1.9 Chapter Review and Extra Practice

Overview of Intermediate Accounting

This chapter has briefly described financial reporting and the accounting standard-setting process, introduced the organizations (and their acronyms) that all accountants should know, outlined the FASB conceptual framework (the “constitution” of accounting), discussed the major accounting-related careers, and reminded you of the importance of personal ethics. In the next four chapters, we will review everything you learned in introductory financial accounting, starting with the accountant’s basic tools of analysis, the journal entry and the T-account. The text then covers the accounting standards for the different aspects of a business: operating, investing, and financing. The text concludes with individual chapters on a number of important topics such as deferred taxes, derivative financial instruments, and earnings per share.

As mentioned at the start of this chapter, now is an exciting time to be studying accounting because things are changing so fast. For example, one of the topics most discussed currently is the accounting for financial instruments. Thirty years ago when we took intermediate financial accounting, the accounting for financial instruments was a minortopic. The important point is that we really can’t know what the important accounting issues will be 30 years from now. The best preparation for this unknown future is to learn the existing accounting rules, to understand how these rules arose, and to recognize the underlying concepts. That is the aim of this textbook.

Learning Objectives

1. Describe the purpose of financial reporting and identify the primary financial statements.

The purpose of financial reporting is to aid interested parties in evaluating the company’s past performance and in forecasting its future performance. The information about past events is intended to improve future operations and forecasts of future cash flows.

Internal users have the ability to receive customdesigned accounting reports. External users must rely on the general-purpose financial statements. The five major components of the financial statements follow:

• Balance sheet

• Income statement

• Statement of cash flows

• Explanatory notes

• Auditor’s opinion

2. Explain the function of accounting standards and describe the role of the FASB in setting those standards in the United States.

Accounting standards help accountants meet the information demands of users by providing guidelines and limits for financial reporting. Accounting standards also improve the comparability of financial reports among different companies. There are many different ways to account for the same underlying economic events, and users are never satisfied with the amount of financial informationthey receive—they always want to know more. By defining which methods to use and how much information to disclose, accounting standards save time and money for accountants. Users also benefit because they can learn one set of accounting rules to apply to all companies

The Financial Accounting Standards Board (FASB) sets accounting standards in the United States. The FASB is a private-sector body and has no legal authority. Accordingly, the FASB must carefully balance theory and practice in order to maintain credibility in the business community. The issuance of a new accounting standard is preceded by a lengthy public discussion. The Emerging Issues Task Force (EITF) works under the direction of the FASB. The EITF formulates a timely expert consensus on how to handle new issues not yet covered in FASB pronouncements. The authoritative accounting standards are contained in the FASB Accounting Standards Codification.

3. Recognize the importance of the SEC, AICPA, AAA, and IRS to financial reporting.

• Securities and Exchange Commission (SEC). The SEC has legal authority to establish U.S. accounting rules but generally allows the FASB to set the standards. To speed the improvement of disclosure, the SEC sometimes implements broad disclosure requirements in areas still being deliberated by the FASB.

• American Institute of Certified Public Accountants (AICPA). The AICPA is a key professional organization of practicing accountants. The AICPA administers the CPA exam, polices the practices of its members, and establishes some accounting guidance, particularly related to specific industries.

• American Accounting Association (AAA). The AAA is the professional organization of accounting professors. The AAA helps disseminate research results and facilitates improvements in accounting education.

• Internal Revenue Service (IRS). Financial accounting is not the same as tax accounting. However, many specifics learned in intermediate accounting are similar to the corresponding tax rules.

4. Realize the growing importance and relevance of international accounting issues to the practice of accounting in the United States and understand the role of the IASB in international accounting standard setting.

Because business is increasingly conducted across national borders, companies must be able to use their financial statements to communicate with external users all over the world. As a result, divergent national accounting practices are converging to an overall global standard.

The International Accounting Standards Board (IASB) is an international body whose goal is to prepare a comprehensive set of financial accounting standards that can be used anywhere in the world. IASB standards have gained almost universal acceptance worldwide. The primary exception is the United States which requires domestic companies to use U.S. GAAP.

5. Understand the significance of the FASB’s conceptual framework in outlining the qualities of good accounting information, defining terms such as asset and revenue, and providing guidance about appropriate recognition, measurement, and reporting.

The conceptual framework allows for the systematic adaptation of accounting standards to a changing business environment. The FASB uses the conceptual framework to aid in an organized and consistent development of new accounting standards. In addition, learning the FASB’s conceptual framework allows one to understand and, perhaps, anticipate future standards.

The conceptual framework outlines the objectives of financial reporting and the qualities of good accounting information, precisely defines commonly used terms such as asset and revenue, and provides guidance about appropriate recognition, measurement, and reporting.

The key financial reporting objectives are as follows:

• Usefulness

• Understandability

• Target audience of investors, lenders, and other creditors

• Assessment of future cash flows and existing economic resources

• Financial performance reflected by accrual accounting

Qualities of useful accounting information are the following:

• Fundamental characteristics

  • Relevance—predictive value, confirmatory value, and materiality

  • Faithful representation—complete, neutral, and free from error

• Enhancing characteristics

  • Comparability

  • Verifiability

  • Timeliness

  • Understandability

Recording an item in the accounting records through a journal entry is called recognition. To be recognized, an item must meet the definition of an element and be measurable, relevant, and reliable.

The following are the five measurement attributes used in practice:

• Historical cost

• Current replacement cost

• Fair value

• Net realizable value

• Present (or discounted) value

A full set of financial statements includes a balance sheet, income statement, statement of cash flows, statement of changes in owners’ equity, and statement of comprehensive income.

6. Identify career opportunities related to accounting and financial reporting and understand the importance of personal ethics in the practice of accounting.

Public accountants are freelance accountants who provide auditing, tax, and a variety of other customer services. In addition, since all companies have some financial reporting responsibilities, there are many financial accounting career opportunities in industry. Because accounting is the language of business, any business career requires a familiarity with financial accounting. Finally, our financial reporting system is of limited value if the accountants who operate the system do not have strong personal ethics.

FASB-IASB Codification Summary

Questions Exercises