Transparency Master 12-10

INDEPENDENT AUDITORS' REPORT

Unqualified or "Clean" Opinion
1. Introductory Paragraph

a. Lists financial statements audited

b. States management's responsibility for the financial statements

c. States auditors' responsibility is to express an opinion on financial

statements

2. Scope Paragraph

a. Audit conducted using generally accepted auditing standards

b. Audit tests provide "reasonable assurance" that financial statements do

not include material misstatements

3. Opinion Paragraph

a. Financial statements present fairly, in all material respects, the

company's financial position, results of operations, and cash flows.

b. Financial statements conform to generally accepted accounting

principles
Transparency Master 12-11

INDEPENDENT AUDITORS' REPORT

Types of Opinions
1. Unqualified or "Clean"
Financial statements "present fairly, in all material aspects. . ."

2. Qualified
Some aspects of the financial statements do not conform to generally
accepted accounting principles

3. Adverse or Negative
The financial statements have serious departures from generally accepted
accounting principles

4. Disclaimer
Auditors unable to reach an opinion on the financial statements
Handout 12 -1

ACCOUNTING CONCEPTS
BUSINESS ENTITY CONCEPT -From an accounting perspective, a business is a
separate entity from its owner, Therefore, the financial transactions of a business are
maintained separately from those of its owner ,

GOING CONCER.CONCEPT --Unless there is evidence to the contra!)', assume that a

business will continue its operations indefinitely ~.hen recording and reporting
accounting data,

OBJECTIVITY PRINCIPLE--Accounting entries should be made using objective

(verifiable) evidence.

UNIT OF MEASUREMENT CONCEPT -All transactions are recorded in dollars.

ACCOUNTING PERIOD CONCEPT -Managers. owners, and others need periodic

reports on the operations and financial condition of a business in order to make informed
decisions.

MATCIUNG PRINCIPLE.- To determine a business' profit (net income), you must

recognize all revenues earned and all expenses necessary to run the business and earn this
revenue, Therefore, expenses are "matched.' against the revenues they generate.

ADEQUATE DISCLOSTRE CONCEPT --Financial statements and the accompanying

notes should disclose all the relevant information needed to understand a company's
financial condition.

CONSISTENCY CONCEPT --Financial statement users consider changes in a company's

earnings and financial position from year to year when judging its success. Therefore,
accounting principles used to prepare financial statements should be the same from year
to year.

MATERIALITY CONCEPT--Accountants must follow generally accepted accounting

principles (GAAP) for all material items reported in a company's financial statements.
Immaterial items may be reported using the easiest method available; this method does
not have to follow GAAP . An item is material if its omission or misstatement would
influence or change the judgments of a reasonable person.

CONSERV A TISM CONCEPT -Accountants strive to ensure that financial statements do

not suggest that a company is financially stronger that it really is. Therefore, when
choosing between alternative accounting principles, the method that yields the lowest net
income or asset value should be chosen.
Transparency Master 1 2-1

FINANCIAL ACCOUNTING FOUNDATION

Independent!
nonprofit
Financial organization
Accounting
Foundation (FAF) Appoints
members to F
ASB and GASB

Raises funds to
support FASB
and GASB

Financial Accounting Govern mental

Standards Board Accounting
(FASB) Standards Board
(GASB)
Establishes accounting
Establishes accounting
standards for state and
standards for financial
municipal governments
reporting by profit and
nonprofit organizations
 Transparency Master 12-2

FINANCIAL ACCOUNTING STANDARDS BOARD

Securities and SEC has delegated

Exchange authority for setting
Commission accounting standards
(SEC) to FASB

SEC has authority

to regulate
accounting
practices of
publicly traded
corporations Financial
Accounting
Standards Board
(FASB)

Publicly Traded
Corporations
 Transparency Master 12-3

FINANCIAL ACCOUNTING STANDARDS BOARD

American AICPA and State

Institute of Boards of
Certified Public Accountancy
Accountants recognize FASB

}
(AICP A) as the
organization with
and authority to
establish GAAP
State Boards of
CPAs practice under Accountancy
the jurisdiction of the
AICPA and their state
board of accountancy

A business must
follow GAAP to
receive a "clean" Certified Public
audit report Accountants
(CPAs)

Financial
Accounting
Standards
Board
Companies
Requiring
Audited
Financial
Statement
Transparency Master 12-4

INFLUENTIAL ACCOUNTING ORGANIZATIONS

Financial Accounting Standards Board (FASB)The primary accounting
principle-setting body in the United States.

Governmental Accounting Standards Board (GASB)- The organization

responsible for setting accounting standards followed by state and municipal
governments.

International Accounting Standards Committee (IASC)- The organization

working to develop uniform international accounting standards.

Securities and Exchange Commission (SEC)The governmental agency with

legal authority to govern companies that issue publicly traded securities. The
SEC has delegated its authority to establish accounting principles to the
FASB.

(Continued)
Transparency Master 12-5

INFLUENTIAL ACCOUNTING ORGANIZATIONS

(Concluded)

Internal Revenue Service (IRS)-The governmental agency that oversees the

laws and regulations for preparing federal tax returns.

American Institute of Certified Public Accountants (AICPA)- The national

organization for CPAs.

Institute of Management Accountants (IMA)- The national organization for

management accountants and certified management accountants (CMAs).

American Accounting Association (AAA)- The national organization for

accounting educators.

NOTE: The AICP A, AAA, and IMA all research and comment on standards
proposed by the F ASB.
Transparency Master 12-6

WRITING EXERCISE
Assume that you are a member of the FASB and you have been asked to
give your opinion on the following accounting question.

A construction company began work on a $24 million shopping mall during

the current year. This mall will take 3 years to build, at a cost of $18 million.
At the end of the first year, the mall is one-third complete, and $6 million in
costs have been incurred. How much revenue (if any) do you think the
construction company should show on its income statement for the first year
of work on the mall? State the reasons for your answer.
Transparency Master 12-7

ADEQUATE DISCLOSURE CONCEPT

The following information must be disclosed in the financial statement or
the accompanying notes.

1. Accounting Methods Used-State the choice of accounting method when

alternatives exist and the selection has a significant effect on financial
statements. Examples include the following:

a. Inventory method (LIFO, FIFO, average cost)

b. Depreciation method
c. Special revenue recognition methods (percentage-of-completion or
installment method)

2. Effect of Change in Accounting Estimates (if material)

3. Contingent Liabilities-Record this information in financial statements if

probable and can be reasonably estimated; disclose in footnotes if it
cannot be reasonably estimated. Examples include the following:

a. Litigation
b. Guarantees ( such as loan guarantees )
c. Discounted receivables

(Continued)
Transparency Master 12-8

ADEQUATE DISCLOSURE CONCEPT

( Concluded)

4. Financial Instruments-Cash, accounts receivable, notes receivable,

accounts payable, notes payable, bonds payable, and other securities
traded in the marketplace are defined as financial instruments.
Disclosures should include the following:

a. Fair market value of financial instruments

b. Unusual risks related to financial instruments
c. Unusual credit risks

5. Segment information-Disclose the following information by segment:

a. Revenue
b. Income from operations
c. Identifiable assets

6. Events Subsequent to Date of Statements (if material)

Transparency Master 12-9

MATERIALITY CONCEPT
Statement of Financial Accounting Concepts No.2 defines materiality as
follows:

The omission or misstatement of an item in a financial report is material if,

in light of the surrounding circumstances, the magnitude of the item is such
that it is probable that the judgment of a reasonable person relying upon the
report would have been changed or influenced by the inclusion or correction
of the item.

Decide whether or not the following items are material. Be prepared to give
your reasons for your answer.

1. An asset purchased last year was not depreciated. Depreciation on that

asset should have been $500. The company's net income for the year was
$60,000.

2. Early in 1997, before 1996 financial statements are issued, a company

discovers that a major customer has unexpectedly filed for bankruptcy.

3. A chain of fast food restaurants discovered an embezzlement scheme used

by a few of its employees. The company estimates that $5,000 in cash and
food products have been stolen over a 2~year period. The company's yearly
net income averages $300,000.

4. A company is being sued by a competitor for patent infringement. If the

suit is successful~ the company will have to cease production and sale of the
product in question. Sales of this product represent $25;000 out of total sales
of $500,000.