Chapter 1: The Demand for and Supply of Financial Accounting Information Class will cover: Class Intro & Environment Of Financial Reporting Problems and/or Exercises: None specified Class Notes ∙ Introduction and syllabus review ∙ No curving of individual assignments and no bonus. May curve final grades ∙ Attendance is important. ∙ Files kept on dropbox, not on canvas. ∙ TA hours in 301 Lowder - conference room. If not there, it will be posted on the door. ∙ Grades won't be posted in canvas. Grades will be emailed in detail. ∙ Chapter 3 can be difficult. ∙ Exam 2 is mostly memorization ∙ Exam 3 is usually best exam grade on average ∙ Exam 4 is "death exams" - accounting for bonds is horrible ∙ Final exam isn't too bad ∙ "Homework" is not graded, but he recommends you work them repeatedly until you are comfortable solving them ∙ Financial accounting is for external users ∙ Publicly traded companies required by SEC to publish statements, and there are guidelines and rules (GAAP) ∙ A = L + SE - Accounting Equation ∙ S.E. - If a business needs a dollar, it can 1) borrow, 2) owners contribute, 3) the business makes/earns the dollar. ∙ CC vs. RE - contributed capital vs retained earnings ∙ A list of numbers doesn't tell people everything. We label transactions so that users of financial statements can understand what the numbers mean ∙ Not all labels are included on balance sheet, so we use temporary accounts and other statements to keep track of the labels. ∙ Core financial statements ∙ Balance sheet ∙ Income statement ∙ Statement of changes in stockholders' equity ∙ Left side of equation goes up = debit. Right side of equation goes up = credit. Contra accounts are opposite. ∙ DEAD CRLS ∙ Debits increase expenses, assets, and dividends ∙ Credits increase revenues, liabilities, and stockholders' equity ∙ SEC, FASB in CH. 1 ∙ Ch2 is conceptual framework - fundamental characteristics, enhancing characteristics and cost constraintChapter 2: Financial Reporting: Its Conceptual Framework Class will cover: Conceptual Framework Problems & Exercises: E1, E2 Chapter 1 - Powerpoint ∙ In corporations, conflict of interest can more frequently arise ∙ Separation of ownership and control o When things aren't going well, agents have incentive to lie o In comes GAAP, audits, and so on ∙ SEC created in 1933-34 after huge stock market crash o Delegates authority ∙ GAAP standards set by FASB ∙ IFRS standards set by IASB o Be familiar with SEC forms (slide 8)***** ∙ FASB board members are appointed from mix of backgrounds o Academic, industry, legal, public o No ties to industry once appointed - paid by FASB o Sometimes meetings get tense ∙ IASB is one group who set IFRS ∙ US is the most sophisticated standards ∙ US has agreement (Norwalk Agreement) with IASB o No LIFO with FASB ∙ Big players in the US o SEC o AICPA o EITF o IRS o AAA o IASB o GASB o BCAOB o Professional Organizations ∙ FEI ∙ IMA ∙ CFAI ∙ 4 financial statements, notes to financial statements, and MD&A o Balance sheet (statement of financial position) o Income statement (P&L) o Statement of cash flows o Statement of changes in S/E (statement of changes in Retained Earnings)
Comply with applicable laws and regulations regarding how business is run ♦ Who are the Stakeholders?
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Claims on assets
Claims on assets
Contributed capital or Retained earnings
∙ Income statement shows changes in Retained Earnings ∙ Statement of cash flows and Statement of Changes in S/E are secondary financial statements o Cash flows in 3 sections ∙ Operating activities ∙ Investing activities ∙ Financing activities ∙ Cash flows is king (but complicated) ∙ Notes to financial statements are integral. How we came up with numbers is in the notes (FIFO vs. LIFO, Depreciation method, etc.) ∙ MD&A o Talks a lot about financial statements o not super important to us Chapter 1 is 5% of first Exam Don't need to know ∙ Why is ACCT important 1-33 ∙ Ethics and Integrity in Accounting Profession 1-34 Chapter 2 Notes ∙ Slide 8 is VERY IMPORTANT ∙
∙ Relevant ∙ Predictive value ∙ Confirmatory value ∙ Materiality - omission or misstatement of info would influence judgement of someone looking at statement ∙ Deals with size/magnitude ∙ Deals with nature of information even if size is immaterial∙ Faithful Representation ∙ Complete representation (full disclosure) ∙ Neutral - unbiased ∙ Free from error - clerical errors specifically (no obvious mistakes) ∙ Enhancing Qualitative Characteristics ∙ Comparability ∙ Compare one company to another ∙ Compare one year of a company to the previous year(s) ∙ Verifiability ∙ Timeliness ∙ Understandability ∙ Accounting Assumptions and Principles ∙ Reporting entity ∙ Going concern - if auditor believes company won't make it another year, they must disclose in audit ∙ Period of time ∙ Monetary unit ∙ Mixed attribute measurement - in some cases, measure using fair/current values, other cases using historical values ∙ 2 assets ▪ Share of stock - easily measured - current price ▪ Piece of land - could pay for appraisal, but maybe the only way to know for sure is to sell it, which means historical cost is good ∙ Historical cost ∙ Recognition ∙ Meet definition of element ∙ Be measurable ∙ Be relevant ∙ Be representationally faithful ∙ Accrual accounting - recognize economic effects in the period they occur, regardless of when payment occurs ∙ Revenue is revenue when performance obligation is satisfied ∙ Expense recognition - review slide 18 ∙ Conservatism - take care to not overstate assets and income in the current period Do additional exercises in the Notes folder (dropbox). Solutions are posted there as well. https://www.dropbox.com/sh/82n0cfcebnpdpr9/AACkzcXFGf_neW1czX276Xd5a?dl=0Board Work
CC & R/E
What Do They Need to Know?
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Beginning R/E + Net Income - Dividends Ending R/E Revenues - Expenses = Net Income Debit CreditAssets = Liabilities + Stockholders' Equity Intermediate Accounting: Notes for Chapter 1 Key Vocabulary for Chapter 1
Professional standards (U.S. GAAP and IFRS) for how companies should account for and report revenues, expenses, assets, liabilities, and equities that provide the concepts, rules, guidance, and methods that principals and agents need to measure and report financial statements that are relevant and representationally faithful.
Company executives, managers, and employees, who have been hired to run the company's daily business activities.
The process of providing financial statement information to stakeholders of a firm.
Transactions involving obtaining resources from owners and providing them with a return on their investment as well as borrowing money from creditors and repaying those obligations.
Generally Accepted Accounting Principles (U.S. GAAP)
The principles, concepts, guidelines, methods, and practices that regulated companies in the U.S. are required to use in preparing and reporting the accounting information in financial statements for use by external stakeholders and decision makers.
Audits performed by auditors who are typically external, independent experts in accounting and who can carefully evaluate a company's accounting records and verify whether the company has applied the accounting standards and principles fairly and consistently.
information asymmetry problems
Problems that arise due to unequal information between two parties.
International Financial Reporting Standards (IFRS)
A general term that describes an international set of generally accepted accounting standards issued by the IASB.
Transactions that involve acquiring and selling productive assets and investments needed to achieve the operating objectives of the business.
Part of the day-to-day business activities of a company—acquiring (purchasing or manufacturing), selling, and delivering goods and services to customers.
Providers of capital to the firm, such as common shareholders and lenders.
separation of ownership and control
The investors and creditors (principals) who have provided financial capital to a firm own the resources but are separate from the executives, managers, and employees (the agents) who have day-to-day control of those resources.
Individuals or entities that have a claim on the firm (such as investors, lenders, and creditors) or a relationship with the firm (such as employees).
♦ What Drives Stakeholders’ Demand for Accounting Information?
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Financial Accounting Standards Board (FASB)
The primary accounting standard-setter in the United States which has been granted the authority to set standards by the Securities and Exchange Commission.
The form used by U.S.-based registrants to file their annual reports (including annual financial statements) with the SEC.
The form used by registrants to file their quarterly reports (including quarterly financial statements) with the SEC.
The form used by non-U.S. registrants to file their annual reports (including annual financial statements) with the SEC.
The form used by SEC registrants to report significant events that may affect the company.
International Accounting Standards Board (IASB)
An independent, privately funded accounting standard-setting body that establishes IFRS for companies from countries around the world and has the goal of developing a single set of high-quality accounting standards that result in transparent and comparable information reported in general purpose financial statements.
A report filed with the SEC when the management of a company requests the right to vote through proxies for shareholders at shareholders' meetings.
Securities and Exchange Commission (SEC)
The agency within the U.S. Government with formal responsibility and authority to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
Emerging Issues Task Force (EITF)
Technical experts in accounting that work with the FASB to identify emerging accounting issues and to develop consensus positions on implementation and application of accounting standards.
Accounting Standards Update
A new standard issued by the FASB.
FASB Accounting Standards Codification
An electronic database that integrates and topically organizes the U.S. GAAP into one coherent body of literature.
International convergence of accounting standards
The ongoing effort by the FASB, the IASB, and others to attempt to converge IFRS and U.S. GAAP into one set of global financial reporting standards.
The company's economic resources.
An opinion from an independent auditor about whether a company has prepared its' financial statements fairly and consistently under U.S. GAAP or IFRS.
An opinion from an independent auditor about whether a company has prepared its' financial statements fairly and consistently under U.S. GAAP or IFRS.
Also known as the statement of financial position, the balance sheet reports the resources of a firm (assets) and the claims on those resources (liabilities and shareholders' equity) as of a specific date (usually the last day of the fiscal quarter or the fiscal year). The balance sheet reports the following equality: Assets = Liabilities + Shareholders' Equity
The change in equity of a company during a period from transactions, other events, and circumstances relating to nonowner sources; includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
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Another term for net income.
Outflows or using up assets or incurring liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that are the company's ongoing major or central operations.
Reports the financial results of a company's performance for a period of time, usually a quarter or a year, providing information about the profits (or losses) the company has generated during the period by conducting operating, investing, and financing activities.
The company's obligations owed to creditors.
management discussion and analysis (MD&A)
The section in the annual and quarterly report in which the managers of the firm discuss and analyze the firm's financial position and performance.
net income (or net loss)
Measures income based on the net assets created during the period (accomplishments like revenues and gains from asset sales) minus the net assets used up during the period (expenses and losses). Calculated as: Net Income = Revenues − Expenses + Gains – Losses
The notes to the financial statements explain how the amounts and accounts have been determined.
Increases in assets or settlements of liabilities during a period from delivering or producing goods, rendering services, or other activities that are the company's ongoing major or central operations.
Sarbanes-Oxley Act of 2002
Passed in 2002 in response to revelations of misconduct and fraud by several well-known firms, this legislation established stronger governmental control and regulation of public companies in the United States, from enhanced oversight (PCAOB), to increased auditor independence and tightened regulation of corporate governance.
The residual interest of the shareholders in the assets of the corporation, after deducting the liabilities.
statement of cash flows
The third principal financial statement, it reports for a period of time the net cash flows (inflows minus outflows) from the three principal categories of business activities: operating, investing, and financing.
statement of changes in shareholders' equity
A financial statement that reports the shareholders' equity accounts, how those accounts changed during the period, and the ending balances.
statement of financial position
Also called the balance sheet, this financial statement reports the accounting equation: Assets = Liabilities + Owners' Equity
statement of shareholders' equity
See statement of changes in shareholders' equity.
Code of Professional Conduct (CPC)
Six principles adopted by the AICPA that express the basic tenets of ethical and professional conduct and call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.
Situations in which an accountant must make a decision about what is the “right” (ethical) action to take in given circumstances.
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Chapter 1: The Demand for and Supply of Financial Accounting Information Introduction ♦ Learning Objectives ◊ LO 1.1 – Understand the forces that drive the demand for financial accounting information in the world economy. ◊ LO 1.2 – Understand the forces that determine the supply of accounting information, including the role of the SEC ◊ LO 1.3 – Explain the role of the Financial Accounting Standards Board (FASB) for establishing U.S. generally accepted accounting principles (GAAP) ◊ LO 1.4 – Explain and use the FASB Accounting Standards Codification system, and understand the standard-setting process ◊ LO 1.5 – Explain the role of the International Accounting Standards Board (IASB) in establishing International Financial Reporting Standards (IFRS) and the efforts to try to converge accounting standards between the FASB and the IASB. ◊ LO 1.6 – Understand the output of the financial reporting process and the four primary financial statements, as well as the important information reported with financial statements. ◊ LO 1.7 – Understand that, because financial accounting information triggers important economic consequences, integrity and the ability to resolve ethical dilemmas is essential to the accounting profession. ♦ Other notes on how the future of accounting is bright Why Does the World Need Financial Accounting Information ♦ In order for companies to successfully compete for resources, they must have a business plan and be able to justify their position ♦ Business Activities ◊ After companies come up with business/strategic plan, they engage in three sets of activities, sometimes regularly, throughout life of the firm ◊ Financing Activities Companies do this to raise capital it needs to run operations First step is the raise equity by attracting investments from business owners ∙ Owners invest capital with no guarantee of repayment or return on investment ∙ Common shareholders typically have some sort of control of the company After equity capital in place, sometimes more is needed and companies will go to lenders by issuing bonds or taking out loans from financial institutions Creditors take less risk but also don’t profit as much as they could if company does well ◊ Investing Activities After the company has the money it needs to get started, it will begin investing activities Resources companies may invest in include: property, plant, equipment, technology, intellectual property, legal rights, and operating agreements ◊ Operating Activities When company has capital and resources, it will begin operations Produce goods/services Hire employees Acquire inventory, raw materials, & supplies Acquire customer base, sales channels, & markets Comply with applicable laws and regulations regarding how business is run ♦ Who are the Stakeholders? What Do They Need to Know? ◊ Many companies have different types of stakeholders (parties with some type of interest in company) Common equity shareholders Banks Creditors Employees (including managers) Suppliers Customers Government authorities Local communities Unions Pension funds ◊ Investors need to know: Investors will benefit from profits or bear risks They want information to help them decide if company is a good risk Resources owned by company Debts of company Cash flows and profit generation (over time) Most interested in profits ◊ Creditors Less risk of loss, but still bear some risk Is company likely to be able to pay back borrowed money How is company run and are they successful or struggling Most interested in cash flows (meet deadlines for payment) ♦ What Drives Stakeholders’ Demand for Accounting Information? ◊ Most people are risk-averse and when provided with little to no information, will refuse to invest in or lend money to the company ◊ Prospective employees, suppliers, and customers will be wary of the company as well ◊ This demand for information leads to an imperative for the company to provide it ◊ The demand is also for it to be provided in a logical, rational, and comparable way because companies are competing for scarce resources ◊ Financial reporting is about communicating the information to existing and potential stakeholders ◊ Separation of Ownership and Control Common equity shareholders and creditors are called the principals Company executives, managers, and employees are called the agents Principals provide financial resources by investing in and lending to company Agents have been hired to invest those financial resources and run the company’s daily business activities on behalf of the investors and creditors The different roles lead to separation of ownership (principals) and control (agents) and can produce information asymmetry problems (parties not having access to same information) Agents (managers especially) have detailed knowledge that principals want/need, and financial accounting bridges that gap Periodic reporting of relevant and representationally faithful financial statement information helps resolve the info asymmetry problems Financial reporting enables company managers to provide principals with info necessary for them to make informed decisions ♦ What Drives the Demand for Accounting Standards and Independent Audits? ◊ Were it up to the companies (agents) to self-report what’s going on, the info asymmetry problem wouldn’t be resolved, because there would be incentive for agents to lie to the principals to make it seem like everything was all good ◊ Thus, the need for accounting standards ◊ GAAP and IFRS are the principles, concepts, guidelines, methods, and practices that regulated companies are required to use in reporting accounting info in fin. Statements◊ Standards are not enough all by themselves because people may still lie, which gives rise to the need for independent audits ◊ Auditors are generally external, independent experts in accounting who can carefully evaluate a company’s accounting records and verify whether the company has applied the accounting standards and principles fairly and consistently ◊ Auditor will provide a statement of opinion regarding financial statements’ compliance with GAAP or IFRS The Supply of Financial Accounting Information ♦ The supply of accounting info that companies report determined mainly by interactions between 2 forces: authoritative professional accounting standards (GAAP or IFRS) by country of incorporation and choices, methods, estimates, & judgments that the company must make in order to apply those accounting standards to measure and report their financial statments ♦ The Role of the Securities and Exchange Commission (SEC) ◊ U.S. Congress created the SEC in 1933 & 1934 with the Securities Act and Securities Exchange Act respectively ◊ The SEC has the legal authority to prescribe accounting principles and reporting practices for all corporations issuing publicly traded securities within U.S. capital markets ◊ SEC stated mission – protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation ◊ There are approx. 17,000 corporations subject to SEC authority ◊ The SEC has the largest regulatory authority and responsibility for companies, investors, creditors, and capital markets in the world ◊ SEC has mandated accounting information be reported according to professionally established accounting principles like GAAP for US companies and IFRS for international companies ◊ The SEC’s Reporting Requirements The Securities Act of 1033 requires each company offering securities (shares of stock, bonds, other securities) for sale to the public in the primary and secondary markets to file a registration statement (Form S-1) Securities Exchange Act of 1034 established extensive reporting requirements for listed companies Most commonly required reports are ∙ Form 10-K – extensive annual report including financial statements ∙ Form 10-Q – extensive quarterly report including financial statements ∙ Form 20-F – extensive annual report including financial statements for non-US companies ∙ Form 8-K – report used to describe significant events that have affected or may affect the company ∙ Proxy Statement – report used when management requests right to vote through proxies for shareholders at shareholders’ meetings The forms must be filed electronically ◊ The SEC’s authority over accounting standards and financial reporting The SEC enforces regulations, but doesn’t really establish the standards; they delegate that to the Financial Accounting Standards Board (FASB) for US companies and the International Accounting Standards Board (IASB) for foreign companies SEC closely monitors FASB (GAAP) and IASB (IFRS) developing standards SEC essentially supports FASB-developed guidelines rather than deciding where FASB should go next The FASB ♦ The beginnings (how FASB came to be) ◊ Setting of standards in US started in 1938 when AICPA formed Committee on Accounting Procedure (CAP), which issued ARBs (Accounting Research Bulletins) to establish acceptable accounting procedures.◊ AICPA replaced CAP by forming Accounting Principles Board (APB) in 1959 – APB issued pronouncements called APB Opinions ◊ 1973 – AICPA phased out APB and replaced it with FASB ◊ ARBs and APB Opinions are foundation for GAAP unless superseded or amended by FASB ♦ The Structure of the FASB ◊ 7 full-time employees on the board with NO OTHER organizational ties Represent wide cross-section – financial statement preparers, auditors, users, and academics Must have a knowledge of and experience in accounting, finance, business, and accounting education and research Must be highly intelligent, have integrity and discipline, a concern for public interest regarding investing, financial accounting, and financial reporting ◊ Responsible for identifying financial accounting issues, conducting research to address issues, and resolving them by issuing new accounting standards ◊ Supported by a full-time professional research and technical staff Conducts research Communicates with constituents Drafts preliminary findings Assists FASB by handling library, publications, personnel, and other activities Exhibit 1.3 in book and notes shows structure of FASB ◊ FAF (Financial Accounting Foundation) is parent org or FASB and governed by 14-18- member Board of Trustees appointed from memberships of 8 orgs interested in establishment of acct principles ◊ FAF oversees effectiveness and efficiency of standard-setting process and appoints members of FASB ◊ FAF also appoints and oversees Financial Accounting Standards Advisory Council as well as the Private Company Council who both give advisory input to FASB on standard-setting issues ♦ FASB Emerging Issues Task Force ◊ FASB established EITH in 1984 ◊ It was in response to need for timely guidance on new, specific accounting issues ◊ Members include tech experts from all major CPA firms and reps from smaller CPA firms and from industry ◊ All knowledgeable in accounting and financial reporting and in positions to be aware of emerging problems ◊ Chief accountant of SEC participates in EITF meetings ◊ Primary objectives ID significant emerging acct issues (unique transactions, acct problems) it feels FASB should address Develop consensus positions on implementation issues involving application of standards Consensus positions may be viewed as best available guidance on GAAP (especially regarding new acct issues) FASB Accounting Standards Codification ♦ FASB Pronouncements ◊ Prior to 2009, FASB issued pronouncements with differing levels or authority ◊ Exhibit 1.4 is the Historical Types of FASB Pronouncements Statements of Financial Acct Standards – highest authority, established methods and procedures required on specific acct issues Interpretations – refined GAAP by clarifying conflicting or unclear issues relating to prev. issued standards Staff Positions – provided more timely and consistent application guidance and to make narrow and limited revisions of standards Technical Bulletins – issued to clarify, explain, or elaborate on acct and reporting problems related to specific standards Statements of Financial Accounting Concepts – established theoretical foundation for fin acct and reporting standards. (output of conceptual framework) – fundamental principles that guide development of GAAP Other pronouncements – on a major topic, issued guide for implementation in form of questions and answers ◊ Important in accounting to be familiar with pronouncements even though no longer in use because they are cited and used to justify application of GAAP ◊ FASB had issued over 2,000 pronouncements which were often confusing. FASB got organized and logical and called the project codification ♦ Codification ◊ Electronic database that integrates and topically organizes GAAP into 1 coherent body of literature ◊ Over 200 people worked on this for about 5 years, ending in mid-2009 ◊ Became effective 7/1/09 ◊ Three goals Simplify user access by codifying all authoritative GAAP in one database Ensure codified content accurately represented all authoritative GAAP Create codification research system that’s up to date (including recent standards) ◊ Is now only source of GAAP for US companies to determine how to record transactions, events, or circumstances ◊ Did not change GAAP, but all is now same level of authority ◊ Framework contains 6 levels Areas ∙ General principles ∙ Presentation ∙ Assets ∙ Liabilities ∙ Equity ∙ Revenue ∙ Expenses ∙ Broad transactions ∙ Industry ∙ Master Glossary ∙ “Go To” box for those who know what they need Topics – related guidance on particular subject area Subtopics – subsets of topic and distinguished by type or scope Sections – characterize nature of content in subtopic Subsections – if necessary refine and break down sections into narrower and more specific items Paragraphs – contains specific guidance that constitutes GAAP ◊ Home page has search box ◊ Using the Codification Drill down until you find what you need Use the numbers for each level for reference and to find again ♦ The FASB’s Process and Operating Procedures ◊ New standards referred to as Accounting Standards Update Topic identified and place on agenda Task force may be appointed to advise and consult with FASB research and tech staff Staff conducts any additional necessary research FASB then (usually) published prelim views document or invitation to comment FASB holds public hearings FASB deliberates on views expressed and info collected, then issues exposure draft Interested parties have 30-90 days to respond Maybe more public hearings or field tests? FASB drafts proposed standard for final vote Standard passes if super-majority vote (5 out of 7) ◊ An Accounting Standards Update will describe how the update changes GAAP and when changes become effective – also allows for explanation of dissenting opinions, if any The IASB and IFRS ♦ International companies use IFRS – set by IASB. Similar in structure to GAAP set by FASB ♦ IFRS consists of group of trustees responsible for fund-raising, appointing IASB members, and overseeing effectiveness of IASB ◊ IASB includes 16 members from various countries ◊ IFRS Interpretations Committee provides authoritative interpretive guidance (IFRICs) on how to apply IFRA to various accounting issues ◊ IASB follow a thorough, open, and transparent process for setting new IFRSs ◊ New IFRSs must be approved by at least 10 or 16 (or 9 of fewer than 16) members to go into effect ♦ IFRS has issued 13 IFRSs in addition to 41 International Accounting Standards (IASs) that were issued by its predecessor the International Accounting Standards Committee ♦ IFRS Interpretations Committee has issued 21 IFRICs to date ♦ Convergence of FASB and IASB Accounting Standards ◊ Globalization of business activities creates increasing demand for consistent and comparable financial statements ◊ Rising need for accountants to understand IFRS and GAAP ◊ Of companies that list securities on US capital markets like NYSE, those headquartered outside US must use IFRS or accounting standards set by their national accounting standards boards ◊ Still, differences in GAAP and IFRS make comparability of financial statements difficult ◊ International convergence of accounting standards – goal and path taken to reach it FASB believes ultimate goal of convergence is development of unified set of high quality, international accounting standards that companies worldwide would use for both domestic and cross-border financial reporting Working to minimize or eliminate differences between GAAP and IFRS Accounting Standards Advisory Forum (ASAF) – provides quarterly progress reports Norwalk Agreement – 2002 – IASB and FASB join in development of high-quality, compatible accounting standards used for both domestic and cross-border financial reporting ∙ In 2009-2010, boards identified number of major projects to undertake jointly as well as short-term projects ∙ Already completed convergences of accounting standards Consolidated financial statements Fair value measurement Financial statement presentation Revenue recognition ♦ The SEC and International Convergence ◊ Decided to allow foreign companies to use IFRS in 2007 using Form 20-F and not have to reconcile differences between IFRS and GAAP ◊ Looking Ahead and Potential Problems with International Convergence July of 2012 – SEC issues final report regarding issues with convergence Basically, needed more thinking about before incorporation of IFRS can occur US companies financial statements differ from foreign companies financial statements even though in direct competition for scarce resources US companies operating globally may be required to submit using IFRS, so yay for doubling down on the work Other potential issues include Other smaller US companies don’t operate globally and wouldn’t benefit from going to IFRS Many US corps are small and don’t issue publicly traded securities and are not regulated by SEC – would continue to use GAAP and we’d still have dueling systems Retraining for accountants, auditors, financial statement users to understand impact of IFRS on preparation of financial statements Companies have entered into contracts based on GAAP – possible renegotiations required ♦ Standard Setting in a Political Environment ◊ Accounting standards have significant economic consequences ◊ Standard setting is well-researched and takes due process ◊ Standard setting can be seriously contentious because of economic and financial impact ◊ 1990s – stock option expensing was strongly opposed and the FASB received pressure from Congress to rescind the proposal, FASB said optional until IASB required it in 2004 and FASB then revised ◊ New standards sometimes compromise between conflicting views and interests What is the Product? Financial Reporting and the Financial Statements ♦ Opening Paragraphs ◊ After reviewing the need for and structure of financial accounting and reporting standards, we dig into the output of financial reports and financial statements ◊ Primary financial statements – balance sheet, income statement, statement of cash flows, and statement of shareholders’ equity, and the notes and such that accompany the statements ♦ Brief Introduction: Starbucks’s Business ◊ End of fiscal 2015, Starbucks had over 23,000 shops worldwide ◊ Starbucks owns and operates 53ish % of those shops, and licensees own and operate almost 47% ◊ Licensees pay Starbucks a license fee and royalty in exchange for rights to use *$ name, trademarks, logos, products, and methods ◊ 8,240 *$ located in countries other than US ◊ *$ also sells coffee beans, tea and instant coffe to distributors, and sells packaged coffee and tea in stores ◊ They are a partner in several joint ventures to develop and sell coffee-based products with other companies ♦ The Balance Sheet: Measuring Financial Position ◊ Cornerstone of financial reporting (also known as – statement of financial position) ◊ Snapshot of resources and claims on resources as of a certain date ◊ Assets = Liabilities + Shareholders’ Equity Assets must balance the claims on the company and ownership Assets are probable future economic benefits obtained or controlled by a company as a result of past transactions or events Assets section reports effects of operating and investing decisions (assets used in day-to-day activities, long-lived tangible resources, etc.) Liabilities are probable future sacrifices of economic benefits arising from present obligations of a company to transfer assets or provide services in the future to other entities as a result of past transactions or events, arising from operating and financing decisions Obligations to pay employees and suppliers, deliver products to customers, and debt to banks and other lenders Shareholders’ Equity – residual interest claim (claim on all assets not require to pay back creditors) S/E has two general categories – Contributed capital accounts and earned capital accounts ♦ Income Statement: Measuring and Reporting Performance ◊ Measures and reports the financial results of a firm’s performance for a period of time ◊ Provides information about profits or losses company has generated ◊ Majority of a company’s income arises from revenues generated minus expenses incurred in operating activities of the business◊ Revenues are inflows of assets and settlements of obligations ◊ Expenses measure outflows of assets that a company consumes and obligations it incurs in process of operating ◊ Investing and financing activities Investing activities like holding stock or bonds can generate interest or income Investing activities can also generate income through joint ventures or interests in other companies Financing activities generally incur expenses (interest expense, for instance) ◊ Net Income Measures the bottom-line profit or loss of a company for a period of time Net income = revenues – expenses + gains - losses Income statements also report effects of income taxes ◊ Comprehensive income Change in equity of a company during a period from transactions, events, and circumstances relating to non-owner sources Includes net income, some gains and losses GAAP requires 4 types of gains and losses be recognized here, to be discussed in later chapters ♦ Statement of Cash Flows ◊ Reports net cash flows from operating, investing, and financing activities for a period of time ◊ Purpose is to provide useful info about how a firm is generating and using cash ◊ Provides info to complement income statement ◊ Useful to creditors and other stakeholders to help evaluate company’s cash-generating ability and to give info about likelihood of future cash flows for future payments of obligations ◊ Divided into 3 parts Operating Activities ∙ Selling goods and providing services ∙ Generate revenues in cash ∙ Pay expenses and obligations and acquire inventory and other assets Investing Activities ∙ Acquisition of long-lived productive assets Financing Activities ∙ Issuance of preferred or common stock ∙ Long-term borrowing ∙ Short-term borrowing ∙ Repayment of loans ♦ Statement of Shareholders’ Equity ◊ AKA statement of changes in shareholders’ equity ◊ Provides info about equity claims on company and how they changed during a period ◊ Will report Amounts initially contributed by shareholders for interest in company (common stock, other stock, Additional paid-in capital, other additional paid-in capital) Cumulative net income in excess of dividends declared (retained earnings) Shareholders’ equity effects from recognition or valuation of certain assets or liabilities Cumulative amounts of cash distributed to shareholders to repurchase shares (treasury stock – sometimes amounts taken from R/E like dividends) ◊ Statement provides detail about how each of the accounts changed during the period ◊ Statement not required by GAAP, but most large firms report it ◊ Statement is required by IFRS ♦ Important Information with the Financial Statements ◊ Notes Explain how accounts and amounts have been determined Details accounting principles, methods, and estimates company has used to measure assets, liabilities, equity, revenues, expenses, gains, and losses Type of inventory accounting, valuation of cost of goods sold, depreciation method, etc. ◊ Management Discussion and Analysis Narrative discussion and quantitative analysis from managers Insights into strategies and evaluation of performance Discussion and analysis of company’s exposure to business risk factors Possible future expectations for company ◊ Managers’ and Independent Auditors’ Attestations Because sometimes people don’t behave ethically, Congress passed the Sarbanes Oxley Act of 2002 which defines responsibility of managers for financial statements and underlying accounting and control systems that generate financial statements The CEO and CFO must sign management report SEC and most stock exchanges require independent audit ∙ Audit assesses internal controls ∙ Designs audit tests in light of quality of internal controls ∙ Forms opinion about fairness of amounts reported in financial statements ∙ Essential element for reliability of financial statements in capital markets ∙ Financial statements not considered reliable until independent auditor has examined and concluded they are fair and reliable according to GAAP or IFRS Why is Accounting Important? The Economic Consequences of Financial Reporting (not covered on exam)