Lesson 11
Understanding
Accounting Principles
Task Team of
FUNDAMENTAL ACCOUNTING
Business School,Sun Yat-sen University
2
Outlines
?Accounting standards,a tool for trusting
?Introduction of Accounting Standards
?Accounting Standards in China
?A Brief of Accounting Theory
3
Opening Story
?Enron scandal again!
?Filed 8-K to restate its financial statements in
November 8,2001;
?Filed bankruptcy protection under Chapter 11
in December 3,2001;
?Mr,Berardino,then CEO of Andersen,issued
an announcement,Enron,a wakeup call;
→ Accounting standards is the first
to be blamed;
4
Opening Story
?The standards involved in Enron case;
?Special purpose entity (SPE);
?FASB on SPE;
→ 3% independent interest;
→ Assume substantially the risk;
?Enron and Andersen,stick to 3% requirement,
ignoring the risk assessment requirement;
?Accounting Standards or standards
enforcement?
5
Accounting and Trust
?How could accounting help to develop trust?
?Translate all business activities into numeric so
it could be summarized,measured and
evaluated;
?Managers may report and discharge their
accountability;
→ Principal-agent problem;
?Since all common investors are principals;
?Free-rider issues are pervasive;
?How to assure managers to provide financial
report truthfully and reliably?
6
Accounting and Trust
?Are financial reports reliable and objective?
?The inherent limitation of financial accounting;
→ Monetary measurement,penny wise and pound foolish;
?Where to put Bill Gates on Microsoft’s Financial Statements?
→ Historical cost,accrual basis,periodic report:
?Financial reporting are lagged,no matter good news or bad news;
?Be aware,all managers,including accountants,are
REMMs;
→ Accounting comes down to the-vehicle-for-bank-robbers;
→ All the blames to accounting for its,unique role” in
Yinguangxia,Enron,WorldCom,etc.
7
Accounting and Trust
?To assure the reliability of accounting
information,many mechanism are
devised and employed;
?Periodic and timely disclosure;
?Full disclosure;
?Accounting standards,
→ Why generally accepted?
?Auditing,
→ Additional tool to assure the reliability of
accounting information.
8
Accounting Standards:
a Trust Perspective
?REMMs push the lines as hard as possible;
?Executives will abuse accounting numbers
given that these numbers are essential in
their performance evaluation;
?Incentive to manage and manipulate earnings,
9
Open discussion
?Revenue recognition criteria:
?Earned process done,considerations
guaranteed;
?How to account for
?Sell and repurchase transactions?
?Sell and lease-back transactions?
→ The criteria satisfied;
→ But they are financing in substance;
10
Accounting Standards:
a Trust Perspective
?In order to solve the disputes on
accounting choices,agreement on
the set of accounting choices is
necessary;
?We define this as accounting standards;
?It is also named as GAAP in US;
11
Introduction of
Accounting Standards
?Varied terms,
?Accounting norms;
?Accounting principles;
?Accounting standards;
?GAAP;
?International Accounting Standards,
?Financial reporting standards;
?,,,
?Focus on substance,not form;
12
Introduction of
Accounting Standards
?Accounting standards,
?Must be authoritatively supported;
?Otherwise,no binding effect;
?Two ways to gain authoritative support;
?Authoritativeness from Governmental
administration;
→ Ministry of Finance acting as standards setter;
?Widely represented to gain authoritativeness;
→ This is the case of FASB before 2002;
→ PCAOB,a quasi-governmental agency,stepped in
after 2002.
13
Introduction of
Accounting Standards
?Accounting standards must be effective
in resolving disputes;
?Still two ways to reduce disputes;
→ Focus on,scientific” principles to guide;
→ Furnish with cooking-book solutions;
→ This is the story of principle-based and rule-
based.
14
Introduction of
Accounting Standards
?Accounting standards in China;
?Accounting Law,2000;
?Regulations for Business Financial
Reporting,State Council,2000;
?Business Accounting Standards,Ministry of
Finance;
→ New standards will be expected;
?Unified Accounting Systems,Ministry of
Finance,2001;
?Temporary explanations;
15
Introduction of
Accounting Standards
?CSRC and its role in regulating public
companies’ accounting practice;
?Two sets of regulations;
→ Information disclosure on forms and contents;
→ Rules for information disclosure;
?Actually affect public companies’ accounting
practice;
→ The change of rules on Non-recurring gains and
losses;
16
Introduction of
Accounting Standards
?Accounting standards itself is in the
state of keep-changing;
?The early stage of A/S,easy and simple;
→ The first batch of A/S only includes 6 items
when approved by AIA and NYSEC in 1933;
?More complicated;
→ 154 statements published by FASB as to
May 2005;
17
Introduction of
Accounting Standards
?Although A/S is in the state of
changing,there are still some stable
contents;
?Accounting assumptions;
?Basic principles;
?Accounting conventions;
18
Introduction of
Accounting Standards
?Accounting assumptions;
?Impossibility to prove to be true;
?Indispensable to accounting practice;
?May be treated as prerequisites;
→ Business Entity;
→ Going-concern;
→ Periodic reporting;
→ Monetary valuation;
19
Introduction of
Accounting Standards
?Basic Accounting Principles;
?Substance over Form;
→ Most important one;
→ Theoretically,one for all;
→ Back to Enron case;
?Accrual Basis
?Revenue Realization;
?Matching
20
Introduction of
Accounting Standards
?Actual cost;
→ Historical cost;
→ Fair Value;
→ Why does Historical Cost dominate?
?Prudence
→ The definition;
→ Why do we need it?
21
Class discussion
?Read the materials about Southern Airlines
and Xiamen Airlines;
?Which one is more prudent?
?Please find out the underlying reason;
22
Story about Principle-based and
Rule-based
?From high quality accounting standards to
principle-based;
?Definition of Principle-based;
→ Are IASs principles-based?
?Definition of Rule-based;
→ Are US GAAP rule-based?
?Objective-based:
→ A right way?
23
Accounting Standards Evolution
in China
?After 1949,we killed all the market;
?Everything is under central planning;
→ We planned everything,including those
unplannable;
?No corporate finance;
?No decision making oriented management
accounting;
?Costing not cost controlling;
?No auditing;
?No accounting standards too.
24
Accounting Standards Evolution
in China
?Capital markets were founded in Shanghai
and Shenzhen in early 1990s;
?Public companies will be responsible for
common investors;
?Accounting standards are necessary again;
?1992,Business Enterprises Accounting
Standards are issued;
?1997,the first operational accounting standards
was issued;
25
Accounting Standards Evolution
in China
?Completely revised since 2001;
?The issuance of Unified Accounting System;
?Abandon fair value accounting;
?Readopt actual cost;
?Put restrictiveness on earnings;
→ From earning to capital surplus;
?Internationalization or localization
26
Accounting Theory:
a deconstruction view
?Derrida and Deconstruction;
?Accounting theory;
?Traditional normative definition;
?A Classical article for positive definition
?Watts and Zimmerman,1979,
27
Accounting Theory:
A deconstruction view
?Accounting theory is regarded as nothing
different from common goods;
?It is demanded;
?It is supplied;
?Who does?
?Unregulated and regulated society;
28
Accounting Theory:
A deconstruction view
?The demand for A/T in unregulated society;
?Pedagogy;
?Information;
?Justification;
?The demand for A/T in regulated society;
?Accounting numbers based regulation and its
impact on the demand for,right” A/T;
29
Accounting Theory:
A deconstruction view
?The implication to A/R;
?Generally accepted,an expectation,not reality;
?Cases from China;
?Debate on internationalization of accounting
standards;
?Supplementary auditing;
?High quality accounting standards;
30
Summary
?The unique value of accounting,
?Cost-effective trusting mechanism;
?Accounting numbers are the center of the
interest disputes;
?Accounting standards are necessary;
?REMMs determine that A/Ss are relatively
effective;
?The demands lead the making of
accounting theory;
31
Case for Open Discussion
?Please find articles and comments on Enron
and WorldCom,answer following questions:
?Which is abusing standards? Which completely
false information?
?Check with FASB website and find out the
standards issued raised in Enron case;
?Based on the discussion of principle-based,do
you think these new standards/regulations are
effective enough? Why?
The End of Lesson 11
Understanding
Accounting Principles
Task Team of
FUNDAMENTAL ACCOUNTING
Business School,Sun Yat-sen University
2
Outlines
?Accounting standards,a tool for trusting
?Introduction of Accounting Standards
?Accounting Standards in China
?A Brief of Accounting Theory
3
Opening Story
?Enron scandal again!
?Filed 8-K to restate its financial statements in
November 8,2001;
?Filed bankruptcy protection under Chapter 11
in December 3,2001;
?Mr,Berardino,then CEO of Andersen,issued
an announcement,Enron,a wakeup call;
→ Accounting standards is the first
to be blamed;
4
Opening Story
?The standards involved in Enron case;
?Special purpose entity (SPE);
?FASB on SPE;
→ 3% independent interest;
→ Assume substantially the risk;
?Enron and Andersen,stick to 3% requirement,
ignoring the risk assessment requirement;
?Accounting Standards or standards
enforcement?
5
Accounting and Trust
?How could accounting help to develop trust?
?Translate all business activities into numeric so
it could be summarized,measured and
evaluated;
?Managers may report and discharge their
accountability;
→ Principal-agent problem;
?Since all common investors are principals;
?Free-rider issues are pervasive;
?How to assure managers to provide financial
report truthfully and reliably?
6
Accounting and Trust
?Are financial reports reliable and objective?
?The inherent limitation of financial accounting;
→ Monetary measurement,penny wise and pound foolish;
?Where to put Bill Gates on Microsoft’s Financial Statements?
→ Historical cost,accrual basis,periodic report:
?Financial reporting are lagged,no matter good news or bad news;
?Be aware,all managers,including accountants,are
REMMs;
→ Accounting comes down to the-vehicle-for-bank-robbers;
→ All the blames to accounting for its,unique role” in
Yinguangxia,Enron,WorldCom,etc.
7
Accounting and Trust
?To assure the reliability of accounting
information,many mechanism are
devised and employed;
?Periodic and timely disclosure;
?Full disclosure;
?Accounting standards,
→ Why generally accepted?
?Auditing,
→ Additional tool to assure the reliability of
accounting information.
8
Accounting Standards:
a Trust Perspective
?REMMs push the lines as hard as possible;
?Executives will abuse accounting numbers
given that these numbers are essential in
their performance evaluation;
?Incentive to manage and manipulate earnings,
9
Open discussion
?Revenue recognition criteria:
?Earned process done,considerations
guaranteed;
?How to account for
?Sell and repurchase transactions?
?Sell and lease-back transactions?
→ The criteria satisfied;
→ But they are financing in substance;
10
Accounting Standards:
a Trust Perspective
?In order to solve the disputes on
accounting choices,agreement on
the set of accounting choices is
necessary;
?We define this as accounting standards;
?It is also named as GAAP in US;
11
Introduction of
Accounting Standards
?Varied terms,
?Accounting norms;
?Accounting principles;
?Accounting standards;
?GAAP;
?International Accounting Standards,
?Financial reporting standards;
?,,,
?Focus on substance,not form;
12
Introduction of
Accounting Standards
?Accounting standards,
?Must be authoritatively supported;
?Otherwise,no binding effect;
?Two ways to gain authoritative support;
?Authoritativeness from Governmental
administration;
→ Ministry of Finance acting as standards setter;
?Widely represented to gain authoritativeness;
→ This is the case of FASB before 2002;
→ PCAOB,a quasi-governmental agency,stepped in
after 2002.
13
Introduction of
Accounting Standards
?Accounting standards must be effective
in resolving disputes;
?Still two ways to reduce disputes;
→ Focus on,scientific” principles to guide;
→ Furnish with cooking-book solutions;
→ This is the story of principle-based and rule-
based.
14
Introduction of
Accounting Standards
?Accounting standards in China;
?Accounting Law,2000;
?Regulations for Business Financial
Reporting,State Council,2000;
?Business Accounting Standards,Ministry of
Finance;
→ New standards will be expected;
?Unified Accounting Systems,Ministry of
Finance,2001;
?Temporary explanations;
15
Introduction of
Accounting Standards
?CSRC and its role in regulating public
companies’ accounting practice;
?Two sets of regulations;
→ Information disclosure on forms and contents;
→ Rules for information disclosure;
?Actually affect public companies’ accounting
practice;
→ The change of rules on Non-recurring gains and
losses;
16
Introduction of
Accounting Standards
?Accounting standards itself is in the
state of keep-changing;
?The early stage of A/S,easy and simple;
→ The first batch of A/S only includes 6 items
when approved by AIA and NYSEC in 1933;
?More complicated;
→ 154 statements published by FASB as to
May 2005;
17
Introduction of
Accounting Standards
?Although A/S is in the state of
changing,there are still some stable
contents;
?Accounting assumptions;
?Basic principles;
?Accounting conventions;
18
Introduction of
Accounting Standards
?Accounting assumptions;
?Impossibility to prove to be true;
?Indispensable to accounting practice;
?May be treated as prerequisites;
→ Business Entity;
→ Going-concern;
→ Periodic reporting;
→ Monetary valuation;
19
Introduction of
Accounting Standards
?Basic Accounting Principles;
?Substance over Form;
→ Most important one;
→ Theoretically,one for all;
→ Back to Enron case;
?Accrual Basis
?Revenue Realization;
?Matching
20
Introduction of
Accounting Standards
?Actual cost;
→ Historical cost;
→ Fair Value;
→ Why does Historical Cost dominate?
?Prudence
→ The definition;
→ Why do we need it?
21
Class discussion
?Read the materials about Southern Airlines
and Xiamen Airlines;
?Which one is more prudent?
?Please find out the underlying reason;
22
Story about Principle-based and
Rule-based
?From high quality accounting standards to
principle-based;
?Definition of Principle-based;
→ Are IASs principles-based?
?Definition of Rule-based;
→ Are US GAAP rule-based?
?Objective-based:
→ A right way?
23
Accounting Standards Evolution
in China
?After 1949,we killed all the market;
?Everything is under central planning;
→ We planned everything,including those
unplannable;
?No corporate finance;
?No decision making oriented management
accounting;
?Costing not cost controlling;
?No auditing;
?No accounting standards too.
24
Accounting Standards Evolution
in China
?Capital markets were founded in Shanghai
and Shenzhen in early 1990s;
?Public companies will be responsible for
common investors;
?Accounting standards are necessary again;
?1992,Business Enterprises Accounting
Standards are issued;
?1997,the first operational accounting standards
was issued;
25
Accounting Standards Evolution
in China
?Completely revised since 2001;
?The issuance of Unified Accounting System;
?Abandon fair value accounting;
?Readopt actual cost;
?Put restrictiveness on earnings;
→ From earning to capital surplus;
?Internationalization or localization
26
Accounting Theory:
a deconstruction view
?Derrida and Deconstruction;
?Accounting theory;
?Traditional normative definition;
?A Classical article for positive definition
?Watts and Zimmerman,1979,
27
Accounting Theory:
A deconstruction view
?Accounting theory is regarded as nothing
different from common goods;
?It is demanded;
?It is supplied;
?Who does?
?Unregulated and regulated society;
28
Accounting Theory:
A deconstruction view
?The demand for A/T in unregulated society;
?Pedagogy;
?Information;
?Justification;
?The demand for A/T in regulated society;
?Accounting numbers based regulation and its
impact on the demand for,right” A/T;
29
Accounting Theory:
A deconstruction view
?The implication to A/R;
?Generally accepted,an expectation,not reality;
?Cases from China;
?Debate on internationalization of accounting
standards;
?Supplementary auditing;
?High quality accounting standards;
30
Summary
?The unique value of accounting,
?Cost-effective trusting mechanism;
?Accounting numbers are the center of the
interest disputes;
?Accounting standards are necessary;
?REMMs determine that A/Ss are relatively
effective;
?The demands lead the making of
accounting theory;
31
Case for Open Discussion
?Please find articles and comments on Enron
and WorldCom,answer following questions:
?Which is abusing standards? Which completely
false information?
?Check with FASB website and find out the
standards issued raised in Enron case;
?Based on the discussion of principle-based,do
you think these new standards/regulations are
effective enough? Why?
The End of Lesson 11
