CHAPTER 1

Development of Accounting Principles

and Professional Practice

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 Financial Reporting and Accounting Standards

Objective of Financial
Standard-Setting
Global Markets Financial Reporting
Organizations
Reporting Challenges

Financial General-purpose IOSCO Political

statements and financial environment
IASB
financial reporting statements
Expectations gap
Hierarchy of IFRS
Accounting and Capital providers
Significant financial
capital allocation
Entity perspective reporting issues
High-quality
Decision- Ethics
standards
usefulness
International
convergence

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 Global Markets

World markets are becoming increasingly intertwined.

Top 20 Global Companies In Terms Of Sales

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 Global Markets

Financial Statements and Financial Reporting

Characteristics of accounting are:
Accounting is the universal language of business.

(1) the identification, measurement, and communication

of financial information about

(2) economic entities to

(3) interested parties.

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 Global Markets

Economic Entity Financial Statements Additional Information

Financial Statement of President’s letter

Information Financial Position
Prospectuses
Accounting? Income Statement
Reports filed with
or Statement of
Identify governmental
Comprehensive
agencies
and Income
Measure News releases
Statement of Cash
and Flows Forecasts
Communicate Statement of Environmental
Changes in Equity impact statements
Note Disclosures
Etc.
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 Global Markets

Accounting and Capital Allocation

Resources are limited. Efficient use of resources often

determines whether a business thrives.
Illustration 1-3
Capital Allocation Process

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 Global Markets

High Quality Standards

Globalization demands a single set of high-quality
international accounting standards. Some elements:
1. Single set of high-quality accounting standards established by
a single standard-setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants.
(Continued)
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 Global Markets

High Quality Standards

Globalization demands a single set of high-quality
international accounting standards. Some elements:
7. Common delivery systems (e.g., extensible Business
Reporting Language—XBRL).
8. Common approach to corporate governance and legal
frameworks around the world

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Slide
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 Objective of Financial Accounting

Objective: Provide financial information about the reporting

entity that is useful to
present and potential equity investors,

lenders, and
other creditors
in making decisions in their capacity as capital providers.

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 Objective of Financial Accounting

General-Purpose Financial Statements

Provide financial reporting information to a wide variety

of users.
Provide the most useful information possible at the
least cost.
Capital Providers (Investors)
Investors are the primary user group.

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 Objective of Financial Accounting

Entity Perspective
Companies viewed as separate and distinct from their owners.

Decision-Usefulness
Investors are interested in assessing the company’s
1. ability to generate net cash inflows and
2. management’s ability to protect and enhance the
capital providers’ investments.

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 Objective of Financial Accounting

Review Question
The objective of financial reporting places most
emphasis on:
a. reporting to capital providers.
b. reporting on stewardship.
c. providing specific guidance related to specific
needs.
d. providing information to individuals who are
experts in the field.

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 Objective of Financial Accounting

Review Question
General-purpose financial statements are prepared
primarily for:
a. internal users.
b. external users.
c. auditors.
d. government regulators.

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 Standard-Setting Organizations

Two Major Organizations:

International Accounting Standards Board (IASB)

 Issues International Financial Reporting Standards

(IFRS).

 Standards used on most foreign exchanges.

 Standards used by foreign companies listing on U.S.

securities exchanges.

 IFRS used in over 150 countries.

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 Standard-Setting Organizations

Two Major Organizations:

Financial Accounting Standards Board (FASB)

 Issues Statements of Financial Accounting

Standards (SFAS).

 Required for all U.S.-based companies.

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 Standard-Setting Organizations

International Organization of Securities

Commissions (IOSCO)

 Does not set accounting standards.

 Dedicated to ensuring that global

markets can operate in an efficient
and effective basis.

http://www.iosco.org/

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 Standard-Setting Organizations

International Accounting Standards Board (IASB)

Composed of four organizations—

 International Accounting Standards
Committee Foundation (IASCF)

 International Accounting Standards

Board (IASB) http://www.iasb.org

 Standards Advisory Council

 International Financial Reporting

Interpretations Committee (IFRIC)
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 Standard-Setting Organizations

Review Question
IFRS stands for:
a. International Federation of Reporting Services.
b. Independent Financial Reporting Standards.
c. International Financial Reporting Standards.
d. Integrated Financial Reporting Services.

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 Standard-Setting Organizations

Review Question
The major key players on the international side are the:
a. IASB and FASB.
b. SEC and FASB.
c. IOSCO and the SEC.
d. IASB and IOSCO.

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 Standard-Setting Organizations

Review Question
Which body from the U.S. side is similar to the IASB?
a. SEC.
b. FASB.
c. FASC.
d. FAF.

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 Due Process

Illustration 1-5
International
Standard-Setting
Structure

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 Due Process

Review Question
Accounting standard-setters use the following process in
establishing international standards:
a. Research, exposure draft, discussion paper, standard.
b. Discussion paper, research, exposure draft, standard.
c. Research, preliminary views, discussion paper,
standard.
d. Research, discussion paper, exposure draft, standard.

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 Types of Pronouncements

Issued by the IASB:

International Financial Reporting Standards.
Framework for financial reporting.
International financial reporting interpretations.

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 Types of Pronouncements

Review Question
IFRS is comprised of:
a. International Financial Reporting Standards and FASB
financial reporting standards.
b. International Financial Reporting Standards, International
Accounting Standards, and international accounting
interpretations.
c. International Accounting Standards and international
accounting interpretations.
d. FASB financial reporting standards and International
Accounting Standards.
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 Financial Reporting Challenges

IFRS in a Political Environment Illustration 1-6

User Groups that Influence the
Formulation of Accounting Standards

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 Financial Reporting Challenges

The Expectations Gap

What the public thinks accountants should do vs. what

accountants think they can do.

Significant Financial Reporting Issues

 Non-financial measurements
 Forward-looking information
 Soft assets
 Timeliness

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 Financial Reporting Challenges

International Convergence

In 2002 the IASB and the FASB formalized their commitment

to the convergence of U.S. GAAP and international
standards. The Boards agreed to:

1. Make their existing financial reporting standards fully

converged as soon as practicable, and

2. Coordinate their future work programs to ensure that

once achieved, convergence is maintained.

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 Financial Reporting Challenges

Review Question
The expectations gap is:
a. what financial information management provides and
what users want.
b. what the public thinks accountants should do and what
accountants think they can do.
c. what the governmental agencies want from standard-
setting and what the standard-setters provide.
d. what the users of financial statements want from the
government and what is provided.
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  The fact that there are differences between IFRS and U.S. GAAP
should not be surprising because standard-setters have developed
standards in response to different user needs.
 IFRS tends to be simpler and more flexible in its accounting and
disclosure requirements.
 The U.S. SEC recently eliminated the need for foreign companies
that trade shares in U.S. markets to reconcile their accounting with
U.S. GAAP.

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 Conceptual Framework For Financial Reporting

Third Level:
Second Level: Recognition,
Conceptual First Level: Basic
Fundamental Measurement, and
Framework Objective
Concepts Disclosure
Concepts

Need Qualitative Basic assumptions

characteristics
Development Basic principles
Basic elements
Overview Constraints
Summary of the
structure

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 Conceptual Framework

Conceptual Framework establishes the concepts

that underlie financial reporting.

Need for a Conceptual Framework

Rule-making should build on and relate to an

established body of concepts.

Enables IASB to issue more useful and consistent

pronouncements over time.

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 Conceptual Framework

Development of a Conceptual Framework

IASB and FASB are working on a joint project to
develop a common conceptual framework

Framework will build on existing IASB and FASB

frameworks.

Project has identified the objective of financial

reporting (Chapter 1) and the qualitative
characteristics of decision-useful financial reporting
information.
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 Conceptual Framework

Overview of the Conceptual Framework

Three levels:
First Level = Basic objective(the why acc)

Second Level = Qualitative characteristics and

elements of financial statements(the bridge)

Third Level = Recognition, measurement, and

disclosure concepts(the how acc)

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 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third
3. Monetary unit 3. Expense recognition
level
4. Periodicity 4. Full disclosure
5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 1-7
Framework for Financial
Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
creditors in their
capacity as capital
Slide Providers.
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 First Level: Basic Objective

OBJECTIVE
“To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions in their
capacity as capital providers.”

 Provided by issuing general-purpose financial statements.

 Assumption is that users have reasonable knowledge of business
and financial accounting matters to understand the information.

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 Second Level: Fundamental Concepts

Qualitative Characteristics of Accounting

Information

IASB identified the Qualitative Characteristics of

accounting information that distinguish better (more
useful) information from inferior (less useful)
information for decision-making purposes.

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 Second Level: Fundamental Concepts
Illustration 1-8 Hierarchy of Accounting Qualities

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 Second Level: Fundamental Concepts
Fundamental Quality - Relevance
Relevance is one of the two fundamental qualities that make
accounting information useful for decision-making. To be
relevant, accounting information must be capable of making
a difference in a decision.

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 Cont’d

 Predictive value, if it has value as an input to

predictive processes used by investors to form
their own expectations about the future.
 Confirmatory value: relevant information also
helps users confirm or correct prior
expectations.
 Materiality: Information is material if omitting it
or misstating it could influence decisions that
users make on the basis of the reported
financial information.

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 Second Level: Fundamental Concepts

Fundamental Quality – Faithful Representation

Faithful representation means that the numbers and
descriptions match what really existed or happened.

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 Cont’d

 Completeness means that all the information

that is necessary for faithful representation is
provided. An omission can cause information to
be false or misleading and thus not be helpful to
the users of financial reports.
 Neutrality means that a company cannot select
information to favor one set of interested parties
over another.
 Free from error will be a more accurate
(faithful) representation of a financial item.

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 Second Level: Fundamental Concepts

Enhancing Qualities
Distinguish more-useful information from less-useful
information.

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 Cont’d
 Comparability: Information that is measured and reported
in a similar manner for different companies is considered
comparable.
 Consistency: is present when a company applies the
same accounting treatment to similar events, from period to
period.
 Verifiability: means that different knowledgeable and
independent observers could reach consensus, although
not necessarily complete agreement, that a particular
depiction is a faithful representation.
 Timeliness: means having information available to
decision-makers before it loses its capacity to influence
decisions.
 Understandability: is the quality of information that lets
reasonably informed users see its significance.
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 ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
Third
3. Monetary unit
4. Periodicity
Basic Elements
3. Expense recognition
4. Full disclosure
level

5. Accrual

QUALITATIVE
CHARACTERISTICS ELEMENTS
1. Fundamental 1. Assets
qualities 2. Liabilities Second level
2. Enhancing 3. Equity
qualities 4. Income
5. Expenses
Illustration 1-9
Framework for Financial
Reporting OBJECTIVE
Provide information
about the reporting
entity that is useful
to present and potential First level
equity investors,
lenders, and other
creditors in their
capacity as capital
Slide Providers.
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LO 4
 Second Level: Basic Elements
Elements of Financial Statements
Asset: A present economic resource controlled by the entity as
a result of past events. (An economic resource is a right that has
the potential to produce economic benefits).
Liability: A present obligation of the entity to transfer an
economic resource as a result of past events.
Equity: The residual interest in the assets of the entity after
deducting all its liabilities. The elements of income and expenses
are defined as follows.
Income: Increases in assets, or decreases in liabilities, that
result in increases in equity, other than those relating to
contributions from holders of equity claims.
Expenses: Decreases in assets, or increases in liabilities, that
result in decreases in equity, other than those relating to
Slide distributions to holders of equity claims.
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 Second Level: Basic Elements
Exercise: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(a) Qualitative characteristic being Relevance
employed when companies in the Faithful representation
same industry are using the same
Predictive value
accounting principles.
Confirmatory value
(b) Quality of information that confirms Neutrality
users’ earlier expectations.
Completeness
(c) Imperative for providing comparisons Timeliness
of a company from period to period.
Verifiability
(d) Ignores the economic consequences Understandability
of a standard or rule. Comparability
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 Second Level: Basic Elements
Exercise: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(e) Requires a high degree of consensus Relevance
among individuals on a given Faithful representation
measurement.
Predictive value
(f) Predictive value is an ingredient of Confirmatory value
which fundamental quality of Neutrality
information.
Completeness
(g) Qualitative characteristics that Timeliness
enhance both relevance and faithful
Verifiability
representation.
Understandability
Comparability
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 Second Level: Basic Elements
Exercise: Identify the qualitative characteristic(s) to be used given
the information provided. Characteristics
(h) Neutrality and completeness are Relevance
ingredients of which fundamental Faithful representation
quality of accounting information.
Predictive value
(i) Two fundamental qualities that make Confirmatory value
accounting information useful for Neutrality
decision-making purposes.
Completeness
(j) Issuance of interim reports is an Timeliness
example of what enhancing
Verifiability
ingredient?
Understandability
Comparability
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 Third Level: Recognition, Measurement, and
Disclosure Concepts

These concepts explain how companies should recognize,

measure, and report financial elements and events.

Recognition, Measurement, and Disclosure Concepts

ASSUMPTIONS PRINCIPLES CONSTRAINTS
1. Economic entity 1. Measurement 1. Cost
2. Going concern 2. Revenue recognition
3. Monetary unit 3. Expense recognition
4. Periodicity 4. Full disclosure
5. Accrual

Illustration 1-10
Framework for
Financial Reporting

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 Third Level: Assumptions

Basic Assumptions
Economic Entity – company keeps its activity separate from
its owners and other business unit.
Going Concern - company to last long enough to fulfill
objectives and commitments.
Monetary Unit - money is the common denominator.
Periodicity - company can divide its economic activities into
time periods.
Accrual Basis of Accounting – transactions are recorded in
the periods in which the events occur.
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 Third Level: Assumptions
Exercise: Identify which basic assumption of accounting is
best described in each item below.
(a) The economic activities of FedEx Corporation
(USA) are divided into 12-month periods for the Periodicity
purpose of issuing annual reports.
(b) Total S.A. (FRA) does not adjust amounts in its Monetary
financial statements for the effects of inflation. Unit
(c) Barclays (GBR) reports current and non-current
classifications in its statement of financial Going Concern
position.
(d) The economic activities of Tokai Rubber
Industries (JPN) and its subsidiaries are merged Economic
for accounting and reporting purposes. Entity

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 Third Level: Principles

Principles
Measurement
Cost is generally thought to be a faithful representation of the
amount paid for a given item.
Fair value is “is defined as “the price that would be received to
sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement
date.” Fair value is therefore a market-based measure.”
Value in use is the present value of the cash flows, or other
economic benefits that a company expects to derive from the
use of an asset and from its ultimate disposal.
IASB has taken the step of giving companies the option to use fair
Slide value as the basis for measurement of financial assets and
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 Third Level: Principles
Revenue Recognition – companies recognize revenue in the
accounting period in which the performance obligation is satisfied.
Illustration 1-11 Timing of Revenue Recognition

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 Third Level: Principles

Expense Recognition - outflows or “using up” of assets

or incurring of liabilities (or a combination of both) during a
period as a result of delivering or producing goods and/or
rendering services. Illustration 1-12
Expense Recognition

“Let the expense follow the revenues.”

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 Third Level: Principles

Full Disclosure – providing information that is of sufficient

importance to influence the judgment and decisions of an
informed user.

Provided through:
Financial Statements
Notes to the Financial Statements
Supplementary information

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 Third Level: Principles
Exercise: Identify which basic principle of accounting is
best described in each item below.
Revenue
(a) Parmalat (ITA) reports revenue in its income
statement when it is earned instead of when the
Recognitio
cash is collected. n

(b) Google (USA) recognizes depreciation expense for Expense

a machine over the 2-year period during which that Recognitio
machine helps the company earn revenue. n
(c) KC Corp. (USA) reports information about pending Full
lawsuits in the notes to its financial statements. Disclosure
(d) Fuji Film (JPN) reports land on its balance sheet at
the amount paid to acquire it, even though the
estimated fair market value is greater. Measurement

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 Third Level: Constraints

Constraints
Cost – the cost of providing the information must be weighed
against the benefits that can be derived from using it.

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 Third Level: Constraints

Exercise: What accounting constraints are illustrated by

the items below?

(a) Willis Company does not disclose any

information in the notes to the financial Cost
statements unless the value of the information
to users exceeds the expense of gathering it.

(b) Beckham Corporation expenses the cost of

Materiality
wastebaskets in the year they are acquired.

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 Summary
of the
Structure

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 End of chapter one on IFA I

THANK YOU!!!!
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