Financial Accounting Fundamentals

Notes from


Accounting Standards

  • Recording, categorizing, summarizing, and communicating financial information about an organization.
  • Accounting is often called as "the language of business."
  • When you think of accounting in a broad sense, you can think of three sets of books.
    1. The financial books
      • Objective: Communicate economic performance and financial position
      • Example: Annual reports
      • Audience: Investors, creditors (External parties)
      • Rules to follow: Ex. IFRS (International Financial Accounting Standards), U.S GAAP (Generally accepted accounting principles) or country specific standards.
      • Authority: SEC (for U.S), country specific.
    2. The management books
      • Facilitate management decision-making
      • Eg. Budgets, Product profitability reports
      • Management (Internal audience)
      • No common rules
      • Management
    3. The tax books
      • Facilitate collection of tax revenue by the government
      • Eg. Tax return
      • Tax authorities
      • Rules to follow: Tax code
      • Tax authority

Securities Market

  • Companies needs money to run business
  • They issue Stocks/bonds to creditors/investors
  • Creditors/Investors provide money to the company for stocks/bonds.
  • Creditors/Investors can continuously trade these stocks between company and themselves.
  • This is broadly categorized as "Securities market".
  • Investors: Where do I put my money? How much should I pay? To answer these questions companies issue Financial statements. So the investors can decide where to put their money and how much to pay for the securities they are buying.
  • Integrity of the financial statements is very important as based on these information, investors decide whether to buy or not to buy.
  • The integrity of financial statement can be achieved through accounting standards.

Accounting Standards

Inside the U.S

  • U.S GAAP
  • Used accrual accounting as opposed to cash basis accounting
  • What is accrual accounting? The transaction are recorded in the books when business activities occur regardless of when the cash effect takes place. For an example, a company might sell some products to a customer and the customer takes the product and promises to pay at a later day. That company can go ahead and record the sales as revenues in its books. Even it hasn't received the cash from the customer. As long as the customer is expected to pay.
  • Accounting standards are intend to promote consistency and comparability across companies, but allow managers some discretion.
  • Who sets these standards? Securities and Exchange Commission (SEC)
  • SEC delegated the responsibilities of the preparation of accounting standards to the Financial Accounting Standard board (FASB).
  • FASB is a non-profit and private org with 7 member board that has 5 years of renewable terms. These members are from different industry background.

Outside the U.S

  • International Financial Reporting Standards (IFRS) is followed in more than 100 countries including E.U.
  • developed by International Accounting Standards Board (IASB). There is an extensive overlap between IFRS and US GAAP related to basic financial accounting topics.
  • IASB does not have any legal authority to impose the standards on any one country. It encourages other countries to adopt IFRS.
  • Some companies outside the U.S voluntarily prepares financial report according to GAAP. The might be trying to seek out investors in the US. The investors in US are accustomed to seeing financial statements prepared according to US GAAP.
  • In 2008, SEC developed a plan for converting to IFRS. It encountered many issues and in 2012 SEC voted not to recommend that the US adopt IFRS.
  • Why not? IFRS and in US GAAP allow companies different choices about how they value inventory on their books. Under US GAAP, companies are allowed to choose this accounting method for inventory called LIFO (Last In - First Out). The companies can choose this method to value their inventories in the US, but they cannot choose this method under IFRS. And in the US, companies that have been using that method have been paying lower income taxes overtime, because of that accounting method.
  • If they have to adopt IFRS, then they would have huge tax bills that they'd have to pay to make up for those lower taxes that they haven't paid over time because of using this LIFO method.

The Financial Statements and Accounting Process

The Balance Sheet

Last updated on: 2017-12-17