Intermediate Accounting 13th Canadian Edition, Volume 1, Chapter 1 - PDF

Intermediate Accounting 13th Canadian Edition, Volume 1 Kieso Weygandt Warfield Wiecek McConomy Chapter 1 The Canadian Financial Reporting Environment This slide deck contains animations. Please disable animations if they cause is...

Intermediate Accounting 13th Canadian Edition, Volume 1 Kieso Weygandt Warfield Wiecek McConomy Chapter 1 The Canadian Financial Reporting Environment This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright ©2022 John Wiley & Sons, Canada, Ltd. The Canadian Financial Reporting Environment After studying this chapter, you should be able to: 1. Understand the financial reporting environment. 2. Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting. 3. Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying G AAP. 4. Discuss some of the challenges and opportunities for accounting. Copyright ©2022 John Wiley & Sons, 2 Canada, Ltd. Characteristics of Accounting Accounting identifies, measures, and communicates financial information about economic entities to interested persons. Accounting has two broad classifications: 1. Financial accounting Preparation of financial statements Internal and external users Investors, creditors, and others 2. Managerial accounting Communicates financial information through varied forms Internal decision-makers Management uses to plan, evaluate, control LO 1 operations Copyright ©2022 John Wiley & Sons, 3 Canada, Ltd. Basic Financial Statements Communicates financial information to outsiders Major financial statements include: o statement of financial position or balance sheet o statement of income/comprehensive income or income statement or statement of profit or loss or statement of financial performance o statement of cash flows or cash flow statement LO 1 o statement of changes in equity (IFRS) or Copyright ©2022 John Wiley & Sons, 4 Canada, Ltd. Additional Financial Reporting President’s letter Schedules in the corporate annual report Prospectuses Reports filed with government agencies News releases Management forecasts Descriptions of social and environmental impacts LO 1 Copyright ©2022 John Wiley & Sons, 5 Canada, Ltd. Accounting and Capital Allocation Financial reporting aids users in the allocation of scarce resources (capital) The accounting profession has the responsibility of measuring a company’s performance accurately and fairly, on a timely basis These measurements enable investors and creditors to compare the income and assets employed by companies Investors can then assess the relative risks and returns associated with companies before making investing decisions LO 1 Copyright ©2022 John Wiley & Sons, 6 Canada, Ltd. Capital Allocation Process Sources for resource allocation: o Debt and equity markets—public stock markets/exchanges and private sources o Financial institutions—banks LO 1 Copyright ©2022 John Wiley & Sons, 7 Canada, Ltd. System for Capital Allocation An effective process of capital allocation is critical to a healthy economy Unreliable and irrelevant information leads to poor capital allocation Accounting information affects transfer of resources Credit rating agencies use accounting to rate a company’s financial stability Gives investors and creditors additional independent information LO 1 Copyright ©2022 John Wiley & Sons, 8 Canada, Ltd. Sources of Capital © TSX Inc., 2018. All rights reserved. LO 1 Copyright ©2022 John Wiley & Sons, 9 Canada, Ltd. Stakeholders in Financial Reporting Key stakeholders include traditional users of financial information and parties with something at risk (at stake) o Users that rely directly on the financial information for resource allocation (investors and creditors) o Users who help in the efficient allocation of resources (financial analysts and regulators) o Anyone who prepares, relies on, reviews, audits, or monitors financial information LO 1 Copyright ©2022 John Wiley & Sons, 10 Canada, Ltd. Stakeholders’ Responsibilities Management prepares the financial statements— investors and creditors rely on them to make decisions Statements are then audited by independent auditors—acting on behalf of shareholders to keep management accountable Standard setters set generally accepted accounting principles (GAAP) to provide direction for accounting Securities commissions and stock exchanges monitor for full and plain disclosure Credit rating agencies and analysts monitor and analyze signs of change in financial condition LO 1 Copyright ©2022 John Wiley & Sons, 11 Canada, Ltd. Selected Key Stakeholders Selected Key Stakeholders in the Financial Reporting Environment LO 1 Copyright ©2022 John Wiley & Sons, 12 Canada, Ltd. What is at Stake for Each Stakeholder? Stakeholder What is at Stake? Investors/creditors Investment/loan Management Job, bonus, reputation, salary increase, access to capital markets by company Securities commissions and Reputation, effective and efficient capital stock exchanges marketplace Analysts and credit rating Reputation, profits agencies Auditors Reputation, profits (companies are their clients) Standard setters Reputation Others Various LO 1 Copyright ©2022 John Wiley & Sons, 13 Canada, Ltd. Objective of Financial Reporting To provide financial information about the reporting entity that is useful to current and potential decision makers (decision- usefulness approach) Entity perspective vs. proprietary perspective Assists investors in assessing o Company’s ability to generate net cash inflows o Management’s ability to protect and enhance investments Need to address different needs and levels of knowledge of users LO 1 Copyright ©2022 John Wiley & Sons, 14 Canada, Ltd. Information Asymmetry Ideally, all stakeholders should have equal access to all relevant information (information symmetry) When managers have access to more information than other stakeholders (information asymmetry) o Weigh the cost/benefit of sharing information o More information--Could facilitate flow of capital and lower the cost of capital o Too much information--give away proprietary information that could cause profits to fall and impact a company’s competitive advantage LO 1 Copyright ©2022 John Wiley & Sons, 15 Canada, Ltd. Types of Information Asymmetry Some reasons for information asymmetry o Efficient markets hypothesis suggests markets reflect publicly available information o Human behaviour sometimes motivated by maximizing self-interest Two types of asymmetry problems: o Adverse selection: knowing that there is information asymmetry, capital markets may attract wrong kinds of participants o Moral Hazard: concept that people will shirk responsibility if there is no accountability LO 1 Copyright ©2022 John Wiley & Sons, 16 Canada, Ltd. Information Asymmetry Issues Management bias o Aggressive accounting—downplay the negative and focus on the positive o Conservative accounting—downplay the positives and focus on the negatives Reasons managers may present biased information o Evaluation of management performance o Compensation structures o Access to capital markets and meeting analyst expectations o Meeting contractual obligations LO 1 Copyright ©2022 John Wiley & Sons, 17 Canada, Ltd. Need for Standards Accounting standards help reduce information asymmetry problems in financial reporting Transactions and events must be recognized, measured, presented and disclosed in a specific way Standards are not rules, regulations or laws; they are recommendations Standards are intended to be generally accepted and universally practiced In addition to set standards, some principles are generally accepted because they are universally practiced LO 2 Copyright ©2022 John Wiley & Sons, 18 Canada, Ltd. Standards Development Basics Two underlying premises for standards development o Be responsive to the needs and viewpoints of the entire economic community o Operate in full public view through due process Parties involved in standard setting in Canada o The Canadian Accounting Standards Board (AcSB) o The International Accounting Standards Board (IASB) o The Financial Accounting Standards Board LO 2 (FASB) Copyright ©2022 John Wiley & Sons, 19 Canada, Ltd. Canadian Accounting Standards Board (AcSB) Primarily responsible for setting GAAP in Canada (and producing the CPA Canada Handbook) Since 2011 develops standards for private enterprises, NFP entities, pension plans Adopts international standards (IFRS) into Canadian GAAP Affiliates: Accounting Standards Oversight Council (AcSOC) and the IFRS Discussion Group subcommittee LO 2 Copyright ©2022 John Wiley & Sons, 20 Canada, Ltd. Objectives of the Canadian Accounting Standards Board Establish standards that improve the quality of information Facilitate the capital allocation process through improved information Participate with other standard setters to develop internationally accepted standards Support the implementation of standards and the resolution of issues LO 2 Copyright ©2022 John Wiley & Sons, 21 Canada, Ltd. International Accounting Standards Board (IASB) Dominant global standard-setting body Tries to lessen differences among countries’ standards Aim to improve and harmonize regulations, accounting standards and procedures Affiliates: IFRS Foundation, IFRS Advisory Council, Accounting Standards Advisory Forum, IFRS Interpretations Committee (IF RIC) L O 2 I FR S used byCopyright public ©2022 companies John Wiley & Sons, in Canada 22 Canada, Ltd. Financial Accounting Standards Board (FASB) FASB is the major standard setting body in the U.S. o But Securities Exchange Commission has the final authority U.S. GAAP has a significant impact on Canadian GAAP o U.S. GAAP—more prescriptive, provides more specific guidance than ASPE which is principle based Many Canadian companies are listed on U.S. exchanges and these companies must follow U.S. LO 2 GAAP or IFRS Copyright ©2022 John Wiley & Sons, 23 Canada, Ltd. Securities Commissions Provincial Securities Commissions o Oversee and monitor capital marketplace in their provinces o Securities law and legislation requires companies whose shares trade in Canada to use GAAP financial statements Ontario Securities Commission o Ontario home to the Toronto Stock Exchange o Most large companies registered with OSC o OSC monitors financial statements of publicly traded companies for fair representation of financial position and financial results LO 2 Copyright ©2022 John Wiley & Sons, 24 Canada, Ltd. Summary of Entities Responsible for GAAP Standard-Setter GAAP Application AcSB: Canadian Canadian private companies (ASPE); Accounting pension plans; not-for-profit entities; not- Standards Board for-profit entities in public sector may have to follow public sector GAAP IASB: International Public companies (IFRS); option for not-for- Accounting profit entities and private companies Standards Board FASB: Financial For U.S. entities (U.S. GAAP); option for Accounting Canadian public companies that are listed Standards Board on a US stock exchange Security Not responsible for GAAP, but may require Commissions additional disclosures for public companies LO 2 Copyright ©2022 John Wiley & Sons, 25 Canada, Ltd. Generally Accepted Accounting Principles Hierarchy (Aprimary Under ASPE, the SPE)sources for GAAP are: o CPA Canada Handbook Sections 1400 to 3870 o Accounting guidelines Other sources o Background documents and implementation AcSB guidance o Pronouncements in other jurisdictions o Research studies and approved drafts of primary sources o Accounting textbooks, journals, studies, LO 3 Copyright ©2022 John Wiley & Sons, 26 articles Canada, Ltd. Generally Accepted Accounting Principles Hierarchy Under IFRS, GA(I APFincludes RS) o International financial reporting standards (I FR S) o International accounting standards (I AS) o Interpretations (IFRIC or the former Standards Interpretation Committee) Other sources o Pronouncements of other standard-setting bodies o Other accounting literature o Accepted industry practices LO 3 Copyright ©2022 John Wiley & Sons, 27 Canada, Ltd. Generally Accepted Accounting Principles Hierarchy Hierarchy identifies sources of GAAP in descending order of authority Purposes of the Hierarchy o Guidance as to “What is G AAP?” o Rank sources in order of importance o Grounded in the conceptual framework o Establish the value of and expect the use of professional judgement LO 3 Copyright ©2022 John Wiley & Sons, 28 Canada, Ltd. Professional Judgement There cannot be a rule for every situation Standards in Canada are based primarily on principles rather than specific rules Expected that professional accountants can apply them appropriately to any situation If no principle exists, then use conceptual framework and professional judgement to find a solution U.S. GAAP is more prescriptive; provides more detailed guidance than IFRS and ASP LO 3 E Copyright ©2022 John Wiley & Sons, Canada, Ltd. 29 Challenges and Opportunities for the Accounting Profession As a result of Covid-19, many businesses moved online Employees and business owners migrated to a remote work environment Led to a dramatic increase in automation and the use of certain technologies Accountants had to re-examine their roles in this changed environment Two areas emerged: data governance and economic value creation LO 4 Copyright ©2022 John Wiley & Sons, 30 Canada, Ltd. Impact of Technology: Data Analytics Information is becoming more abundant: digitization, digitalization, artificial intelligence (I A) Compounded by the speed at which it accumulates Corresponding impact on amount and variety of information available (big data) Challenge—decision-making in the context of big data Need for systems to capture, store and access the data Emergence of data analytics and related new jobs Accountants must embrace new opportunities LO 4 without losing the quality Copyright ©2022 John and content of Wiley & Sons, 31 Canada, Ltd. Impact of Technology: Data Governance According to CPA Canada, “… data governance is often defined as a collection of processes, roles, policies, standards and metrics that ensure the effective and efficient use of information in enabling an organization to achieve its goals." LO 4 Copyright ©2022 John Wiley & Sons, 32 Canada, Ltd. Sustainability Reporting (ES G) Value creation: process of creating potential for o Revenue and net income in the future o Future benefits for stakeholders Encompasses a broader stakeholder perspective—beyond shareholders and profits How businesses deal with environmental, social, and governance (E SG) issues is related to creating economic value Standards require disclosure of this information LO 4 Copyright ©2022 John Wiley & Sons, 33 Canada, Ltd. Some Issues to be Addressed Environmental:with E S G climate change, air quality, energy management, biodiversity, land uses, greenhouse gas emissions Social: human capital management, diversity and inclusion, health and safety, product safety, cybersecurity and data privacy Governance: quality of board of directors, oversight of executive performance/compensation, oversight of company’s strategy, risk management, L O 4 performance, and©2022 Copyright disclosure John Wiley & Sons, 34 Canada, Ltd. Disclosure Guidelines and Frameworks Global Sustainability Standards Board (GSSB): sustainability reporting including E SG International Integrated Reporting Council (IIRC): integrated reporting Sustainability Accounting Standards Board (SASB): environmental, social, and governance disclosures Financial Stability Board (FSB): climate-related disclosures Climate Disclosure Standards Board (CDSB): climate-related disclosures World Economic Forum (WEF): core metrics and disclosures for non-financial metrics LO 4 Copyright ©2022 John Wiley & Sons, 35 Canada, Ltd. Oversight in the Capital Marketplace The Sarbanes-Oxley Act (S OX) was enacted in 2002 (in the United States) after prominent accounting scandals Some of the legislation’s key provisions: o Public Company Accounting Oversight Board (P CAOB) o Stronger independence rules o CEO/CFO certification and bonus/profit forfeiture o Management report on effectiveness of internal controls systems o Independent and expert audit committee LO 4 Copyright ©2022 John Wiley & Sons, 36 members Canada, Ltd. Oversight: Canadian Approach The Canadian Public Accountability Board (CPAB) SOX requirements put in place in Canada: o Increased disclosures o Management responsibility for appropriateness and fairness of financial statements o Independent audit committees for public companies Canadian companies that issue shares in the U.S. are bound by SOX LO 4 Copyright ©2022 John Wiley & Sons, 37 Canada, Ltd. Centrality of Ethics Ethical dilemmas are common in accounting and other areas of business Biases sometimes lead to an emphasis on short-term results and place accountants in an environment of conflict It is not always easy to do the right thing, or make the right decision Ethical decisions often go beyond applying GAAP or rules of the profession Process of ethical sensitivity and choosing among alternatives can be complicated by work pressures LO 4 Copyright ©2022 John Wiley & Sons, 38 Canada, Ltd. Standard-Setting in a Political Environment Standards are affected by political action, not just logic or research findings Stakeholder influence and special interest groups can have a significant impact on accounting standards—some supporting, some opposing Compounded by diverse needs of a global membership (e.g. IFRS) Complication of how standard-setters are funded: broad-based, compelling, open-ended, country-specific Challenge: giving stakeholders a voice without LO 4 Copyright ©2022 John Wiley & Sons, 39 becoming political Canada, Ltd. Principles versus Rules Rules-based standards (like Canadian tax system) have many rules which are usually interpreted literally Rules-based approach usually has a larger body of knowledge Principle-based standards (like A SPE and IFRS) are more dependent on professional judgment with bright-line tests minimized Standards should be o based on a cohesive set of principles and a conceptual framework that are consistently applied o flexible to cover many industries o detailed enough to provide good guidance LO 4 Copyright ©2022 John Wiley & Sons, 40 Canada, Ltd. Copyright Copyright © 2022 John Wiley & Sons, Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. Copyright ©2022 John Wiley & Sons, 41 Canada, Ltd.