepared on a real-time basis (not just quarterly and annually)

• Providing forward-looking information, in addition to historical information

• Developing and reporting non-financial measurements

Challenges Facing Financial Challenges Facing Financial AccountingAccounting

• Pension accounting: many defined benefit plans are underfunded and now firms must put the liability on the books

• Variable interest firms and Special Purpose Entities (like Enron): had 90% interest in firms, but gave up control and therefore did not consolidate entity with debt

• Stock options:– Expensing – Senate trying to make applicable only to top 5

executives– Back-dating

Controversies in Financial Controversies in Financial Accounting NowAccounting Now

More Recent History and Challenges: SOXMore Recent History and Challenges: SOX

• The Sarbanes-Oxley Act of 2002 (SOX) was enacted to restore investor confidence following the numerous accounting scandals including Enron and Worldcom

• SOX has increased the level of corporate governance at publicly traded companies, has increased criminal penalties for corporate executives, and has increased the independence between firms and their auditors, including:– Creation of the Public Company Accounting Oversight Board (PCAOB) that

now creates auditing standards and performs CPA firm inspections– CEO and CFO certifications over financial statements and internal controls– SOX Section 404 internal control audits– Audit committee members must be independent, financially literate, must

approve all services performed by audit firm, and are responsible for retaining and terminating the auditor. In addition, the firm must disclose financial experts on the audit committee.

– Certain non-audit services prohibited by audit firm– Audit partner rotation– Prohibition on loans to executive officers and directors– Prohibition of audit if CEO, controller, CFO, or chief accounting officer was

employed by auditor and participated in audit of issuer within prior year

• Trust drives the accounting profession– SOX, PCAOB, and class action lawsuits are a

result of a breach of trust– From a broad perspective, we pay a heavy price

for low trust:• Waits at airports, audit fees

• Implications for personal conduct?

TrustTrust

An expectations gap exists between what the public thinks accountants and auditors should do and what accountants and auditors think they can do– Consider: what is earnings management? Is it

unethical?– Do accountants “manage” earnings by recording

accruals, adjustments, and depreciation?– Transparency

The Expectations GapThe Expectations Gap

The Challenges Ahead

Robert Herz, Chairman of FASB:• The most pressing challenges to our reporting system are the

need to reduce complexity and to improve transparency– The basic principles found in our accounting standards have often been

overwhelmed by detailed rules, “bright lines,” and exceptions– The detail and volume of our rules (GAAP) pose a major problem

• And make it easier for those who attempt to structure “form-over substance” arrangements to manipulate their f/s

• If Herz is successful: basic principles will be strengthened and clarified, and (just maybe) we will see less complexity on the horizon for accounting– But if the underlying transactions are complex, how can you make the

accounting for them simple?– FASB is working on integrating GAAP into one comprehensive

volume, similar to the Canadian (CICA) Handbook

The objectives are specified in Statement of Financial Accounting Concepts No. 1.The objectives are as follows:

• Information provided must be useful in investment and credit decisions.

• Information must be useful in assessing cash flow prospects.

• Information must be about enterprise resources, claims to those resources and changes therein.

Objectives of Financial Reporting Objectives of Financial Reporting by Business Enterprisesby Business Enterprises