Chapter 1

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C H A P T E R 1
FINANCIAL REPORTING AND
ACCOUNTING STANDARDS
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield

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1. Identify the major financial statements and other means of
financial reporting.
2. Explain how accounting assists in the efficient use of scarce
resources.
3. Explain the need for high-quality standards.
4. Identify the objective of financial reporting.
5. Identify the major policy-setting bodies and their role in the
standard-setting process.
6. Explain the meaning of IFRS.
7. Describe the challenges facing financial reporting.
Learning Objectives

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General-purpose
financial
statements
Capital providers
Entity perspective
Decision-
usefulness
Global Markets
Objective of
Financial
Reporting
Standard-Setting
Organizations
Financial
Reporting
Challenges
Financial
statements and
financial reporting
Accounting and
capital allocation
High-quality
standards
IOSCO
IASB
Hierarchy of IFRS
Political
environment
Expectations gap
Significant financial
reporting issues
Ethics
International
convergence
Financial Reporting and Accounting Standards

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What is accounting?
Accounting:
Broadly, is an information system that is meant to
provide a fair and balanced reporting and measurement
of financial performance for a given economic entity
donated in monetary terms.
Why do we need this information? … who uses
this information? And what do they use it for?
You have to keep this question in mind as you
study to become a professional accountant

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Objective of Financial Accounting
Objective: Provide financial 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.

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Capital Providers (Investors)
Investors are the primary user group.
General-Purpose Financial Statements
 Provide financial reporting information to a wide variety
of users.
 Provide the most useful information possible at the
least cost. (costs vs. benefits)

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Decision-Usefulness
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 (i.e. stewardship)
Entity Perspective
As we provide information about an entity, we have to view the
entity (company) as a separate and distinct being from its
owners.

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How Do We Prepare Accounting Information?
Follow a set of standards we can all accept and agree on:
1. Can be local for a specific country. (U.S. GAAP, Saudi
GAAP, Chinese GAAP)
2. Can be common for a group of countries (IFRS).
We need to use a common method?... Otherwise!
Question: do we really need international standards? Or, is
having local accounting standards for your country enough?

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The Case for IFRS
1. World economies have become greatly intertwined in a
globalized world economy.
2. Investors have become international in their investment
strategies.
3. The rise of multinational corporations.
4. Companies list their shares in global exchange markets and
seek to raise capital from different countries.
5. It is costly to have more than one set of standards.
Why use IFRS instead of Custom Standards?

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Global Markets
World markets are becoming increasingly intertwined.
Top 20 Global Companies In Terms Of Sales

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Global Markets
Significant number of foreign companies are found on
national exchanges.
By 2013, 213 of the largest 500 global companies in the
world will be using IFRS.

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Characteristics of Accounting Information
Financial Statements and Financial Reporting
Characteristics of accounting are:
(1) the identification, measurement, and communication
of financial information about
(2) economic entities to
(3) interested parties.

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Financial
Information
Accounting?
Identify
and
Measure
and
Communicate
Statement of
Financial Position
Income Statement
or Statement of
Comprehensive
Income
Statement of Cash
Flows
Statement of
Changes in Equity
Note Disclosures
President’s letter
Prospectuses
Reports filed with
governmental
agencies
News releases
Forecasts
Environmental
impact statements
Etc.
Financial Statements Additional InformationEconomic Entity
Accounting Information Forms

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Resources are limited. Efficient use of resources often
determines whether a business thrives.
Accounting and Capital Allocation
What is the role of accounting in society?
Accountants must measure performance accurately and
fairly, so that the right managers and companies are able
to attract investment capital.

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High Quality Standards
Elements of Global Accounting Standards
Globalization demands a single set of high-quality
international accounting standards.
How?  Some elements needed for success:
1. Single set of high-quality accounting standards established by
a single standard-setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants. (Continued)

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High Quality Standards
Global Markets
Globalization demands a single set of high-quality
international accounting standards. Some elements:
7. Common delivery systems (e.g., eXtensible Business
Reporting Language—XBRL).
8. Common approach to corporate governance and legal
frameworks around the world.

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The objective of financial reporting places the most
emphasis on:
a. reporting to capital providers.
b. reporting on stewardship.
c. providing specific guidance related to specific needs.
d. providing information to individuals who are experts in
the field.
Review Question

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General-purpose financial statements are prepared
primarily for:
a. internal users.
b. external users.
c. auditors.
d. government regulators.
Review Question

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Two Major Organizations:
 International Accounting Standards Board (IASB)
 Issues International Financial Reporting Standards
(IFRS).
 Standards used on most foreign exchanges.
 Standards used by foreign companies listing on U.S.
securities exchanges.
 IFRS used in over 115 countries.
 To be implemented in Saudi Arabia in 2014!
Standard-Setting Organizations

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Two Major Organizations:
Financial Accounting Standards Board (FASB)
 Issues Statements of Financial Accounting
Standards (SFAS).
 Required for all U.S.-based companies.
 FASB standards are more detailed and outnumber
current IASB standards.

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International Organization of Securities
Commissions (IOSCO)
 Does not set accounting standards.
 Dedicated to ensuring that global
markets can operate in an efficient
and effective basis.
 Is the equivalent of the SEC
(securities and exchange
commission) in the U.S. and CMA
(Capital Markets Authority) in Saudi
Arabia.
http://www.iosco.org/
http://www.cma.gov.sa/

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International Accounting Standards Board (IASB)
Composed of four organizations—
 International Accounting Standards Committee Foundation
(IASCF)
 International Accounting Standards Board (IASB)
 Standards Advisory Council
 International Financial Reporting Interpretations
Committee (IFRIC)
http://www.iasb.org

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The major key players on the international side
(outside the United States) are the:
a. IASB and FASB.
b. SEC and FASB.
c. IOSCO and the SEC.
d. IASB and IOSCO.
Review Question

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Which body from the U.S. side is similar to the IASB?
a. SEC.
b. FASB.
c. FASC.
d. FAF.
Review Question

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Due Process
The IASB due process has the following elements:
1. Independent standard-setting board;
2. Thorough and systematic process for developing
standards;
3. Engagement with investors, regulators, business
leaders, and the global accountancy profession at
every stage of the process; and
4. Collaborative efforts with the worldwide standard-
setting community.

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Due Process
The IASB characteristics are as follows:
• Membership: 14 members from different countries (2-part-
time);
• Autonomy: The IASB is NOT part of any other
professional organization, only follows IASC.
• Independence: Full-time IASB members must sever all
ties to any past employer.
• Voting: 9 out of 14 votes are required to approve a
standard.

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Issued by the IASB:
Types of Pronouncements
International Financial Reporting Standards.
Framework for financial reporting.
International financial reporting interpretations.

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Hierarchy of IFRS
Companies first look to:
1. International Financial Reporting Standards (IFRS);
2. International Accounting Standards (IAS) (i.e. old
standards); and
3. Interpretations originated by the International
Financial Reporting Interpretations Committee (IFRIC)
or the former Standing Interpretations Committee (SIC).

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Financial Reporting Challenges
IFRS in a Political Environment

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The independence of the IASB:
 IASC is funded primarily by the private sector
(including U.S. big accounting firms).
 IASC has been seeking joint government funding to
become more independent financially.
 The SEC has still NOT issued guidelines for U.S.
companies to use IFRS. Currently, foreign companies
listed in the U.S. are allowed to use IFRS instead of
U.S. GAAP.

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Accounting standard-setters use the following process
in establishing international standards:
a. Research, exposure draft, discussion paper, standard.
b. Discussion paper, research, exposure draft, standard.
c. Research, preliminary views, discussion paper,
standard.
d. Research, discussion paper, exposure draft, standard.
Review Question
Due Process

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What the public thinks accountants should do VS. what
accountants think they can do.
The Expectations Gap
Significant Financial Reporting Issues
 Non-financial measurements
 Forward-looking information
 Soft assets
 Timeliness

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Ethics in the Environment of Financial Accounting
 Companies that concentrate on “maximizing the bottom
line,” “facing the challenges of competition,” and
“stressing short-term results” place accountants in an
environment of conflict and pressure.
 IFRS does not always provide an answer.
 This is why your job is interesting!
 Doing the right thing is not always easy or obvious.

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International Convergence
In 2002, the IASB and the FASB formalized their commitment
to the convergence of U.S. GAAP and international
standards. The two Boards agreed to:
1. Make their existing financial reporting standards fully
converged as soon as practicable, and
2. Coordinate their future work programs to ensure that
once achieved, convergence is maintained.

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 The fact that there are differences between IFRS and U.S.
GAAP should not be surprising because standard-setters
have developed standards in response to different user
needs.
 IFRS tends to be simpler and more flexible in its
accounting and disclosure requirements.
 The U.S. SEC recently eliminated the need for foreign
companies that trade shares in U.S. markets to reconcile
their accounting with U.S. GAAP.

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The expectations gap is:
a. what financial information management provides and
what users want.
b. what the public thinks accountants should do and what
accountants think they can do.
c. what the governmental agencies want from standard-
setting and what the standard-setters provide.
d. what the users of financial statements want from the
government and what is provided.
Review Question

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Appendix 1A THE U.S. STANDARD-SETTING ENVIRONMENT
Organizations responsible for developing financial
accounting standards (GAAP) in the United States:
1. Securities and Exchange Commission (SEC).
2. Financial Accounting Standards Board (FASB).
http://www.sec.gov/
http://www.fasb.org/

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Securities Act
of 1933
Securities Act
of 1934
Securities and Exchange Commission
 Established by federal government
 Accounting and reporting for public companies
 Encouraged private standard-setting body
 SEC requires public companies to adhere to GAAP
 SEC provides oversight & enforcement
authority.

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Financial Accounting Standards Board
Wheat Committee’s recommendations resulted in the creation of a the
Financial Accounting Standards Board (FASB) in 1973.
Financial
Accounting
Foundation
Selects members of the FASB
Funds their activities
Exercises general oversight.
Financial
Accounting
Standards Board
Financial Accounting
Standards Advisory
Council
Mission to establish and improve
standards of financial accounting
and reporting.
Consult on major policy issues.

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Mission is to establish and improve standards of financial
accounting and reporting. Differences between FASB and
APB include:
Smaller Membership
Full-time, Remunerated Membership
Greater Autonomy
Increased Independence
Broader Representation

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FASB relies on two basic premises:
(1) Responsive to entire economic community
(2) Operate in full view of the public
Step 1 = Topic placed on agenda
Step 2 = Research conducted and Discussion Memorandum issued.
Step 3 = Public hearing
Step 4 = Board evaluates research, public response and issues
Exposure Draft
Step 5 = Board evaluates responses and issues final Statement of
Financial Accounting Standard
Due Process

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Standards, Interpretations, and Staff Positions.
Financial Accounting Concepts
Emerging Issues Task Force Statements

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Hierarchy of U.S. GAAP
FASB Statements of Financial Accounting Standards,
FASB Interpretations, SEC rules and interpretive
releases, AICPA Accounting Research Bulletins,
Accounting Principles Board Opinions
FASB Technical Bulletins, AICPA Industry Audit and
Accounting Guides and Statements of Position
AICPA Accounting Standards Executive
Committee Practice Bulletins
FASB Implementation Guides, AICPA Accounting
Interpretations, and widely recognized general or industry
practices.
Most
Authoritative
Least
Authoritative

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Establishment of Accounting Standards
A Political Process
GAAP
Internal Revenue
Service
www.irs.gov
American Institute
of CPAs
www.aicpa.org
Securities and
Exchange
Commission
www.sec.gov
American
Accounting
Association
www.aaa-edu.org
Governmental
Accounting
Standards Board
www.gasb.org
Financial Executives
International
www.fei.org

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Sarbanes-Oxley Act of 2002
 Became law in 2002 after numerous accounting scandals.
 Established the Public Company Accounting Oversight Board.
 Implements stronger independence rules for auditors.
 Requires CEOs and CFOs to personally certify that financial
reports are complete and accurate.
 Requires CEOs and CFOs to forfeit bonuses when there are
accounting restatements.
 Requires audit committee members to be independent have
financial expertise.
 Requires codes of ethics for senior financial officers.
 Requires public companies to attest to the effectiveness of their
internal controls.

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Principles that have substantial authoritative support.
Major sources of GAAP:
FASB Standards, Interpretations, and Staff Positions
APB Opinions
AICPA Accounting Research Bulletins
U.S. Generally Accepted Accounting Principles
When the Board approves a new standard, staff position, etc., the results are
included in the Codification through an Accounting Standards Update.

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IASB and FASB have set up an extensive work plan to achieve
one set of international standards.
Improvements in Accounting Standards
International Accounting Convergence
Illustration 1A-3
IFRS Adoption Timeline

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SEC Work Plan
International Accounting Convergence
Sufficient development and application of IFRS.
Independent standard-setting for the benefit of investors.
Investor understanding and education.
Regulatory environment.
Impact on large and small financial statement preparers.
Human capital readiness.

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