Financial

Accoun+ng

Lecture 1 Introduc)on to Financial Accoun)ng

Serena Morricone

Agenda
n What is accoun0ng n Management and Financial accoun0ng n Users of nancial Informa0on n Regula0on of nancial accoun0ng

oAccoun0ng standards oHarmoniza0on of nancial repor0ng

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What is accoun+ng?
Example: Don Blair, CFO NIKE Inc.

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What is accoun+ng?
Example: James Singh, CFO Nestle

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What is accoun+ng? The informa0on system that...

n measures business ac0vi0es n processes data into reports n communicates results to decision makers n presents informa0on in monetary terms

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Who are the users of nancial informa+on?

Financial informa+on
Decision makers INSIDE the company Decision makers OUTSIDE the company

Managers, internal auditors, ocers of the company

Investors, creditors, analysts, compe0tors Tax/supervisory authori0es Regulators

Management accoun0ng
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Financial accoun0ng
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Financial and Managerial Accoun+ng Financial Accoun+ng

o It is concerned with the prepara0on of nancial statements for decision makers outside the company o It is governed by both local and interna0onal accoun0ng standards o Periodic nancial statements and related disclosures

Managerial Accoun+ng
o It is concerned with the provisions and use of accoun0ng informa0on to managers within organiza0ons, to provide them with the basis to make informed business decisions that will allow them to be beVer equipped in their management and control func0ons. o Detailed plans con0nuous performance reports

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Financial and Managerial Accoun+ng Main dierences

Management accoun0ng is: o designed and intended for use by managers within the organiza0on, instead of being intended for use by shareholders, creditors, and public regulators; o usually conden0al and used by management, instead of publicly reported; o forward-looking, instead of historical; o computed by reference to the needs of managers, o\en using management informa0on system, instead of by reference to general nancial accoun0ng standards.

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External users and their informa+on requirements

User Investors Informa+on Requirements Needs for informa0on to help them decide whether to buy, hold or sell equity securi0es in the company, and whether the company can pay dividends. Need informa0on about the stability and the protability of the business. Employees need nancial informa0on to be able to assess the company s ability to provide employment opportuni0es, and to pay compensa0on and re0rement benets. The major concern is whether their loans and the associated interest will be paid when due. Financial informa0on is needed to understand whether the business en0ty can pay its debts, and if not, what assets are available to secure debts. Interested in whether amounts they are owed by the company will be paid. Interested in the long-term viability of the en0ty Need informa0on for regulatory purposes, taxa0on and to develop na0onal income and other sta0s0cs.

Employees

Lenders

Suppliers Customers Governments

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Users of nancial informa+on

Suppose you are the manager of Greg s Tunes, Inc. The company needs a bank loan in order to purchase music equipment. In evalua0ng the loan request, the banker asks about the assets and liabili0es of the business. In par0cular, the banker wants to know the amount of the business s stockholders equity. Requirements: 1.Is the banker considered an internal or external user of nancial informa0on? 2.Which nancial statement would provide the best informa0on to answer the banker s ques0ons?

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Financial Repor+ng and Investment Decisions

Dynamic nature Managers must understand:

o Economic consequences of nancial statements o How nancial statements are used
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REGULATION

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Why does nancial accoun+ng need regula+on?

n Users of nancial informa0on rely on credible, transparent and comparable nancial informa0on n Prepara0on of nancial statements involves two elements
Recording for individual transac0on Bookkeeping Summary and aggrega0on into a form suitable for presenta0on

n Accoun0ng standards contain the detailed rules that govern the accoun0ng treatment of transac0ons and other items shown in nancial statements.

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Accoun+ng Standards
Financial repor0ng standard seVers establish the rules under which rms report nancial results to external par0es. Accoun0ng standards aim to regulate the repor0ng choices available to managers in presen0ng the rms nancial statements in order to reduce processing costs for nancial statement users by providing a commonly accepted language that managers can use to communicate with investors

IAS 1 denes IFRSs as comprising:

o Interna0onal Financial Repor0ng Standards; o Interna0onal Accoun0ng Standards; and o Interpreta0ons originated by the IFRS Interpreta0ons CommiVee (IFRIC) or the former Standing Interpreta0ons CommiVee (SIC).
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Interna+onal Financial Repor+ng Standards (IFRS)

IFRS
International Accounting Standards Board (IASB)

IFRS

International Accounting Standards (IAS)

International Accounting Standards Committee (IASC) replaced by the IASB International Financial Reporting Interpretations Committee (IFRIC)

Interpretations
Standing Interpretations Committee replaced by the IFRIC
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Accoun+ng Standards

Rules-based Standard- seVng approaches

Specic guidelines

Principles- based

Broad objec+ves which leave room for interpreta+on

Interna)onal Financial Repor)ng Standards (IFRS)

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Standard-SeVng Approaches
Rules-based standards Principles-based standards

Provide specific guidelines for those who Focus on broad objectives which leave prepare financial statements room for interpretation Rules must be clear and understandable in their application and enforcement Rules must be comprehensive to avoid gaps that fail to provide guidance in all circumstances Critics believe that management has an incentive to apply by the letter of the law rather than spirit of the law Can be applied flexibly to different jurisdictions to satisfy local laws and culture Those who prepare financial statements are expected to comply or explain Critics believe that principles-based standards create uncertainty about compliance

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Who does set standards?

IASB: Global (private) standard seVer; > Interna0onal Financial Repor0ng Standard (IFRS, former IAS) European Union: > direc0ves, regula0ons, implemen0ng measures Na0onal legislator: > na0onal law such as the code of obliga0ons (Swiss); Commercial Code (German) etc. Na0onal private standard seVer > standards/accoun0ng and repor0ng recommenda0ons Other legislators: FASB >US GAAP
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Governing Organiza+ons IASB FASB SEC AICPA GAAP

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Interna0onal Accoun0ng Standards Board Publishes the Interna0onal Financial Repor0ng Standards, the interna0onal accoun0ng rule book Financial Accoun0ng Standards Board A privately funded organiza0on, formulates accoun0ng standards. Securi0es and Exchange Commission U.S. governmental agency that oversees U.S. nancial markets. American Ins0tute of Cer0ed Public Accountants Private organiza0on of public accountants

Generally Accepted Accoun0ng Principles Main U.S. accoun0ng rule book

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The Accoun+ng Policymaking Process

Policymakers
SEC FASB/IASB
Congress, White House, government agencies Public hearings, leCers

Public Input

Generally Accepted Accoun0ng Principles (GAAP)

Actual Accoun0ng Prac0ces

Perceived economic consequences

Economic Consequences
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Legisla0ve background Laws and standards

-Direc0ves/regula0ons -Swiss law, standards -IASB Standards

Standard seVer
-EU -Legislator, FER -IASB

develop Company Financial repor0ng

-Individual accounts -Consolidated accounts -Other publica0ons

determine Basic valua0on principles

-Recogni0on -Valua0on -...

specify Specic rules

-Goodwill -Leasing -...

regulate Management repor0ng

-Basis for decisions -Informa0on -Compensa0on ...

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IASB

The Interna0onal Accoun0ng Standards Board is an independent, private-sector body that develops and approves Interna0onal Financial Repor0ng Standards (IFRSs). Main Objec0ve: develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions The IASB operates under the oversight of the Interna0onal Financial Repor0ng Standards Founda0on. The IASB was formed in 2001 to replace the Interna0onal Accoun0ng Standards CommiVee (IASC).

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Dis+nc+on between IASs and IFRSs

Narrowly: o IFRSs refers to the new numbered series of pronouncements that the IASB is issuing (e.g. IFRS 1, IFRS 3) o IASs refers to the old numbered series of pronouncements issued by IASC
(e.g. IAS 1, IAS 38)

More broadly: o IFRSs refers to the en0re body of IASB pronouncements (IFRSs) and IASC standards (IASs)

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Harmonisa+on of nancial repor+ng in Europe

Prior to 2005 every na0on applied its domes0c accoun0ng standards (Local GAAP) developed by na0onal standard seVers such as Financial Accoun0ng Standards Board in USA, Consiglio Nazionale dei DoVori Commercialis0 in Italy, Compagnie Na0onale des Commissaires aux Comptes in France and Rechnungslegungs Standards CommiVee in Germany. Over last thirty years, the rapid globaliza0on of stock markets around the world has progressively raised the requirement for a common language for both companies and investors that, respec0vely, are willing to be listed and invest in foreign capital markets.

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Harmonisa+on of nancial repor+ng in Europe

In order to achieve a more comparability of nancial statements and consequently a broader integra0on of capital markets across countries, the interna0onal harmoniza0on of accoun0ng standards has been undertaken since 2002. The accoun0ng harmoniza0on aims at making nancial repor0ng consistent around the world through two-pronged approaches:
o the adop0on of one single set of accoun0ng standards, o the progressive convergence between accoun0ng standards.

More than one hundred countries permit or require some or all rms to replacing na0onal GAAPs with Interna0onal Financial Repor0ng Standards (IFRS).
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Harmonisa+on of nancial repor+ng in Europe: IAS Regula+on I

The milestone of the harmoniza0on of accoun0ng standards: n In June 2002 the Council of the European Union has adopted an 'IAS Regula0on' requiring capital market orientated companies to prepare their consolidated accounts in accordance with IAS/IFRS from 2005 onwards. n The Regula0on has the force of law without requiring transposi0on into na0onal legisla0on. n Member States may defer applica0on un0l 2007 for those companies that are listed both in the EU and elsewhere and that currently use US GAAP (or other GAAP) as their primary basis of accoun0ng, as well as for companies that have only publicly traded debt securi0es.

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Harmonisa+on of nancial repor+ng in Europe: IAS Regula+on I

Capital market orientated Not capital market orientated

Individual accounts

Member state op0on

Member state op0on

Consolidated accounts

IFRS required

Member state op0on

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Harmonisa+on of nancial repor+ng in Europe: IAS Regula+on I

Consolidated accounts, not capital market oriented Enterprise op+on Required Individual accounts, capital market oriented Individual accounts, not capital market oriented DK, FI, GR, IT, IR, LU, NL, PL, SE, GB, EE, SI

AT, BE, DK, FI, FR, DE, DK un0l 2009, FI, IR, GR, IT, IR, LU, NL, PT, LU, NL, SE, GB, PL ES, SE, GB, CZ, EE, HU, SI CY*, MT*, SK DK a\er 2009, GR, IT, BE, IT, SE, EE, LT, PL, SI PL, CZ, CY*, EE, LT, MT*, SK, SI for nancial ins0tu0ons LV, LT, PL

CY*, MT* EE, LT, SI for banks

Forbidden

AT, BE, FR, DE, ES, HU, AT, BE, FR, DE, ES, CZ, LV HU, LV, LT, PL, SK

*= IFRS na0onal nancial repor0ng standard

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Harmonisa+on of nancial repor+ng in Europe: Requirements for Swiss or EU companies

Type of issuer Equity main segment Equity other segments (investment, real estate, local cap) Debt only

Switzerland IFRS, US GAAP FER, IFRS, US GAAP FER, IFRS, US GAAP

EU member states IFRS (US GAAP un0l 2006) IFRS (US GAAP un0l 2006) IFRS from 2007

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Harmonisa+on of nancial repor+ng in Europe: Accoun+ng standards applied in Switzerland

Accoun+ng Standard IFRS US GAAP Swiss GAAP FER (incl. RRV-EBK) Total 2008 192 17 50 259 2007 193 17 52 262 2006 187 20 54 261 2005 186 18 59 263 2004 146 19 101 266

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Convergence between accoun+ng standards

Some countries such as U.S., Japan, and China prefer to converge their standards with IFRS

In 2002, the FASB and the IASB formalised their commitment to the convergence of US GAAP and IFRS by issuing a memorandum of understanding (the Norwalk agreement) in which the two boards pledged to make their nancial repor0ng standards fully compa0ble and to coordinate their future work programmes to ensure that once achieved, compa0bility is maintained In 2007 the SEC removed the reconcilia0on requirement for non-U.S. companies that are registered in the United States and use IFRS. Plan for transi0on to IFRSs for US domes0c issuers star0ng for scal years ending on or a\er 15 December 2014

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ues)ons on:

Introduc)on to Financial Accoun)ng

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Ques+ons
1. Dis0nguish managerial accoun0ng from nancial accoun0ng, and describe how the informa0on provided by the two systems is used dierently. 2. What are the accoun0ng standards? What is their main goal? 3. Who does set the accoun0ng standards? 4. What is the harmoniza0on of accoun0ng standards? 5. Which companies are directly inuenced by the IAS Regula0on?

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6. Con0nental Airlines signed contracts with its major creditors (mostly banks) that require the company to maintain a minimum cash balance of $600 million, a minimum shareholders equity balance of $972 million, and dividend payments restricted to no more than $576 million. Discuss why the creditors impose such restric0ons on Con0nental. 7. The FASB and IASB are working on converging U.S. GAAP and IFRS into a single repor0ng system. Currently, the SEC accepts IFRS nancial statements from non-U.S. companies, while requiring U.S. GAAP from U.S. companies. Comment on the dicul0es faced by nancial analysts who analyze nancial statements to assess the nancial condi0on and performance of companies. Consider, for example, the plight of an analyst in the pharmaceu0cal industry who must assess and compare the nancial performance of giants Novar0s (a Swiss rm using IFRS) and Johnson & Johnson (a U.S. rm using U.S. GAAP).
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Mul+ple choice
1. Generally accepted accoun0ng principles (GAAP) are formulated by the: a. Financial Accoun0ng Standards Board (FASB). b. Securi0es and Exchange Commission (SEC). c. Ins0tute of Management Accountants (IMA). d. American Ins0tute of Cer0ed Public Accountants (AICPA). 2. Accoun0ng is the informa0on system that: a. measures business ac0vity. b. communicates the results to decision makers. c. processes data into reports. d. does all of the above. 3. Which of the following is least likely to be a user of a business s nancial informa0on? a. Taxing authori0es b. Customers c. Creditors d. Investors
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