This also only formally applies to public companies. But private companies that need to go to a bank to borrow money oftentimes are required to provide financial statements on a quarterly or annual frequency because the banks are so used to getting financial statement information in that format and in that frequency. So this is a pretty universal set of filing requirements that apply to public and private companies around the world.
4:24
These periodic filing requirements create much of the tension in financial accounting. For example, let's say we ship goods to a customer in one quarter, but we collect cash in the next quarter. When did the sale occur? Was it when we shipped the goods or collected the cash? And let's say we buy some equipment in one quarter, and then use it to manufacture goods over the next 23 quarters. When does the expense occur? When we pay cash to buy the equipment or as we use it over the next 23 quarters? A lot of what we're going to do in this course is try to figure out what quarter to put various business activities into when we put together the financial statements.
5:02
So who makes the rules? Generally accepted accounting principles, or GAAP, are established by the US Congress, but they're usually too busy trying to do things like investigating steroids in baseball or figuring out whether they should shut down the US government again. They don't have time to deal with accounting standards, so they delegate to the Securities and Exchange Commission. But they're often too busy trying to catch the bad guy, so they don't have time to make the rules. So they delegate to the Financial Accounting Standards Board, of FASB, which is a seven-person board in Norwalk, Connecticut, that has the authority to make the accounting rules in the US. And sometimes they're even too busy to make all the rules, and so there's an emerging issues task force and the AICPA that can also have a hand in making accounting rules, or US GAAP. Now this is just in the US. Internationally, there are international financial reporting standards, or IFRS, that are established by the International Accounting Standards Board, or IASB, which is based in London, and are now required in over 100 countries including all of the EU.
6:04
But as of now, US GAAP is still required for US firms. So basically there are two big sets of accounting standards in the world. But the good news is, for almost all of the introductory accounting topics that we look at in this course, there's a very high degree of overlap in the two standards.
6:23
>> Why doesn't the US just switch to IFRS? Do you think there will ever be one global accounting standard?
6:32
>> Actually, in the summer of 2008, the SEC came out with a roadmap that would move US firms to IFRS by basically now. But then what happened was, Lehman Brothers went bankrupt, the financial crisis hit and the roadmap dropped way off the SEC's radar screen. So for the foreseeable future, we're going to have two big sets of standards in the world, US GAAP and IFRS. But as I just mentioned, the good news is the two standards are getting closer to each other all the time. The FASB and IASB are working together on any new standards. So, all the stuff that we talk about that's under US GAAP in this course will be very similar to what you would see under IFRS.
7:12
So who's responsible for financial reporting? Management is responsible for preparing financial statements.
7:19
>> Wait! What? That is like a professor allowing students to give themselves their own grade. Everyone gets an A plus.
7:29
>> Yes, that's correct. We allow managers to put together their own financial statements because they have the most information about what happened in the company. And we hope that they use their discretion in financial reporting to better communicate their activities. However, it is important to remember that they may use this discretion to try to manipulate the perceptions, and we need to be on the lookout for such opportunistic behavior.
7:51
So we put in a number of checks and balances to try to curb managers' opportunistic behavior. First, the Audit Committee of the Board of Directors provides oversight of management's accounting process. However, this is not a foolproof check on managers' behavior. You know, one of the biggest finance statement frauds ever was Enron, and the head of their audit committee was, was a guy whose full-time job was accounting professor. Which means you could put someone like me on the board and still have these kinds of problems.
8:18
So then the auditors are hired by the board to express an opinion about whether the statements are prepared in accord, accordance with GAAP. This again is not foolproof, because in the case of Enron, their au, auditor, Arthur Anderson, signed off on some of the more aggressive things they did, and part of the reason was because they were being hired by Enron to approve their accounting. If they lost Enron because of a dis