Chapter 1 Lecture Outline Flashcards
The roles of financial accounting are?
- Information role of financial accounting
- Prediction role of financial accounting
Why is reducing information asymmetry important?
Stock market … THE company knows THE true condition, but an investor doesn’t
The solution is to look at the financial statements!
Without financial reporting, investors cannot distinguish good companies/investments from bad ones.
Prediction role of financial accounting.
- What are we trying to predict?
- What information might allow us to make good predictions?
- We are trying to predict the future
- Debt, earnings(net income) might allow us to make good predictions
What are the benefits of accounting information?
- It improves decision making for external users
- Facilitates economic transactions for M&A and supplier
- Fosters efficient allocation of resources in the economy, that way we can find the best decision to increase wealth
What are the costs of accounting information?
The direct costs are auditing, systems costs, and controls
Indirect costs are compliance forms (SEC)
The demand for accounting information - Who is using it?
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Financial statements summarize the results of a firm’s what … ?
- Current and past business activities
- Current and past financial position
What are the opinions an auditor expresses on the fairness of companies financial statements?
- Unqualified (clean) and opinion (the one desired)
Other opinions may include qualified, adverse, and disclaimer
What are the types of mandatory financial reporting?
10K, 10Q, 8K, anything that the government require for certain reporting
Why would some companies give voluntary financial reporting?
To build credibility, and turn that into investments into the company
What are managers incentives when it comes to financial reporting?
Managerial incentives for financial reporting are rewards that align a manager’s interests with a company’s success. These incentives can include cash bonuses, stock options, and other compensation
Net income measured under accrual based accounting (revenue when earned)
- Expenses when incurred is a better representation of underlying value of the company and underlying economic transactions of company
- Best indicator for estimating future cash flow
Net income when measured under cash based accounting (cash from operating activities) is
- Not as good even though possibly more intuitive, choice of small businesses
Most companies hit their earnings target exactly … what does this mean?
- A lot of companies “hit” their earnings target, but it is not that amazing of a look when you understand what’s going on with their financials
Accrual based accounting numbers have more ____ than cash based accounting numbers?
- Predictive value
Accruals are more what?
- Useful and relevant
There is a ___ between ___________ & ______________________ in accrual accounting?
- Tradeoff ; Relevance & Faithful Representation
Accruals are potentially less what?
Reliable
What is the distinction between Financial and Managerial Accounting?
- Types of users
Purpose of financial accounting ….
To inform investors and creditors through a few components ….
- General Purpose Financial Statements (BS, IS, SCF …)
- That are “Decision Useful” including …. credit decisions (extend or not) and Investment decisions (Buy/Sell shares or not)
The entire purpose, then, of financial reporting is to _______________________________ that can be relied upon __________________________________________________________________________________ about providing resources to the entity
Develop information about a financial entity ……. to help present and future equity investors, lenders, and other creditors in making useful decisions
What is the SEC?
- Main enforcement body. Any registrant who offers securities to the stock exchange must file and be subject to the rules of the SEC.
- Must file statements
- Developed after crash of 1929
- Government oversight body
- Do not SET standards, but they enforce.
What are the authoritative bodies in financial accounting?
SEC, AICPA, FASB, “GAAP” , PCAOB
What is the AICPA?
- Prior to FASB, AICPA was the authoritative body that created many of financial accounting standards.
- No longer do so, just provide guidance
- They mostly do CPA Exam stuff now
What is FASB?
- Financial Accounting Standards Board
- In charge of creating the standards for financial accounting and reporting
- Their missions is to establish and improve standards of financial accounting and reporting for everyone
What is GAAP?
- Financial Accounting “Law”
- A lot of authoritative bodies are involved in the creation of GAAP
What is PCAOB?
- Public Company Accounting Oversight Board
- they are the standard setters within the auditing profession
What are the limitations of accounting information? (Has 5 given to us in the notes)
- Fails to provide some key performance measures utilized by management
- It is either a snapshot in time/ and or rearward looking … investors are trying to predict future …. therein lies a mismatch
- Soft Assets are not accounted for well in our current system of financial accounting
- Timeliness … accounting creates information that is released to the public AFTER its been created
- Understandability … as transactions become more and more complex, so too do the financial statements
The purpose of the conceptual framework is?
to guide standards-setters as they craft accounting regulation in order to stay consistent in their standards setting agenda
What are the three levels of conceptual framework?
- Level One: general purpose of financial reporting (the why)
- Level Two: The qualitative characteristics and financial statement elements (the bridge)
- Level Three: The more specific methods of implementing (The How)
Level one - Basic Objective - is the pervasive criterion that overrides all else: Decision Usefulness - if the information we as accountants craft doesnt aid in decision making, it is what?
IRRELEVANT
Level Two - Fundamental Concepts - the bridge between the why and the how?
Two aspects of the information that is produced … qualitative characteristics and hard elements of financial information
(Reliability) Faithful representation (fundamental quality) - amounts of descriptions match what really happened … its reflective of the economic truth …
- Completeness - all necessary information is provided
- Neutrality - not selecting information to favor certain users
- Free from error: higher accuracy, considering judgement and estimation
Relevance (Fundamental Quality) - information that can influence decisions ….
- Predictive value - helps predict future outcomes
- Confirmatory Value - Helps predict future outcomes
- Materiality - relative size and importance of transaction/information
What are the hard characteristics (defining the components of the information we create)
- Assets, liabilities, equities, revenues and expenses
- Investment by owners
- Distributions to owners
- Comprehensive income
- Gains/Losses
- Revenues
- Expenses
When crafting regulations the idea is that the regulation must create information that adheres to those principles … now, there are a few enhancing qualities as well … what the heck is that? (There is a tradeoff)
Comparability - similarities and differences between companies
Verifiability - multiple measurers get generally the same results applying similar methods to the same economic events
Timeliness - Available soon enough to influence decisions
Understandability - allowing reasonably informed decision makers to see significance of information
Level Three; recognition and measurement (the How) it consists of three areas, what are those three areas?
Principles, Assumptions, and Constraints
