Financial Accounting

1. Chapter 13
Accounting Concepts, Professional Judgments,
and Ethical Conduct
Presented by:
• Noman Khelgi
• Kiran Kiyani
• Tooba Riaz
• M. Anwar

2. The Need for Recognized Accounting Standards
• The basic purpose of financial statements is to provide information about a business
entity
• Information that will be useful in making economic decisions
• Investors, managers, creditors, financial analysts, economists and government policy
makers all rely upon financial statements
• The information should be
-Relevant to the information needs of the decision makers
-As reliable as possible
-Comparable to the financial statements of prior accounting periods
-Understandable to the users

3. Generally Accepted Accounting Principles(GAAP)
• Ground rules for financial reporting
• Accounting principles may also be termed standards, assumptions, conventions, concepts
• Constructing a satisfactory body of accounting theory is an ongoing process, because
accounting theory must change continually with changes in the business environment and
changes in the need of financial statements users

4. Generally Accepted Accounting Principles(GAAP)
Nature of Accounting Principles
• Accounting principles do not exist in nature, rather they are developed by humans
• Need for consensus within the economic community is an important aspect
• Accounting principles may vary somewhat from one country to another

5. Generally Accepted Accounting Principles(GAAP)
Authoritative Support for Accounting Principles
Official Sources of GAAP
• AICPA
• FASB
• SEC
• AAA
Unofficial Sources of GAAP
• Common sense
• Tradition
• Widespread use

6. Generally Accepted Accounting Principles(GAAP)
The Accounting Entity Concept
• An accounting entity is any economic unit which controls resources and engage in
economic activities
• All business entities should be accounted separately
• The owner and the business are two separate entities and should be accounted separately
• The partner’s and shareholders’ activities should be kept separately from the business
The Going-Concern Assumption
• An accounting entity will continue in operation for a period of time
• The accountants believe that the company will not liquidate in near future

7. Generally Accepted Accounting Principles(GAAP)
The Time Period Principle
• Regular financial reporting is very important
• So all the companies and organizations can divide activities into time periods
• These time periods can be weekly, monthly, annually, or semi annually
The Stable-Dollar Assumption
• Money is used as the basic measuring unit for financial reporting
• It indicates the relative price of different goods and services
• Dollar is a stable unit od measure

8. Generally Accepted Accounting Principles(GAAP)
The Objectivity Principle
• The financial statements of an organization should be based on solid evidence
• Accountants rely on various kinds of evidence to support their financial measurements
• Objectivity has its roots in the quest of reliability
• Accountants want to make their economic measurements reliable and relevant to
decision makers

9. Generally Accepted Accounting Principles(GAAP)
Asset Valuation: The Cost Principle
• The asset be recorded at the cash amount at the time when asset is acquired
• Many accountants believe that current market value should be used as the basis for asset
valuation rather than historical cost
• Current value would be more meaningful

10. Generally Accepted Accounting Principles(GAAP)
Revenue Recognition: The Realization Principle
• Under the assumption of accrual accounting revenue should be recognized “when it is
earned”
• Revenue is realized when
-The earning process is essentially completed
-Objective evidence exits as to the amount of revenue earned

11. Generally Accepted Accounting Principles(GAAP)
Revenue Recognition: The Realization Principle
- The Installment Method
• Suitable for construction companies, especially for home builders as they routinely make contracts to
build and receive some revenue before and during the project while majority of revenue is received
after completion
- Percentage of Completion Method
• Suitable for those with much longer term contracts for huge projects
• Revenue and expenses are recorded based on how much work has been completed

12. Generally Accepted Accounting Principles (GAAP)
Matching Principle:
Matching principle require that expenses incurred by an organization must be charged
to the income statement in the accounting period in which the revenue, to which those
expenses relate, is earned.
Examples
1. Accrued Expense
2. Prepaid Expense
3. Depreciation Expense

13. Generally Accepted Accounting Principles (GAAP)
• Costs are matched with revenue in one of the two ways:
1. Immediate Recognition: Expenses are expected to have no future benefit or are even
without future benefit, they should be written-off in the current accounting period. For
e.g cost of goods sold, commission paid to salespeople, advertising expense etc.
1. Systematic Allocation of Costs: When the cost benefit several accounting periods. They
should be recognized on the basis of a systematic allocation method. Examples include
cost of insurance policies, depreciation asset, intangible asset such as good will.

14. Generally Accepted Accounting Principles (GAAP)
The Consistency Principles:
An assumption that once a particular accounting method is adopted, it will not be
changed from period to period.
• Changes are permitted only when the new method is considered better and can reflect
true and fair position of the company.
• The change and its effects should be disclosed in the financial statements.

15. Generally Accepted Accounting Principles (GAAP)
The Disclosure Principle:
All material and relevant fact concerning financial position and the result of operation
are communicated to user.
Example:
• Defendant company should be disclosed.
• Summary of accounting method.
• Dollar effect of any change in these methods.
• Any loss contingencies.

16. Generally Accepted Accounting Principles (GAAP)
Materiality:
The term materiality refers to the relative importance of an item or an event.
• Material  If knowledge of item influence decision of users of financial statements.
• Immaterial items have no value to decision makers and are treated as easiest and most
convenient manner.
• Allows accountant to ignore other accounting principles with respect to items that are not
material.

17. Generally Accepted Accounting Principles (GAAP)
Conservatism as a guide in resolving Uncertainties:
• It is more useful when matters of judgment or estimates are involved
• Accountant should select those accounting methods which neither overstate neither
understate the fact
• When some doubt exists about the valuation of an asset, accountant traditionally select
the accounting option which produces a lower net income for the current period and less
favorable financial position

18. Audited Financial Statements:
• Annual financial statements are audited by Independent certified Public Accountants
(CPA’s)
• Audit is an investigation of company’s financial statement, designed to determine fairness
of these statements. It is a thorough investigation of every item, dollar amount and
disclosure which appear in financial statement.
• CPA’s express their their opinion fairness of financial statement which is known as
auditor’s repots.

19. Setting new Accounting Standards
• To meet the needs of the entire economic community, the FASB invites all elements of
the community to express their views during the standard setting process. For
example
i. Discussion Memorandum
ii. Exposure Draft
iii. Statement of Financial Accounting Standards

20. The Conceptual Framework Project
• The FASB make each new accounting standard consistent with the general framework of
accounting theory by the board in the series of Statement of Financial Accounting
Concepts. These statements explain
i. Objective of financial reporting
ii. Desired characteristics of accounting information
iii. Element of financial statements
iv. Criteria for deciding what information to include in financial statement
v. Valuation concepts relating to the determination of financial statement amounts.

21. Professional Judgment: An Essential Element in
Financial Reporting

22. Ethical Conduct in the Accounting Profession
What are Ethics?
• Moral principles that an individual uses in governing his/her behavior
• Distinguishing b/w right from wrong
Ethics relating to certain types of activities
• It is wrong to steal, apply to all situations
• Some ethical concepts relate specifically to doing business
E.g manufacturing a product that is useful, legal and profitable but its use is harmful to the
environment should we continue to produce that product?
• To understand and appreciate the ethics applicable to a specific type of activity we first
understand the nature of that activity

23. Ethical Conduct in the Accounting Profession
Ethics relating to the practice of accounting
• Accountants have unique ethical responsibilities
E.g An accountant preparing an income tax return has an ethical obligation to prepare the
return honestly
• An accountant of a private company has the ethical obligation of respecting the
confidentiality of information gained on the job and also making appropriate disclosures
to the people outside the organization

24. Ethical Conduct in the Accounting Profession
The concept of a “Profession”
• All professions do have common characteristics. The most important of these is the
special responsibility of persons practicing a profession to serve the public interest even at
the sacrifice of personal gain

25. Professional Codes of Ethics
• All recognized professions have developed codes of ethics
• The basic purpose of these codes is to provide members of the profession with guidelines
for conducting themselves in a manner with the responsibilities of the profession
• Also there are many laws, income tax regulations, and professional pronouncements that
govern conduct of practicing accountants

26. The American Institute of Certified Public Accountants(AICPA)
• The membership of this association has voted to adopt a code of professional conduct to
provide its members with guidelines in fulfilling their professional responsibilities
• AICPA Code of Professional Conduct focuses upon ethical concepts relating to the practice
of public accounting
• The Code consist of two sections
-Principles
-Rules

27. Section-I Principles
Article 1 Responsibilities
• Professional members should exercise sensitive professional and moral judgment in their
activities
Article 2 The Public Interest
• Members should serve the public interest, honor the public trust, and demonstrate commitment
to professionalism
Article 3 Integrity
• Members should perform all responsibilities with highest sense of integrity
Article 4 Objectivity and Independence
• Members should be free of conflicts of interest
• A member should be independent in fact and appearance when providing auditing and other
attestation service

28. Section-I Principles
Article 5 Due Care
• A member should observe the profession’s technical and ethical standards
• Strive continually to improve competence and the quality of service
• Discharge professional responsibilities to the best of member’s ability
Article 6 Scope and Nature of Service
• Member should observe the Principles of the Code of Professional Conduct in
determining the scope and nature of services

29. Section II Rules
Integrity and Objectivity
• Rule 102 all members should maintain objectivity and integrity, shall be free of conflicts of
interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to
others
Confidential Client Information
• Rule 301 A member shall not disclose any confidential client information without permission

30. A Closer Look at Some Key Concepts
Independence
• Auditors must be independent of the company issuing the financial statements .By
independent, we mean that the auditor must not be perceived as being under the
company's influence or control or as having any vested interest in the results reported in
the financial statements.
• CPAs take extensive measures to be independent in fact and to appear independent of
their audit clients.
• CPAs must not have any financial interest in a client firm.
• Close relatives of the CPAs not have major investments or hold key managements
positions with a client company.

31. A Closer Look at Some Key Concepts
Integrity and objectivity
• A member shall not knowingly misrepresent facts.
• A CPAs must not be associated with misleading financial statements, income tax returns, or
other accounting reports. If a client insists upon preparing an accounting document in a
misleading manner, the CPA must resign from the engagement.
Confidentiality
• If individuals are to discuss sensitive and private matters openly with professionals, they must
trust that professional not to misuse the information.
• If CPAs are to earn the trust and respect of their clients, they should not disclose sensitive
information to the company's competitors or to other outsiders, or use that information for
the CPAs personal gain.

32. IMA Standards of Ethical Conduct For Management
Accountants
The IMA is an association consisting primarily of management accountants that is
• The accountants working for one particular organization.
• The members of the IMA have adopted a code of professional ethics designed to assist
management accountants in executing their duties in an ethical and professional manner. The
standards comprising this code are as follows:
Competence:
Management accountants have a responsibility to:
• Maintain an appropriate level of professional competence by ongoing development of their
knowledge and skills.
• Perform their professional duties in accordance with relevant laws, regulations< and technical
standards.
• Prepare complete and clear reports and recommendations after appropriate analysis of relevant
and reliable information.

33. Confidentiality:
Management accountants have a responsibility to:
• Refrain from disclosing confidential information acquired in the course of their work except when
authorized, unless legally obligated to do so.
• Inform subordinates as apparent conflicts of interest and advise all appropriate parties of any
potential conflict.
• Refrain from using or appearing to use confidential information acquired in the course of their
work for unethical or illegal advantages either personally or through third parties.
Integrity:
• Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential
conflict.
• Refrain from engaging in any activity that would prejudice their ability to carry out their duties
ethically.
• Communicate unfavorable as well as favorable information and professional judgements or
opinions.

34. IMA Standards of Ethical Conduct For Management
Accountants
Objectivity:
• Communicate information fairly and objectively.
• Disclose fully all relevant information that could reasonably be expected to influence an intended
user’s understanding of the reports, comments, and recommendations presented.
Applicability of the IMA’s Code of Ethics:
• Applies to all members of the organization in their role as management accountants.
• All CMA’s (Certified Management Accountants) also agree to abide by this code.
A Closer Look at Some Key Concepts:
• Confidentiality Every organization views much of its internal accounting information as confidential_
that is the information that should not be disclosed to people outside the organization, or even to
many employees inside the organization.

35. IMA Standards of Ethical Conduct For Management
Accountants
What About Independence?
• IMA’s code does not mention the concept of Independence.
• Independence is an ethical concept pertaining only to public accountants engaged in auditing
activities.
• The important distinction between the management accountant and a public accountant is that
the management accountant is an employee of the company for which he or she performs
accounting services.
• The public accountant, on the other hand, is employed by a public accounting firm but provides
accounting services for s variety of different clients.
Resolution of Ethical Conflicts:
• The IMA also makes suggestions to its members on how to resolve ethical conflicts.
• When faced with a significant ethical issue, the member should first follow any established policies
within the employer organization for resolving such issues.
• If the ethical conflicts cannot be resolved after exhausting all levels of internal review.
• The management accountant may have no alternative other than to resign from the organization,
and to submit a memorandum describing the situation to an appropriate level of management.

36. IMA Standards of Ethical Conduct For Management
Accountants
The Challenge of Adhering to a code of Ethics:
• In principle, a professional code of ethics is a good thing.
• Society benefits when professional conduct themselves in an honorable and ethical manner.
• A professional code of ethics provides professionals with some general guidelines in conducting
themselves in an ethical manner.
The Price of Ethical Behavior:
• This is an easier course of action to advocate than to follow.
• Management accountants, interestingly, may have to pay a far greater “price” of ethical conduct
than the public accountants.
Incomplete Information:
• A professional accountant may “suspect” that activities in which he or she is asked to participate
are unethical, but not be sure.
• In most situations, accountants have neither the responsibility nor the right to investigate their
employers or clients.

37. IMA Standards of Ethical Conduct For Management
Accountants
What is the “Ethical” Things to Do?
• Codes of ethics consist of broad general guidelines, intended to be useful to practitioners in
identifying and resolving ethical problems.
• Every “ethical dilemma” is somewhat unique, having its own facts and circumstances.
• In many situations, however, the ethical course of action is not readily apparent.
• Codes of ethics, including the “official interpretations,” typically do not address such specific
questions.
• In deciding when an ethical problem exist, and in determining what constitutes ethical behavior, the
practitioner must often rely primarily upon his or her own professional judgement.