Handout 1 Essay

I. Financial accounting environment
a. Accounting is a language used to communicate financial information about a business to those who wish to use the information to make decisions.
b. Financial accounting is chiefly concerned with providing relevant financial information to various external users.
II. The economic environment and financial reporting
a. Background information
a.i. Capital markets provide a mechanism to help allocate resources efficiently.
a.ii. Initial market transactions involve issuance of stocks and bonds by the corporation in return for cash to be used to run the business.
a.iii. Secondary market transactions involve the transfer of stocks and bonds between individuals and institutions.
b. The investment-credit decision: a cash flow perspective
b.i. The primary objective of financial reporting is to provide investors and creditors with information to help them evaluate the amounts, timing and uncertainty of the enterprise’s future cash receipts and disbursements.
c. Cash versus accrual accounting
c.i. Cash basis accounting
c.i.1. Net operating cash flow is the difference between cash receipts and cash payments from transactions related to providing goods and services to customers during a reporting period.
c.ii. Accrual accounting
c.ii.1. Net income is considered a better indicator of future operating cash flows than is current net operating cash flows.
c.ii.2. Accrual income attempts to measure the resource inflows and outflows generated by operations during the reporting period.

III. The development of financial accounting and reporting standards
a. Hierarchy of standard – setting authority

b. Codification
b.i. The Codification integrates and topically organizes all relevant accounting pronouncements comprising GAAP in a searchable, online database.
c. International standard setting

U.S. GAAP
IFRS
Regulatory oversight
Provided by
SEC
IOSCO
Foundation providing oversight, appointing members, raising funds
FAF
20 members
IASCF
22 trustees
Standard-setting board
FASB
7 full time members
IASB
12 full-time; 2 part-time
Advisory council providing
Input on agenda
FASAC
30 – 40 members
SAC
30 – 40 members
Group to deal with emerging issues EITF
15 members
IFRIC
14 members
d. The establishment of accounting standards
d.i. Due process
d.i.1. Open hearings, deliberations, and requests for written comments from interested parties
d.ii. Politics in standard setting
IV. Encouraging high-quality financial reporting
a. The role of the auditor
a.i. Auditors examine (audit) financial statements to express a professional, independent opinion about whether the statements fairly present the company’s financial position, its results of operations, and its cash flows in compliance with GAAP.
b. Financial reporting reform
b.i. Sarbanes-Oxley Act (SOX)
b.i.1. It provides for the regulation of auditors and the types of services they furnish to clients, increases accountability of corporate executives, addresses conflicts of interest for securities analysts, and provides for stiff criminal penalties for violators.
b.i.2. Section 404 is perhaps the most controversial provision of SOX. It requires that company management document internal controls and report on their adequacy. Auditors also must express an opinion on whether the company has maintained effective control over financial reporting.
V. The conceptual framework

Objective: To provide financial information that is useful to capital providers

Qualitative characteristics
FUNDAMENTAL
Relevance
Predictive value
Feedback value
Materiality
Faithful representation
Completeness
Neutrality
Free from error
ENHANCING
Comparability
Verifiability
Timeliness
Understandability

Elements
Recognition, measurement and disclosure concepts
Assumptions
Economic entity
Going concern
Periodicity
Monetary unit
Principles
Revenue recognition
Expense recognition

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