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CA (170,000)
UTSG (10,000)
Chapter 1

CHAPTER 1 TEXTBOOK REVIEW A six page summary of the entire first chapter of the RSM220 Textbook (Intermediate Accounting)

Rotman Commerce
Course Code
Dragan Stojanovic

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Accounting: largely a part of its environment; accounting theory and practice have always evolved and
will continue to evolve
Accounting: identification, measurement and communication of financial information about economic
entities to interested persons
Financial accounting/financial reporting – the process that culminates in the preparation of financial
reports that cover all of the enterprise’s business activities that are used by both internal and external
Managerial accounting is the process of identifying, measuring, analyzing and communicating financial
information to internal decision makers
Financial statements: principal way of communicating financial information to those who are outside an
enterprise; they give the firm’s history, quantified in terms of money
o(1) balance sheet, (2) income statement, (3) statement of cash flows, (f) statement of owners’ or
shareholders’ equity/statement of retained earnings
Markets, free enterprise and competition determine whether a business will succeed and thrive
Accounting profession: responsibility of measuring company performance accurately, fairly and timely
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
oCreditors/investors can then channel their resources based on these assessments
In Canada, primary exchange mechanisms for allocating resources are debt, equity markets, and
financial institutions (banks)
Debt and equity marketplace includes both stock markets/exchanges and private sources
An effective process of capital allocation is critical to a healthy economy – promotes productivity,
encourages innovation and provides an efficient and liquid market for buying and selling securities and
obtaining/granting credit
Unreliable/irrelevant information – leads to poor capital allocation – negative impact on securities
markets and economic growth
The accounting reports affect the transfer of resources among companies and individuals
Stock prices – rise when positive news is expected/released
Credit rating agencies – use accounting and other information to rate companies’ financial stability
Gives investors/creditors additional independent information to use when making decisions
Stakeholders – parties who have something at risk in the financial reporting environment
Key stakeholders in the financial reporting environment include traditional users of financial
information as well as others
Users – may be more broadly defined to include not only parties who are relying directly on the
financial information for resource allocation (ie. investors/creditors), but also others who help in the
efficient allocation of resources (such as financial analysts/regulators)
Users (broader definition): anyone who prepares, relies on, reviews, audits, or monitors financial
Company management: prepares the financial statements – has best insight into the business and
therefore knows what should be included in the financial statements
Statements are then audited and reviewed by auditors – may discuss with management how economic
events/transactions have been communicated in the financial statements
Investors/creditors rely on the financial statements to make decisions
GAAP: Generally Accepted Accounting Principles – used to prepare financial statements
oReduces management bias – providing direction as to how events should be accounting for
Securities commissions and stock exchanges – monitor the financial statements to ensure full/plain
disclosure of material information and to determine whether the companies may continue to list their
shares on stock exchanges

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Credit-rating agencies and analysts: monitor and analyze the information produced by the company,
looking for signs of change (ie. an improved or weakened financial condition)
Objective of Financial Reporting:
oOverall objective of financial reporting: to provide financial information that is useful to users
(primarily capital providers, such as investors and lenders), and that is decision relevant (ie. will
help them make decisions about allocating capital)
Management bias:
oManagement best understands the business and therefore is best suited to communicating
information about the business to users
oBiased information: information that presents the company in its best light
Referred to sometimes as aggressive financial reporting (compared to conservative)
Overstates assets and/or net income, understate liabilities and/or expenses, or
carefully selected note disclosures that emphasize only positive events
oStatements give information to users about management stewardship: managers are often
compensated (ie paid) based on the company’s net income or share value
oStrong desire to meet financial analysts’ expectations = this affects a company’s access to
capital markets
o“earnings surprises” – occur when a company reports net income figures that are different from
what the market expects (ie. different from prior expectations)
oIf net income is lower than expected, this is a negative earnings surprise and the market will
react unfavorably – leading to resulting share prices
oDesire to comply with contracts that the company has
oMany lending agreements and contracts require that certain benchmarks be met – relate to
financial stability or liquidity
oRequirements often state that the company must maintain certain minimum financial ratios
oThe lenders then monitor whether the company is respecting the contract by reviewing periodic
financial statements that the company must submit
Users’ Needs
oObjective of financial reporting – to provide useful information to users
oProviding information that is useful to users is a challenging task since they have different
needs and levels of knowledge
oInstitutional investors – hold an increasing percentage of equity share holdings and generally
put a lot of their resources into managing their investment portfolios
oMeeting all user needs is made more challenging when linked with the potential for
management bias
oFinancial statements are aggressively prepared might be misleading to potential investors,
who may want to see a company in its worst light before they decide to invest
GAAP – assume users have a reasonable knowledge of business and accounting
Standard setting:
The users of financial statements have both coinciding and conflicting needs for information of various
A single set of general-purpose financial statements is therefore prepared with the expectation that the
majority of these needs will be met by the statements
Set of standards developed that are generally accepted and universally practiced
Without these standards, each enterprise would have to develop its own standards, and readers of
financial statements would have to become familiar with every company’s particular accounting and
reporting practices
GAAP – Generally Accepted Accounting Principles
“generally accepted” – either than an authoritative rule-making body in accounting has created a
reporting principle in a particular area or that, over time, a specific practice has been accepted as
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