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CHAPTER 1

Financial Accounting and Accounting Standards

ASSIGNMENT CLASSIFICATION TABLE

Topics Questions Cases

1. Subject matter of accounting. 1 4

2. Environment of accounting. 2, 3, 29 6, 7

3. Role of principles, objectives, standards,

and accounting theory. 4, 5, 6, 7 1, 2, 3, 5

4. Historical development of GAAP. 8, 9, 10, 11 8

5. Authoritative pronouncements and rule-

making bodies. 12, 13, 14, 15,

16, 17, 18, 19,

20, 21, 22, 23

3, 9, 11, 12, 13,

14, 16, 17

6. Role of pressure groups. 23, 24, 25,

26, 27, 28 10, 19, 20

7. Ethical issues. 30 15, 18

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ASSIGNMENT CHARACTERISTICS TABLE

Item Description Level of

Difficulty Time

(minutes)

CA1-1 FASB and standard-setting. Simple 15–20

CA1-2 GAAP and standard-setting. Simple 15–20

CA1-3 Financial reporting and accounting standards. Simple 15–20

CA1-4 Financial accounting. Simple 15–20

CA1-5 Objective of financial reporting. Moderate 20–25

CA1-6 Accounting numbers and the environment. Simple 10–15

CA1-7 Need for GAAP. Simple 15–20

CA1-8 AICPA’s role in rule-making. Simple 20–25

CA1-9 FASB role in rule-making. Simple 20–25

CA1-10 Politicalization of GAAP. Complex 30–40

CA1-11 Models for setting GAAP. Simple 15–20

CA1-12 GAAP terminology. Moderate 30–40

CA1-13 Accounting organizations and documents issued. Simple 15–20

CA1-14 Accounting pronouncements. Simple 10–15

CA1-15 Rule-making Issues. Complex 20–25

CA1-16 Securities and Exchange Commission. Moderate 30–40

CA1-17 Rule-making process. Moderate 25–35

CA1-18 Financial reporting pressures. Moderate 25–35

CA1-19 Economic consequences. Moderate 25–35

CA1-20 GAAP and economic consequences. Moderate 25–35

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SOLUTIONS TO CODIFICATION EXERCISES

CE1-1

There is no answer to this requirement as it asks the student to register to use the Codification.

CE1-2

(a) The Codification Overview module illustrates three items (1) the topic structure (2) different methods of

accessing and viewing content, and (3) a summary of the unique features of the Codification

Research System.

(b) The Codification is intended to (1) become the single source of U.S. accounting standards and

(2) supersede all of the non-SEC documents used to populate the Codification.

CE1-3

The “What’s New” page provides links to Codification content that has been recently issued. During the

verification phase, updates may result from either the issuance of Codification update instructions that

accompany new Standards or from changes to the Codification due to incorporation of constituent

feedback.

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ANSWERS TO QUESTIONS

1. Financial accounting measures, classifies, and summarizes in report form those activities and that

information which relate to the enterprise as a whole for use by parties both internal and external to a

business enterprise. Managerial accounting also measures, classifies, and summarizes in report

form enterprise activities, but the communication is for the use of internal, managerial parties, and

relates more to subsystems of the entity. Managerial accounting is management decision oriented

and directed more toward product line, division, and profit center reporting.

2. Financial statements generally refer to the four basic financial statements: balance sheet, income

statement, statement of cash flows, and statement of changes in owners’ or stockholders’ equity.

Financial reporting is a broader concept; it includes the basic financial statements and any other

means of communicating financial and economic data to interested external parties. Examples of

financial reporting other than financial statements are annual reports, prospectuses, reports filed with

the government, news releases, management forecasts or plans, and descriptions of an enterprise’s

social or environmental impact.

3. If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right

managers and companies are able to attract investment capital. To provide unreliable and irrelevant

information leads to poor capital allocation which adversely affects the securities market.

4. The objective of general purpose financial reporting is to provide financial information about the

reporting entity that is useful to present and potential equity investors, lenders, and other creditors

in decisions about providing resources to the entity through equity investments and loans or other

forms of credit. Information that is decision-useful to capital providers (investors) may also be useful

to other users of financial reporting who are not investors.

5. Investors are interested in financial reporting because it provides information that is useful for

making decisions (referred to as the decision-usefulness approach). When making these

decisions, 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.

Financial reporting should therefore help investors assess the amounts, timing, and uncertainty of

prospective cash inflows from dividends or interest, and the proceeds from the sale, redemption,

or maturity of securities or loans. In order for investors to make these assessments, the economic

resources of an enterprise, the claims to those resources, and the changes in them must be

understood.

6. A common set of standards applied by all businesses and entities provides financial statements

which are reasonably comparable. Without a common set of standards, each enterprise could, and

would, develop its own theory structure and set of practices, resulting in noncomparability among

enterprises.

7. General-purpose financial statements are not likely to satisfy the specific needs of all interested

parties. Since the needs of interested parties such as creditors, managers, owners, governmental

agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements

is equally appropriate for these varied uses.

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Questions Chapter 1 (Continued)

8. The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and

principles to be employed by the companies that fall within its jurisdiction. Because the SEC receives

audited financial statements from nearly all companies that issue securities to the public or are listed

on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the

statements. For many years the SEC relied on the AICPA to regulate the profession and develop

and enforce accounting principles. Lately, the SEC has assumed a more active role in the develop-

ment of accounting standards, especially in the area of disclosure requirements. In December 1973,

in ASR No. 150, the SEC said the FASB’s statements would be presumed to carry substantial

authoritative support and anything contrary to them to lack such support. It thereby supports the

development of accounting principles in the private sector.

9. The Committee on Accounting Procedure was a special committee of the American Institute of CPAs

that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with

a wide variety of timely accounting problems. These bulletins provided solutions to immediate

problems and narrowed the range of alternative practices. But, the Committee’s problem-by-problem

approach failed to provide a well-defined and well-structured body of accounting theory that was so

badly needed. The Committee on Accounting Procedure was replaced in 1959 by the Accounting

Principles Board.

10. The creation of the Accounting Principles Board was intended to advance the written expression

of accounting principles, to determine appropriate practices, and to narrow the differences and

inconsistencies in practice. To achieve its basic objectives, its mission was to develop an overall

conceptual framework to assist in the resolution of problems as they became evident and to do

substantive research on individual issues before pronouncements were issued.

11. Accounting Research Bulletins were pronouncements on accounting practice issued by the

Committee on Accounting Procedure between 1939 and 1959; since 1964 they have been

recognized as accepted accounting practice unless superseded in part or in whole by an opinion of

the APB or an FASB standard. APB Opinions were issued by the Accounting Principles Board

during the years 1959 through 1973 and, unless superseded by FASB Statements, are recognized

as accepted practice and constitute the requirements to be followed by all business enterprises.

FASB Statements are pronouncements of the Financial Accounting Standards Board and currently

represent the accounting profession’s authoritative pronouncements on financial accounting and

reporting practices.

12. The explanation should note that generally accepted accounting principles or standards have

“substantial authoritative support.” They consist of accounting practices, procedures, theories,

concepts, and methods which are recognized by a large majority of practicing accountants as well

as other members of the business and financial community. Bulletins issued by the Committee on

Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements

issued by the Financial Accounting Standards Board constitute “substantial authoritative support.”

13. It was believed that FASB Statements would carry greater weight than APB Opinions because of

significant differences between the FASB and the APB, namely: (1) The FASB has a smaller mem-

bership, (2) full-time compensated members; (3) the FASB has greater autonomy, (4) increased

independence; (5) the FASB has broader representation than the APB.

14. The technical staff of the FASB conducts research on an identified accounting topic and prepares

a “preliminary views” that is released by the Board for public reaction. The Board analyzes and

evaluates the public response to the preliminary views, deliberates on the issues, and issues an

“exposure draft” for public comment. The preliminary views merely present all facts and alternatives

related to a specific topic or problem, whereas the exposure draft is a tentative “statement.” Afte

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studying the public’s reaction to the exposure draft, the Board may reevaluate its position, revise

the draft, and vote on the issuance of a final statement.

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Questions Chapter 1 (Continued)

15. Statements of financial accounting standards constitute generally accepted accounting principles

and dictate acceptable financial accounting and reporting practices as promulgated by the FASB.

The first standards statement was issued by the FASB in 1973.

Statements of financial accounting concepts do not establish generally accepted accounting

principles. Rather, the concepts statements set forth fundamental objectives and concepts that the

FASB intends to use as a basis for developing future standards. The concepts serve as guidelines

in solving existing and emerging accounting problems in a consistent, sound manner. Both the

standards statements and the concepts statements may develop through the same process from

discussion memorandum, to exposure draft, to a final approved statement.

16. Rule 203 of the Code of Professional Conduct prohibits a member of the AICPA from expressing

an opinion that financial statements conform with GAAP if those statements contain a material

departure from an accounting principle promulgated by the FASB, or its predecessors, the APB

and the CAP, unless the member can demonstrate that because of unusual circumstances the

financial statements would otherwise have been misleading. Failure to follow Rule 203 can lead to

a loss of a CPA’s license to practice. This rule is extremely important because it requires auditors

to follow FASB standards.

17. FASB Standards, FASB Technical Bulletins, AICPA Practice Bulletins.

18. The chairman of the FASB was indicating that too much attention is put on the bottom line and not

enough on the development of quality products. Managers should be less concerned with short-

term results and be more concerned with the long-term results. In addition, short-term tax benefits

often lead to long-term problems.

The second part of his comment relates to accountants being overly concerned with following a set

of rules, so that if litigation ensues, they will be able to argue that they followed the rules exactly.

The problem with this approach is that accountants want more and more rules with less reliance

on professional judgment. Less professional judgment leads to inappropriate use of accounting

procedures in difficult situations.

In the accountants’ defense, recent legal decisions have imposed vast new liability on accountants.

The concept of accountant’s liability that has emerged in these cases is broad and expansive; the

number of classes of people to whom the accountant is held responsible are almost limitless.

19. FASB Staff Positions (FSP) are used to provide interpretive guidance and to make minor amend-

ments to existing standards. The due process used to issue a FSP is the same used to issue a

new standard.

20. The Emerging Issues Task Force often arrives at consensus conclusions on certain financial report–

ing issues. These consensus conclusions are then looked upon as GAAP by practitioners because

the SEC has indicated that it will view consensus solutions as preferred accounting and will require

persuasive justification for departing from them. Thus, at least for public companies which are sub-

ject to SEC oversight, consensus solutions developed by the Emerging Issues Task Force are

followed unless subsequently overturned by the FASB. It should be noted that the FASB took

greater direct ownership of GAAP established by the EITF by requiring that consensus positions be

ratified by the FASB.

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Questions Chapter 1 (Continued)

21. The Financial Accounting Standards Board Accounting Standards Codification (Codifications) is a

compilation of all GAAP in one place. Its purpose is to integrate and synthesize existing GAAP and

not to create new GAAP. It creates one level of GAAP which is considered authoritative. The FASB

Codification Research Systems (CRS) is an-on-line real time data base which provides easy access

to the Codification. The Codification and the related CRS provide a topically organized structure

which is subdivided into topic, subtopics, sections, and paragraphs.

22. Hopefully, the codification will help users to better understand what GAAP is. If this occurs,

companies will be more likely to comply with GAAP and the time to research accounting issues will

be substantially reduced. In addition, through the electronic web-based format, GAAP can be easil

y

updated which will help users stay current.

23. The sources of pressure are innumerable, but the most intense and continuous pressure to

change or influence accounting principles or standards come from individual companies, industr

y

associations, governmental agencies, practicing accountants, academicians, professional accoun-

ting organizations, and public opinion.

24. Economic consequences means the impact of accounting reports on the wealth positions of issuers

and users of financial information and the decision-making behavior resulting from that impact. In

other words, accounting information impacts various users in many different ways which leads to

wealth transfers among these various groups.

If politics plays an important role in the development of accounting rules, the rules will be subject

to manipulation for the purpose of furthering whatever policy prevails at the moment. No matte

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