3. Accrual based accounting is a requirement of Generally Accepted Accounting Pr

Question

3. Accrual based accounting is a requirement of Generally Accepted Accounting Principles (GAAP). The use of both the Matching Principles and Revenue Recognition Principles has both benefitted and undermined the reliability of the reporting process. Discuss the implications of accrual based accounting in the financial statement reporting process. Provide specific indicators of problems which might lead a reader to discover a potential misstatement or misrepresentation in the financial statements. Discuss the impact that restatements have on the credibility of the reporting process. Include specific references to cases discussed in class

Explanation / Answer

Generally Accepted Accounting Principles are accounting rules used to prepare, present and report financial statements for a wide variety of entities, including publicly traded and privately held companies, non-profit organizations, and government authorities. The term is usually confined to the United States; where it is commonly abbreviated as US GAAP or simply GAAP. However, theoretically, Generally Accepted Accounting Principles encompass all accepted rules which generally apply to accountancy, and not only the United States. Like many other common law countries, the United States government does not directly set accounting standards by statute. However, the U.S. Securities and Exchange Commission (SEC) requires that US GAAP be followed in financial reporting by publicly traded companies. Currently, the Financial Accounting Standards Board (FASB) establishes generally accepted accounting principles for public and private companies, as well as for non-profit organizations. For local and state governments, the Governmental Accounting Standards Board (GASB) determines the GAAP which operate using a set of assumptions, principles, and constraints, different from those of standard private-sector GAAP. The Federal Accounting Standards Advisory Board (FASAB) regulates the financial reporting standards in federal government entities. The US GAAP provisions differ somewhat from International Financial Reporting Standards (IFRS), though former SEC Chairman Christopher Cox set out a timetable for all U.S. companies to drop GAAP by 2016, with the largest companies switching to IFRS as early as 2009.[1] rinciples Historical cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values. Revenue recognition principle requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting. Matching principle. Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost may be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle. Full Disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information The accrual basis is when you account for what you owe, with the intent of paying the liability. And, you account for what is owed to you, hopefully with the intent of collecting the full amount. The cash basis is when you account for what you have paid and what you have collected.

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