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INTERMEDIATE ACCOUNTING

Seventh Canadian Edition


KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK

Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology

C H A P T E R

1
The Canadian Financial Reporting Environment

Learning Objectives
1. Describe the essential characteristics of accounting. 2. Identify the major financial statements and other means of financial reporting. 3. Explain how accounting assists in the efficient use of scarce resources. 4. Explain the meaning of stakeholder and identify key stakeholders in financial reporting.

Learning Objectives
5. Identify the objective of financial reporting. 6. Explain the notion of management bias with respect to financial reporting. 7. Understand the importance of user needs in the financial reporting process. 8. Explain the need for accounting standards.

Learning Objectives
9. Identify the major entities that influence the standard-setting process and explain how they influence financial reporting. 10. Explain the meaning of Generally Accepted Accounting Principles (GAAP). 11. Explain the significance of professional judgement in applying GAAP. 12. Understand issues related to ethics and financial accounting. 13. Identify some of the challenges facing accounting.

The Canadian Financial Reporting Environment


Role of Financial Reporting Financial statements and financial reporting Accounting and capital allocation Stakeholders Objective of Financial Reporting Management bias Users needs Standard Setting Need to develop standards Parties involved in standard setting Standard setting in a political environment GAAP GAAP hierarchy Professional judgement Role of ethics Challenges Facing Financial Reporting Globalization of companies and capital markets Impact of technology Changing nature of economy Increased requirement for accountability

Characteristics of Accounting
Accounting identifies, measures, analyses, and communicates financial information for various users (decision makers) Accounting has two broad classifications
Financial accounting Managerial accounting

Financial Reporting
Financial accounting reporting provides historical information Financial reporting is used by both internal and external users External users would include such decision makers as investors, creditors, unions and governmental agencies Managerial accounting provides both historical and forecast information Managerial reporting information is used by management (internal users only)

Financial Reporting
Major financial statements include:
Balance Sheet Income Statement Statement of Cash Flows Statement of Owners (or shareholders) Equity Note disclosures Presidents letter Prospectuses Government reporting News releases Management forecasts

Other forms of financial reporting include:

Flow of Information through the Financial Statements


Income Statement
Reports Net Income

Balance Sheet
Ending balance reported Change in cash as reported displays the change in cash position

Statement of Equity

Statement of Cash Flows

Accounting and the Efficient Use of Scarce Resources

Financial Reporting aids users in the allocation of scarce resources.

Accounting and the Efficient Use of Scarce Resources


Financial Reporting aids Users (present and potential) in Users include: investors, creditors, Unions, and government agencies Capital Allocation decisions Involves determining how funds are allocated among competing interests

Financial statements and other forms of financial reporting

Stakeholders in Financial Reporting


Stakeholder: someone who prepares, relies on, reviews, audits or monitors financial information Includes both internal and external parties Key stakeholders include:
investors, creditors, auditors, regulators, analysts, management, standard setters, and others

Objectives of Financial

Reporting

The CICA Handbook, Section 1000, par. 15 outlines the overall objective as: The objective is to communicate information that is useful to users in making their resource allocation decisions and/or assessing management stewardship. financial statements provide information about: 1. an entitys economic resources, obligations and equity/net assets; 2. changes in an entitys economic resources, obligations and equity/net assets; and 3. the economic performance of the entity

Objectives of Financial
Resource Allocation Decisions
Was income earned to generate future cash?

Reporting

Yes

Able to meet obligations and pay a return on investment Capital continues to be available

Assess Management Stewardship


Did managements decisions on resource acquisition and allocation increase shareholder wealth?

Yes

Investor and Creditor confidence continues

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

What safeguards are in place to protect financial users from management bias?

Understanding User Needs in the Financial Reporting Process


Management
Prepare the reports Use the reports to acquire capital

Users
Use the reports for investment/lending decisions

Financial Statements
Aggressive financial reporting has a direct impact on the users decision-making process

The Need to Develop Standards


Standards are set to aid preparers and users of financial statements They allow the preparers of the financial statements to present fairly the enterprise operations Presented to the users in a single set of financial statements to meet the majority of the user needs Standards are not rules, regulations, or laws They are intended to be generally accepted and universally practiced

The Standard Setting Process in Canada Parties Involved


Canadian Institute of Chartered Accountants (CICA) www .cica.ca
Accounting Standards Board (AcSB) of the CICA Primarily responsible for setting GAAP Two underlying premises for development of standards
1. Be responsive to the needs and viewpoints of the entire economic community 2. Operate in full public view through due process

Ensures that companies listed on the exchange prepare their statements in accordance with GAAP Key objective to ensure framework for measurement and reporting facilitates the global flow of capital and serves the public interest

The Standard Setting Process in Canada Parties Involved


Provincial Securities Commission (e.g. Ontario www.osc.gov.on.ca) To oversee and monitor capital marketplace Ensure strict adherence to securities law/legislation Financial Accounting Standards Board (FASB) www.fasb.org and the U.S. Securities and Exchange Commission www.sec.gov Major standard setting body International Accounting Standards Board (IASB) www.iasb.org.uk

International Accounting Standards


The International Accounting Standards Board (IASB) was formed in 2001 The objective was to narrow divergence in international financial reporting Difficult task due to differing objectives, institutional structures, and national tendencies in various countries Strives towards a single, global method of accounting

Generally Accepted Accounting Principles (GAAP)


The profession has developed GAAP, which present fairly, clearly, and completely the financial operations of the enterprise GAAP consist of authoritative pronouncements issued by certain accounting bodies CICA Handbook is the foremost source for GAAP

The GAAP Hierarchy


Primary Sources Other Sources


Considered only after primary sources have been researched

GAAP HierarchyPrimary Sources


Section 1100 of the Handbook (in order of authority)
1. 2. 3. 4. 5. 6. Handbook Sections (1300-4460) Accounting Guidelines Background Information and Basis for Conclusion EIC Abstracts Illustrative Examples (of the above) Implementation Guides

GAAP HierarchyOther Sources


Other Sources include:
1. 2. 3. Pronouncements in other jurisdictions Research Studies Accounting textbooks, journals, studies, and articles 4. Other

Must be consistent with primary sources and conceptual framework

Professional Judgement
There cannot be a rule for every situation Rules vs. principles

Ethics
Reporting bias Ethical sensitivity Doing the right thing

Sarbanes-Oxley Act (SOX)


Public Company Accounting Oversight Board (PCAOB) Independence rules Bonus/profit forfeiture CEO/CFO certification Independent audit committees Codes of ethics

Canadian Response to SOX


Canadian Public Accounting Board (CPAB) Ontario Securities Commission rules CSA harmonized rules Amendments to Securities Act Other

Challenges Facing Accounting


Globalization Technology New economy Accountability
A move to global markets and global investors Ability to produce and access timely information A move from the traditional resource-based to a knowledge-based economy Driven by more sophisticated and varied investors

The Impact of these Challenges


Globalization Global marketplace requires information to be globally comparative Global capital allocation: move from Canadian stakeholders to global stakeholders Technology As the ability to produce information increases, the need or demand for readily accessible information increases Possible scenarios:
Online real-time information Continuous reporting

Will annual financial statements fill the information need?

The Impact of these Challenges


New Economy
Measuring and reporting value creating assets not currently being reported The challenge is to find an objective value and measure impact on future earnings

The Impact of these Challenges


Accountability
An expectations gap exists between the
publics perception of the professions accountability professions perception of its accountability to the public

Shift from traditional financial reporting to business reporting


e.g. internal financial controls; regulatory compliance

Balanced Scorecard model current move in this direction

COPYRIGHT
Copyright 2005 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

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