Chapter 1 — The Canadian Financial Reporting Environment
Accounting: identifies, measures, and communicates financial information about economic entities to
interest persons.
● Separated into two classifications
○ (1) Financial Accounting: focuses on an organization’s external financial processes
(reports to external parties)
■ Preparation of financial statements
■ Internal (managers and employees) and external users (investors, creditors, etc)
○ (2) Managerial Accounting: focuses on an organization’s internal financial processes
(reports to managers)
■ Communicates financial information through varied forms
■ Internal decision makers
■ Management uses to plan, evaluate, and control operations
Functions of Accounting (IMRCC)
I: Identifying (identifying transactions → what is a transaction?)
● A transaction is only recorded once an event takes place or a prepayment is made
M: Measuring (measuring transactions)
● Transactions can be measured with..
○ Cost (historical cost)
○ Net Realizable Value (NRV)
■ Ex: Accounts receivables are calculated at the amount you’re expected to collect
○ Lower cost or Net Realizable Value (LCNRV)
■ We use this specifically for inventory
○ Fair Value
■ Ex: investments are measured at fair value
○ Value In Use (VIU)
■ Used for property and equipment assets
R: Recording (recording transactions → how do we record transactions?)
● Transactions can be recorded with..
○ Step 1: Journal entries
○ Step 2: T-accounts
○ Step 3: Trial balances
○ Step 4: Adjusting entries and putting them into Financial Statements
C: Classifying (classifying transactions by accounts)
● Assets and Liabilities are classified as..
○ Current
○ Non-Current
● Shareholders’ Equity is classified by source..
○ Source 1: Common Shares / Preferred Shares
○
Source 2: Retained Earnings / Deficit (deficit = negative retained earnings)
C: Communicating (communicating results of the transactions)
● Communicate to external users through a variety of reports
○ Stakeholders → anyone who doesn’t work for the company
■ creditors, suppliers, investors
● We are not concerned with internal users
Basic Financial Statements
● Serve to communicate financial info to outsiders
(IFRS OR ASPE)
○ Statement of financial position OR balance sheet
○ Statement of income/comprehensive income OR income statement OR statement of
profit or loss OR statement of financial performance
○ Statement of cash flows OR cash flow statement
○ Statement of changes in equity OR statement of retained earnings
■ Retained earnings = all accumulated incomes retained by the company
Balance Sheet vs Statement of Financial Position
● ASPE → Balance Sheet → private companies
○ Private companies have a choice to follow ASPE or IFRS
○ Must not report to external users
● IFRS → Statement of Financial Position → public companies must follow
○ Must report annually to external users
○ Shares of public companies trade publicly
○ Must have their financial statements verified by external auditors
Information Asymmetry
● Occurs when one party has access to more information than other stakeholders
● Ex: when managers have access to more information than other stakeholders
● More information can lead to easy flow of capital and lower the cost of capital
● Too much info could give away proprietary info that could cause profits to fall/impact firm’s
competitive advantage
● Two types of asymmetry problems: (1) adverse selection, (2) moral hazard)
●
(1) Adverse Selection – you expose yourself to more risks because you know you will be protected
from the consequences of what it is you’re doing (when one party deliberately withholds
information that the other party is not aware of )
○ A smoker withholds the information that he smokes on his application form for a health
insurance because he knows that a smoker has a higher risk of declining health
○ He then gets insurance for the same cost as a non-smoker
○ In reality, he would be paying a higher premium bc he is a smoker
○ Now, he is “protected” by health insurance and does not need to worry about his smoking
(2) Moral Hazard – concept that people will shirk responsibility if there is no accountability (is the
risks that one party has not entered into the contract in good faith or has provided false details
about its assets/liabilities/credit capacity in order to benefit themselves)
○ Ex: now that the smoker has gotten the lower-rate, they can act carelessly and continue to
smoke b/c they’re fully covered by health insurance
○ Ex: a manager of a pharmaceutical company may choose not to disclose negative info
about ongoing drug trials knowing that it will result in a decline in share prices and
perhaps a manager’s bonus
○ Acts in their own self-interest after the transaction has been made
Information Asymmetry Issues
○ Management bias → managers presenting biased information
■ Aggressive accounting –downplay the negative and focus on the positive
■ Conservative accounting –downplay the positives and focus on the negatives
Need for Standards
● Standards help reduce information asymmetry problems
● Transactions and events must be recognized, measured, presented, and disclosed in a specific way
● Standards are not rules/laws, they are recommendations that are generally/universally accepted
● Parties involved in standard setting in Canada
○ The Canadian Accounting Standards Board (AcSB) –since 2011
■ Responsible for setting GAAP in Canada and producing the CPA Handbook
■ Adopts IFRS into Canadian GAAP
■ Monitored by AcSOC (accounting standards oversight council) and the IFRS
discussion group
○ The International Accounting standards Board (IASB)
■
Global standard-setting body that tries to lessen differences among countries;
standards
■ Aim to improve and harmonized regulations, accounting standards, and
procedures among countries
■ Overseen by IFRS Advisory Council, Accounting Standards Advisory Forum, etc
○ The Financial Accounting Standards Board (FASB)
■ Is the major standard setting body in the USA where Securities Exchange
Commission has the final authority
■ U.S. GAAP impacts Canadian GAAP to be more prescriptive, specific
■ Many canadian companies are listed on US exchanges and so, must follow U.S.
GAAP
○ Various Securities Commissions
■ Provincial Securities Commissions
● Oversees and monitors capital marketplace in their provinces
Accounting Standards
● IFRS (international financial reporting standards)
○ Followed by public companies –it is obligatory for them
○ Private companies can choose to follow
○ International Accounting Standards Board is responsible for harmonizing accounting
standards worldwide (it can be hard to understand if many countries follow different
standards)
■ Primary sources of standards
● IFRS handbooks
● IAS handbooks (international accounting standards; predecessors of
IFRS)
○ Issued by the predecessor of International Accounting
Standards Board → (International Accounting Standards
○
●
Committee)
● Interpretations (standards covered by IFRIC*, not IFRS or IAS)
○ Created by International Financial Reporting Guidelines
○ *IFRIC or the former Standards Interpretation Committee
■ Secondary source of standards
● Industry Practice
● Other accounting literature (textbooks, journals, etc)
● Pronouncements by other standards-setting bodies (ex: USA)
○ If we didn’t have a standard for a situation, we would look at
what the USA would do and familiarly replicate it
■ ***If there is no standard, we can also use our professional judgment! (for IFRS
and ASPE)***
The International Financial Reporting Standards Foundation oversees the activities
of the Internal Accounting Standards Board
ASPE (accounting standards for private enterprises)
○ Followed by private companies
○
○
Accounting Standards Board is responsible for setting these standards
■ Primary sources of standards (all standards can be found in..)
● (1) CPA handbook
● (2) Accounting Guidelines representing the AcSB’s opinions
■ Secondary sources –consult if you cannot find standards in primary sources
● Research study
● Accounting textbooks/journals/articles written on that specific issue
● Drafts of new or amended primary sources (i.e. exposure drafts) where
no primary sources apply
● Industry Practice (how does the industry handle this situation?)
The Accounting Standards Oversight Council monitors the activities of the
Accounting Standards Board to make sure everything is right
■ Formed of people from different expertise (lawyers, etc)
■ They try to make standards that cover every single possible situation
Competency Quiz Details
● 30 marks - 60 minutes
● Includes 5 questions
○ Adjusting entries (4 marks) – appendix C
○ Statement of financial position (6 marks) – chap 5
○ Canadian financial reporting environment (5 marks) – chap 1
○ Conceptual framework (5 marks) – chap 2
○ Statement of financial position (10 marks) – chap 5
Chapter 2 — Conceptual framework underlying financial reporting
Conceptual Framework in Accounting
● A coherent system of interrelated objectives and fundamentals
1) The system can lead to consistent standards
2) The system prescribes the nature, function, and limits of financial accounting and
financial statements.
3) Enhances comparability of different companies’ financial statements
4) Helps address information asymmetry
First level – Objectives of Financial Reporting
● To communicate information that is useful to investors/creditors + in making decisions about
resource allocation
● Usefulness (we must make our accounting information useful in order to allow external users to
make decisions and only report the most relevant information whereby benefits exceed costs)
Second level – (1) Qualitative Characteristics of Accounting Information
●
●
Fundamental qualities – how accounting info is useful for decision making
○ Relevance – accounting information must be capable of making a difference in decision
■ Predictive value (helps users make predictions about the final outcome of
past/present/future events)
■ Feedback/confirmatory value (can conclude/evaluate what happened in the past
so we can confirm/correct previous expectations —give compensation to staff)
■ Materiality (how important a piece of info is– is sensitive to decision making)
● Dynamic materiality: encompasses both the information on financial
statements and matters that reflect the organization’s significant impacts
on the economy, environment, and people, and also sustainability topics
that are material for enterprise value creation.
○ Representational faithfulness
■ Completeness (information must be show the whole picture of the company’s
finances: liabilities, assets, etc)
■ Neutrality (information is collected without bias, we follow the accounting
standards)
■ Freedom from Error (i.e, free from material error)
Enhancing Qualities – how accounting info can improve decision making
○ Comparability & consistency (information is measured and reported in a similar way —
can be compared only if they follow the same accounting standards… IFRS, ASPE, or
methods.. FIFO, this is consistency)
○ Verifiability (we must make sure that the info can be verifiable and proven, users achieve
similar results or reach consensus regarding the particular transactions)
○ Timeliness (info must be presented in a timely manner to avoid losing relevance, ex: info
must be reported during the period it is made.. by presenting financial statements yearly,
quarterly, or monthly)
○ Understandability (info is presented in a more simple/clear way in order for those with
basic accounting knowledge to understand the financial statements)
Second level – (2) Elements of Financial Statements
● Elements — how we present accounting transactions/measure a firm’s performance
○ Summarized under 7 categories in this order:
○ (1) Assets → a company’s resources that bring economic benefits
○
(2) Liabilities → company’s obligations resulting from a past transaction of event
○
(3) Equity → a residual interest in an entity that remains after deducting liabilities
from assets (aka net worth) – consists of common/preferred shares, retained earnings,
and other comprehensive income under IFRS
○
(4) Revenues, (5) Expenses, (6) Gains, (7) Losses
Third level — Foundational Principles (serves to implement the objectives on the 1st level)
●
Recognition/derecognition → what type of transactions we must recognize and remove on the
statement of financial position/income statement (journal entry is used to organize these data)
○ Economic entity assumption (an economic activity can be identified with a particular unit
of accountability, ex: a company, a division, an individual –who has control?)
○ Control: under IFRS, it’s determined by the number of common shares owned and
exposure to the risks/rewards of the entity –under ASPE, control is the continuing power
to determine strategic decisions without the cooperation of others
○
Revenue recognition/realization (determines how to recognize and realize revenue –
revenue is measurable, collectible)
○
●
●
Matching (matches money spent to earn revenues (efforts) to their revenues themselves
(accomplishments)
Measurement – determines how much we record/book
○ Periodicity assumption (we must assume that transactions/revenues are incurred/earned in
a certain period –dividing its economic activities in periods –monthly, quarterly, yearly)
○ Monetary unit (assumes money is the common unit, ignores price-level changes)
○ Going concern assumption (the assumption that the company will keep going
forward/remain active for the foreseeable future – this is because once a company enters
bankruptcy, some records in the financial statements will lose relevance.. the whole
accounting information will change and have different meaning since goals have changed
–ex: a company facing bankruptcy will want to know how much they can earn for selling
their assets)
○ Historical cost (transactions are measured at the price paid/received for an asset when it
was purchased –or at the fair value of the initial transaction)
■ Cannot be used for non-monetary transactions
○ Fair value/value in use (the estimated current value, market-based cost of the asset) (fair
value = market based, value in use = entity-specific based)
Presentation and Disclosure
○ Full disclosure (gives financial users all information that is useful to them, ex: risks and
opportunities) –anytime they are “reporting” something, it’s automatically full disclosure
Factors That Contribute to Choice and/or Bias in Financial Reporting Decisions
● Choice
● Financial engineering
○ Process of legally structuring transactions to meet the company’s financial reporting
objective —leads to biased information.
● Fraudulent financial reporting
○ Stems from weak internal controls/governance/pressures on individuals or the firm
■ To lessen it → implement governance structure that may include an
independent audit committee, strong internal control systems, etc
IFRS / ASPE Comparison
● IFRS and ASPE differences in conceptual framework
○ Less stringent standards under ASPE
○ Naming conventions for financial statements
○ Definitions for the elements
○ Criteria for revenue recognition
○ Definition of control
○ Definition of fair value
Statement of Financial Position (IFRS)
●
●
The only statement referred to as a “point statement”
○ Records a statement for a specific point in time (day)
○ Not “for the year ended..”
Statement is classified → assets (current/non current), liabilities (current/nc), shareholder’s
equity
○ Non-current assets follow IPIO order (long-term investments, PP&E, intangibles, other)
Assets
● Recording cash : include for compensating balances (restrictions)
○ Overdraft, etc
○ Make sure to disclose the restriction in the notes
○ For example: having a compensating balance of 20% means that we are restricted by 20%
and can only access 80% of the cash collected
○ We recorded cash as 80% of the original amount and “restricted cash” as 20% of the
amount
● Not all cash can be collected for accounts receivables
○ We include the uncollected cash in a contra account: “Allowance for doubtful accounts”
A/R
100,000
Allowance for doubtful accounts (700)
A/R (net)
99,300
●
●
FV-NI investments = current asset
Inventory should be recorded at the lower of cost and NRV
Liabilities
● Always disclose the interest rates and term (maturity date) in notes for notes payable/bonds
payable
● Disclose number of shares authorized, issued and outstanding in notes
● Show the calculations for retained earnings in the statement
○ Beginning retained earnings + net income (loss) - dividends = ending retained earnings
Midterm Exam
● 180 minutes, 3 hours, 100 marks
● Allocate 1.8 minutes per mark, recommended 1.6 min/mark for buffer
● Chapters 4, 6, 6A, 7, 8 (at least one question per)
● No multiple choice questions, very little theory involved
●
●
No specific questions on conceptual framework but still need to know definitions to apply
concepts to other questions
Total of 6 questions (some questions are multipart - prob chap 4, 7, 8)
○ 2 questions on chapter 6/6A (33 or 34 marks)
■ Revenue recognition (COPAR, sale returns/consignment, etc)
○ 1 question on adjusting entries (10 marks)
■ 5 questions for adjusting entries
○ 1 question on chap 4
■ Income statement
■ Statement of retained earnings
■ Statement of changes in equity
○ 1 question on chap 7
■ Account receivables (write offs, recovery, impairments, etc)
■ Note receivables (selling price, blended payments, factoring)
○ 1 question on chap 8 (20 marks)
■ Ratios are examinable in the context of inventory (P. 5-44)
● Study activity ratios, liquidity ratios, profitability
FV OCI - with recycling (debt)
- Adjust for FV every year
- Sale
1. Adjust for fv
2. Record proceeds
3. Reclassify
Loss on sale of FV-OCI investment – NI
Unrealized gain/loss
FV - OCI - without recycling (equity)
- Adjust at year end
- Sale
1. Adjust for fv
Unrealized gain/loss
FV-OCI investment
2. Record proceeds
Cash
FV-OCI investment
3. Reclassify
AOCI
Retained earnings
FV - NI
-
Adjust for FV every entry
Revaluation model
1. Record depreciation
2. Record accumulated dep
3. Revaluation surplus
1. New depreciation charge
2. Accumulated dep
3. Revaluation surplus
Sale
Cash
loss/gain
Asset
Revaluation surplus