WEBVTT NOTE session-04 1 00:00:00.000 --> 00:00:09.400 Before we begin, consider the predator question on screen. Choose an animal, then pause the video if you want more time. 2 00:00:15.400 --> 00:00:26.021 The answer is the dragonfly. Welcome to Lecture 4, Understanding GAAP in the US. GAAP means generally accepted accounting principles. 3 00:00:26.021 --> 00:00:37.200 We'll see where the rules come from, use them to answer an accounting question, and consider how the reported information affects decisions. 4 00:00:37.200 --> 00:00:52.549 In our earlier classes, we recorded transactions, made adjustments, and connected the financial statements. That process can produce a balanced set of records even when an accounting choice is wrong. 5 00:00:52.549 --> 00:00:58.333 But how do we know whether the company followed the right accounting rules? 6 00:00:58.333 --> 00:01:11.372 Imagine that each company could choose its own accounting rules. Two equal profit figures might describe different things. How could an investor compare them? 7 00:01:11.372 --> 00:01:22.100 A regulator would face a related problem: which rule could it use to challenge misleading accounting? Keep both questions in mind. 8 00:01:28.100 --> 00:01:40.547 First, you should be able to tell the organizations and their sources apart. Accounting standards, filing requirements, and audit standards answer different questions. 9 00:01:40.547 --> 00:01:50.833 You should be able to name the organization responsible for each, rather than treating every official-looking document as interchangeable. 10 00:01:50.833 --> 00:02:02.375 Second, you'll research an accounting question in the Accounting Standards Codification, or ASC. Finding a paragraph is only part of the work. 11 00:02:02.375 --> 00:02:09.933 You must also establish whether it applies to the company, transaction, and reporting period. 12 00:02:09.933 --> 00:02:26.528 Third, consider the people who read the financial statements. You will explain how a reporting choice could affect a decision. We'll ask whether the information helps them decide and accurately describes what happened. 13 00:02:26.528 --> 00:02:31.400 Those are questions about relevance and faithful representation. 14 00:02:31.400 --> 00:02:44.867 Begin with the institutions behind the rules. The history helps explain who writes the accounting standards, who prepares the reports, and who oversees the auditors. 15 00:02:44.867 --> 00:03:01.712 The federal system developed in stages. The Securities Acts of 1933 and 1934 established disclosure requirements, and the latter created the Securities and Exchange Commission, or SEC. 16 00:03:01.712 --> 00:03:18.467 Private accounting bodies followed: the Committee on Accounting Procedure, then the Accounting Principles Board. The Financial Accounting Standards Board, or FASB, began work in 1973. 17 00:03:18.467 --> 00:03:34.489 After WorldCom and other failures, the 2002 Sarbanes-Oxley Act created the Public Company Accounting Oversight Board, or PCAOB. The SEC recognized FASB under that law in 2003. 18 00:03:34.489 --> 00:03:38.700 The Codification became authoritative in 2009. 19 00:03:38.700 --> 00:03:52.068 Follow the network costs from the middle of the diagram. WorldCom had used capacity supplied by other telecommunications companies. Those costs belonged in current expense. 20 00:03:52.068 --> 00:04:03.183 Recording them as assets instead understated expense and overstated income. It also left unsupported costs among the company's reported assets. 21 00:04:03.183 --> 00:04:09.867 The accounting changed the picture without changing the service WorldCom had consumed. 22 00:04:09.867 --> 00:04:24.927 Look at how much that accounting choice changed WorldCom's reported income. For 2001, WorldCom reported 2.393 billion dollars of income before taxes and minority interests. 23 00:04:24.927 --> 00:04:41.563 Correcting the unsupported capitalization produced a 622 million dollar loss on that same basis. The wider fraud involved at least 11 billion dollars of overstated income over several years. 24 00:04:41.563 --> 00:04:47.167 That broader figure is not the amount of this single correction. 25 00:04:47.167 --> 00:05:02.460 Separate each participant's job. FASB develops accounting standards, while management prepares the statements and applies those standards. The external auditor tests the statements and issues an opinion. 26 00:05:02.460 --> 00:05:16.472 The SEC enforces public-company reporting requirements. The PCAOB oversees audit firms; it does not perform each company's audit. Management still remains responsible for the statements. 27 00:05:16.472 --> 00:05:30.334 According to WorldCom's account, Cynthia Cooper and her internal audit team investigated the transfers. The chief financial officer asked Cooper to delay the review, but she continued. 28 00:05:30.334 --> 00:05:35.833 Internal audit is distinct from the external auditor shown in this table. 29 00:05:35.833 --> 00:05:53.440 The question determines the source. For nongovernmental US accounting, use the FASB Codification. For SEC filing obligations, use applicable SEC requirements. For a public-company audit, use PCAOB standards. 30 00:05:53.440 --> 00:06:10.367 International Financial Reporting Standards, or IFRS Accounting Standards, come from the International Accounting Standards Board. Identify which reporting system applies before choosing your source. 31 00:06:10.367 --> 00:06:28.773 Read the arrows as different relationships. The SEC recognizes FASB standards for federal securities-law purposes. FASB develops nongovernmental US GAAP. The Codification contains the authoritative accounting guidance. 32 00:06:28.773 --> 00:06:41.775 You don't cite an organization as your accounting support. You cite the applicable guidance in the Codification. Recognition did not begin after WorldCom. 33 00:06:41.775 --> 00:06:56.467 The SEC had recognized FASB's role in 1973; its 2003 statement reaffirmed that role under the new law. The SEC also retained its own authority over public-company accounting. 34 00:06:56.467 --> 00:07:12.185 An Accounting Standards Update, or ASU, communicates amendments to the Codification. Start with existing guidance, read what the Update changes, and follow those amendments into the ASC. 35 00:07:12.185 --> 00:07:25.200 The return arrow shows that a later amendment starts from the updated guidance. An Update's issue date does not tell you when every company must apply it. 36 00:07:25.200 --> 00:07:41.443 After an external audit, who remains responsible for a public company's financial statements? Choose among the external auditor, company management, FASB, and the PCAOB. Take a minute to choose your answer. 37 00:07:41.443 --> 00:07:43.967 Pause the video while you think. 38 00:07:53.967 --> 00:08:09.168 The answer is B, company management. The auditor's opinion does not transfer responsibility for preparing the statements. FASB provides accounting standards, and the PCAOB oversees audit firms. 39 00:08:09.168 --> 00:08:14.367 Neither organization takes over management's reporting obligation. 40 00:08:14.367 --> 00:08:30.867 How does FASB reason about the standards it writes? The Conceptual Framework gives FASB objectives and concepts to use when developing standards. Companies follow the applicable requirements in the Codification. 41 00:08:30.867 --> 00:08:47.626 FASB uses the Framework to develop requirements and explain its decisions. Readers can use those explanations to understand a standard's reasoning. But a concept is not permission to ignore an applicable ASC paragraph. 42 00:08:47.626 --> 00:08:55.391 When researching a company's transaction, separate the reason for a rule from what the rule requires. 43 00:08:55.391 --> 00:09:11.767 WorldCom's chief financial officer defended the transfers by arguing that the costs should be matched with future revenue. That explanation did not justify the entries under the applicable accounting requirements. 44 00:09:11.767 --> 00:09:25.362 The Framework developed over decades, beginning with the first Concepts Statement in 1978. FASB resumed its review in 2014 and completed the update in 2024. 45 00:09:25.362 --> 00:09:44.100 That year's ASU 2024-02 removed unnecessary references to Concepts Statements from the Codification. The ASC requirements remained authoritative. A reference to a Concepts Statement did not make that statement GAAP. 46 00:09:44.100 --> 00:09:55.667 We now move from the institutions to the source itself. Learn the structure first, then use it to research a specific advertising cost. 47 00:09:55.667 --> 00:10:07.756 The ASC covers roughly a hundred topics and thousands of pages. You don't need to memorize those counts. They show why it helps to narrow your search. 48 00:10:07.756 --> 00:10:13.800 Find the relevant topic before you start reading its detailed requirements. 49 00:10:13.800 --> 00:10:28.262 A library keeps related subjects together and gives each book an address. The ASC uses a similar hierarchy. Start with an area, narrow to a topic and subtopic, then choose the section and paragraph. 50 00:10:28.262 --> 00:10:41.774 A complete citation lets another accountant return to the same passage and check your reasoning. Before the Codification, researchers had to work across thousands of separate standards. 51 00:10:41.774 --> 00:10:56.967 The project reorganized the literature by subject rather than setting out to rewrite GAAP. FASB acknowledged that the older structure had contributed to errors when researchers overlooked applicable guidance. 52 00:10:56.967 --> 00:11:10.661 The nine areas range from General Principles to Industry guidance. Use the categories to see where your subject belongs. These counts come from the collection used for this class. 53 00:11:10.661 --> 00:11:23.667 They show how the guidance is organized, but they aren't verified current totals. SEC sections are included in the section totals, so do not add the two columns together. 54 00:11:23.667 --> 00:11:41.061 Read the address from left to right. Topic 720 is Other Expenses. Subtopic 35 is Advertising Costs. Section 25 concerns recognition, meaning when an item is recorded in the statements. 55 00:11:41.061 --> 00:11:52.500 Paragraph 1 identifies the particular passage. The address locates the text; it does not establish that the text applies. 56 00:11:52.500 --> 00:12:10.437 Section numbers answer recurring questions. Begin with Section 15 for scope and Section 20 for defined terms. Section 25 addresses recognition, while Sections 30 and 35 address measurement. 57 00:12:10.437 --> 00:12:29.133 Presentation concerns where information appears; disclosure concerns what the notes explain. Section 55 provides implementation guidance. An S prefix identifies SEC content within the Codification. 58 00:12:29.133 --> 00:12:40.488 Some subtopics contain hundreds of paragraphs across several sections. These examples use counts from our class collection, not verified current totals. 59 00:12:40.488 --> 00:12:47.733 Cite the specific paragraph so another reader can find the requirement that supports your answer. 60 00:12:47.733 --> 00:13:08.013 An Update number works differently from an ASC address. In ASU 2024-02, 2024 is the publication year and 02 identifies the second Update issued that year. Neither part identifies a topic or establishes an effective date. 61 00:13:08.013 --> 00:13:17.600 Read what changed and when companies must apply the change. Then check the applicable Codification text. 62 00:13:17.600 --> 00:13:33.298 FASB provides the official Codification, with free enhanced access. PwC Viewpoint and Deloitte DART also provide accounting research resources, including explanations and licensed material. 63 00:13:33.298 --> 00:13:47.500 Distinguish the ASC text from a firm's commentary about it. Use commentary to help your research, but support the accounting conclusion with the applicable ASC paragraphs. 64 00:13:47.500 --> 00:13:52.567 Free access does not mean unrestricted redistribution rights. 65 00:13:52.567 --> 00:14:01.479 An ASC search returns a paragraph that seems relevant. What should you check before applying it? Choose an answer on screen. 66 00:14:01.479 --> 00:14:11.900 Consider whether finding text about the subject is enough to establish a rule for this company and period. Pause the video if you need more time. 67 00:14:21.900 --> 00:14:32.505 The answer is C. Check scope, context, cross-references, and effective dates. A search result gives you somewhere to start reading. 68 00:14:32.505 --> 00:14:41.733 Its position in the results doesn't prove that it applies, even if the wording matches the company's account name. 69 00:14:41.733 --> 00:14:52.267 Use the ASC to work through one complete example. Compare the company's facts with the guidance so you can explain your answer. 70 00:14:52.267 --> 00:15:05.512 The company pays 12,000 dollars to produce a television advertisement for its own products. Production finishes on December 15, but the advertisement first airs on January 10. 71 00:15:05.512 --> 00:15:18.833 The annual reporting date falls between those events. The company consistently expenses production costs when an advertisement first airs. What should it report at December 31? 72 00:15:18.833 --> 00:15:34.194 Frame the question neutrally: how should the company report this production cost at year-end under its existing policy? Asking whether it can keep an asset would build a preferred answer into the question. 73 00:15:34.194 --> 00:15:44.833 Next locate guidance, check what applies, and support the conclusion. Follow along on the ASC website, pausing whenever you need time to read. 74 00:15:44.833 --> 00:15:58.346 Start with the Expenses area in the topic menu. We know the subject, so browsing is a reasonable starting point. If the subject were unclear, a text search could help us find a topic to investigate. 75 00:15:58.346 --> 00:16:13.293 The company's own account name may differ from the terminology used in the guidance. FASB's research guide warns that a text search can miss relevant guidance when it uses different words from the ones you searched for. 76 00:16:13.293 --> 00:16:22.233 If searching an account name returns nothing, relevant guidance may still exist. Browse the topic and inspect the terms used there. 77 00:16:25.233 --> 00:16:39.233 Within Expenses, open Topic 720, Other Expenses. The broad area remains visible above it. Each step narrows the subject without changing the underlying research question. 78 00:16:42.233 --> 00:17:01.233 Open Subtopic 35, Advertising Costs. The address is now ASC 720-35. Confirm the subject before choosing a section; a familiar word in a search result does not replace that check. 79 00:17:04.233 --> 00:17:23.133 Choose Section 15, Scope and Scope Exceptions. Before using a recognition rule, establish whether the subtopic covers the company and activity. The complete path remains visible so you can see where this section sits. 80 00:17:28.133 --> 00:17:47.080 When you already know the address, the Go To field can take you directly to ASC 720-35-15. Confirm the destination heading after opening it. Go To locates an address, while Search looks for words. 81 00:17:47.080 --> 00:17:51.333 Pause here if you are following the website. 82 00:17:56.333 --> 00:18:08.165 The scope paragraph covers advertising transactions and activities, subject to exceptions. Our case concerns annual statements and the company's own products. 83 00:18:08.165 --> 00:18:23.967 The displayed exceptions include advertising in interim periods and advertising conducted for others under contracts. Read the full list and check whether any exception applies to the company or its advertising. 84 00:18:23.967 --> 00:18:39.932 The company is a retailer, not an insurance company or nonprofit. The 12,000 dollars covers only production of its own advertisement, with no customer reimbursements or promotional prizes. 85 00:18:39.932 --> 00:18:52.500 Those facts rule out the listed exceptions for this case. Use December 31, 2025 as the reporting date and January 10, 2026 as the first-airing date. 86 00:18:52.500 --> 00:19:06.923 Keep Topic 720 and Subtopic 35, but change the section to 25, Recognition. We have moved from whether the guidance applies to when the company records the expense. 87 00:19:06.923 --> 00:19:11.967 Notice that only the section part of the address changes. 88 00:19:11.967 --> 00:19:28.133 Paragraph 1 permits two policies for costs within its scope: expense them as incurred or when the advertising first takes place. It also requires consistent application to similar advertising activities. 89 00:19:28.133 --> 00:19:41.033 Our company already uses the first-airing policy. We are applying that established policy, not selecting whichever treatment produces a preferred year-end result. 90 00:19:46.033 --> 00:19:59.449 Paragraph 4 says production costs are incurred during production. That establishes when the cost arises, but the permitted policy still determines the expense date. 91 00:19:59.449 --> 00:20:13.600 Paragraph 1 also requires immediate expense if the advertising is not expected to occur. Here production is complete, and the company still expects the ad to air in January. 92 00:20:13.600 --> 00:20:29.981 Use the Status section to trace amendments. Its table connects the paragraph to ASU 2018-09. Issue 8 points to the transition guidance in ASC Topic 105, Subtopic 10, Section 65, paragraph 4. 93 00:20:29.981 --> 00:20:45.328 The archived paragraph records that the transition period ended. The September 2026 copy of the ASC supplied for this class supports the guidance we're applying to the 2025 case. 94 00:20:45.328 --> 00:20:58.433 For new research, also check pending content: amendments shown in the ASC before they take effect. Check when they apply and which companies they cover. 95 00:20:58.433 --> 00:21:16.214 An advertisement is produced and paid for December 15, then first airs January 10. Under a consistent first-airing policy, when is its production cost expensed? Choose among the four dates or allocations shown. 96 00:21:16.214 --> 00:21:21.633 Use the policy and guidance, rather than the payment date alone. 97 00:21:31.633 --> 00:21:44.420 The answer is D, January 10. ASC Topic 720, Subtopic 35, Section 25, paragraph 1 permits the company's consistent first-use policy. 98 00:21:44.420 --> 00:21:54.767 Production and payment occurred in December, but neither event changes the expense date under that policy. 99 00:21:54.767 --> 00:22:06.207 At December 31, the company reports the 12,000 dollar deferred cost as an asset. The company records no advertising expense for this ad in 2025. 100 00:22:06.207 --> 00:22:23.367 On January 10, the advertisement first airs, so the company records 12,000 dollars of expense and removes the deferred asset. The conclusion depends on the established policy and the expectation that the ad will air. 101 00:22:23.367 --> 00:22:40.480 The conclusion also needs disclosure. ASC Topic 720, Subtopic 35, Section 50, paragraph 1 requires the selected policy and total advertising expense for each income statement presented. 102 00:22:40.480 --> 00:22:59.167 This advertisement adds no 2025 expense, but other advertising could. Determine the company-wide total before drafting the note. Keep the facts, scope, dates, policy, citations, and conclusion together. 103 00:22:59.167 --> 00:23:12.067 We've used GAAP to answer an accounting question. Now consider how financial reports help people decide, and how misleading information could affect those decisions. 104 00:23:12.067 --> 00:23:23.892 Common requirements give users a basis for comparing reports and questioning accounting choices. Policy disclosures explain choices that GAAP permits. 105 00:23:23.892 --> 00:23:38.633 Management must show that its accounting follows the applicable standard. These safeguards do not guarantee compliance or remove the need to examine estimates, errors, and possible fraud. 106 00:23:38.633 --> 00:23:51.992 Information is relevant when it can affect a user's decision. Faithful representation means describing the economic activity completely, neutrally, and without error. 107 00:23:51.992 --> 00:24:09.133 That does not require perfect certainty in every estimate; the method and explanation must fairly describe what is known. These qualities help evaluate the report, but they do not override applicable ASC guidance. 108 00:24:09.133 --> 00:24:20.020 An investor uses reported profit trends to decide whether to buy shares. Which quality describes the information's ability to affect that decision? 109 00:24:20.020 --> 00:24:28.167 Select the quality, rather than an organization or a claim about audit assurance. Pause if you need more time. 110 00:24:38.167 --> 00:24:46.923 The answer is A, relevance. The question asks whether the information can affect the investment decision. 111 00:24:46.923 --> 00:25:00.933 Faithful representation asks a different question: whether the report accurately depicts the performance it claims to describe. Useful information needs both qualities. 112 00:25:00.933 --> 00:25:15.815 Remember the network services WorldCom had already used. Recording those costs as an asset did not change the fact that WorldCom had used the services. It made profit and assets look stronger. 113 00:25:15.815 --> 00:25:20.233 The reports made the business look healthier than it was. 114 00:25:20.233 --> 00:25:36.275 Consider either role on screen. As an investor, how might overstated profit change your assessment of performance? As a lender, how might overstated assets and profit change your assessment of repayment risk? 115 00:25:36.275 --> 00:25:45.067 Explain how the misleading figures could affect your decision. Pause the video while you work through your answer. 116 00:25:57.067 --> 00:26:12.596 An investor might see stronger performance than the business achieved. A lender might think the company was more likely to repay than it really was. The information is relevant because it could affect those decisions. 117 00:26:12.596 --> 00:26:25.191 Reporting the cost of services already used as an asset also failed to represent what happened faithfully. The report changed users' information without improving the business. 118 00:26:25.191 --> 00:26:32.633 GAAP provides a basis for challenging that treatment, not a guarantee that management follows the rules. 119 00:26:32.633 --> 00:26:42.284 WorldCom incorrectly reported operating costs as assets. Why did this misstatement matter to investors and lenders? 120 00:26:42.284 --> 00:26:54.200 Choose the answer that connects reporting to a user's decision without claiming that the accounting created cash or proved repayment capacity. 121 00:27:04.200 --> 00:27:16.689 The answer is C. Misleading reports could affect users' decisions. Overstated profit and assets may change an assessment without creating cash or improving the business. 122 00:27:16.689 --> 00:27:23.267 Users could make different decisions even though nothing about the business had improved. 123 00:27:23.267 --> 00:27:40.689 Before Tuesday's class on verifying filing figures, read Chapter 4 on the course website. The optional equivalent is Kieso Chapter 1, Sections 1.1 through 1.2, pages 1-2 through 1-18. 124 00:27:40.689 --> 00:27:56.208 The Unit 1 review assignment deadline is extended to Wednesday, September 16, at 11:59 PM in D2L. Optional Chapter 4 practice is also available on the course site.