Financial accounting 10th pratt peters chapter 01

Chapter 1: Financial Accounting and Its Economic Context Learning Objective Discuss the role of financial reports in investment decisions and the difference between the economic consequence and user perspectives The Role of Financial Reporting in Investment Decisions • Profit-seeking companies - managers prepare reports for owners of the companies • Owners and other interested parties (users) - use reports to assess financial condition and performance of companies • User decisions - users obtain information from reports to make investment decisions • Effects of user decisions - decisions affect the company and its managers because of the need for capital Financial Reporting and Investment Decisions Learning Objective Explain the difference between consumption and investment and why investors demand documentation and independent audits Consumption and Investment • Consumption • Purchase of goods and services for enjoyment with no future value • Investment • Little immediate gratification, generates returns for a later date • Documentation provides information to investors • Independent audits of the documentation provides verification by an independent third party, a certified public accountant (CPA) Concept Practice Learning Objective Describe the standard audit report, management letter, four financial statements, and related footnotes Content of Financial Reports • The Auditor’s Report • The Management Letter • The Financial Statements: Balance Sheet Income Statement Statement of Shareholders’ Equity Statement of Cash Flows • The Footnotes Corporate Governance and Capital Markets • Capital markets value the publicly traded equity and debt securities • The financials are a component of the information that the markets use to value companies securities, along with a number of nonfinancial measures • The market reacts to financial and other information as it is released by management Debt Covenants and Management Compensation • Debt covenants are part of debt contracts between the company and creditors Violation of debt covenants may lead to more costly debt terms • Management compensation contracts often base pay on certain income or stock price goals • Such goals are designed to encourage certain management behavior Independent Auditors and Sarbanes-Oxley • An independent audit is conducted in accordance with standards established by the Public Company Accounting Oversight Board (PCAOB) This includes presentation in accordance with generally accepted accounting principles (GAAP) • The Sarbanes Oxley Act of 2002 • Executive and financial officers must certify financial reports are fairly stated • Internal controls are in place • Emphasis on the quality of financial statement user information Independent Auditors Audit reports provide assurance on the fair presentation of the financial statements and effectiveness of internal controls Legal Liability • Management is legally responsible to the shareholders to act in their interest • Auditors are legally responsible to the shareholders to conduct a thorough and independent audit • If management or auditors fail in their duties, investors and others may sue to recover any losses that might occur as a result of the failure • Many recent examples of management and audit failure exist: Enron, WorldCom (MCI), HealthSouth, Xerox, and Rite Aid Professional Reputation and Ethics • Ethical behavior is in the long-run interest of managers, shareholders, and auditors • Many companies, universities, and professional organizations have enacted increased emphasis on ethics • Auditors’ reputations are integral to their ability to perform their duties High ethical conduct is imperative to their continued success The advantage to the user of financial accounting statements that are audited by independent certified public accountants (CPAs) is assurance that the a statements are produced in accordance with generally accepted accounting principles b company will be solvent for at least one more year c company cannot remain profitable for more than to years d company pays its fair share of income taxes GAAP is an acronym for a General Asset Accounting Procedures b Government Agency Accounting Procedures c Generally Accepted Accounting Principles d Global Accounting Activity Principles Learning Objective Summarize the current status of accounting standard setting – both in the United States and internationally Regulations and Standards • The Securities and Exchange Commission (SEC) governs financial reporting for publicly traded companies Congress and other regulatory agencies have influence with the SEC • The Financial Accounting Standards Board (FASB) is responsible for the promulgation of generally accepted accounting principles (GAAP) for financial statements The FASB accepts input from all interested parties, including accountants, corporations, academics, and governmental entities • The International Accounting Standards Board (IASB) establishes International Financial Reporting Standards (IFRS) which are an internationally accepted set of standards also used by some companies in the United States Concept Practice Concept Practice – cont Appendix - Learning Objective Discuss other kinds of accounting Three Other Kinds of Accounting *Appendix 1A • There are three other types of accounting, besides financial accounting: • Not-for-profit accounting • Fund accounting for public entities like cities • Managerial accounting • Used for specific internal business decision making • Tax accounting • Applying IRS tax law to business operations Wiley © 2017 .. .Chapter 1: Financial Accounting and Its Economic Context Learning Objective Discuss the role of financial reports in investment decisions and the... to safeguard assets Financial Statements (Balance Sheet) Financial Statements (Bal Sheet cont.) Financial Statements (Income Statement & Statement of Shareholder’s Equity) Financial Statements... the financials, and explain many of the policies and assumptions used to prepare the financials A statement that “the financial statements were prepared in accordance with generally accepted accounting