Financial Accounting Standards Board & Accounting Cycle

FASB

            The Financial Accounting Standards Board is a private, non-profit organization whose primary purpose is to establish and improve generally accepted accounting principles within the United States in the public's interest.

            Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting that governs the preparation of financial reports by nongovernmental entities. Those standards are officially recognized as authoritative by the Securities and Exchange Commission (SEC) (Financial Reporting Release No. 1, Section 101, and reaffirmed in its April 2003 Policy Statement) and the American Institute of Certified Public Accountants (Rule 203, Rules of Professional Conduct, as amended May 1973 and May 1979). Such standards are important to the efficient functioning of the economy because decisions about the allocation of resources rely heavily on credible, concise, and understandable financial information.

1.         Statement of Comprehensive income:

            The change in a company's net assets from non owner sources over a specified period of time. Comprehensive income is a statement of all income and expenses recognized during that period. The statement includes revenue, finance costs, tax expenses, discontinued operations, profit share and profit/loss.

2.         Statement of Change in Owner equity:

            The statement of owner’s equity is the second report of the financial statements. Its full name is the statement of changes in owner's equity.

            This accounting report shows all the changes to the owners equity that have occurred during the period. These changes comprise capital, drawings and the profit for the period.

The format of the statement is shown below:

3.         Statement of Financial position:

            The statement of financial position is another name for the balance sheet. It is one of the main financial statements and it reports an entity's assets, liabilities, and the difference in their totals.

4.         Statement of Cash flow:

            In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities.

5.         Accounting Cycle

            The accounting cycle is a process which performed during the accounting period, to analyze, record, classify, summarize, and report financial information.

Accounting Cycle Defined

            There is ebb and a flow to every industry. In accounting, the ebb and flow is the accounting cycle. The term accounting cycle refers to the specific steps that are involved in completing the accounting process. The cycle is like a circle. It begins at one point and revolves through specific steps, before starting again at the same point and then repeating those same steps.

            The length of the accounting cycle varies from company to company. It may be monthly, quarterly, semiannually, or annually depending on when the financial statements of the company are published. Regardless of the timing of the accounting cycle, the processes involved remain the same.

Steps in the Accounting Cycle

There are ten basic steps to the accounting cycle.

1. Collect source documents

The very first step in the accounting cycle is to gather all the documents that are related to financial transactions of the organization. These documents, called source documents, are things like receipts, bank statements, checks, and purchase orders. They are the items that describe what a transaction was for.

2. Analyze transactions

The second step in the accounting cycle is to analyze the source documents. The purpose of this is to look them over and then decide what effect they have had on company accounts.

3. Journalize transactions

The third step in the accounting cycle is to post entries into the journal for the analyzed transactions. A journal is the book or electronic record that documents all the financial transactions for a company and the accounts that are affected by each transaction. When a journal entry is made, the 'double-entry' rule is used. This means that for every one transaction, at least two accounts are affected. There must be a debit and a credit for each transaction, and the total of debits and credits must equal the amount of the transaction. Journal entries are entered in chronological order, and debits are entered before credits.

4. Post transactions

The fourth step in the accounting cycle is to transfer information from the journal to the ledger. A ledger is a book or an electronic record of all the accounts that a company has. These accounts are broken down by account number and class. When the information from the journal is transferred to the ledger, it is transferred to each account that was affected by a transaction.

5. Prepare an unadjusted trial balance

A trial balance is a list of all the company's accounts and their balance at the time the trial balance is prepared. An unadjusted trial balance is a trial balance that is prepared before adjusting entries are made into accounts. This information comes directly from the ledger. The total debit balance and total credit balance must be equal.

6. Prepare adjusting entries

Adjusting entries are entries that are made in the journal and posted in the ledger. The purpose of these entries is to bring account balances to the proper amounts. Not all accounts will have an adjusting entry. Adjusting entries are made at the end of the accounting period but not the end of the accounting cycle.

7. Prepare trial balance

Remember, the trial balance is a list of all accounts and their balances after adjustments have been made. This trial balance is prepared to check and make sure that debits and credits equal after adjusting entries are made. It is used to prepare the financial statements.

8. Prepare financial statements

These are prepared in a specific order because information from one financial statement is often used in preparing another financial statement. The order that the financial statements need to be prepared is.

7.         Going concern concept:

The going concern concept or going concern assumption states that businesses should be treated as if they will continue to operate indefinitely or at least long enough to accomplish their objectives. In other words, the going concern concept assumes that businesses will have a long life and not close or be sold in the immediate future. Companies that are expected to continue are said to be a going concern. Companies that are expected to close in the near future are not a going concern.

Examples

- In the early 2000s, General Motors was experiencing great financial difficulties and was ready to declare bankruptcy and close operations all over the world. The Federal government stepped in and gave GM a bailout as well as a guarantee. In normal circumstances, GM would not be considered a going concern, but since the Federal government stepped in, we have no reason to believe that GM will cease to operate

8.         Accounting Period concept:

            The Accounting period (Reporting period) is the time period for which a company or organization reports financial performance and financial position. Normally the accounting period is defined with respect to the organization's fiscal year, Typically, four quarterly accounting periods correspond to the organization's fiscal quarters, and an annual accounting period covers the entire fiscal year.

9.         The matching concept:

            The matching concept is a primary differentiator between accrual accounting and cash basis accounting. With the matching concept, revenues are reported along with the expenses that brought them in the same period.

10. Revenue recognition principle

             The revenue recognition principle states that, the revenue are recorded when earned not necessarily when cash received or the revenue recognition principle states that, under the accrual basis of accounting, you should only record revenue when an entity has substantially completed a revenue generation process; thus, you record revenue when it has been earned. For example, a snow plowing service completes the plowing of a company's parking lot for its standard fee of $100. It can recognize the revenue immediately upon completion of the plowing, even if it does not expect payment from the customer for several weeks.

11.       Cost Principle

            The cost principle requires that assets be recorded at the cash amount (or its equivalent) at the time that an asset is acquired. For example, if equipment is acquired for the cash amount of $50,000, the equipment will be recorded at $50,000. If the equipment will be useful for 10 years with no salvage value, the straight-line depreciation expense will be $5,000 per year (cost of $50,000 divided by 10 years).

12.       L.C.M Rule:

            Lower of Cost or Market (LCM) is the approach of valuing and reporting inventory at historical costs or current value, whichever is lower. It is a conservative accounting approach in tune with GAAP rules to record inventory at the lowest of production costs, repurchase costs, or market value.

Example

Company A owns an item of inventory having original cost of $900. Its replacement cost is $880. The company expects to sell it at $980. However an expense of $40 must be incurred to make the sale. Calculate the value of inventory according to lower of cost of market rule.

Solution

Upper Limit: NRV     = 980 − 40       = $940

Replacement Cost                  = $880

Lower Limit: NRV − Normal Profit  = 940 − (980 − 880)    = $840