Chapter 2 Lecture 2 June 3rdThe Conceptual FrameworkA. Basic Objective of Financial Reporting: To provide economic information abouta company that is useful in making an “informed decision”.Decision makers are expected to have a reasonable understanding of accountingconcepts.An “Informed Decision” means the investor/creditor/supplier wants to be able toanalyze the financial statements to determine the amounts, timing and uncertainty offuture cash flows.B. Underlying assumptions of accounting help the decision maker to understandwhat accounting information reports as well as inherent limitations.1. Economic entity – business transactions are separate from the personaltransactions of the owners2. Going-Concern – company will continue to operate into the foreseeablefuture without forced liquidation3. Monetary Unit – all information will be measured in its national currency4. Time Period Assumption – The long life of a company can bereported over a series of shorter time periods.5. Cost principle – assets are recorded @ original cost (what we paid forthem)C. In order for the information to be useful (relevant & reliable), it should have thefollowing Qualitative Characteristics (p. 56):1. Understandability – info should be comprehensible to those who arewilling to spend the time to understand it2. Relevance – Information makes a difference in decision making3. Faithful Representation complete, neutral, free from error4. Comparability – between companies; similar methods have beenapplied; “apples to apples; oranges to oranges”; disclosure of whatmethods have been used5. Consistency – between accounting periods within the same company6. Materiality – The $ size of the transaction makes a difference in how it getsrecorded.7. Conservatism – Never want to overstate Assets or Revenues or understateLiabilities or Expenses**** Expensing- Not balance sheet, note made (Pg.56)*** Objectives and qualitative characteristics of financial reporting are not the same for ISAB andFASB ***Financial statement content – the rulesTo understand financial statements, users must understand the measurement rules used toreport them.Generally Accepted Accounting Principles (GAAP) – a common set of “Rules” used toprepare and report financial information in U.S. financial statements.**** very specific set of rules for accounting principals; can be looked up for how to doWho makes these rules?A. For U.S. Companies:1. Financial Accounting Standards Board (FASB) – private sector body given responsibility todevelop GAAP.*** responsible for creating rules2. Securities & Exchange Commission (SEC) – federal (government) agency that has broadpowers to prescribe accounting practices and standards to public companies that trade securitieson the major exchanges (NYSE & NASDAQ). The SEC can influence or override any FASBruling.**** Does NOT create rules. Are tasked with regulating the rulesHas the power to override/influence rules/procedures of FASB rulingFederal agencyPowers to prescribe accounting standards/practices*** Do not confuse who is in charge of making rules/procedures and who is in charge ofenforcing/influencing and prescribing them ***3. American Institute of Certified Public Accountants (AICPA) – professional organization ofcertified public accountants**professional organization for certified accountantsB. For Non-U.S. Companies:International Accounting Standards Board (IASB) – working towards aconvergence of International Financial Reporting Standards (IFRS) & GAAP.Global Differences in Accounting Standards – some IFRS Principles differ fromGAAP.Examples: 1. Accounting for Inventories2. Accounting for Losses on Income Statements3. Accounting for Plant, Property & Equipment4. Accounting for Research & Developmentmanagement responsibility and the demand for auditing****see sarbanes-oxley handout at end of notes: Chapter 1 PG. 13 handoutA. Public Company Accounting Oversight Board – five member body thatsets auditing standardsB. Management’s Responsibility – Management always holds the responsibility forwhat takes place on all statementsC. Purpose of an Audit – VERIFY statements sent by management, give opinion,agree/disagree with statements, give a reasonable assuranceClassified 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 equivalents2. Marketable securities3. Accounts receivables4. Inventory5. Prepaid expenses*** Must be shown in order of liquidityB.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 investmentC. 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 life2. Buildings3. Equipment, vehicles, furniture4. (Accumulated Depreciation) on PPE/Fixed assets that have a “useful life”*** contra account goes along with brother/sister/ has opposite signD. Intangible Assets (or Other Assets):1. Patent – exclusive right to manufacture or sell a product2. Copyright – protects artistic material3. Trademark/Tradename – IPOD, Coca Cola4. Franchise/Licenses – excl. right to operate in a geographic area5. Goodwill – when a company pays more than fair value of the assets of another company topurchase it2. Liabilities: debtsA. Current Liabilities - requires the use of current assets to settle within the next 12 months.1. Accounts Payable2. Accrued Expenses – expenses that have been incurred, but not yet pd3. Unearned Revenue – customer has paid, but we have not yet deliveredgoods/services4. Short term note payableB. Long-term Liabilities:1. Note payable; long term2. Bond payable3. Mortgage payable3. Stockholders Equity: claims of owners against the net assets of the firm.(Assets - Liabilities = SHE)(2) Parts:1. Common Stock/Capital Stock – Capital contributed by the owner2. Retained Earnings – Prophets retained in the company that are NOTdistributed to owners in the form of dividends, accumulated over the life of