16-1 Notes
CHAPTER 16
SYNTHESIS OF FINANCIAL REPORTING
I. Learning Objectives
1. Review the conceptual framework underlying the authoritative guidance for
financial reporting and potential changes in that framework.
2. Review financial reporting standards discussed in previous chapters,
including instances where U.S. GAAP and IFRS diverge.
3. Understand proposed changes in financial statement presentation.
II. Organization of Class Sessions
Because most of the material in the chapter draws on the accounting
principles discussed in Chapters 7 through 14, we use this chapter as a time
for synthesizing and reviewing. The professor might organize the class lecture
around Problem 16.3 or Problem 16.4, both of which serve as a review of the
entire book.
III. Lecture Outline
1. Review the conceptual framework underlying the authoritative
guidance for financial reporting and potential changes in that
framework.
Begin by considering Figure 16.1 provided in text which provides the
components of the conceptual framework. Comment that the FASB and the
IASB rely on a conceptual framework to guide their standard-setting
decisions in order to enhance the quality and consistency of those decisions.
However, both FASB and the IASB have separately developed their
conceptual frameworks, but are similar. Currently these two standard-
setting bodies are working to develop a common conceptual framework for
financial reporting. Explain the financial reporting objectives as provided
by the FASB.
Later, begin by asking: How do we identify a “good” or “acceptable”
principle in the natural sciences (for example, physics or chemistry)?
Scientists hypothesize a relation between two natural events. The
scientists then empirically test this relation to see if it holds in repeated
Notes 16-2
experiments. If so, then the hypothesis becomes accepted as a principle.
Principles in the natural sciences naturally exist, awaiting discovery.
Next, ask: How do we identify a “good” or “acceptable” principle in
mathematics? Mathematicians evaluate a proposed principle by assessing
its logical, deductive consistency with the definitions, axioms and theorems
of the field. Finally, ask: How do we identify a “good” principle in
accounting?
Accounting principles do not naturally exist awaiting discovery. Nor
can standard-setting bodies deductively derive accounting principles from
an accepted logical structure of concepts and definitions. We judge
acceptable accounting principles along at least three dimensions: (1) Does
the accounting principle reflect faithfully the economic effects of a
transaction or event relevant to users of the financial statements? (2) Does
the principle permit measurement of a transaction or event in a
sufficiently objective manner to produce reasonably reliable accounting
data? And (3) is the accounting principle acceptable to a broad range of
preparers and users of financial statements?
A summary of the recent changes in the financial reporting
environment includes the following: (1) the adoption or planned adoption of
IFRS, or standards based on IFRS, for financial reporting in over 100
countries (2) The willingness of the Securities and Exchange Commission
in the United States to permit non-U.S. firms that list and trade their
securities in the United States to report using IFRS without reconciliation
to U.S. GAAP (3.) The requirement to measure certain assets and
liabilities at fair value instead of acquisition cost, and in some cases, to
include the changes in fair value in net income instead of other
comprehensive income (4) The codification of U.S. GAAP into a single body
of literature.
2. Review financial reporting standards discussed in previous
chapters, including instances where U.S. GAAP and IFRS diverge.
We find it useful to think about the firm’s accounting principles
selections decision in terms of satisfying certain reporting objectives. The
reporting objectives of conservation, profit maximization, and income
smoothing are possibilities. For many firms, it is difficult to classify their
behavior very easily. One factor, which probably enters the selection of
accounting principles and which is difficult to assess from information
contained in the annual report, is the benefit/cost tradeoff a firm considers
in making its decision. For example, a profit-maximizing firm might
capitalize and amortize intangibles development costs where possible.
However, such costs might be sufficiently insignificant so that the
16-3 Notes
favorable earnings benefits are not worth the extra record-keeping cost of
following the deferral approach. The firm, therefore, expenses the costs in
the period incurred.
The reporting objectives of U.S. GAAP and IFRS recognize that the
user group is broader than just shareholders, some accounting standards,
particularly those related to consolidated financial statements, have
historically taken a proprietary perspective instead of an entity
perspective. Examples include expenditures for creating a brand name and
researching new technologies. U.S. GAAP and IFRS differ in the extent to
which they require firms to recognize a portion of these expenditures as
assets versus treating the expenditures fully as expenses.
We have the class discuss the appropriate time for understanding
Problem 16.3, and 16.4, comprehensively. In each case, we attempt to
analyze financial reporting standards discussed in previous chapters and
the solution to Problem 16.3 and 16.4 includes detailed outlines of the
direction we try to steer the discussion in each case.
3. Understand proposed changes in financial statement presentation.
The proposed reporting objectives specifies that firms should prepare
financial reports from the perspective of the reporting entity (entity
perspective), rather than from the perspective of its owners or a particular
class of owners (proprietary perspective). Although the reporting
objectives of U.S. GAAP and IFRS recognize that the user group is broader
than just shareholders, some accounting standards, particularly those
related to consolidated financial statements, have historically taken a
proprietary perspective instead of an entity perspective.
Explain the students that a proposed reporting format does not change
the recognition and measurement of assets, liabilities, revenues, expenses,
and cash flows, but does affect the arrangement and classification of these
items in the principal financial statements. In addition, the extent of the
proposed changes in arrangement and classification is considerable and
will require users to rethink how they read, interpret, and analyze
financial reports
To serve as a basis for the discussion on presentation of financial
statements, we place the following diagram; Problem 16.5 or Problem 16.6,
in understanding changes are straightforward illustrations in financial
statement presentation.
Notes 16-4
16-5 Notes
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