Lecture 1 - Accounting Standards, Management & Auditor Responsibilities

Accounting Standards
In the US, accounting standards are set by the FASB, by permission of the SEC (who has statutory authority and has delegated it to FASB). Their rules are known as GAAP - generally accepted accounting principles. Committees of the AICPA sets rules on more minor or industry-specific issues. "Industry practice" also sets accounting rules.

To be listed on US exchanges, foreign companies must abide by FASB standards. Many other countries follow IASB rules, known as IFRS (International Financial Reporting Standards). In the late 90s, the EU required listed companies to use IASB rules. Basic structure of statements and rules are the same between FASB and IASB, but they differ in the details.

SEC was traditionally against adopting IASB rules in the US. It would reduce their level of control. However, according to a recent announcement, they will be transitioning from FASB to IASB rules within the next few years.

The Public Company Accounting Oversight Board sets auditing standards. They were created by the Sarbanes-Oxley Act and they report to the SEC.

Setting Accounting Standards
Accounting standards focus on three areas: Recognition, Valuation, Classification

Recognition - When are events recorded on the books? What types of events need to be recorded?
Valuation - In the US, we value assets at cost. Other countries revalue if the price changes.
Classification - The breakdown of assets, liabilities, equity and other categories on financial statements.

Responsibilities of Management

• Management of the firm is responsible for the preparation of the financial statements.
• Management of the firm is responsible for the internal controls over financial reporting.
• Auditors perform tests to support an opinion on the quality of internal control and an opinion that the financial statements "fairly present" the company's financial position and results of operations.

Review by auditors is a condition for being listed on US exchanges. An IPO requires 3 years of audited financial statements. Lenders (banks) may also require them.

The Accounting Cycle
There's a process between the original recording of the transaction and the final appearance on the financial statement. This is known as the Accounting Cycle.

The cycle looks like this:
Journal - General Ledger - Trial Balance - Worksheet - Financial Statement

General Ledger contains different accounts for each category of assets and liabilities. Accounts are used to accumulate amounts from similar transactions and to act as the basic storage units for accounting data. An account is the sheet on which individual transactions affecting a particular item are "posted".

T Accounts - A representation of the way that account transactions are divided between debits (left side) and credits (right side).

Asset accounts - the left side represents an increase in the account.
Liability and Owners' Equity accounts - the right side represents an increase in the account.

When entering corresponding asset/liability pairs in corresponding accounts, note the relationship with numbers.