ADMS 3585 Intermediate Financial Accounting I

John Kucharczuk jkuchar@yorku.ca ADMS3585@YORKU.CA

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CHAPTER

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The Canadian Financial Reporting Environment
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Chapter Overview

What is financial reporting?

Characteristics, role, objective

Environment of financial reporting

Who set standards? Who use standards? Challenges facing financial reporting
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The Canadian Financial Reporting Environment

Role of Financial Reporting Financial statements and financial reporting Accounting and capital allocation Stakeholders Objective of Financial Reporting Management bias Users needs Standard Setting Need to develop standards Parties involved in standard setting Standard setting in a political environment GAAP GAAP hierarchy Professional judgement Role of ethics

Challenges Facing Financial Reporting Globalization of companies and capital markets Impact of technology Changing nature of the economy Increased requirement for accountability
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The Canadian Financial Reporting Environment

Role of Financial Reporting Financial statements and financial reporting Accounting and capital allocation Stakeholders
Objective of Financial Reporting Management bias Users needs Standard Setting Need to develop standards Parties involved in standard setting Standard setting in a political environment GAAP GAAP hierarchy Professional judgement Role of ethics

Challenges Facing Financial Reporting Globalization of companies and capital markets Impact of technology Changing nature of the economy Increased requirement for accountability
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Characteristics of Financial Reporting 3 Ws

What does FR do? For whom? Why do it? (To achieve what?)

Financial reporting
1. identifies, measures, and communicates financial information about 2. economic entities to 3. interested persons (decision makers)
Identify - Whether to record Measure - What amount to record Communicate - How to report
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Financial aspects

Accounting Cycle

Accounting information

Business Activities

Financial Reporting
Decision Makers

Flow of

Financial Reports

Decisions

Auditing
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Think: Financial Reporting vs. (1) Accounting (2) Financial Accounting

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Think:

Financial Statements = Financial Reporting? = Business Reporting?

Wileyplus: Shoppers 2008 Annual Report
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Flow of Information through the Financial Statements

Income Statement
Reports Net Income

Balance Sheet
Ending balance reported

Change in cash as reported displays the change in cash position

Statement of Equity

Statement of Cash Flows

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Financial Reporting
Other forms of financial reporting include:
Presidents letter Prospectuses Government reporting News releases Management forecasts

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Financial Reporting For Whom?

Why bother to report?
Benefits? Costs?

Depends on the nature of reporting entity

Public firms Private firms Other (NPOs, pension funds)

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Financial Reporting For Whom?

Stakeholder: any parties that have a stake with a firms financial information.
Includes anyone who prepares, relies on, reviews, audits, or monitors financial information

Key stakeholders include

Internal: management, employees, etc. External: investors, creditors, external auditors, regulators, analysts, standard setters, etc.

What is at stake?

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Why Financial Reporting?

Financial reporting aids users in the allocation of scarce resources (capital)
What is capital? Who possess capital? Why an effective process of capital allocation is critical?
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Think OBJECTIVES of financial reporting vs.

MOTIVATIONS of management
Worldcom - What went wrong
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Management Bias
Preparation of the financial statements are the responsibility of internal management May lead to preparing statements that report the enterprise in its best light Motives include:
to reflect positive management stewardship (job, compensation) meet financial analysts expectations, resulting in a positive reaction in the capital markets
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Management Bias
What safeguards are in place to protect financial users from management bias?
Principles: GAAP > Watchdogs
- Auditors
- Whether the firm follows GAAP

- Market regulators (US: SEC; Canada: provincial securities commission):

- Whether market players comply with securities 18 law

The Canadian Financial Reporting Environment

Role of Financial Reporting Financial statements and financial reporting Accounting and capital allocation Stakeholders Objective of Financial Reporting Management bias Users needs

Standard Setting Need to develop standards Parties involved in standard setting Standard setting in a political environment

GAAP GAAP hierarchy Professional judgement Role of ethics

Challenges Facing Financial Reporting Globalization of companies and capital markets Impact of technology Changing nature of the economy Increased requirement for accountability
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Canadas Move to IFRS Whats the move Why the move to IFRS? Transition Issues

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Whats the Move?

Starting from Jan 1 , 2011: Public firms: IFRS Private firms, NPO, pensions: Canadian GAAP
Why separate GAAP - One GAAP does not fit all Publically accountable enterprises 3,249 Non-Publically accountable (Private) enterprises 2,289,329 Other: Not for Profit Organizations (NPO); pensions Divergent needs of these different groups Making one set of standards will end in not serving any one of the groups properly 21

Why the Move to IFRS?

"IFRS Ready by PWC

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Why the Move to IFRS?

Canada makes up only 4% of the world market Greater access to global capital markets IFRS has gained strong support worldwide

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Global Adoption of IFRS A Recent Trend

Canada - by 2011, all public firms EU - 2005 with exceptions on fair value standards China - substantial convergence with IFRS in 2007 US FASBs agreement with IASB on IFRS Active convergence project IFRS by Dladd17
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IFRS WORLD WIDE

More than 100 countries now require or permit the use of IFRSs or are converging Blue areas indicate countries that require or permit IFRSs. Grey areas are countries seeking convergence or pursuing adoption of IFRSs.

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IFRS
The International Accounting Standards Board (IASB) was formed in 2001 (Predecessor in 1973) The set of standards developed by IASB is called International Financial Reporting Standards (IFRS) The objective was to narrow divergence in international financial reporting Difficult task due to differing objectives, institutional structures, and national tendencies in various countries Strives towards a single, global method of accounting
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TRANSITION ISSUES FOR STUDENTS

ALL PROFESSIONAL EXAMS WILL NOW BE BASED ON IFRS
How will we cope with this change in this class? Remember the Business hasnt changed business events remain the same Previous standards are what is covered in the text book PE GAAP based on previous Canadian Standards (largely the same as Canada) IFRS based on a similar framework causing only some differences
These differences will be discussed in class
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GAAP BASICS

What is GAAP? Scope of GAAP Why GAAP? Who sets GAAP? GAAP Hierarchy
Primary vs. Secondary
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What is GAAP
Generally Accepted Accounting Principles The profession has developed GAAP, which present fairly, clearly, and completely the financial operations of the enterprise GAAP consist of authoritative pronouncements issued by certain accounting bodies GAAP varies by country and region
US GAAP, Cananian GAAP, IFRS, etc.

Standards are not rules, regulations, or laws Standards are intended to be generally accepted and universally practised

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Scope of GAAP
CICA HANDBOOK (CICAHB)

Part Part Part Part Part

I: IFRS II: Private Entity GAAP III: Accounting for NPOs IV: Accounting for Pensions V: Existing GAAP
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Scope of GAAP?
Broad scope
Part I through Part IV

Narrow scope
Part II only (PE GAAP) Part II through Part IV (Non-public Entity GAAP)

Text comparison is between IFRS and PE GAAP

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Why GAAP?
Standards are set to aid preparers and users of financial statements They allow the preparers of the financial statements to present fairly the operations of the company A single set of financial statements is prepared to meet the majority of the users needs
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Who Sets GAAP?

Canadian Accounting Standards Board (AcSB)
Primarily responsible for setting GAAP in Canada
From 2011, this will be limited to standards for private enterprises, not-for-profit entities, and pension plans only (standards for publicly accountable entities will be set by the International Accounting Standards Board)

IASB responsible for IFRS FASB responsible for US GAAP, but has huge
impact on IFRS and Canadian GAAP

Provincial Securities Commission

responsible for setting additional regulations that 33 must be complied by listed firms

GAAP Hierarchy
Primary sources Secondary sources
Secondary sources are used when primary sources do not specifically apply; Must be consistent with primary sources and in accordance with the conceptual framework (i.e. CICA Handbook Section 1000)

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GAAP Hierarchy PE GAAP

For private companies, pension plans, and notfor-profit entities, GAAP consists of :
Primary sources CICA Handbook Sections 1400 to 3870 Accounting guidelines Secondary sources Background documents and implementation guidance issued by AcSB Pronouncements in other jurisdictions Research studies, accounting textbooks, journals, etc.
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GAAP Hierarchy IFRS

For public companies (reporting under IFRS), GAAP (Primary sources) includes:
Primary sources
IFRS International Accounting Standards (IAS) Interpretations (IFRIC or SIC)

Secondary sources
Pronouncements of other standard-setting bodies Other accounting literature Accepted industry practices
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Role of Ethics
Ethical dilemmas are common in accounting and other areas of business 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

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Rule-based or Principle-based? (Professional Judgment)

There cannot be a rule for every situation Standards in Canada are based primarily on principles rather than specific rules Therefore, must use professional judgement IFRS are based on principles as well The United States uses a rules-based approach

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 Finance lease definition: US GAAP vs. IFRS

US GAAP: A lease is finance lease if one of the following is satisfied:
the lease term equals or exceeds 75% of the asset's estimated useful life; The present value of the lease payments >= 90% of the total original cost of the leased asset; . The least term is for the major part of the economic life of an asset The present value of the lease payments amounts to substantially all of the total original cost of the leased asset

Rule-Based or Principle-Based? An Example

IFRS

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The Canadian Financial Reporting Environment

Role of Financial Reporting Financial statements and financial reporting Accounting and capital allocation Stakeholders Objective of Financial Reporting Management bias Users needs Standard Setting Need to develop standards Parties involved in standard setting Standard setting in a political environment GAAP GAAP hierarchy Professional judgement Role of ethics Challenges Facing Financial Reporting Globalization of companies and capital markets Impact of technology Changing nature of the economy Increased requirement for accountability
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Challenges Facing Accounting

Need for international harmonization of standards Globalization
Technology New economy Accountability Ability to produce and access timely information A move from the traditional resource-based to a knowledge-based economy Driven by more sophisticated and varied investors
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