CHAPTER 1

Financial Accounting and Accounting Standards

LEARNING OBJECTIVES
1.Identify the major fnancial statements and other means of fnancial reporting.
2.Explain how accounting assists in the efcient use of scarce resources.
3.Identify the objective of fnancial reporting.
4.Explain the need for accounting standards.
5.Identify the major policy-setting bodies and their role in the standard-setting process.
6.Explain the meaning of generally accepted accounting principles (GAAP) and the role of
the Codifcation for GAAP.
7.Describe the impact of user groups on the rule-making process.
8.Describe some of the challenges facing fnancial reporting.
9.Understand issues related to ethics and fnancial accounting.

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Partial Outline Chapter 1
A.(L.O. 1)Major fnancial statements and fnancial reporting.
1. Identifcation, measurement, and communication of fnancial information (discuss
diference between fnancial statements and fnancial reporting).
a. Financial statements:
(1)Income statement.
(2)Balance sheet.
(3)Statement of cash fows.
(4)Statement of owners or stockholders equity.
b. Financial reporting:
(1)Presidents letter or supplementary schedules in the annual report.
(2)Prospectuses.
(3)Reports fled with the SEC and other government agencies.
(4)News releases and management forecasts.
(5)Social or environmental impact statements.
2. To interested parties (discuss stockholders, creditors, government agencies, management,
employees, consumers, labor unions, etc.).
B.(L.O. 2)How accounting assists in the use of scare resources.
1. A world of scarce resources. Accounting helps to identify efcient and inefcient users
of resources.
2. Capital allocation. Accounting assists in the efective capital allocation process by
providing fnancial reports to interested users.
3. Changing user needs. Accounting will continue to be faced with challenges to providing
information needed for an efcient capital allocation process.
C.(L.O. 3)Objective of fnancial reporting.
1. To provide fnancial 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.
D.(L.O. 4)Need for accounting standards.

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1. To meet the various needs of users, companies prepare a single set of general-
purpose fnancial statements.
2. Users expect fnancial statements to present fairly, clearly, and completely the
companys fnancial operations.
3. The accounting profession has developed a set of standards and procedures called
generally accepted accounting principles (GAAP).
E.(L.O. 5)Parties involved in standard-setting.
1. Standard setting in the public sector:
a. Discuss the role of the SEC, reasons for its establishment, SEC jurisdiction.
b. Delegation of SECs authority to the private sector (AICPA and FASB).
2. Standard setting in the private sector.
a. History of private-sector standard setting from the CAP to the APB to the FASB.
b. Reasons for establishment of the FASB.
c. Composition, membership, and voting rules of the FASB.
d. Organization and funding of the FASB.
e. Description of the FASBs due process system in setting standards.
f. Emerging Issues Task ForceCreated by FASB for the purpose of reaching a
consensus on how to account for new and unusual fnancial transactions that
have a potential for creating difering fnancial reporting practices.
3. The SEC continues to play an active role in infuencing standards, e.g., accounting for
business combinations and intangible assets; and concerns about the accounting for
of-balance sheet items raised by the failure of Enron.
F.(L.O. 6)Meaning of GAAP.
1. Generally accepted accounting principles (GAAP) have substantive authoritative support.
2. The AICPAs Code of Professional Conduct requires that members prepare fnancial
statements in accordance with GAAP.
3. GAAP includes:
a. FASB Standards and Interpretations, APB Opinions, AICPA Accounting Research
Bulletins. (Most authoritative.)

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b. AICPA Industry Audit and Accounting Guides, AICPA Statements of Position, FASB
Technical Bulletins.
c. FASB Emerging Issues Task Force, AICPA AcSEC Practice Bulletins, widely
recognized/prevalent industry practices.
(1)Mention that the AICPA will no longer issue authoritative accounting guidance
for public companies.
d. AICPA Accounting Interpretations, FASB Implementation Guides (Q and A)
4. The FASB developed the Financial Accounting Standards Board Accounting Standards
Codifcation (the Codifcation).
a. The Codifcation changes the way GAAP is documented, presented and updated.
b. Explains what GAAP is and eliminates nonessential information.
G.(L.O. 7)Impact of user groups.
1. Describe user (pressure) groups, their composition and their interests.
2. Discuss impact of accounting on the interests of each group.
3. Discuss impact of economic consequences. Although accounting standards should be
based on sound concepts, the FASB must be attentive to the economic consequences
of its pronouncements.
H.The expectations gap.
1. What people think accountants should do vs. what accountants think they can do.
2. Discuss the Sarbanes-Oxley Act and the Public Company Accounting Oversight Board.
I.(L.O. 8)Challenges facing fnancial reporting.
1. Nonfnancial measurements.
2. Forward-looking information.
3. Soft assets.
4. Timeliness.
J.(L.O. 9)Ethics and fnancial accounting.
1.In accounting, companies frequently encounter ethical dilemmas. Some of these
dilemmas are easy to resolve but many are not, requiring difcult choices among
allowable alternatives.

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2.Time, job, client, personal, and peer pressures can complicate the process of ethical
sensitivity and selection among alternatives.
3.Decisions are sometimes difcult because a public consensus has not emerged to
formulate a comprehensive ethical system that provides guidelines in making ethical
judgments.
K.International accounting standards.
1. Companies outside the U.S. often prepare fnancial statements using standards
diferent from GAAP.
2. There is a growing demand for one set of high-quality international standards.
3. There are two sets of acceptable rules for international useGAAP and International
Financial Reporting Standards issued by the International Accounting Standards Board
(IASB).
4. The FASB and the IASB have agreed to use their best eforts to:
a. Make their existing fnancial reporting standards fully compatible as soon as
practicable, and
b. Coordinate their future work programs to ensure that once achieved, compatibility
is maintained.

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*IFRS Insights
Most agree that there is a need for one set of international accounting standards. Here is why:
Multinational corporations. Todays companies view the entire world as their market. For
example, Coca-Cola, Intel, and McDonalds generate more than 50 percent of their sales
outside the United States, and many foreign companies, such as Toyota, Nestl, and Sony, fnd
their largest market to be the United States.
Mergers and acquisitions. The mergers between Fiat/Chrysler and Vodafone/Mannesmann
suggest that we will see even more such business combinations in the future.
Information technology. As communication barriers continue to topple through advances in
technology, companies and individuals in diferent countries and markets are becoming more
comfortable buying and selling goods and services from one another.
Financial markets. Financial markets are of international signifcance today. Whether it is
currency, equity securities (stocks), bonds, or derivatives, there are active markets throughout
the world trading these types of instruments.
RELEVANT FACTS
International standards are referred to as International Financial Reporting Standards
(IFRS), developed by the International Accounting Standards Board (IASB). Recent events
in the global capital markets have underscored the importance of fnancial disclosure and
transparency not only in the United States but in markets around the world. As a result,
many are examining which accounting and fnancial disclosure rules should be followed.
U.S. standards, referred to as generally accepted accounting principles (GAAP), are
developed by the Financial Accounting Standards Board (FASB). The fact that there are
diferences between what is in this textbook (which is based on U.S. standards) and IFRS
should not be surprising because the FASB and IASB have responded to diferent user
needs. In some countries, the primary users of fnancial statements are private investors; in
others, the primary users are tax authorities or central government planners. It appears that
the United States and the international standard-setting environment are primarily driven by
meeting the needs of investors and creditors.
The internal control standards applicable to Sarbanes-Oxley (SOX) apply only to large
public companies listed on U.S. exchanges. There is a continuing debate as to whether
non-U.S. companies should have to comply with this extra layer of regulation. Debate about
international companies (non-U.S.) adopting SOX-type standards centers on whether the
benefts exceed the costs. The concern is that the higher costs of SOX compliance are
making the U.S. securities markets less competitive.
IFRS tends to be simpler in its accounting and disclosure requirements; some people say
more principles-based. GAAP is more detailed; some people say more rules-based. This
diference in approach has resulted in a debate about the merits of principles-based
versus rules-based standards.

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ILLUSTRATION 1-1
THE ESSENTIAL CHARACTERISTICS
OF ACCOUNTING AND FINANCIAL REPORTING

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ILLUSTRATION 1-2
ORGANIZATIONAL STRUCTURE FOR SETTING ACCOUNTING
STANDARDS

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Copyright 2012 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 14/e
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ILLUSTRATION 1-3
STEPS TAKEN IN THE EVOLUTION OF A FASB STATEMENT OF
THE FINANCIAL ACCOUNTING STANDARDS BOARD

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ILLUSTRATION 1-4
GAAP DOCUMENTS

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ILLUSTRATION 1-5
USER GROUPS THAT INFLUENCE THE
FORMULATION OF ACCOUNTING STANDARDS

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ILLUSTRATION 1-6
KEY PROVISIONS OF THE SARBANES-OXLEY ACT

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ILLUSTRATION 1-7
THE CHALLENGES FACING FINANCIAL REPORTING

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