CHAPTER 1The 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

Identification, measurement, and communication of financial information about;Economic entities to;Interested persons.

*FINANCIAL REPORTINGFinancial accounting provides historical informationFinancial reporting is used by both internal and external usersExternal users include such decision makers as investors, creditors, unions, government agenciesMajor financial statements (required by GAAP):Statement of Financial Position (Balance Sheet)Statement of Comprehensive Income (Income Statement)Statement of Cash FlowsStatement of Changes in Equity (Statement of Shareholders Equity)+Note DisclosuresWhat is the role of note disclosures?

*The overall objective of financial reporting is to provide information that is:useful to users, and decision relevantFinancial statements should provide information about:the entitys economic resources and claims to those resources, and changes in those resources and claimsFinancial reporting aids users in the allocation of scarce resources (capital)The accounting profession has the responsibility of measuring a companys performance accurately, fairly, and on a timely basis

OBJECTIVE OF FINANCIAL REPORTING

????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 BIASPreparation of the financial statements are the responsibility of internal managementMay lead to preparing statements that report the enterprise in its best lightMotives include:to reflect positive management stewardship (job, compensation)meet financial analysts expectations, resulting in a positive reaction in the capital marketsTo access capitalWhat safeguards are in place to protect financial users from management bias?Standard setters set Generally Accepted Accounting Principles (GAAP) for direction on accountingGAAP is used to help reduce management bias and to ensure the information is useful to users

*THE STANDARD SETTING PROCESS IN CANADA PARTIES INVOLVEDCanadian Accounting Standards Board (AcSB)Primarily responsible for setting GAAP in CanadaFrom 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 standardsBe responsive to the needs and viewpoints of the entire economic communityOperate in full public view through due process

*THE STANDARD SETTING PROCESS IN CANADA PARTIES INVOLVEDInternational Accounting Standards Board (IASB)Major international standard setting bodyMission 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 INVOLVEDFinancial 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.SProvincial Securities Commission (e.g. Ontario Securities Commission)To oversee and monitor capital marketplaceEnsure strict adherence to securities law/legislation

*GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)For private companies, pension plans, and not-for-profit entities, GAAP consists of :Primary sourcesCICA Handbook Sections 1400 to 3870Accounting guidelinesOther sourcesBackground documents and implementation guidance issued by AcSB Pronouncements in other jurisdictionsResearch studies, accounting textbooks, journals, etc.Must be consistent with primary sources and in accordance with the conceptual framework (i.e. CICA Handbook Section 1000)

*GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)For public companies (reporting under IFRS), GAAP includes:IFRSInternational Accounting Standards (IAS)Interpretations (IFRIC or SIC)If above sources do not specifically apply, other sources may be considered:Pronouncements of other standard-setting bodiesOther accounting literatureAccepted industry practices

???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 JUDGEMENTThere cannot be a rule for every situationStandards in Canada are based primarily on principles rather than specific rulesTherefore, must use professional judgement The United States uses a rules-based approach

*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 rulesBonus/profit forfeitureCEO/CFO certificationManagement report on effectiveness of internal controls over financial reportingIndependent audit committeesCodes of ethics

???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*

CLICKER QUESTIONSAll 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 entityd) 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) Investorsb) Creditorsc) Analystsd) Standard-setters

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CLICKER QUESTIONSPotential causes of management bias include all of the following except:Financial statement users must exercise significant professional judgement in interpretation of financial information

Financial statements provide information to users about management stewardship.

Managers are often compensated based on the companys net income or share value.

Many lending agreements and contracts require that certain financial benchmarks must be met.

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