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CHAPTER 1

The Reporting Environment

WHY DO WE HAVE ACCOUNTING?

Lets say there are 2 companies in the economy,


company A and company B. One of these two
companies will go bankrupt and the other will
enjoy a 50% ROI. How will you invest?

CHARACTERISTICS OF ACCOUNTING
1.
2.
3.

Identification, measurement, and communication


of financial information about;
Economic entities to;
Interested persons.

FINANCIAL REPORTING
Financial accounting provides historical information
Financial reporting is used by both internal and
external users
External users include such decision makers as
investors, creditors, unions, government agencies
Major financial statements (required by GAAP):

Statement of Financial Position (Balance Sheet)

Statement of Comprehensive Income (Income Statement)

Statement of Cash Flows

Statement of Changes in Equity (Statement of Shareholders


Equity)
+

What

Note Disclosures

is the role of note disclosures?

OBJECTIVE OF FINANCIAL REPORTING

The overall objective of financial reporting is to provide


information that is:
useful to users, and
2. decision relevant
1.

Financial statements should provide information about:


the entitys economic resources and claims to those
resources, and
2. changes in those resources and claims
1.

Financial reporting aids users in the allocation of scarce


resources (capital)
The accounting profession has the responsibility of
measuring a companys performance accurately, fairly,
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and on a timely basis

????

What is Capital Allocation, why is it important,


and how does accounting help?

In Canada, the primary exchange mechanisms


for allocating resources are:
Debt

and equity markets (e.g. TSX)

Financial

institutions (e.g. banks)


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MANAGEMENT BIAS

Preparation of the financial statements are the responsibility


of internal management
May lead to preparing statements that report the enterprise
in its best light
Motives include:

to reflect positive management stewardship (job, compensation)


meet financial analysts expectations, resulting in a positive
reaction in the capital markets
To access capital

What safeguards are in place to protect financial users from


management bias?

Standard setters set Generally Accepted Accounting Principles


(GAAP) for direction on accounting
GAAP is used to help reduce management bias and to ensure the
information is useful to users

THE STANDARD SETTING


PROCESS IN CANADA PARTIES
INVOLVED

Canadian Accounting Standards Board (AcSB)

Primarily responsible for setting GAAP in Canada

From 2011, this will be limited to standards for private enterprises,


not-for-profit entities, and pension plans only (standards for publicly
accountable entities will be set by the International Accounting
Standards Board)

Two underlying premises for development of standards

Be responsive to the needs and viewpoints of the


entire economic community
Operate in full public view through due process
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THE STANDARD SETTING


PROCESS IN CANADA PARTIES
INVOLVED

International Accounting Standards Board (IASB)


Major

international standard setting body


Mission to develop, in the public interest, a single set of high
quality, understandable and international reporting standards
(IFRSs) for general purpose financial statements

THE STANDARD SETTING PROCESS IN


CANADA PARTIES INVOLVED

Financial Accounting Standards Board (FASB) and


the Securities and Exchange Commission (SEC)
FASB

is the major standard setting body in the U.S.


SEC has the final authority over accounting standards in
the U.S

Provincial Securities Commission


(e.g. Ontario Securities Commission)
To

oversee and monitor capital marketplace


Ensure strict adherence to securities law/legislation

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GENERALLY ACCEPTED ACCOUNTING


PRINCIPLES (GAAP)

For private companies, pension plans, and not-forprofit entities, GAAP consists of :
Primary

sources

CICA Handbook Sections 1400 to 3870


Accounting guidelines

Other

sources

Background documents and implementation guidance issued by


AcSB

Pronouncements in other jurisdictions


Research studies, accounting textbooks, journals, etc.
Must be consistent with primary sources and in accordance
with the conceptual framework (i.e. CICA Handbook Section
1000)

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GENERALLY ACCEPTED ACCOUNTING


PRINCIPLES (GAAP)

For public companies (reporting under IFRS), GAAP


includes:
IFRS

International

Accounting Standards (IAS)


Interpretations (IFRIC or SIC)
If above sources do not specifically apply, other sources
may be considered:

Pronouncements of other standard-setting bodies


Other accounting literature
Accepted industry practices

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???

Is the standard setting process free from political


actions? List interested parties and their impact
on the standard setting process.

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PROFESSIONAL JUDGEMENT
There cannot be a rule for every situation
Standards in Canada are based primarily on
principles rather than specific rules
Therefore, must use professional judgement
The United States uses a rules-based approach

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SARBANES-OXLEY ACT (SOX)


The Sarbanes-Oxley Act (SOX) was enacted in 2002
(in the United States)
Some of the legislations key provisions:

Public

Company Accounting Oversight Board (PCAOB)


Independence rules
Bonus/profit forfeiture
CEO/CFO certification
Management report on effectiveness of internal controls
over financial reporting
Independent audit committees
Codes of ethics

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???

What are some challenges facing financial


accounting

WA1-4 Should firms use a continuous reporting


model (weekly) instead of the current discrete
model where financial statements are generally
issued only quarterly and annually?
Consider

Pros and Cons for different stakeholders

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CLICKER QUESTIONS
All of the following are objectives of financial reporting except to
provide information:
a) about entity resources, claims to those resources, and changes to
them.
b) that is useful in capital allocation decisions.
c) about the major shareholders of an entity
d) that is useful in assessing management stewardship.

Which of the following stakeholders do not typically rely on the


financial statements to make resource allocation decisions?
a) Investors
b) Creditors
c) Analysts
d) Standard-setters

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CLICKER QUESTIONS
Potential causes of management bias include all of the
following except:
a)Financial statement users must exercise significant
professional judgement in interpretation of financial
information
b)Financial

statements provide information to users


about management stewardship.
c)Managers

are often compensated based on the


companys net income or share value.
d)Many

lending agreements and contracts require that


certain financial benchmarks must be met.

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