CHAPTER 1
Overview of Corporate Financial Reporting
ASSESSING YOUR RECALL SOLUTIONS
1-1 Accounting, as an information system, provides economic information
to users to allow them to determine whether the entity is operating
effectively and efficiently. In addition, accounting facilitates the
making of important decisions in the management of the entity, such
as whether new assets should be purchased or leased or whether
equity financing should be used as opposed to debt financing.
1-2 A private corporation is one whose ownership shares are held by a
small number of individuals. This makes the transfer of ownership
more difficult, as the shares do not trade on a public stock exchange.
A public corporation has shares held by a larger number of
individuals or entities, and these shares are bought and sold on a
public stock exchange (such as the Toronto Stock Exchange).
,1-3 Shareholders – These users are interested in the performance of
their investment in the company. They will use the financial
statements to evaluate how well management is handling their
investment.
Financial Institutions – These users are interested in evaluating the
company to decide whether to lend money to it. They will use the
statements to evaluate the risk that will be taken in making the loan.
Taxing Authorities – These users establish the rules for how taxable
income will be measured. They are interested in the fair
measurement of the financial position of the company so that the
appropriate tax will be paid. Note, however, that income taxes are not
paid based on the net earnings reported in the financial statements;
rather, income taxes are based on taxable income. In preparing the
tax return, the financial statements’ net income is the starting point
and is then adjusted to arrive at taxable income.
Financial Analysts – These users provide investment advice to their
customers. They are interested in evaluating the investment potential
of various companies. They will want to evaluate not only individual
companies, but also make cross-company comparisons.
Credit Rating Agencies – These agencies evaluate companies as to
their credit risks. These ratings are then supplied to investors who
want to make investments in these companies, either through their
common shares or through their debt.
(Note: there are other users discussed in the chapter that would
be equally acceptable answers to this question.)
,1-4 Financial accounting is governed by a set of accounting guidelines.
These guidelines are referred to as Generally Accepted Accounting
Principles (GAAP) or Financial Reporting Standards. The Accounting
Standards Board (AcSB) of the Canadian Institute of Chartered
Accountants (CICA) sets accounting and reporting standards for
private companies following accounting standards for private
enterprises. The International Accounting Standards Board (IASB)
sets the International Financial Reporting Standards (IFRS) for public
companies, These guidelines have the force of law because they are
recognized in both federal and provincial statutes that govern
companies.
1-5 The main role of the International Accounting Standards Board
(IASB) is to promote the harmonization of international accounting
standards around the world. To that effect, the IASB has developed
relationships with standard-setting bodies in many countries,
including the Accounting Standards Board of the Canadian Institute of
Chartered Accountants in Canada and the Financial Accounting
Standards Board in the United States, in trying to encourage them to
change their accounting standards to international standards. In
Canada, effective January 1, 2011, IFRS must be implemented as
the financial reporting standard for public companies.
, 1-6 The major qualitative characteristics that accounting information
should possess are:
Understandability – The information must be understandable to a
reasonably well-informed user.
Relevance – The information must be relevant for the decision under
consideration. Relevance consists of several sub-characteristics:
Predictive Value – The information is useful in predicting future
results, such as income or cash flow, and therefore should be
helpful to users who make decisions that depend on predictions
of future events.
Confirmatory Value – The information must provide the user
with the ability to evaluate the outcomes of previous decisions,
giving them feedback on their past decisions.
Reliability – The information must be reliable to be of use to a
decision maker. Reliability has five sub-characteristics:
Representational Faithfulness – The information must
represent what it purports to represent.
Substance Over Form – Accountants need to convey the
underlying substance of the transaction rather than just record
and repeat transactions according to required transactions.
They need to look beyond the accounting standards and ensure
that the information conveys economic reality.
Neutrality – The information must not be produced in a biased
way relative to the effects it has on the entity being measured.
Prudence – Accountants and users must use caution when
making judgements since accounting transactions and
measurements are not always exact and often include
uncertainties.
Overview of Corporate Financial Reporting
ASSESSING YOUR RECALL SOLUTIONS
1-1 Accounting, as an information system, provides economic information
to users to allow them to determine whether the entity is operating
effectively and efficiently. In addition, accounting facilitates the
making of important decisions in the management of the entity, such
as whether new assets should be purchased or leased or whether
equity financing should be used as opposed to debt financing.
1-2 A private corporation is one whose ownership shares are held by a
small number of individuals. This makes the transfer of ownership
more difficult, as the shares do not trade on a public stock exchange.
A public corporation has shares held by a larger number of
individuals or entities, and these shares are bought and sold on a
public stock exchange (such as the Toronto Stock Exchange).
,1-3 Shareholders – These users are interested in the performance of
their investment in the company. They will use the financial
statements to evaluate how well management is handling their
investment.
Financial Institutions – These users are interested in evaluating the
company to decide whether to lend money to it. They will use the
statements to evaluate the risk that will be taken in making the loan.
Taxing Authorities – These users establish the rules for how taxable
income will be measured. They are interested in the fair
measurement of the financial position of the company so that the
appropriate tax will be paid. Note, however, that income taxes are not
paid based on the net earnings reported in the financial statements;
rather, income taxes are based on taxable income. In preparing the
tax return, the financial statements’ net income is the starting point
and is then adjusted to arrive at taxable income.
Financial Analysts – These users provide investment advice to their
customers. They are interested in evaluating the investment potential
of various companies. They will want to evaluate not only individual
companies, but also make cross-company comparisons.
Credit Rating Agencies – These agencies evaluate companies as to
their credit risks. These ratings are then supplied to investors who
want to make investments in these companies, either through their
common shares or through their debt.
(Note: there are other users discussed in the chapter that would
be equally acceptable answers to this question.)
,1-4 Financial accounting is governed by a set of accounting guidelines.
These guidelines are referred to as Generally Accepted Accounting
Principles (GAAP) or Financial Reporting Standards. The Accounting
Standards Board (AcSB) of the Canadian Institute of Chartered
Accountants (CICA) sets accounting and reporting standards for
private companies following accounting standards for private
enterprises. The International Accounting Standards Board (IASB)
sets the International Financial Reporting Standards (IFRS) for public
companies, These guidelines have the force of law because they are
recognized in both federal and provincial statutes that govern
companies.
1-5 The main role of the International Accounting Standards Board
(IASB) is to promote the harmonization of international accounting
standards around the world. To that effect, the IASB has developed
relationships with standard-setting bodies in many countries,
including the Accounting Standards Board of the Canadian Institute of
Chartered Accountants in Canada and the Financial Accounting
Standards Board in the United States, in trying to encourage them to
change their accounting standards to international standards. In
Canada, effective January 1, 2011, IFRS must be implemented as
the financial reporting standard for public companies.
, 1-6 The major qualitative characteristics that accounting information
should possess are:
Understandability – The information must be understandable to a
reasonably well-informed user.
Relevance – The information must be relevant for the decision under
consideration. Relevance consists of several sub-characteristics:
Predictive Value – The information is useful in predicting future
results, such as income or cash flow, and therefore should be
helpful to users who make decisions that depend on predictions
of future events.
Confirmatory Value – The information must provide the user
with the ability to evaluate the outcomes of previous decisions,
giving them feedback on their past decisions.
Reliability – The information must be reliable to be of use to a
decision maker. Reliability has five sub-characteristics:
Representational Faithfulness – The information must
represent what it purports to represent.
Substance Over Form – Accountants need to convey the
underlying substance of the transaction rather than just record
and repeat transactions according to required transactions.
They need to look beyond the accounting standards and ensure
that the information conveys economic reality.
Neutrality – The information must not be produced in a biased
way relative to the effects it has on the entity being measured.
Prudence – Accountants and users must use caution when
making judgements since accounting transactions and
measurements are not always exact and often include
uncertainties.
