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Chapter 1 Lecture

Accounting is a service activity. Its function is to provide useful financial information about economic entities to interested parties, such as managers, investors, and creditors. Financial accounting provides information to those decision makers who are outside the economic entity, such as investors, creditors, and governmental agencies. Financial accounting information also is used by managers inside the economic entity.

A.What is accounting?

1.Identification, measurement, and communication of financial information (discuss difference between financial statements and financial reporting).

Review Illustration 1-1 to identify the essential characteristics of accounting and financial reporting.

a.Financial statements:

(1)Income statement.

(2)Balance sheet.

(3)Statement of cash flows.

(4)Statement of changes in owner’s or stockholders' equity.

b.Financial reporting:

(1)President's letter or supplementary schedules in the annual report.

(2)Prospectuses.

(3)Reports filed with the SEC and other government agencies.

(4)News releases and management forecasts.

2.About economic entities (such as corporations, partnerships, and proprietorships).

3.To interested parties (discuss stockholders, creditors, government agencies, management, employees, consumers, labor unions, etc.).

B.What is the environment in which accounting operates?

1.A world of scarce resources. Accounting helps to identify efficient and inefficient users of resources.

2.Capital allocation. Accounting assists in the effective capital allocation process by providing financial reports to interested users.

3.Changing user needs. Accounting will continue to be faced with challenges to providing information needed for an efficient capital allocation process. C.Challenges facing financial accounting.

1. Non-financial measurements.

2. Forward-looking information.

3. Soft assets.

4. Timeliness.

D.What are the objectives of accounting?

Objectives of financial reporting identified in SFAC No. 1, are to provide:

1.Information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. (Note the FASB's emphasis on investors and creditors as primary users. However, this does not exclude other interested parties.)

2.Information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. (We will review the difference between the cash basis and the accrual basis of accounting in later chapters. Accountants believe that the accrual basis is more useful for predicting future cash flows.)

3. Information about the economic resources of an enterprise, the claims on those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

E. Why are standards needed?

1.Need for comparability among the financial statements of different enterprises.

2.Need to minimize bias, ambiguity, inexactness, and misinterpretation.

F. What is meant by GAAP?

Those principles that have "substantive authoritative support:"

1. Principles established by an authoritative rule-making body.

Refer to the "House of GAAP" as shown in Illustration 1-3, Review the various levels of "authoritative support."

a.Category (A)—FASB Standards and Interpretations, APB Opinions and Interpretations, CAP Accounting Research Bulletins. (Most authoritative.)

b.Category (B)—AICPA Accounting and Audit Guides, AICPA Statements of Position, FASB Technical Bulletins....
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