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In: Accounting

New Approaches to Revenue Recognitions Must include the following: 1. Historical development of financial accounting theory....

New Approaches to Revenue Recognitions

Must include the following:

1. Historical development of financial accounting theory.

2. Current GAAP.

3. Compare and contrast U.S. GAAP and IFRS in respect to your topic.

4. Suggested changes or problem areas revealed in the debate arena.

5. Analyze points 2 and 3 in relation to the Conceptual Framework (include qualitative characteristics of useful information).

6. Suggest appropriate courses of action.

7. Provide a biblical application, supported by Scripture, in respect to your topic.

Solutions

Expert Solution

Accounting is the system of recording, classifying and summarizing financial information in such a way that users of the information can make economic decisions based upon it. Accounting began as a simple system of clay tokens to keep track of goods and animals, but has developed throughout history into a way of keeping track of complex transactions and other financial information.

Early Accounting

Accountancy has its roots in the earliest history of civilization. With the rise of agriculture and trade, people needed a way to keep track of their goods and of transactions. Around 7500 B.C., Mesopotamians began using clay tokens to represent goods, such as animals, tools, food items or units of grain. This helped owners keep track of their property. Instead of counting heads of cattle or bushels of grain every time one was consumed or traded, people could simply add or subtract tokens. Different shapes were used for different goods. Around 4000 B.C., the Sumerians began placing these tokens in sealed clay envelopes. Each token would be stamped into the clay of the outside of the envelope, so the owner would know how many tokens were inside, but the tokens themselves would be kept safe from tampering or loss. This practice of pressing the tokens into the clay may have been the earliest genesis of writing. A few hundred years later, more complex tokens began to be used. These tokens had special markings to denote different units or types of goods. Starting around 3000 B.C., the Chinese developed the abacus, a tool for counting and calculating.

Double-entry Bookkeeping and Luca Pacioli

Throughout much of ancient history and the Middle Ages, accountancy remained a fairly simple affair. The adoption of coinage meant that accounting now dealt with money rather than actual goods, but single-entry bookkeeping, much like that used in modern check registers, was used to keep track of money exchanged, where it went and who owed what. During and after the Crusades, European trade markets opened up to Middle Eastern trade, and European merchants, especially in Genoa and Venice, became increasingly wealthy. They needed a better way to keep track of large amounts of money and complex transactions, and this led to the development of double-entry bookkeeping. Double-entry bookkeeping means that each transaction is recorded at least twice, as a debit from one account and a credit to another. In 1494, a Franciscan monk and mathematician named Luca Pacioli published a math book titled "Summa de arithmetica, geometria, proportione et proportionalita," which contained a description of double-entry accounting. As the book's popularity grew, double-entry accounting began to sweep Europe, as merchants realized what a valuable tool it gave them for keeping track of detailed financial information. For this accomplishment, Luca Pacioli is often called the "Father of Accounting." Still, at this point in history, accountancy was not yet a specific profession, but rather an extension of the clerical duties of scribes, officials, bankers and merchants.

The Industrial Revolution and the Rise of Professional Accountancy

With the advent of the Industrial Revolution in the late eighteenth and early nineteenth centuries, accounting developed further and came into its own as a profession. The practice of cost accounting became prevalent as business owners and managers sought to understand how best to make their businesses as cost efficient as possible. Josiah Wedgwood, the owner of the famous English pottery factory, was among the first to use cost accounting to understand what his company's money was being spent on and to eliminate unnecessary spending. With the new complexity of accounting and the increasing demand for accurate bookkeeping, people began to specialize in accountancy, thus becoming the first professional public accountants. Some of the accounting firms that are still in operation today were founded in the mid-nineteenth century. William Deloitte opened his firm in 1845, and Samuel Price and Edwin Waterhouse opened their joint business in 1849.

Modern Professional Accounting

Today, accounting is a business unto itself, with thousands of practitioners worldwide and a large number of professional organizations and official guidelines to codify practices and requirements. Particularly in the United States during the Great Depression, demands were made for better standardization of accounting practices and a set code of professional guidelines. Today, the Generally Accepted Accounting Principles, or GAAP, set forth the standards by which public accountants must do business. Every country has a similar set of accounting guidelines.

Specialized Accounting

Due to the complex nature of today's economic system, specialized branches of accounting have developed. In addition to traditional financial accounting, there are now subdivisions, such as tax accounting, management accounting, lean accounting, fund accounting and project accounting. Professional accountants are required for these fields, as they involve the need for a thorough and specific understanding of business needs and accountancy practices.

Generally accepted accounting principles, or GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.

U.S. law requires businesses that release financial statements to the public and companies that are publicly traded on stock exchanges and indices to follow GAAP guidelines, which incorporate 10 key concepts:

  • Principle of regularity: GAAP-compliant accountants strictly adhere to established rules and regulations.
  • Principle of consistency: Consistent standards are applied throughout the financial reporting process.
  • Principle of sincerity: GAAP-compliant accountants are committed to accuracy and impartiality.
  • Principle of permanence of methods: Consistent procedures are used in the preparation of all financial reports.
  • Principle of non-compensation: All aspects of an organization’s performance, whether positive or negative, are fully reported with no prospect of debt compensation.
  • Principle of prudence: Speculation does not influence the reporting of financial data.
  • Principle of continuity: Asset valuations assume the organization’s operations will continue.
  • Principle of periodicity: Reporting of revenues is divided by standard accounting time periods, such as fiscal quarters or fiscal years.
  • Principle of materiality: Financial reports fully disclose the organization’s monetary situation.
  • Principle of utmost good faith: All involved parties are assumed to be acting honestly.

GAAP compliance makes the financial reporting process transparent and standardizes assumptions, terminology, definitions, and methods. External parties can easily compare financial statements issued by GAAP-compliant entities and safely assume consistency, which allows for quick and accurate cross-company comparisons.

Because GAAP standards deliver transparency and continuity, they enable investors and stakeholders to make sound, evidence-based decisions. The consistency of GAAP compliance also allows companies to more easily evaluate strategic business options.

WHAT ARE THE BASIC PRINCIPLES OF ACCOUNTING?

Beyond the 10 principles, GAAP compliance is built on three rules that eliminate misleading accounting and financial reporting practices. These rules create consistent accounting and reporting standards, which provide prospective and existing investors with reliable methods of evaluating an organization’s financial standing. Without these rules, accountants could use misleading methods to paint a deceptive picture of a company or organization’s financial standing.

These three rules are:

Basic accounting principles and guidelines: These 10 guidelines separate an organization’s transactions from the personal transactions of its owners, standardize currency units used in reports, and explicitly disclose the time periods covered by specific reports. They also draw on established best practices governing cost, disclosure, going concern, matching, revenue recognition, professional judgment, and conservatism.

Rules and standards issued by the FASB and its predecessor, the Accounting Principles Board (APB): The FASB issues an officially endorsed, regularly updated compendium of principles known as the FASB Accounting Standards Codification. The compendium includes standards based on the best practices previously established by the APB. These organizations are rooted in historic regulations governing financial reporting, which were implemented by the federal government following the 1929 stock market crash that triggered the Great Depression.

Generally accepted industry practices: There is no universal GAAP model followed by all organizations across every industry. Rather, particular businesses follow industry-specific best practices designed to reflect the nuances and complexities of different areas of business. For example, banks operate using a different set of accounting and financial reporting methods than those used by retail businesses.

Us GAAP and IFRS

To be successful in the US capital markets, it is increasingly important to be financially bilingual – you have to speak both IFRS and US GAAP. Why, you ask, given that there are no current US plans to require or permit domestic public companies to use IFRS? Because we operate in a global marketplace and the impact of IFRS on US capital markets is not just about its domestic use in capital filings. IFRS requirements elsewhere in the world affect many US companies – public or private, large or small — through cross-border, M&A activity, and due to the IFRS reporting demands of stakeholders outside the US. and the continued global adoption of IFRS means that the impact on multinational US businesses will only grow stronger, as additional countries permit or require IFRS for statutory reporting purposes and public filings.

  1. From an investor perspective, the need to understand IFRS is arguably even greater. US investors keep looking overseas for investment opportunities. Recent estimates suggest that over $7 trillion of US capital is invested in non-US securities. The US markets also remain open to non-US companies that prepare their financial statements using IFRS. There are currently approximately 500 non-US filers with market capitalization in the multiple of trillions of US dollars that use IFRS without reconciliation to US GAAP.
  2. To assist investors and preparers in becoming financially bilingual, this guide provides a broad understanding of the major differences between IFRS and US GAAP, as well as insight into the level of change on the horizon.
  3. When it comes to accounting standards, there is debate about whether principles or rules are better. Some argue that the rules based US GAAP approach is better while others argue that the principles based IFRS is better. But which approach, principles or rules, do you think is best?
  4. While US GAAP is often considered rules based, it is better to think about individual standards within US GAAP as being more or less rules-based. There are advantages and disadvantages to a rules based approach. Advantages include clarity in application, reduction of risk (but only when the applicable rule is followed), and comparability for companies in the same industry for the same rule. Disadvantages include a regimented approach where a transaction must be accounted for in accordance with the rule even if the applied accounting is misleading, non-comparability between different industries when the transactions are similar, and increased risk when the applicable rule is not followed (its hard to defend a position when the rule is broken).
  5. Similarly, IFRS is often thought of as principles based, but is better considered more or less principles based. Clearly defined principles provide many advantages as a basis of accounting, including allowing preparers the ability to consider the best way to account for and report a transaction, increased comparability among companies with similar transactions no matter the industry and the ability to defend positions based on the principles followed. Disadvantages include an increased ability to manipulate transactional accounting, increased variations in accounting approaches for similar transactions, and fewer bright lines to consider in determining how to account for a transaction.
  6. In today’s global marketplace IFRS has a distinct advantage over US GAAP. The fact is that IFRS is either permitted or required in over 120 jurisdictions while US GAAP is required in one. The SEC will decide later this year when, whether and how IFRS should be adopted in the United States. If IFRS is permitted or required in the United States, companies will need to develop a judgment framework that documents how accounting decisions will be made in a principles based accounting environment. Because there could be variations in accounting by different companies for similar transactions, companies should disclose the basis for the accounting followed as well as the factors considered and reasons for accounting decisions made.

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