Part A: Financial Accounting Environment

1. The Function and Primary Purpose of Financial Accounting
   1. There are a number of financial information supplier groups as well as several external user groups.  Here is a summary.
   2. The primary focus of financial accounting is on the information needs of investors and creditors.
   3. Financial statements convey financial information to external users.
      1. Balance sheet or statement of financial position
      2. Income statement or statement of operations
      3. Statement of cash flows
      4. Statement of shareholders' equity

2. The Economic Environment and Financial Reporting
   1. The capital markets provide a mechanism to help our economy allocate resources efficiently.
   2. Corporations, the dominant form of business organization in the United States in terms of the ownership of productive resources, acquire capital from investors in exchange for ownership interest and by borrowing from creditors.
   3. The investment-credit decision—A cash flow perspective
      1. A company will be able to provide a return to investors and creditors only if it can generate cash receipts from selling a product or service that exceed the cash disbursements necessary to provide that product or service.
      2. The objective of financial accounting is to provide information to investors and creditors to help them predict future cash flows.
   
   

   Concept Check The _____________________ and ____________________ or ___________ of that return are key variables in the investment decision.  See answers Information should help investors and creditors evaluate the __________, __________, and ______________ of the enterprise's future cash receipts and disbursements.  See answers

   
   
   4. Cash versus accrual accounting
      1. Over short periods of time, operating cash flow may not be an accurate predictor of future operating cash flows.
      2. The accrual accounting model provides a measure of periodic performance called net income.
      3. Net income is considered a better indicator of future operating cash flows than is current net operating cash flows.  Illustration

3. The Development of Financial Accounting and Reporting Standards
   1. Historical perspective and standards
      1.  Generally accepted accounting principles (GAAP) are a set of guidelines companies follow in measuring and reporting financial information.
      2. The Securities and Exchange Commission (SEC) has the authority to set accounting standards for companies, but always has delegated the responsibility to the accounting profession. The author of this article calls for tougher  regulations after the Enron scandal
      3. The Financial Accounting Standards Board  (FASB) currently sets accounting standards. Read about the perceptions of chief financial officers concerning the  FASB in a CPA Journal article.
   
   

   Concept Check What are Generally Accepted Accounting Principles?  See answers

   
   
   2. The establishment of accounting standards—A  political process
      1. The FASB must consider potential economic consequences of accounting standards.
      2. The FASB undertakes a series of  information gathering steps before issuing a substantive accounting standard.  How timely is the FASB's standard-setting process?
      3. The International Accounting Standards Committee (IASC) was in 1973 to develop global accounting standards. The IASC recently reorganized itself and created a new standard-setting body called the International Accounting Standards Board (IASB). The IASC acts as an umbrella organization similar to the Financial Accounting Foundation in the United States. This article in Strategic Finance examines the history of the IASC and the challenges it now faces in developing  one set of global accounting standards. Who will benefit from  International Accounting Standards?
      4. Auditors offer credibility to financial statements by verifying that they are presented fairly in conformity with GAAP.
      5. The  Public Company Accounting Reform and Investor Protection Act of 2002, commonly referred to as the Sarbanes-Oxley Act, provides for the regulation of auditors and the types of services they furnish to clients, increases accountability if corporate executives, addresses conflicts of interest for securities analysts, and provides for stiff criminal penalties for violators.
      6. Recent accounting scandals have rekindled the debate over principles-based, or more recently termed, objectives-oriented, versus rules-based accounting standards. A principles-based approach to standard setting stresses professional judgment, as opposed to following a list of rules

Part B: The Conceptual Framework

1. Purpose of the Conceptual Framework
   1. The conceptual framework does not prescribe GAAP.
   2. It provides an underlying foundation for accounting standards.
   3. The  framework consists of financial reporting objectives, qualitative characteristics of information, financial statement elements, recognition and measurement concepts, and constraints.  Here is an overview.
   
   
2.  Objectives of Financial Reporting
   1. To provide information that is useful to present and potential investors and creditors.
   2. Information is useful to investors and creditors if it helps them assess the amounts, timing, and uncertainty of prospective cash flows.
   3. Useful cash flow information includes information about economic resources, the claims to those resources, and the effects of transactions, events, and circumstances that cause changes in resources and claims.
   
   
3. Qualitative Characteristics of Accounting Information  Here is an overview.
   1. Overriding objective is decision usefulness.
   2. Primary qualities of useful information are relevance and reliability.
   3. Components of relevance are:
      1. Predictive value
      2. Feedback value
      3. Timeliness
   4. Components of reliability are:
      1. Verifiability
      2. Neutrality
      3. Representational faithfulness
   5. Secondary qualities are comparability and consistency.
   6. Constraints are cost effectiveness and materiality.
   
   
4. Elements of Financial Statements  Here is a description of each of the elements.
   1. Balance sheet elements:
      1. Assets
      2. Liabilities
      3. Equity
      4. Investments by owners
      5. Distributions to owners
   2. Income statement elements:
      1. Revenues
      2. Gains
      3. Expenses
      4. Losses
      5. Comprehensive income
   
   
5. Recognition and Measurement Concepts  Here is an overview.
   1. Recognition—an item should be recognized in the basic financial statements when it meets certain criteria.
   2. Measurement
      1. The monetary unit used in financial statements is nominal units of money without any adjustment for changes in purchasing power.
      2. Different attributes are used to measure different financial statement elements.
   3. There are important assumptions that underlie fundamental principles.
      1. Economic entity assumption
      2. Going concern assumption
      3. Periodicity assumption
      4. Monetary unit assumption
   4. There are four broad accounting principles that guide accounting practice.
      1. Historical cost principle
      2. Realization principle
      3. Matching principle
      4.  Full-disclosure principle
   
   
6. Ethics in Accounting
   1. Ethics deal with the ability to distinguish right from wrong.
   2. Many professions have articulated ethical standards in a code of ethics.
   3. There are a number of  steps that provide a framework for analyzing ethical issues.

 Here is a quiz to test your understanding of this chapter.