Chapter 1 Flashcards
What is the definition of accounting?
identifies, measures, and communicates financial information about economic entities to interested people
What are the two types of accounting?
Financial and managerial accounting
What is financial accounting?
preparation of financial statements
Who is financial accounting for?
Internal and external users
Investors, creditors, and other
What is managerial accounting?
Communicating financial information through varied forms
Who is managerial accounting for?
Internal decision makers
Management uses to plan, evaluate, and control operations
What is the purpose of basic financial statements?
Communicates financial information to outsiders
What are the major financial statements?
Statement of financial position (Balance sheet)
Statement of income / comprehensive income (Income statement)
Statement of cash flows
Statement of changes in equity (IFRS) or statement of retained earnings (ASPE)
What does accounting help investors and creditors do?
They help compare the income and assets of companies
Assess the risks and returns associated with companies before making an investment decision
What is the responsibility of the accounting profession?
measuring a company’s performance accurately and fairly on a timely basis
What is necessary for a healthy economy?
an effective process of capital allocation
How is accounting involved in credit ratings?
Accounting is used to rate a companies financial stability
List stakeholders in financial reporting:
investors and creditors (resource allocation)
financial analysts and regulators (help allocation of resources)
Anyone who prepares, relies on, reviews, audits, or monitors financial information
Who audits statements?
Independent auditors
They act on behalf of shareholders to ensure accountability
What is at stake for investors/creditors?
Investments or loans
What is at stake for managers?
Jobs, bonuses, reputation, salary increase…
What is at stake for securities commissions and stock exchanges?
reputation, effective and efficient capital marketplace
What is at stake for analysts and credit rating agencies?
reputation & profits
What is the objective of financial reporting?
to provide financial information that is useful to current and potential decision makers
What is the entity perspective of financial reporting?
Companies are viewed as separate from their owners
Assets are rights accruing to the entity where capital providers have claim on those assets
Assets = Creditor equities + owner equities
What is the proprietary perspective?
owners are the central position of financial reporting
assets are resources of the owner, liabilities are obligations of the owner
Assets - Liabilities = proprietorship (equity)
What is information asymmetry?
managers having access to more information than other stakeholders
In an ideal world, what would the flow of information look like?
there would be information symmetry where all stakeholders have equal access to all relevant information
What are the reasons information asymmetry exists?
Capital markets - not all information is available and incorporated into stock prices of companies
Human behaviour - individuals and companies act according to their self interest at the cost of capital market participants
What is information symmetry?
all stakeholders have equal access to relevant information
nice in theory, doesn’t work in practice
What are two types of asymmetry problems?
Adverse selection
Moral hazard
What is the adverse selection problem (information asymmetry)
when information asymmetry exists, the marketplace attracts the wrong kind of participants
What is the moral hazard problem (information asymmetry)
concept where people shrink their responsibilities if they think no one is watching
What is aggressive accounting?
downplay the negatives and focus on the positives
What is conservative accounting?
downplay the positives and focus on the negatives
What are the reasons managers may present biased information?
evaluation of their performance
compensation structures
access to capital markets and meeting analyst expectations
meeting contractual obligations
Are accounting standards the law?
No
What are accounting standards classified as?
Recommendations, they are not rules or the law
Why do accounting standards exist?
they help reduce information asymmetry problems in financial reporting
When creating accounting standards who is considered?
the entire economic community
What does AcSB stand for?
The Canadian Accounting Standards Board
What does IASB stand for?
The International Accounting Standards Board
What does FASB stand for?
The Financial Accounting Standards Board (FASB)
What does GAAP stand for?
Generally accepted accounting principles
Who is responsible for setting GAAP in Canada?
The Canadian Accounting Standards Board (AcSB)
What are the objectives of AcSB?
establish standards that improve the quality of information
participate with other standard setters to develop internationally accepted standards
facilitate the capital allocation process through improved information
What does the IASB do?
dominant global standard-setting body
tries to lessen differences among countries
Who uses IFRS in Canada?
Public companies in Canada
Who uses GAAP in Canada
Private companies
What does FASB do?
they are the major standard-setting body in the United States
How does US GAAP compare with ASPE (accounting standards for private enterprises)?
ASPE - principle-based
US GAAP - more prescriptive and provides more guidance
If a Canadian company is listed on US exchanges, what standard must they follow?
IFRS or US GAAP
Why are most large Canadian companies registered with the Ontario Securities Commission?
Because the Toronto Stock Exchange is in Ontario and governed by the Ontario Securities Commission
How does professional judgment come into play for standards in accounting?
There cant be a rule for every situation
Canadian standards are based primarily on principles rather than rules
If no principle exists, accountants must use professional judgement
US GAAP provides more detailed guidance than IFRS and ASPE
What is data governance?
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
What is value creation?
the process of creating the potential for
- revenue and net income in the future
- future benefits for stakeholders
What is sustainability reporting (ESG) all about?
encompassing a broader stakeholder perspective - beyond shareholders and profits
What is looked at when analyzing ESG?
how businesses deal with environmental, social, and governance (ESG) issues is related to creating economic value
What are examples of environmental issues that ESG addresses?
climate change, air quality, energy management, land use, greenhouse gas emissions
What are examples of social issues ESG addresses?
human capital management, diversity and inclusion, health and safety, product safety
What are examples of governance issues ESG addresses?
quality of the board of directors, oversight of executive performance / compensation, oversight of company’s risk strategy, risk management, performance, and disclosure
Do accountants face ethical dilemmas?
Yes, they are in environments of conflict and must be able to make the right decision
Are accounting standards affected by just logic/research findings?
No, they are affected by political action too
What is the challenge of setting standards in a political environment?
Giving stakeholders a voice without becoming political
Explain the difference between principles vs. rules
Rule-based standards like the Canadian tax system have many rules for almost every scenario.
Principle-based standards (ASPE and IFRS) are more reliant on professional judgement with bright-line tests minimized
Principle-based standards can be easier to defend (as it has some interpretation to it)
Rule-based approach might not communicate the best information to users.
What are bright-line tests?
numeric benchmarks for determining accounting treatment.
For example: a loan must be greater than 75% of the economic life of the asset to be treated a certain way… making it a threshold that is black and white.
Often times it isn’t black and white (its not always clear cut)
What should standards be?
Based on cohesive set of principles and a conceptual framework that is consistently applied
Flexible to cover many industries
Detailed enough to provide good guidance
