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The Financial Reporting Environment IIll IIll IIll
IIll Solutions
Questions
Q1-1 Financial information is a much broader concept than simply the financial statements
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and footnotes to the financial statements. Financial information includes items such as the
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President‘s letter to the owners, management‘s discussion and analysis, the auditors‘ report,
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the management report and press releases. Of course, the basic financial statements and
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footnotes are included in the term financial information. The basic financial statements are:
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the balance sheet (also referred to as the statement of financial position), the statement of
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comprehensive income (also referred to as the statement of net income and the statement of
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comprehensive income), the statement of cash flows, and the statement of shareholders‘
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equity. Financial information is not synonymous with the term financial statements because
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the financial statements are a subset of the different types of financial information provided.
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Q1-2 The purpose of generating financial statements is to provide useful information to users
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to evaluate economic entities and make efficient resource allocation decisions based on the
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risks and returns of a particular investment. The Financial Accounting Standards Board
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(FASB) identifies investors, lenders and other creditors as the primary users of the financial
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statements. The financial statements are the culmination of the financial reporting process.
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Q1-3 Capital is a scarce resource. Investors and creditors have to make decisions as to how
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much capital to invest in any given entity; therefore, they demand relevant and faithfully
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representative information about the economic performance and financial position of a
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company. This information is provided in the financial statements.
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Q1-4 External auditors ensure that the management of a company has prepared financial
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statements in accordance with Generally Accepted Accounting Principles and fairly present the
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financial position and economic performance of a company. In addition, external auditors
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must be an independent party and cannot be employees of the company they are auditing.
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External auditors provide a significant amount of credibility to the financial statements.
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Q1-5 Data analytics is the process of analyzing large data sets in order to draw useful
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conclusions. It involves converting raw data into useful knowledge. In financial reporting, data
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analytics can be used to improve the quality of estimates and valuations.
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Q1-6 Standard setters create accounting concepts, rules, and guidelines to ensure that financial
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statements accurately present the economic performance and financial position of a firm.
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The standards encourage transparent and truthful reporting.
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Q1-7 U.S. companies listed on U.S. stock exchanges do not have the option to report under
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IFRS. However, foreign companies that trade in the U.S. exchanges can report under IFRS.
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The SEC permits the use of IFRS-based financial statements by international companies with
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shares trading on U.S. stock exchanges.
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Q1-8 The FASB seeks and welcomes comments from all parties in the financial reporting
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process including managers, investors, accountants, preparers, creditors, lenders, financial
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statement users, governmental agencies, financial analysts, industry groups, and auditors.
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FASB also receives feedback from public roundtable discussions, public meetings, the
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FASAC, the Private Company Council, and EITF.
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Q1-9 Yes, the promulgation of financial accounting standards is a political process. There
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are several groups that influence the standard setting process. The standard setting process
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is a political process that is affected by the impact of several lobbying groups. The
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government, through the SEC, influences accounting standards. The SEC has the authority to
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issue accounting standards but has assigned this responsibility to the private sector.
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Nonetheless, the SEC can exert pressure on the FASB to issue accounting standards and
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veto the standards promulgated by the FASB. Auditing firms, the corporate sector, creditors,
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financial analysts, the financial community, accounting organizations, industry groups, and
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investors can influence the FASB by written comments about Exposure Drafts and
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participation in public meetings and public roundtables regarding a proposed financial
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reporting standard.
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Q1-10 A principles-based standard is consistent with a theoretical framework. In contrast,
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a rules-based standard does not necessarily rely on a consistent theoretical framework.
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Rather, it contains more specific and prescriptive rules.
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Q1-11 Recently, the FASB has taken an asset/liability approach in setting standards. With
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this approach, a transaction is recorded based on whether an asset or liability is created.
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Another trend has been the movement toward the use of fair value measurements as an
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alternative to historical cost. FASB has also focused on the promulgation of principles-based
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standards instead of rules-based standards.
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Brief Exercises IIll
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General-purpose financial statements provide general financial information about an entity IIll IIll IIll IIll IIll IIll IIll IIll IIll
that will be useful to many types of users. General-purpose financial statements provide
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information to a wide spectrum of user groups: investors, creditors, financial analysts,
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customers, employees, competitors, suppliers, unions, and government agencies. Most
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financial information in general purpose financial statements is provided to satisfy users with
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limited ability or authority to obtain additional information, which includes investors and
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creditors. The Financial Accounting Standards Board (FASB) identifies investors, lenders,
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and other creditors as the primary users of the financial statements.
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EN V IR O N MEN T
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Solution to BE1-2 IIll IIll
Financial accounting is the process of identifying, measuring, and communicating financial
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information about an economic entity to various user groups within the legal, economic,
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political, and social environment. This definition contains four major elements: 1. Financial
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information; 2.Economic entity; 3. User groups and 4. Legal, economic, political, and social
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environment
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Financial Statement Users IIl IIl
and Other Parties
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10. Are shareholders of the company.
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1. Are banks and other financial institutions that lend IIll IIll IIll IIll IIll IIll IIll
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5. Use financial information to review and
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IIll 5 Financial Analysts
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analyze reported results of the companies they
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cover and make investment recommendations.
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IIll 8 Employees and Labor
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IIll Unions 8. Use financial information during negotiation of IIll IIll IIll IIll IIll
new labor agreements and compensation contracts.
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IIll 2 Suppliers and Customers
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conduct business or purchase products from a
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IIll 7 Government Agencies
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7. Review the financial statements of publicly
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traded companies for a variety of reasons that are
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in the public interest. IIll IIll IIll IIll
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3. Use financial information to determine their market IIll IIll IIl IIll IIll IIll
IIll 6 Internal Auditors
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position relative to the reporting entity and to
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attempt to identify future strategies of the
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IIll 11 Regulatory Bodies
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4. Are independent of the company and IIll IIll IIll IIll IIll
IIll 9 Professional Organizations
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responsible for ensuring that management
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prepares and issues financial statements that
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comply with accounting standards and fairly
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present the financial position and economic
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performance of the company. IIll IIll IIll IIll
6. Are employees of the company serving in an
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advisory role to management. They provide
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information to management regarding the
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company‘s operations and proper functioning of its
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internal controls. IIll IIll
11. Protect investors and oversee the accounting and IIll IIll IIll IIll IIll IIll
auditing standard setting processes.
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9. Support accounting professionals throughout their IIll IIll IIll IIll
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careers by providing training, professional skills
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development, and other resources.
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Solution to BE1-4 IIll IIll
Financial statement users and why each would use the financial statements are summarized
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below:
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1. Equity investors - Equity investors buy stock in the company, that is, they
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purchase a percentage of the company itself. The financial statements help them
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make investment decisions.
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2. Creditors - Creditors loan money to the company. The financial statements help them
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assess the creditworthiness of the company, and whether principal and interest will be
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repaid. IIll
3. Competitors - Competitors use financial statements to determine their market IIll IIll IIll IIll IIll IIll IIll IIll IIll
position relative to the reporting entity.
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