Chapter 2 Lecture 2 June 3rd The Conceptual Framework A Basic Objective of Financial Reporting To provide economic information about a company that is useful in making an informed decision Decision makers are expected to have a reasonable understanding of accounting concepts An Informed Decision means the investor creditor supplier wants to be able to analyze the financial statements to determine the amounts timing and uncertainty of future cash flows B Underlying assumptions of accounting help the decision maker to understand what accounting information reports as well as inherent limitations 1 Economic entity business transactions are separate from the personal transactions of the owners 2 Going Concern company will continue to operate into the foreseeable future without forced liquidation 3 Monetary Unit all information will be measured in its national currency 4 Time Period Assumption The long life of a company can be reported over a series of shorter time periods 5 Cost principle assets are recorded original cost what we paid for them C In order for the information to be useful relevant reliable it should have the following Qualitative Characteristics p 56 1 Understandability info should be comprehensible to those who are willing to spend the time to understand it 2 Relevance Information makes a difference in decision making 3 Faithful Representation complete neutral free from error 4 Comparability between companies similar methods have been applied apples to apples oranges to oranges disclosure of what methods have been used 5 Consistency between accounting periods within the same company 6 Materiality The size of the transaction makes a difference in how it gets recorded 7 Conservatism Never want to overstate Assets or Revenues or understate Liabilities or Expenses Expensing Not balance sheet note made Pg 56 Objectives and qualitative characteristics of financial reporting are not the same for ISAB and FASB Financial statement content the rules To understand financial statements users must understand the measurement rules used to report them Generally Accepted Accounting Principles GAAP a common set of Rules used to prepare and report financial information in U S financial statements very specific set of rules for accounting principals can be looked up for how to do Who makes these rules A For U S Companies 1 Financial Accounting Standards Board FASB private sector body given responsibility to develop GAAP responsible for creating rules 2 Securities Exchange Commission SEC federal government agency that has broad powers to prescribe accounting practices and standards to public companies that trade securities on the major exchanges NYSE NASDAQ The SEC can influence or override any FASB ruling Does NOT create rules Are tasked with regulating the rules Has the power to override influence rules procedures of FASB ruling Federal agency Powers to prescribe accounting standards practices Do not confuse who is in charge of making rules procedures and who is in charge of enforcing influencing and prescribing them 3 American Institute of Certified Public Accountants AICPA professional organization of certified public accountants professional organization for certified accountants B For Non U S Companies International Accounting Standards Board IASB working towards a convergence of International Financial Reporting Standards IFRS GAAP Global Differences in Accounting Standards some IFRS Principles differ from GAAP Examples 1 Accounting for Inventories 2 Accounting for Losses on Income Statements 3 Accounting for Plant Property Equipment 4 Accounting for Research Development management responsibility and the demand for auditing see sarbanes oxley handout at end of notes Chapter 1 PG 13 handout A Public Company Accounting Oversight Board five member body that sets auditing standards B Management s Responsibility Management always holds the responsibility for what takes place on all statements C Purpose of an Audit VERIFY statements sent by management give opinion agree disagree with statements give a reasonable assurance Classified Balance Sheet what obligations will be due liabilities and what resources assets will be available to meet those obligations 1 Assets future economic benefits resources owned by or owed to the firm A Current Assets converted into cash sold or used up during current period within 12 mos 1 Cash cash equivalents 2 Marketable securities 3 Accounts receivables 4 Inventory 5 Prepaid expenses Must be shown in order of liquidity B Long term Investments Investments in stocks bonds of other companies to be held for 1 year If the investment is held for less than a year it is now a short term investment C Plant Property Equipment acquired for use in business rather than resale to customers Relatively long useful lives 1 Land does not have a limited useful life 2 Buildings 3 Equipment vehicles furniture 4 Accumulated Depreciation on PPE Fixed assets that have a useful life contra account goes along with brother sister has opposite sign D Intangible Assets or Other Assets 1 Patent exclusive right to manufacture or sell a product 2 Copyright protects artistic material 3 Trademark Tradename IPOD Coca Cola 4 Franchise Licenses excl right to operate in a geographic area 5 Goodwill when a company pays more than fair value of the assets of another company to purchase it 2 Liabilities debts A Current Liabilities requires the use of current assets to settle within the next 12 months 1 Accounts Payable 2 Accrued Expenses expenses that have been incurred but not yet pd 3 Unearned Revenue customer has paid but we have not yet delivered goods services 4 Short term note payable B Long term Liabilities 1 Note payable long term 2 Bond payable 3 Mortgage payable Assets Liabilities SHE 2 Parts 3 Stockholders Equity claims of owners against the net assets of the firm 1 Common Stock Capital Stock Capital contributed by the owner 2 Retained Earnings Prophets retained in the company that are NOT distributed to owners in the form of dividends accumulated over the life of a company