Module 1 summary

Outline of the course and update on recent developments

This module begins with an outline of the course as given in Chapter 1, with particular attention to the structure of accounting standard setting bodies and the concept of due process. You should be aware of the structure of standard setting, since standard setting comes up many times in the course.

The module also provides an outline of important events leading up to the market meltdowns beginning in 2007, since these events have several important implications for accountants and are not discussed specifically in Section 2.1 in the text.

Accounting under ideal conditions

This module defines the concepts of ideal conditions and illustrates preparation of financial statements when ideal conditions hold. Balance sheet values are on the basis of expected present values of future cash receipts from assets and liabilities. Net income is composed of accretion of discount on opening net assets, plus or minus any deviation of actual cash flows for the period from expected cash flows. Reserve recognition accounting (RRA) for oil and gas companies is used to illustrate the challenges of present value accounting when ideal conditions do not hold. The concepts of relevance and reliability of financial statement information are reviewed, and the reliability problems of RRA are explained.

Historical cost-based accounting is analyzed in terms of relevance and reliability, revenue recognition, recognition lag and matching. It provides a trade-off of these characteristics, between the extremes of current value accounting and cash flow accounting. Despite the moves by accounting standard setters toward increased use of current values, accounting for several important classes of assets and liabilities remains based on historical costs.

Explain the concept of due process and understand how the structure of accounting standard setting bodies attains due process.

Review recent development relevant to financial accounting.

Implications for financial accounting of Enron and World.com scandals and the current market collapse:

Define the concept of ideal conditions and outline the necessary assumptions that underlie the definition.

Explain and illustrate the concepts of states of nature and the probabilities of states of nature (both objective and subjective).

Explain and illustrate the concepts of expected value of an asset or liability, abnormal earnings, and risk.

Use the present value model, under conditions of certainty, to prepare an articulated set of financial statements for a simple firm.

Use the present value model, under conditions of uncertainty, to prepare an articulated set of financial statements for a simple firm.

Critically evaluate reserve recognition accounting (RRA) as an application of the present value model.

Explain why relevance and reliability of accounting information have to be traded off.

Evaluate historical cost-based accounting in terms of relevance and reliability, revenue recognition, recognition lag, and matching.