The Main Function of Financial Accounting is to provide relevant and reliable financial information to creditors and investors. These users make critical decisions based upon this information that affects the nation’s economy, Therefore, they make their decisions based solely upon the data that is reported in financial statements and disclosure notes. Our job is to insure the integrity of that information and adhere to GAAP (Generally Accepted Accounting Principals) set forth by the FASB (Financial Accounting Standards Board).
This tutorial will summarize the chapter and offer a Power Point Presentation on the covered material. Towards the end of this tutorial, you will be given links to more tutorials on the Exercises and Problems Solved for this given chapter. I do hope this helps you. I am writing this series of hubs because I struggled with this material and I do not wish to put my worst enemy through that experience.
What is Financial Accounting?
Financial accounting is concerned with providing relevant financial information about variouskinds of organizations to different types of external users. The primary focus of financial accounting is on the financial information provided by profit-oriented companies to their present and potential investors and creditors.
Accounting Basics 1- Where did Accounting Come From?
More Help – The Accounting Coach
Two extremely important variables
that must be considered in any investment decision are the expected rate of return and the uncertainty or risk of that expected return.
In the long run, a company will be able to provide investors and creditors with a rate of return only if it can generate a profit.
That is, it must be able to use the resources provided to it to generate cash receipts from selling a product or service that exceeds the cash disbursements necessary to provide that product or service.
The primary objective of financial accounting is
to provide investors and creditors with information that will help in evaluating the amounts, timing, and uncertainty of a business enterpriseâ€™s future cash receipts and disbursements.
Net operating cash flows are
the difference between cash receipts and cash disbursements during a period of time from transactions related to providing goods and services to customers. Net operating cash flows may not be a good indicator of future cash flows because, by ignoring uncompleted transactions, they may not match the accomplishments and sacrifices of the period.
GAAP (generally accepted accounting principles) are a
dynamic set of both broad and specific guidelines that a company should follow in measuring and reporting the information in their financial statements and related notes. It is important that all companies follow GAAP so that investors can compare financial information across companies to make their resource allocation decisions.
In 1934, Congress created the SEC and
gave it both the power and responsibility for setting accounting and reporting standards for companies whose securities are publicly traded. The SEC has retained the power, but has delegated the responsibility to private sector bodies. The current private sector body responsible for setting accounting standards is the FASB.
Resources are efficiently allocated
if they are given to enterprises that will use them to provide goods and services desired by society and not to enterprises that will waste them. The capital markets are the mechanism that fosters this efficient allocation of resources.
New accounting standards, or changes in standards, can
have significant differential effects on companies, investors and creditors, and other interest groups by causing redistribution of wealth. There also is the possibility that standards could harm the economy as a whole by causing companies to change their behavior.
Auditors are independent, professional accountants who
examine financial statements to express an opinion. The opinion reflects the auditorsâ€™ assessment of the statements’ fairness, which is determined by the extent to which they are prepared in compliance with GAAP. The auditor adds credibility to the financial statements, which increases the confidence of capital market participants relying on that information.
The FASB undertakes a series of
elaborate information gathering steps before issuing a substantive accounting standard to determine consensus as to the preferred method of accounting, as well as to anticipate adverse economic consequences.
Relevance and reliability are the primary
qualities that make information decision-useful. Relevant information will possess predictive and/or feedback value and also will be provided in a timely manner. Reliability is the extent to which information can be relied upon by users.
The purpose of the conceptual framework is to
guide the Board in developing accounting standards by providing an underlying foundation and basic reasoning on which to consider merits of alternatives. The framework does not prescribe GAAP.
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002.
The most dramatic change to federal securities laws since the 1930s, the Act radically redesigns federal regulation of public company corporate governance and reporting obligations. It also significantly tightens accountability standards for directors and officers, auditors, securities analysts and legal counsel. Student opinions as to the relative importance of the key provisions of the act will vary.
Key provisions in the order of presentation in the text are:
- Creation of an Oversight Board
- Corporate executive accountability
- Non-audit services
- Retention of work papers
- Auditor rotation
- Conflicts of interest
- Hiring of auditor
- Internal control
The components of:
- relevant information are predictive and/or feedback value and timeliness.
- reliable information are verifiability, representational faithfulness, and neutrality.
The benefit from providing accounting information is
increased decision usefulness. If the information is relevant and reliable, it will improve the decisions made by investors and creditors. However, there are costs to providing information that include costs to gather, process and disseminate that information. There also are costs to users in interpreting the information as well as possible adverse economic consequences that could result from disclosing information. Information should not be provided unless the benefits exceed the costs.
Accounting Overview & Review
- Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
- Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions.
- Equity is the residual interest in the assets of any entity that remains after deducting its liabilities.
- Investments by owners are increases in equity resulting from transfers of resources, usually cash, to a company in exchange for ownership interest.
- Distributions to owners are decreases in equity resulting from transfers to owners.
- Revenues are inflows of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entityâ€™s ongoing major or central operations.
- Expenses are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entityâ€™s ongoing major or central operations.
- Gains are defined as increases in equity from peripheral or incidental transactions of an entity.
- Losses represent decreases in equity arising from peripheral or incidental transactions of an entity.
- Comprehensive income is defined as the change in equity of an entity during a period from nonowner transactions.
The four basic assumptions underlying GAAP are:
- the economic entity assumption
- the going concern assumption
- the periodicity assumption
- the monetary unit assumption.
Information is material if it is deemed
to have an effect on a decision made by a user. The threshold for materiality will depend principally on the relative dollar amount of the transaction being considered. One consequence of materiality is that GAAP need not be followed in measuring and reporting a transaction if that transaction is not material. The threshold for materiality has been left to subjective judgment.
The going concern assumption means
that, in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. This assumption is important to many broad and specific accounting principles such as the historical cost principle.
The periodicity assumption relates to
needs of external users to receive timely financial information. This assumption requires that the economic life of a company be divided into artificial periods for financial reporting. Companies usually report to external users at least once a year.
The four key broad accounting principles that guide accounting practice are:
- (1) the historical cost or original transaction value principle,
- (2) the realization or revenue recognition principle,
- (3) the matching principle
- (4) the full disclosure principle.
Two important reasons to base valuation on historical cost are
- (1) historical cost provides important cash flow information since it represents the cash or cash equivalent paid for an asset or received in exchange for the assumption of a liability
- (2) historical cost valuation is the result of an exchange transaction between two independent parties and the agreed upon exchange value is, therefore, objective and possesses a high degree of verifiability.
The four different approaches to implementing the matching principle are:
- (1) Recognizing an expense based on an exact cause-and-effect relationship between a revenue and expense event. Cost of goods sold is an example of an expense recognized by this approach.
- (2) Recognizing an expense by identifying the expense with the revenues recognized in a specific time period. Office salaries is an example of an expense recognized by this approach.
- (3) Recognizing an expense by a systematic and rational allocation to specific time periods. Depreciation is an example of an expense recognized by this approach.
- (4) Recognizing expenses in the period incurred, without regard to related revenues. Advertising is an example of an expense recognized by this approach.
The realization principle requires that two criteria be satisfied before revenue can be recognized:
- (1) The earnings process is judged to be complete or virtually complete
- (2) There is reasonable certainty as to the collectibility of the asset to be received (usually
In addition to the financial statement
elements arrayed in the basic financial statements,information is disclosed by means of parenthetical or modifying comments, notes, and supplemental financial statements.