FINANCIAL ACCOUNTING

THEORY AND ANALYSIS:

TEXT AND CASES
11TH EDITION

RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY
 CHAPTER 1

THE DEVELOPMENT OF
ACCOUNTING THEORY
Introduction
 What is theory?
 Webster defines theory as:
“Systematically organized knowledge, applicable in a relatively wide
variety of circumstances, a system of assumptions, accepted principles
and rules of procedure to analyze, predict or otherwise explain the
nature of behavior of a specified set of phenomena.”
Theories may be described as:
Normative theory – explain what sould be
Positive theory – explain what is
 Why is the development of a general theory of
accounting important?
 The role accounting in economic society to allocate scare
resources
 The goal of accounting theory:
 To provide a set of principles and relationship that explains
observed practice and predict unobserved practices
 Accounting Theory should be verifiable through accounting
research.
 THE EARLY HISTORY OF ACCOUNTING
 Denise Schmandt-Besserat
 Origins of writing are actually found in counting.
 Pieces of fired clay in Middle Eastern archeological sites.
 Tokens comprised an elaborate system of accounting that was used
throughout the Middle East from approximately 8000 to 3000 B. C.
 Each token stood for a specific item (a sheep or a jar of oil)
 Used to take inventory and keep accounts

 Other accounting records dating back several thousand

years have been found in various parts of the world.
 These records indicate that at all levels of development, people desire
information about their efforts and accomplishments.
 For example the Zenon Papyri
 Zenon was private secretary for Apollonius in Egypt (260 BC)
 Information about the construction projects, agricultural activities, and
business operations of the private estate of Apollonius
 Give evidence of accounting system which had been used in Greece
since 5th century B.C  written record of all transaction
THE EARLY HISTORY OF ACCOUNTING

 The impact of the Renaissance (1300 – 1500)

 Romans were not able to develop any structured system of
accounting because they express numbers through letters of
the alphabet.
 Italian merchants borrowed the Arabic numeral system
 Italians pursuing trade and commerce needed records
 1494 Fra Luca Pacioli: wrote a book on arithmatic that
included a description of double-entry bookkeeping

 The evolution of joint ventures into ongoing

businesses (1600)
 Many people needed information about corporation’s activities
 Caused need for external financial reporting
 THE EARLY HISTORY OF ACCOUNTING

 The impact of the industrial revolution and the

progressive movement
 needed for more formal accounting procedures and standards
 Widespread speculation in the securities markets, watered
stocks, and large monopolies that controlled segments of
the U.S. economy.
 1900 report suggested that independent public accounting
profession should be established to curtail observed
corporate abuses.
 The major concern of accounting during the early 1900s
was the development of a theory that cope with corporate
abuse.
THE EARLY HISTORY OF ACCOUNTING

 The concept of capital maintenance

 Viewed as a way to curb corporate abuses
 The Accountant’s role as protector of third parties
 1882- The Institute of Accountant of New York (first professional
accounting organization)
 1887- American Association of Public Accountant (AAPA)
 1904 – The merger of the Institute of Accountant (formed 1882) and
American Association of Public Accountants (formed 1887)
 1916 - American Institute of Accountants (AIA)
 1916 - American Association of the University Instructors in Accounting
 1920 – World War I : The Accountans as protector of business
interest (stewardship role and permitted too much flexibility in
financial reporting)
 1929 – Stock market crashed, Great Depression in US
 ACCOUNTING IN THE UNITED STATES
SINCE 1930
 Great Depression caused business interests concerned
about government intervention and looked for ways to self
reform:
 Meetings between NYSE and AIA – discussed about investors
interest
 1935 AAA – Did research and development of accounting principles
and standards
 SEC – under powers provided by Congress, the SEC was given the
authority to prescribe accounting principles and reporting practices
 Difference between public and private sector formulation of
accounting principles
 ACCOUNTING IN THE UNITED STATES
SINCE 1930
 1936 - 1938
 SEC: internal debate about whether it
should develop accounting standards.
 1938
 Accounting Series Release (ASR No. 4)
 SEC allowed private sector to set accounting principles
 Reports filed with SEC must be prepared in accordance with accounting principles
that have “substantial authoritative support{.

 A Statement of Accounting Principles

 Sanders, Hatfield & Moore
 Because accounting profession did not think it had time to develop
theoretical framework of accounting
 “Do what you think is best.”
American Institute of Certified Public Accountants
(AICPA)
 1936 – AIA merged with American Society of CPA 
AICPA
 AICPA had influence on development of accounting
theory by established several committees and boards:
 Committee on Accounting Procedure
 Accounting Principles Board
 Financial Accounting Standards Board
 Each has issued pronouncements
 Have become primary source of today’s generally accepted
accounting principles
Committee on Accounting Procedure (CAP)
 Formed in 1936
 Professional accountants
 AICPA’s committee that had authority to issues pronouncements on
matters of accouting practice and procedure in order to establish
generally accepted practices
 The work CAP were published in Accounting Research Bulletins (ARBs)
 Accounting Research Bulletins (ARBs)
 Pronouncements
 Did not dictate mandatory practice
 Received authority only from general acceptance
 ARBs consolidated in 1953
 Accounting Terminology Bulletin NO. 1, “Review and Resume” and ARB
No. 43
 ARB 44-53 published 1953 – 1959
 FASB Accounting Standards Codification (Discussed later in the
chapter) includes recommendations of these bulletins that
have not been superseded
THE ACCOUNTING PRINCIPLES BOARD
(APB)

 1959 The CAP was criticized for acting in a

piecemeal fashion and issuing standard that in
many cases were inconsistent  IACPA formed
APB
 Pronouncements of the APB  APB Opinion
 THE ACCOUNTING PRINCIPLES BOARD
(APB)
 Criticism of the APB
 Independence of members
 Members had full-time responsibilities elsewhere that could influence
views
 Structure
 “Big 8” automatically awarded 1 member
 Usually 5 or 6 other public accountants on board
 Response time
 Part-time members not able to investigate
and resolve emergency issues in timely
manner
 THE FINANCIAL ACCOUNTING STANDARDS
BOARD (FASB)

 Formed in 1971 to response the criticism of APB

 The lack of support for some of APB’s pronouncements
 The members of APB were volunteers  duties on the APB
become secondary
 Members FASB was full time paid employees and
representatives from various organization
 1971: Board of Directors of AICPA appointed 2
committees:
 The Wheat Committee
 How to establish accounting principles
 The Trueblood Committee
 Objectives of financial statements
 Structure of the FASB
Appoint and Financial Govern Appoint
Board of Electors
fund
------- Accounting
| Trustees
| Foundation
|
Appoint and
fund
Financial
Accounting Financial
Task Forces
Standards Accounting Appoint
of the
Advisory Standards
Standards
Committee Board
Board
(approx. ( 7 members)
20 members)

Admin. Research Staff

Staff
 FASB
 Mission – establish standards

 Types of pronouncements

Statements of Financial Accounting Concepts

Statements of Financial Accounting Standards
Interpretations
Technical Bulletins
FASB
 Emerging Issues
 Failing to provide timely guidance on emerging implementation and
practice problems
 Standards Overload
 Too many standards
 Not all GAAP requirements are relevant to small business
 Standard setting as a political process
 Accounting standards are a product of political action
 A variety of parties are interested in and affected by the
development of accounting standards
 Economic Consequences
 The impact of accounting report on various segments of economic
society.
 The accounting practice a company adopts affect its security price and
value
GAAP
 Evolution of phrase:
 Changed wording of auditor’s certificate brought about by
meetings between NYSE and AIA
 The APB’s definition
 “present fairly…in conformity with generally accepted accounting
principles:
 The Auditing Standards Executive Committee’s definition
 No singular reference source exists for all principles
 Makes general acceptance of a specific principle
difficult
 The current sources of GAAP consist of four levels
described as A, B, C, and D by Statement of Auditing
Standards No 69
SFAS No. 162
 Hierarchy of GAAP
 Four levels
A
 FASB codification project reduced
B this to 2 levels:
 Authoritative
C  Not authoritative

D
GAAP Hierarchy

LEVEL A:
FASB Statements
FASB Interpretations
SEC Rules and Interpretive Releases
Accounting Principles Board Opinions (unless amended)
Account Research Bulletins (unless amended)

LEVEL B:
FASB Technical Bulletins
AICPA Industry Audit Guides that have been reviewed by the FASB
GAAP Hierarchy

LEVEL C:
AcSEC Practice Bulletins that have been reviewed by the FASB
Consensuses reached by the EITF

LEVEL D:
AICPA Accounting Interpretations (no longer issued)
FASB Implementation Guides
Other widely recognized or prevalent accounting practices
The FASB’s Accounting Standards Codification

 Hundreds of accounting standards promulgated by

several different accounting standard setters.
 Accounting standards had evolved to the point that
professionals could not keep up.
 September, 2004: the FAF Trustees approved funding
for the FASB’s codification and retrieval project
The FASB’s Accounting Standards Codification

 June 2009
 FASB announced Codification
would be single source of all
nongovernmental US GAAP
effective 9/15/09.
 Involved following steps:
1. Restructure all U.S. GAAP literature by
topic into a single authoritative
codification.
2. Modify the standard-setting process to
focus on updating the codification.
The FASB’s Accounting Standards Codification

 Reasons for codification

 Researching multiple authoritative sources
complicated research process
 FASB, EITF, AICPA & SEC literature
 FASB ASC contains all current
authoritative accounting literature
 If guidance is not specified, first source to
consider is accounting principles for similar
issue with a source of authoritative GAAP
 Nonauthoritative guidance from other sources
may be considered if similar transactions aren’t
discovered in GAAP.
THE ROLE OF ETHICS IN
ACCOUNTING
 The public accountant as a
watchdog
 What is basic conflict of interest
facing public accountants?
Accounting in Crisis – The Events of
the Early 2000s
 Enron and the Accounting Scandals
 “Special-purpose entities” (SPEs)
 Now termed variable interest entities (VIEs)
 Purpose:
 Access capital
 Hedge risk

 Allowed company to increase financial leverage

and return on assets without reporting debt on
balance sheet
 Losses were kept off Enron’s books
 Enron filed for bankruptcy and stock became
virtually worthless.
 Accounting in Crisis – The Events of
the Early 2000s
 Two major changes in the accounting profession have
taken place in the wake of the accounting scandals:
1. Arthur Andersen
 formerly one the Big 5 audit firms
 has gone out of business
2. Sarbanes-Oxley Act

 President Bush signed into law July 2002

 imposes a number of corporate governance rules on publicly traded
companies (Discussed in chapter 17)
 International Accounting Standards
 The concept of harmonization
 The IASB
 The IASB’s objectives:
1. To formulate and publish in the public interest accounting
standards to be observed in the presentation of financial
statements and to promote their worldwide acceptance and
observance
2. To work generally for the improvement and harmonization
of regulations, accounting standards, and procedures
relating to the presentation of financial statements.
 41 Statements of Accounting Standards and 13
Statements of Financial Reporting Standards to date
 Kondisi di Indonesia
 1957, berdiri organisasi yang mewadahi para akuntan di Indonesia yaitu
Ikatan Akuntansi Indonesia (IAI).
 1973, mulai diaktifkan pasar modal. IAI membentuk suatu panitia
perhimpunan bahan dan struktur GAAP (Generally Accepted Accounting
Principles) dan GAAS (Generally Accepted Auditing Standard). Panitia ini
menghasilkan buku Prinsip Akuntansi Indonesia (PAI).
 1974 dibentuk Komite Prinsip Akuntansi Indonesia (Komite PAI). Komite ini
bertugas sampai tahun 1994
 Setelah tahun 1994, Komite PAI diubah menjadi Komite Standar Akuntansi
Keuangan (SAK). Komite SAK melakukan revisi total terhadap PAI menjadi
Standar Akuntansi Keuangan (SAK)
 1998, Komite SAK ini bertugas kembali menjadi Dewan Standar Akuntansi
Keuangan Indonesia. Dewan SAK bertugas dari tahun 1998 sampai 2002
dan mempunyai otonomi untuk menyusun serta mengesahkan PSAK. Pada
periode ini juga dibentuk Dewan Konsultasi SAK yang anggotanya para
praktisi (pengguna) Akuntansi.
 Ikatan Akuntan Indonesia (IAI) Desember 2008 mendeklarasikan rencana
untuk convergence terhadap International Financial Reporting Standards
(IFRS) dalam pengaturan standar akuntansi keuangan. Konvergen dengan
IFRS akan diterapkan untuk penyusunan laporan keuangan entitas yang
dimulai pada atau setelah tanggal 1 Januari 2012
 End of Chapter 1

Prepared by Kathryn Yarbrough, MBA

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