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.i. The Codification integrates and topically organizes all relevant accounting pronouncements comprising GAAP in a searchable, online database.
c. International standard setting
Foundation providing oversight, appointing members, raising funds
7 full time members
12 full-time; 2 part-time
Advisory council providing
Input on agenda
30 – 40 members
30 – 40 members
Group to deal with emerging issues EITF
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
Free from error
Recognition, measurement and disclosure concepts