Financial statements and financial reporting

Learning objective: Identify the major financial statements and other means of financial reporting.

Nature of Financial Accounting

• Accounting may best be defined by describing the three essential characteristics of accounting: (1) identification, measurement, and communication of financial information about (2) economic entities to (3) interested persons. Financial accounting is the process that culminates in the preparation of financial reports on the enterprise as a whole for use by parties both internal and external to the enterprise

• Financial statements are the principal means through which financial information is communicated to those outside an enterprise. The financial statements most frequently provided are (1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners’ or stockholders’ equity. Other means of financial reporting include the president’s letter or supplementary schedules in the corporate annual report, prospectuses, and reports filed with government agencies

• Accounting is important for markets, free enterprise, and competition because it assists in providing information that leads to capital allocation. The better the information, the more effective the process of capital allocation and then the healthier the economy.

•  The challenges facing financial accounting are the following:

1. Non-financial measurements such as customer satisfaction indexes, backlog information, and reject rates on goods purchased.
2. Forward-looking information.
3. Soft assets.
4. Timeliness

• The objectives of financial accounting are to provide information:

1. That is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions;
2. To help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of perspective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans; and
3. About the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change its resources and claims to those resource.

• The accounting profession has developed a common set of standards and procedures known as generally accepted accounting principles (GAAP). These principles serve as a general guide to the accounting practitioner in accumulating and reporting the financial information of a business enterprise. Although the adoption of some generally accepted accounting principles has caused controversy among accountants as well as members of the financial community, a majority of the members in each group recognize the ultimate benefit an accepted set of accounting principles can bring to the financial reporting process.

Accounting Organizations

•  Financial accounting standards in use at this time in the United States are primarily a result of the accounting profession’s efforts during the past 75 years. Prior to that time accounting practices were relatively unsophisticated owing to the lack of extensive economic development in the United States. The American Institute of Certified Public Accountants (AICPA), the national professional organization of practicing Certified Public Accountants (CPAs), has been a catalyst in the development of GAAP in the United States. Although the responsibility for setting accounting standards now rests with the FASB, the Securities and Exchange Commission (SEC), the Governmental Accounting Standards Board (GASB), and other organizations can and do influence the standards-setting process.

• The SEC takes a great deal of interest in the standards developed by the accounting profession. The SEC is an agency of the federal government that monitors the activities of corporate enterprises whose stock is publicly held. The SEC requires each corporate entity under its jurisdiction to file a set of annual audited financial statements. The SEC has the mandate to establish accounting principles; however, the SEC’s involvement in the development of accounting standards has varied. In general, the SEC has supported the development of accounting standards by the private sector, however, there have been times when they have stepped in and prodded the private sector into a different direction.

• The first group appointed by the AICPA to address the issue of uniformity in accounting practice was the Committee on Accounting Procedure (CAP). This group served the accounting profession from 1939 to 1959. During that period they issued 51 Accounting Research Bulletins (ARBs) that narrowed the wide range of alternative accounting practices then in existence. Even though the work of the Committee on Accounting Procedure was a valuable aid to accounting practitioners, the authority for their pronouncements rested solely on general acceptance by the accounting profession.

•  In 1959, the AICPA created the Accounting Principles Board (APB). The major purposes of this group were (a) to advance the written expression of accounting principles, (b) to determine appropriate practices, and (c) to narrow the areas of difference and inconsistency in practice.

• The APB was designated as the AICPA’s sole authority for public pronouncements on accounting principles. Their pronouncements, known as APB Opinions, were intended to be based mainly on research studies and be supported by reasons and analysis. The APB Opinions constituted GAAP until superseded by subsequent pronouncements of the body designated by the accounting profession to issue such pronouncements. Although the AICPA recognized other sources as providing substantial authoritative support for accounting practices, the burden for justifying a departure from financial accounting standards rests with the reporting member.