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Accounting & Financial Management
AFM 291
Kareen Brown

CHAPTER 1 ROLE OF FINANCIAL REPORTING The Canadian Financial Reporting Environment • Role of Financial Accounting - Accounting theory and practice have evolved and will continue to evolve to meet changing demands and influences - Accounting is defined by three essential characteristics: (1) identification, measurement, and communication of financial information about (2) economic entities to (3) interested persons - Financial accounting (financial reporting) is the process that culminates in the preparation of financial reports that cover all of the enterprise’s business activities and which are used by both internal and external parties (users: investors, creditors) - Managerial accounting is the process of identifying, measuring, analyzing, and communicating financial information to internal decision-maker - Financial statements are the principal way of communicating financial information to those who are outside an enterprise o They give the firm’s history, quantified in terms of money o Most frequently used: balance sheet, income statement, statement of cash flows, statement of owner’s or shareholder’s equity, and note disclosures - Because the resources are limited/scarce, we make efficient use of resources - Accounting profession -> measures company performance accurately and fairly on a timely basis—the info. provided enables investors and creditors to compare the income and assets of companies and thus assess the relative risks and returns of different investment opportunities - Capital Allocation - In Canada, the primary exchange mechanisms for allocating resources are debt and equity markets (i.e. public stock markets/exchanges and private sources) as well as financial institutions such as banks - An effective process of capital allocation is critical to a healthy economy as this promotes productivity, encourages innovation, and provides an efficient and liquid market for buying and selling securities and obtaining and granting credit - Unreliable and irrelevant info. leads to poor capital allocation -> negative impact on securities markets and economic growth - The accounting numbers that companies report affect the transfer of resources among companies and individuals - Credit rating agencies use accounting and other info. to rate companies’ financial stability o Gives investors and creditors additional independent info. to use in decision- making o Good rating = greater access to capital and at lower costs - Stakeholders are parties who have something at risk in the financial reporting environment, e.g., their salary, job, investment, or reputation (key stakeholders included traditional users) - In the stakeholder context, users may be more broadly defined to include not only parties who are relying directly on the financial info. for resource allocation (investors, creditors) but also others who help in the efficient allocation of resources (financial analyst and regulators) - Users: anyone who prepares, relies on, reviews, audits, or monitors financial information - Various stakeholder: company management prepares the financial statements; the statements are then audited and reviewed by the auditors o Auditors act on behalf of the shareholders to ensure that management is accounting properly for the economic transactions o The auditors also review the info. to ensure that it reflects sound accounting choices o Investors and creditors rely on the financial statements to make decisions o Standard setters set GAAP—helps reduce management bias by providing direction as to how the events should be accounted for o Securities commissions and stock exchanges monitor the financial statements to ensure full and plain disclosure of material info. and to determine whether the companies may continue to list their shares on stock exchanges o Credit rating agencies and analysts monitor and analyze the info. produced by the company, looking for signs of change ( improved or weakened financial condition) - As in illustration 1-3 (pg.7) the system provides checks and balances to ensure that the people with capital have good info. to use when deciding where best to allocate the capital o People work on self-interest NOT the best interest of the capital marketplace, and by extension, the economy • Objective of Financial Reporting - Is to communicate info. that is useful to users (primarily capital providers such as investors and lenders) and that is decision relevant (i.e., will help them make decisions about allocating capital) o Users also try to predict the impact of current management decisions on the company’s future financial health - Communicate info. about: o The entity
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