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
