1.

01 Generally Accepted
Accounting Principles –
Definition and Governing Bodies

GAAP PowerPoint #1
What is GAAP?
 Generally Accepted Accounting Principles
 Defined as the set of accepted industry

rules, practices and guidelines for

financial accounting
 Includes the standards, conventions, and

rules accountants follow in recording and

summarizing transactions, and in the
preparation of financial statements
Governing Bodies of GAAP
AICPA
FASB
SEC

◦ Define: Security
◦ Securities Act of 1933
◦ Securities Act of 1934
GASB
AICPA
 American Institute of Certified Public
Accountants (CPA)
 Founded in 1887
 Sets ethical standards for the CPA profession
 Sets U.S. auditing and GAAP standards
 Develops and grades the Uniform CPA

Examination
 http://www.aicpa.org
FASB
 Financial Accounting Standards
Board
 Established in 1973
 Establishes and improves standards

of financial accounting by non-

governmental entities (GAAP)
 www.fasb.org
SEC
 Securities and Exchange Commission
 Created by the Securities Act of 1933 and the

Securities and Exchange Act of 1934

 Holds the primary responsibility for:
◦ Enforcing federal securities laws
◦ Regulating the securities industry
◦ Regulating the stock market and
◦ Preventing corporate abuse of investors
SEC Authority
 Enforcement authority granted by Congress
 Bring civil enforcement actions against

individuals and companies who:

◦ Commit accounting fraud
◦ Provide false information
◦ Engage in insider trading
◦ Violate securities laws
 Bring criminal enforcement actions to
prosecute individuals and companies for
criminal offenses
SEC Objectives
 Maintains fair, orderly and efficient security
markets
 Ensures that securities industry professionals

deal fairly with their customers

 Ensures that corporations make all material

information about themselves public

 Facilitates capital formation for corporations

 www.sec.gov
Securities

 notes
 stock
 treasury stock
 security future
 bond
 debenture
 certificate of interest
 participation in any profit-sharing agreement
Securities Act of 1933
 Referred to as the Truth in Securities
Law
 Two basic objectives:

◦ Requires that investors receive

financial/significant information
concerning securities offered for public
sale
◦ Prohibits deceit, misrepresentations, and
fraud in the sale of securities
Securities Act of 1934
 Empowers the SEC with broad authority over the
securities industry
 Includes the power to register, regulate, and oversee
◦ Brokerage firms
◦ Transfer agents
◦ Clearing agencies
◦ Self-regulatory organizations
 New York Stock Exchange
 American Stock Exchange
 NASDAQ
 Empowers SEC to require periodic reporting by
companies with publicly traded securities (GAAP)
GASB
 Governmental Accounting Standards
Board
 Established in 1984
 To establish and improve standards of

state and local governmental

accounting and financial reporting
(GAAP)
 www.gasb.org
Questions for Understanding and
Discussion
 What is meant by GAAP?
 Why should all companies follow GAAP in

reporting to external users of financial

information?
 Explain the roles of each of the governing

bodies in the setting of accounting standards.

 1.01 Generally Accepted
Accounting Principles – Qualities
of Accounting Information

GAAP PowerPoint #2
Hierarchy of Qualitative
Information
Cost/Benefit (discussed in PPT #3)

Understandability

Decision Usefulness

Relevance Reliability

Timeliness
Timeliness Verifiability
Verifiability

Feedback
Feedback Neutrality
Neutrality
Value
Value
Representational
Representational
Predictive
Predictive
Value Faithfulness
Faithfulness
Value

Comparability and Consistency

Materiality (discussed in PPT #3)

www.fasb.org
Objectives of Financial
Information
 To provide useful, understandable information to users of financial
statements for decision making

 For present and potential investors and creditors and other users in
making rational investment, credit, and similar decisions

 To help present and potential investors and creditors and other users to
assess the amounts, timing, and uncertainty of prospective cash receipts

 To inform users about the

◦ economic resources of an enterprise;
◦ the claims to those resources (obligations);
◦ the effects of transactions, events, and
◦ circumstances that cause changes in resources and claims to those
resources
Objectives of Financial
Information

 Decision usefulness
◦ the quality of being useful to decision
making
 Understandability

◦ users must understand the information

within the context of the decision being
made
Primary Qualities of Accounting
Information
Relevance
◦ Definition: relating to the matter at hand

Reliability
◦ Definition: the quality or state of being reliable;
and the extent to which an experiment, test, or
measuring procedure yields the same results on
repeated trials

 http://www.merriam-webster.com
Relevance
 Capable of making a difference in the
decision making of the user
 Must have predictive or feedback value

◦ Predicts or forecasts for users about the outcome of

events of a company
◦ Provides feedback value for users to confirm or
correct prior expectations of a company
 Must be presented in a timely manner
◦ Provides current information to users to help with
decision making
Reliability
 Must be verifiable
◦ Able to be proven; not subject to opinion
 Must be a faithful representation
◦ Agreement between the accounting numbers and
supporting documentation
 Must be reasonably free from error
◦ No mistakes or inaccuracies should be found in the
financial statements
 Must be reasonably free from bias; should be neutral
◦ Accounting information should not favor any groups or
companies but be a true and factual representation of a
company’s financial position.
Secondary Qualities of Accounting
Information
Comparability
◦ Definition: The quality of information that enables users to identify
similarities in and differences between two sets of economic
phenomena.
Consistency
◦ Definition: Conformity from period to period with unchanging
policies and procedures.

 Information about a particular enterprise gains greatly in

usefulness if it can be compared with similar information.

 www.fasb.org
Comparability
 The purpose of comparison is to detect and
explain similarities and differences.
 Accounting information should be

comparable across different companies and

over different time periods.
Consistency
 Consistent use of accounting principles from
one accounting period to another enhances
the utility of financial statements to users.
 A quality of the relationship between two

accounting numbers
Questions for Understanding and
Discussion
 Explain the concept of the FASB’s conceptual
framework. (Slide 2)
 What is the primary objective of financial
accounting?
 Explain relevance and reliability of financial
statements.
 What are the components of relevant
information?
 What are the components of reliable information?
 Why should financial statements be both
comparable and consistent?
1.01 Generally Accepted
Accounting Principles –
Accounting Constraints,
Concepts, Assumptions,
and Principles
GAAP PowerPoint #3
 Hierarchy of Qualitative
Information
Cost/Benefit

Understandability

Decision Usefulness

Relevance Reliability
Discussed in

Timeliness
Timeliness Verifiability
Verifiability
PPT #2

Feedback
Feedback Neutrality
Neutrality
Value
Value
Representational
Representational
Predictive
Predictive
Value Faithfulness
Faithfulness
Value

Comparability and Consistency

Materiality
www.fasb.org
Constraints
 A constraint is a limit, regulation, or
confinement within prescribed bounds.
 This term refers to the accounting guidelines

that border the Hierarchy of Qualitative

Information
 They consist of:

◦ Cost Effectiveness
◦ Materiality
◦ Conservatism
Cost Effectiveness Constraint
 Also called Cost Benefit Constraint
 The cost of providing accounting information

should not exceed the benefit of the

information it is reporting.
 Example: A company purchases pencils and

pens to use in its business. Rather than

inventory these items, they are included as
supplies and are expensed periodically
because of the minor cost of the items.
Materiality Constraint
 Material means big enough to make a difference
in the user’s decision-making process.
 States that the requirements of any accounting
principle may be ignored when there is no effect
on the decisions of the user of financial
information.
 Example: A company purchases a Trashcan for
$10. Per GAAP, this amount should be
capitalized as an asset and depreciated.
Because the amount is immaterial, the $10 can
be recorded as an expense.
Conservatism Constraint
 Accountants use their judgment to record
transactions that require estimation.
 Conservatism helps the accountant choose

between 2 equally likely alternatives.

 Requires the accountant to record the

transaction using the less optimistic choice.

 Example: There is the potential for a customer

to sue the company. Although, the customer

may choose not to sue, the accountant will
disclose this potential lawsuit to investors.
Concepts
 Concepts are the ground rules of accounting
that should be followed when preparing
financial statements.
 These are:

◦ Recognition Concept
◦ Measurement Concept
Recognition Concept
 States that an item should be recognized
(recorded) in the financial statements when:
◦ It can be defined by GAAP assumptions and
principles
◦ It can be measured
◦ It is relevant to decision-making by users
◦ It is reliable
Measurement Concept
 States that every transaction is measured by
the stated unit of measurement, such as the
dollar
 The stated procedure of valuing assets,

liabilities, equity, revenue, and expenses as

defined by GAAP
Assumptions
 Assumptions are agreed upon rules of
accounting, and are basic, understood
beliefs.
 There are Four Basic Assumptions of

Accounting:
◦ Economic Business Entity
◦ Going Concern
◦ Monetary Unit
◦ Time Period
Economic Business Entity
Assumption
 All of the business transactions should be
separate from the business owner’s personal
transactions
 There should be no co-mingling of personal

funds with business funds.

Going Concern Assumption
 Financial statements are prepared under the
assumption that the company will remain in
business indefinitely unless there is sufficient
evidence otherwise.
 If there is evidence that a company may

possibly have a going concern issue, this

must be disclosed in the financial statements.
Monetary Unit Assumption
 Assumes a stable currency is going to be the
unit of record.
 FASB accepts the nominal value of the US

Dollar as the monetary unit of record

unadjusted for inflation.
Time Period Assumption
 The entity’s activities are separated into
periods of time such as months, quarters or
years.
 Transactions must be accounted for within

the time period they occur regardless of when

cash is exchanged.
Principles of Accounting
 Principles are accounting rules used to
prepare, present, and report financial
statements.
 Principles dictate how events should be

recorded and reported.

Cost Principle
 Assets are recorded at historical cost, not fair
market value.
 For example, if a company purchases a

building for $500,000 it should be recorded

as such, and should remain on the books for
that amount until disposed of.
 If the building appreciates to $700,000 in the

next few years, no adjustment should be

made.
Full Disclosure Principle
 All information pertaining to the operations
and financial position of the entity must be
reported within the period of time in
question.
 Circumstances and events that make a

difference to financial statement users should

be disclosed.
Revenue Recognition
Principle
 Revenue is earned and recognized upon
product delivery or service completion,
without regard to when cash is actually
received.
 Also called accrual basis accounting
 Example: A customer purchases inventory

from a company on credit. Even though no

cash has yet been received, the sale is
recorded.
Matching Principle
 The costs of doing business are recorded in
the same period as the revenue they help
generate, regardless of when the money is
actually paid.
 Also called accrual basis accounting
 Example: A company orders merchandise on

credit and has 30 days in which to pay. This

purchase is recorded immediately, even
though no cash has been paid.
Questions for
Understanding/Discussion
 Explain what is meant by “The benefits of
accounting information must exceed the costs.”
 What is meant by the term materiality in

financial reporting?
 What is meant by the term conservatism in

financial reporting?
 Explain the Going Concern assumption.

 Explain the Time Period assumption.

 Explain the accounting principles that guide

accounting practice.
1.01 Generally Accepted
Accounting Principles –
Financial Statements
GAAP PowerPoint #4
What are Financial
Statements?
 A formal record of the financial activities of a
business
 Includes four basic financial statements:

◦ Balance Sheet (Statement of Financial Position)

◦ Income Statement (Statement of Comprehensive
Income)
◦ Statement of Cash Flows
◦ Statement of Changes in Equity
Balance Sheet
 Reports a company’s financial
position/condition at a given point in time
 Reports on:

◦ Assets
◦ Liabilities and
◦ Equity
 Details about cash in bank, amounts owed to
creditors, and value of company’s assets.
Income Statement
Reports on a company’s income and
expenses over a given period of time
 Reports on

◦ Revenue (income)
◦ Expenses
 Shows a company’s profit or loss over a given
period of time
Statement of Cash Flows
 Reports on a company’s cash flow activities
into and out of the business from:
◦ Operating Activities
◦ Investing Activities and
◦ Financing Activities
 Shows how changes in the balance sheet and
income statement affect cash and cash
equivalents
Statement of Equity
 Reports the changes in the company’s equity
throughout the reporting period
 Reports

◦ profit or loss from the company,

◦ dividends paid, and
◦ other items that are debited/credited to retained
earnings
Questions for
Understanding/Discussion
 Explain the purpose of the Balance Sheet.
 Explain the purpose of the Income Statement.
 Explain the purpose of the Statement of
Equity.
 Explain the purpose of the Statement of Cash
Flows.
1.01 Generally Accepted
Accounting Principles –
International Financial
Reporting Standards

GAAP PowerPoint #5
What is the IFRS?
 International Financial Reporting Standards
 Adopted in 1989 by the International

Accounting Standards Board

 Composed of principles-based standards,

interpretations, and framework that establish

broad rules and treatments of events
 Because of numerous companies operating

globally, standards that are applicable to all

countries need to be developed.
Framework of IFRS
 States the basic principles for IFRS
 Currently being updated and converged with

the IASB and FASB

 Objective is to create a sound foundation for

future accounting standards

US GAAP becoming IFRS
 In February 2010, the SEC voted unanimously
to reaffirm its commitment to the goal of a
single set of High Quality Global Accounting
Standards.
 In October 2010, the SEC began working on a

plan to combine GAAP and IFRS.

 US companies may move to IFRS in

approximately 2015 or 2016.

Questions for
Understanding/Discussion
 Explain the concept behind the IFRS.

 Summarize the projected target date for US

implementation of IFRS.