financial accounting textbook

financial accounting textbook

Modern Principles and Practices of Financial Accounting

1. Introduction to Financial Accounting

The vast majority of people you come into contact with will never have the opportunity to take an accounting course. Nonetheless, they will expect and need you to explain financial data to them. Indeed, many upper-level managers have had less accounting education than you have when you have completed this course. The data generated by the accounting system can provide excellent or poor information. The crucial point is this: human beings produce accounting information, and human beings can alter the information. Many people, not just accountants, assure you of the soundness and reliability of the information produced by the accounting system. You must be able to critically assess that information in order to comply with business regulations and to help run your business.

The primary purpose of this course is to “learn how to learn accounting.” Your supervisor, friends, or family may request specific accounting information from time to time. Even if you use accounting software for some of the information, you will need to understand accounting information and be able to evaluate it. To be a successful businessperson, you need to understand and communicate financial information to people both inside and outside of the business. As a management professional, the vast majority of people you supervise and work with will come from functional areas other than accounting.

2. Fundamental Concepts and Principles

Businesses are broken into three sectors, typically called activities. These are classified as: operating activities, investing activities, and financing activities. Much of your work preparing financial statements will involve identifying operating, financing, and investing activities. Assets are subdivided into two primary categories, current assets, and noncurrent assets. Liabilities are also classified in the same manner, creating current liabilities, and noncurrent liabilities, often called long-term liabilities.

The statement of Financial Accounting Concepts define several fundamental objectives of financial statements. In sum, the conceptual framework explains the elements of financial statements, tenses, objectives of financial statements, recognition and measurement criteria.

The Financial Accounting Standards Board’s objectives for their Statements of Financial Accounting Standards are aimed at serving various informative purposes for management, creditors, investors, companies, and various amounts of such pursuits. However, how objectives are met and standards are set relies on certain stable criteria normally referring to relevance, reliability, understandability, and comparability.

In this section, we will review some of the major fundamental accounting topics necessary to ace the exam. These concepts are from the annotations of the Financial Accounting Standards Board that the CPA examiners use to prepare the Financial Accounting and Reporting sections.

3. Preparation of Financial Statements

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To end Top of Upper Division, Serge Volunteers2 (Volume 50). Five major topics will be covered in this chapter: Topic 3-1: Introduction to the Report Presentation Process Topic 3-2: The Definition of Current Assets, Current Liabilities, Current Ratios, and Current Portions of Long-Term Debt Topic 3-3: The Multi-Step Progressive Income Statement and the Current Earnings Concept of Income Determination Topic 3-4: The Reporting of Changes That Arise from Given Transactions and Events Topic 3-5: An Overview of Cash and Cash Equivalents.

4. Analysis and Interpretation of Financial Statements

There are several approaches to determining financial performance. In their most accounting-specific forms, these approaches consist of calculating accounting-based rates or of performing accounting-based comparisons. The accounting-based rates are derived directly from the numbers contained in the financial statements. Profitability is assessed by contrasting revenues with the resources used to generate revenues; rate of return measures are usually applied to the most broadly-defined resource, economic assets. Performance is also evaluated by contrasting expenses with the revenues generated as a result of incurring these expenses; operating efficiencies are usually evaluated by contrasting two numbers taken from the income statement or the two numbers are combined in a profit ratio. A company’s ability to meet promises is also a matter of importance to outsiders; external report users. The company’s ability to meet promised interest and principal payments is stressed in financial leverage measures.

Analysis of financial statements is concerned with signaling, or predicting a company’s future performance or position, and with using past performance to guide present decisions. These predictions constitute expectations. Analysis is also concerned with testing the implications of these expectations. Testing is essential to rational decision-making. Expectations about future performance or position, not past accomplishments, determine value. This does not mean that there is no value in past performance numbers, only that their purpose is to aid in predicting the future. The analysis of financial statements is actually the means to an end.

In business, we are often called upon to present our conclusions about a subject or situation. Much of the real-world analysis of financial statements is intended to answer a series of related questions about a business or its performance.

5. Contemporary Issues and Developments in Financial Accounting

Publicly traded companies comply with the disclosure requirements of the Securities and Exchange Commission. The SEC has ultimate responsibility for the form and content of financial statements that must be filed with it. Publicly traded enterprises are required to file audited financial statements using GAAP, which are then made available to the public. Its function is to help investors make informed decisions about investment risks and stock prices. Business organizations are often required to disclose detailed procedures for calculating the values reported in their financial statements. More frequently used ratios and procedures are considered industry standards. The diversity of revenues, expenses, and transactions entering into the determination of net income may also reveal important information about corporate functioning, priorities, and strategic efforts. Publicly traded companies are required, as part of their business responsibilities, to pay income taxes to the government. The general operating activities of numerous business entities are also subject to state and federal taxes with which the entities must comply. Taxes required to be paid to the government are determined on a generally accepted financial reporting basis prepared in conformity with GAAP.

5-2 Publicly Traded Financial Statements

The two most significant organizations concerned with the promulgation of accounting principles and the development of accounting standards are the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA). The mission of the FASB is “to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.” The primary function of the AICPA is to issue auditing and attestation standards and to provide guidance for the preparation, compilation, and review of public company financial statements.

5-1 FASB and AICPA