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Chapter 1

MGAC01H3 Chapter Notes - Chapter 1: Financial Statement, Income Statement, Management Accounting

Financial Accounting
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Chapter 1 The Canadian Financial Reporting Environment Notes
Role of Financial Reporting
accounting theory and practice have always evolved and will continue to evolve
accounting is defined best by describing its 3 essential characteristics—it is the (1) identification, measurement, and communication
of financial information about (2) economic entities to (3) interested persons
Financial Statements and Financial Reporting
financial accounting (financial reporting) is the process that culminates in the preparation of financial reports that cover all the
enterprise’s business activities and that are used by both internal and external parties
managerial accounting is the process of identifying, measuring, and analyzing, and communicating financial information to internal
decision-makers, which takes varied forms, such as cost-benefit analyses and forecasts that management uses
financial statements are the principal way of communicating financial information to those who are outside an enterprise
the most frequently provided financial statements are (1) the balance sheet, (2) the income statement, (3) the statement of cash flows,
and (4) the statement of owners’ or shareholders’ equity or statement of retained earnings
Accounting and Capital Allocation
because resources are limited, people try to conserve them, use them effectively, and identify and encourage those who an make
efficient use of them, which increases our standard of living
accounting profession has highly important responsibility of measuring company performance accurately and fairly on a timely basis
the information provided by accounting enables investors and creditors to compare the income and assets of companies and thus
assess the relative risks and returns of different investment opportunities
the primary exchange mechanisms for allocating resources are debt and equity markets, 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
stakeholders are parties who have something at risk in financial reporting environment, e.g., salary, job, investment, or reputation
the broader definition of users includes anyone who prepares, relies on, reviews, audits, or monitors financial information; it includes
investors, creditors, analysts, managers, employees, customers, suppliers, industry groups, unions, government departments and
ministers, the public in general, regulatory agencies, other companies, and standard setters, as well as auditors, lawyers, and others
Objective of Financial Reporting
the overall objective is to provide financial information 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)
statements should communicate info about: (1) entity’s economic resources and claims and (2) changes in resources and claims
the assessment of management stewardship is also important since users need to know whether management is doing their job
Management Bias
there are many reasons why financial statements might be affected by management bias
these include the fact that the statements give information to users about management stewardship, and the fact that managers are
often compensated (i.e., paid) based on the company’s net income or share value
there is also a strong desire to meet financial analysts’ expectations as this affects a company’s access to capital markets
another cause is management’s desire to comply with contracts that the company has
Users’ Needs
the objective of financial reporting is to provide useful information to users
providing information that is useful to users is a challenging task since they have different needs and levels of knowledge
meeting all user needs is made more challenging when linked with the potential for management bias
generally accepted accounting principles assume that users have a reasonable knowledge of business and accounting
Challenges Facing Financial Reporting
Impact of Technology
as technology continues to advance at a dramatic pace, giving users greater access to more and more information more and more
rapidly, the requirement for information that is more timely than annual and quarterly financial statements will rise sharply
from the company’s perspective, providing info over the Internet gives the company access to a much larger group of users
Changing Nature of the Economy
the knowledge-based companies that are beginning to dominate capital markets need more relevant models for measuring and
reporting value in order to evaluate assets that are currently not recognized on the balance sheet
Increased Requirement for Accountability
growing number of institutional investors, partly because more and more capital is being invested in pension plans and mutual funds
the impact is that investors have become more sophisticated and knowledgeable
as a result, companies are being pushed toward increased accountability
the balanced scorecard model notes that financial measures are only one component of useful information that decision makers need
in order to make effective decisions about the company
this model views the company from 4 perspectives: financial, customer, internal processes, and learning and growth
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