3 essential characteristics of accounting:
-
The identification, measurement, and communication of financial info
1.
About economic entities
2.
To interested people
3.
Financial accounting/financial reporting: process that culminates in the preparation of
financial reports that cover all of the enterprise's business activities and that are used by both
internal and external parties
-
Managerial accounting: process of identifying, measuring, and analyzing, and communicating
financial information to internal decision makers
-
Accounting profession responsible for measuring company performance accurately & fairly on
a timely basis
-
Info provided allows investors & creditors to compare income & assets of companies & thus
assess the relative risks & returns of different investment opportunities
-
Illustration 1-1 (p.5)
-
In Canada, the primary exchange mechanisms for allocating resources are debt and equity
markets & financial institutions.
-
Providing an effective system to facilitate capital allocation is critical to a healthy economy.
-
Efficient capital markets promote productivity, encourage innovation, & provide a platform for
buying & selling securities & obtaining & granting credit.
-
Unreliable & irrelevant info -> poor capital allocation
-
Accounting and Capital Allocation
Parties who have something at risk in the financial reporting environment
-
Users: prepares, relies on, reviews, audits, or monitors financial information
-
Illustration 1-4 (p.7)
-
Stakeholders
To provide financial information about the reporting entity that is useful to present & potential
equity investors, lenders, & other creditors in making decisions in their capacity as capital
providers (decision-usefulness approach)
-
General-purpose financial statements provide at the least cost the most useful info possible.
-
Info based on accrual accounting generally better indicates a company's present & future
ability to generate favourable cash flows than does info limited to the financial effects of cash
receipts & payments.
-
Objective of Financial Reporting
State that exists when one party has more info than the other party
-
May interfere with company's ability to access capital and/or minimize cost of capital in
extreme cases
-
If the company is too open, it might give away proprietary info that might cause profits to be
less. Thus, perfect information symmetry does not exist & management rightly has access to
more info than others since they run the company.
-
Efficient market hypothesis: market prices reflect all info about a company
-
Adverse selection: where info asymmetry exists, the capital marketplace may attract the
wrong type of company
-
Moral hazard: human nature & notes that people will often shirk their responsibilities if they
think that no one is watching
-
Aggressive accounting: managers decide to downplay the - & focus on the +
-
Management bias -> take form of overstated assets and/or net income, understated liabilities
-
Information Asymmetry
Chapter 1: The Canadian Financial Reporting Environment
September 9, 2013
5:30 PM
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Management bias -> take form of overstated assets and/or net income, understated liabilities
and/or expenses, or carefully selected note disclosures that emphasize only + events -> results
in less useful info
-
Standard Setting
Reduce info asymmetry problem in financial reporting (by requiring that transactions & events
be recognized, measured, presented, & disclosed in a specific way)
-
Generally accepted accounting principles (GAAP): reporting principles in a particular area or a
specific practice have been accepted as appropriate -> used universally
-
Need for Standards
Financial reports emphasized solvency and liquidity -> need for standardized & corporate
disclosures
-
Major organizations in developing financial reporting standards in Canada:
-
Canadian Accounting Standards Board (AcSB)
1.
Primary responsibility for setting GAAP in Canada & produces a variety of authoritative
material, including the most important source of GAAP, the CICA Handbook
2 basic premises underlie the process of establishing financial accounting standards:
The AcSB should respond to the needs & viewpoints of the entire economic community, not
just the public accounting profession.
The AcSB should operate in full public view through a due process system that gives interested
persons enough opportunity to make their views known.
Responsible for setting standards for public, private, & not-for-profit entities
Accounting Standards Oversight Council (AcSOC) oversees AcSB activities, provide input to
AcSB activities & reporting to the public
International Accounting Standards Board (IASB)
2.
To improve & harmonize regulations, accounting standards, & procedures relating to the
presentation of financial statements
The Financial Accounting Standards Board (FASB) and the U.S. Securities & Exchange
Commission (SEC)
3.
FASB = major standard-setting body but SEC has final authority over standards
Since Canadian GAAP is based on principles & is fairly open to interpretation, accounting
professionals have often relied on the more prescriptive, specific guidance provided in U.S.
GAAP.
Provincial securities commissions (e.g. Ontario Securities Commission (OSC))
4.
Oversee & monitor capital marketplace in their jurisdiction (to make marketplace fair)
Illustration 1-6 (p.13)
-
Parties Involved in Standard Setting
Includes not only specific rules, practices, & procedures for particular circumstances but also
broad principles & conventions that apply generally, including underlying concepts
-
Generally Accepted Accounting Principles
Identifies sources of GAAP & lets users know which ones should be consulted first in asking
"What is GAAP?"
-
GAAP divided into:
-
Primary sources: Handbook sections, accounting guidelines (looked at first)
Other sources: background info & basis for conclusion documents issued by AcSB,
pronouncements, approved drafts of primary sources, research studies, textbooks, journals,
studies, & articles, other including industry practice
Under IFRS, GAAP incorporates: IFRS, International Accounting Standards (IAS), and
interpretations.
-
GAAP Hierarchy
There cannot be a rule for every situation.
-
ASPE & IFRS: based mainly on general principles rather than specific rules
-
Accountants either apply specific standards that are based on the conceptual framework, or, if
-
Professional Judgement
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Accountants either apply specific standards that are based on the conceptual framework, or, if
no specific standard exists, the accountant uses the conceptual framework & professional
judgement to reason through to an answer.
-
Challenges and Opportunities for the Accounting Profession
Accounting oversight board
Independence rules made for auditors
Certify financial statements, company must forfeit bonuses & profits if there is a restatement
of their companies' accounting disclosures
Management must report on the effectiveness of the financial reporting internal control
systems
Audit committees must have independent members with financial expertise
Code of ethics
- Legislation's key provisions:
Accounting standards result as much from political action as they do from careful logic or
researching findings.
-
Standard Setting in a Political Environment
Rules-based approach
-
Like the Canadian tax system
There is a rule for most things (even though the rule may be based on a principle)
Body of knowledge significantly larger -> companies tend to interpret rules literally
Does not always emphasize importance of communicating the best info for users
Principles-based approach
-
e.g. IFRS & ASPE
Body of knowledge is smaller
1 or more principles form the basis for decision-making in many scenarios
Professional judgement fundamental, less emphasis on right & wrong answers
Bright-line tests, numeric benchmarks for determining accounting, are minimized.
Principles versus Rules
Financial performance is rooted in a company's business model (earnings process, how
companies finance the process, & what resources companies invest in).
-
Integrated Reporting
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