Chapter 1 Lecture Outline

Question 1

The roles of financial accounting are?

Answer 1

1. Information role of financial accounting
2. Prediction role of financial accounting

Question 2

Why is reducing information asymmetry important?

Answer 2

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.

Question 3

Prediction role of financial accounting.

• What are we trying to predict?
• What information might allow us to make good predictions?

Answer 3

• We are trying to predict the future
• Debt, earnings(net income) might allow us to make good predictions

Question 4

What are the benefits of accounting information?

Answer 4

• 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

Question 5

What are the costs of accounting information?

Answer 5

The direct costs are auditing, systems costs, and controls

Indirect costs are compliance forms (SEC)

Question 6

The demand for accounting information - Who is using it?

Answer 6

blank

Question 7

Financial statements summarize the results of a firm’s what … ?

Answer 7

• Current and past business activities
• Current and past financial position

Question 8

What are the opinions an auditor expresses on the fairness of companies financial statements?

Answer 8

• Unqualified (clean) and opinion (the one desired)

Other opinions may include qualified, adverse, and disclaimer

Question 9

What are the types of mandatory financial reporting?

Answer 9

10K, 10Q, 8K, anything that the government require for certain reporting

Question 10

Why would some companies give voluntary financial reporting?

Answer 10

To build credibility, and turn that into investments into the company

Question 11

What are managers incentives when it comes to financial reporting?

Answer 11

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

Question 12

Net income measured under accrual based accounting (revenue when earned)

Answer 12

• 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

Question 13

Net income when measured under cash based accounting (cash from operating activities) is

Answer 13

• Not as good even though possibly more intuitive, choice of small businesses

Question 13

Most companies hit their earnings target exactly … what does this mean?

Answer 13

• 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

Question 14

Accrual based accounting numbers have more ____ than cash based accounting numbers?

Answer 14

• Predictive value

Question 15

Accruals are more what?

Answer 15

• Useful and relevant

Question 16

There is a ___ between ___________ & ______________________ in accrual accounting?

Answer 16

• Tradeoff ; Relevance & Faithful Representation

Question 17

Accruals are potentially less what?

Answer 17

Reliable

Question 18

What is the distinction between Financial and Managerial Accounting?

Answer 18

• Types of users

Question 19

Purpose of financial accounting ….

Answer 19

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)

Question 20

The entire purpose, then, of financial reporting is to _______________________________ that can be relied upon __________________________________________________________________________________ about providing resources to the entity

Answer 20

Develop information about a financial entity ……. to help present and future equity investors, lenders, and other creditors in making useful decisions

Question 21

What is the SEC?

Answer 21

• 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.

Question 22

What are the authoritative bodies in financial accounting?

Answer 22

SEC, AICPA, FASB, “GAAP” , PCAOB

Question 23

What is the AICPA?

Answer 23

• 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

Question 24

What is FASB?

Answer 24

- 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

Question 25

What is GAAP?

Answer 25

- Financial Accounting "Law" - A lot of authoritative bodies are involved in the creation of GAAP

Question 26

What is PCAOB?

Answer 26

- Public Company Accounting Oversight Board - they are the standard setters within the auditing profession

Question 27

What are the limitations of accounting information? (Has 5 given to us in the notes)

Answer 27

- 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

Question 28

The purpose of the conceptual framework is?

Answer 28

to guide standards-setters as they craft accounting regulation in order to stay consistent in their standards setting agenda

Question 29

What are the three levels of conceptual framework?

Answer 29

- 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)

Question 30

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?

Answer 30

IRRELEVANT

Question 31

Level Two - Fundamental Concepts - the bridge between the why and the how?

Answer 31

Two aspects of the information that is produced ... qualitative characteristics and hard elements of financial information

Question 32

(Reliability) Faithful representation (fundamental quality) - amounts of descriptions match what really happened ... its reflective of the economic truth ...

Answer 32

- Completeness - all necessary information is provided - Neutrality - not selecting information to favor certain users - Free from error: higher accuracy, considering judgement and estimation

Question 33

Relevance (Fundamental Quality) - information that can influence decisions ....

Answer 33

- Predictive value - helps predict future outcomes - Confirmatory Value - Helps predict future outcomes - Materiality - relative size and importance of transaction/information

Question 34

What are the hard characteristics (defining the components of the information we create)

Answer 34

- Assets, liabilities, equities, revenues and expenses - Investment by owners - Distributions to owners - Comprehensive income - Gains/Losses - Revenues - Expenses

Question 34

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)

Answer 34

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

Question 35

Level Three; recognition and measurement (the How) it consists of three areas, what are those three areas?

Answer 35

Principles, Assumptions, and Constraints