Chapter 1: The Canadian Financial Reporting Environment

Financial Statements & Financial Reporting

Accounting Essential Characteristics

  1. Identifying, measuring, communicating financial info
  2. It is about economic entities
  3. It is to interested persons

Financial Accounting (reporting) – Culminates in preparation of financial reports that cover the enterprises’ business activities to be used by internal and external parties.

  • Users include investors, creditors, etc.

Managerial Accounting – Identifies, measures, analyzes, and communicates financial info to internal decision makers.


Financial Statements

  • Statement of Financial Position (Balance Sheet)
  • Statement of Income/Comprehensive Income (Income Statement)
  • Statement of Cash Flows (Cash Flow Statement)
  • Statement of Changes in Equity (Under ASPE, Statement of Retained Earnings)
  • Note: disclosures express additional financial information.


Allocation & Capital Allocation

  • An efficient use of limited resources allows a higher standard of living.
  • Markets, free enterprise, and competition determine success.
  • Accountants measure company performance accurately and fairly on a timely basis.
  • Info provided allows investors/creditors to compare income and assets to assess relative risks and returns.
  • Canada uses debt and equity markets and financial institutions – an effective system is critical to a healthy economy.
  • Credit Rating is integral to greater access to capital.


Stakeholders

  • Refers to parties who have something at risk in the financial reporting environment. (i.e. salary, job, investment, reputation).
  • Includes anyone who prepares, relies on, reviews, audits, or monitors financial information.

Investors/Creditors – Rely on financial statements for decisions.

Management – Prepares financial statements

Securities Commissions and Stock Exchanges – Monitor financial statements to ensure full disclosure of info and if the company can list shares on stock exchanges.

Analysts & Credit Rating Agencies – Monitor and analyze info for signs of change in financial condition.

Auditors – Audits and discusses communication of financial events in statements

Standard Setters – Set GAAP.

  • The system provides checks and balances to ensure people with capital have the best info for decisions.
  • Human behaviour is often a key unpredictable variable because people act in their own self-interest.


Objective of Financial Reporting

Decision-usefulness approach - To provide financial info about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers.

  • An entity perspective is adopted (companies are separate from owners).
  • Financial statements and related explanations are integral to make assessments on cash inflows and proceeds for investors.
  • Providing useful info is challenging due to varying needs and levels of knowledge of different users.


Information Asymmetry

Reasons

  • Capital markets (i.e. stock exchanges) are not fully efficient, so not all info is incorporated into stock prices.
  • Human behavior causes people to maximize their own well-being to show only positive financial position.

Efficient Markets Hypothesis – Market prices reflect all publicly available information about a company.

Adverse Selection – Capital marketplace may attract wrong type of company.

Moral Hazard – People shirk responsibility if no one is “watching.”

  • Also known as management bias, or aggressive accounting.


Need for Standards

Generally Accepted Accounting Principles (GAAP) - Refers to a common set of standards and procedures adopted to ensure uniform complete statements.

Parties Involved in Standard Setting

  • The stock market crash of 1929 emphasized the need for standardized and increased corporate disclosures.
  • Set by major organizations:
  • Canadian Accounting Standards Board (AcSB)
  • GAAP for private companies, pension plans, NFP entities: ASPE
  • Mandate comes from Canadian Business Corporations Act and Regulations, as well as provincial acts of incorporation.
  • International Accounting Standards Board (IASB)
  • GAAP for public companies: IFRS
  • Must follow GAAP to access capital markets
  • Financial Accounting Standards Board (FASB)
  • GAAP for U.S. Entities
  • Influences IFRS standard setting, public companies listed on U.S> stock exchange may follow U.S. GAAP.
  • Provincial Securities Commissions (i.e. Ontario Securities Commission [OSC])
  • Requires additional disclosures for public companies.


GAAP Hierarchy

  • Identifies sources of GAAP and which should be consulted first.
  • Defines it under primary sources and other sources. Check primary sources first.
  • Primary sources: CICA Handbook and Accounting guidelines
  • Other sources: background info and basis for conclusion documents issued by AcSB, pronouncements, approved drafts of primary GAAP sources, research studies, textbooks, journals, studies, articles, industry practice, etc.

Professional Judgement

  • ASPE and IFRS are based primarily on general principles, so professional accounts must apply principles appropriately.
  • The conceptual Framework may be referred to for reasoning through to an answer.


Challenges

  • Oversight in Capital Marketsreforms put emphasis on government regulation
  • Centrality of Ethicsethical dilemmas
  • Standard setting in a Political EnvironmentStakeholders are prioritized, there needs to be a balance between opinions.
  • Principles-versus Rules-Based Standard Setting – balancing defendable rules vs. professional judgement of principles
  • Impact of Technologyinformation is abundant and readily available, debate is equal access and false information and information theft/manipulation
  • Integrated Reporting – accounting info system is part of a larger info system that contains other non-financial information.
  • Require the accounting profession to continue to strive for excellence


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