Int financial Accounting 1 Midterm

Mid term definition based questions

Financial Accounting

The process that culminates in the preparation of financial reports for the company as a whole for use by both internal and external parties. Also known as Financial reporting.

Managerial Accounting

The process of identifying, measuring, analyzing, and communicating financial information to internal decision-makers.

Financial statement!

The principal means through which financial information is communicated to those outside a company. They provide a company’s history, quantified in money terms

Capital allocation

The process by which accounting enables investors and creditors to assess the relative returns and risks associated with investment opportunities and thereby channel resources effectively. the primary exchange mechanisms for allocating resources are debt and equity markets, as well as financial institutions such as banks.2,3 The debt and equity marketplace includes both public stock markets/exchanges and private sources.

Financial accounting and reporting l’

used by both internal users (decision making) and external (management accounting). Includes financial statements and reports with securities commissions and gov agencies

Stakeholders have different things at stake

Investors and creditors- investment /loan

management - job, bonuses, reputation, salary increase, access to capital markets by company

Audit/analyst/standard setters - reputations

Information Asymmetry

In perfect world everyone has the same information (information symmetry), but this doesnt ever really happen. Some reasons why include capital markets not being fully efficIient, human behaviour sometimes motivated by maximizing self-interest at the cost of others. Managers have more information than other stakeholders, management can act in their own interest for reasons like evaluating personnel performance, compensation structures, access to capital markets and meeting expectations, meeting contractual obligations.

• There are two types of asymmetry problems,

  1. Adverse selection

  2. Moral Hazard

Information asymmetry problems

1. Adverse selection: knowing that there is an information asymmetry, capital markets may attract wrong kinds of companies.

2. Moral Hazard: knowing that there is information asymmetry, individuals may act in their own best interest at the expense of others (management bias)

   Accounting standards help reduce information asymmetry in financial reporting, but standards are not rules.

AcSB Canadian accounting standards board

Primarily responsible for setting GAAP for Canadian private enterprises (ASPE), not for profit entities, and pension plans. Development of standards are to be responsive and operate in the full public view.

Management

Whos responsible for preparing financial statements

Auditors are responsible for…..

Auditors are responsible for providing an opinion on whether the financial statements are presented fairly in accordance with the applicable GAAP (IFRS or ASPE)

CHAPTER TWO

Financial Engineering

Became more visible in the last 3 decades. A process whereby a business arrangement or transaction is structured legally such that it meets the company’s financial reporting objective (for example, to maximize earnings, minimize a debt to equity ratio, or other). These arrangements and instruments are created so that the resulting accounting meets the desired objective within GAAP. (For example, a company that is raising debt financing might want the instrument structured so that it meets the GAAP definition of equity rather than debt. In this way, the debt to equity ratio is not negatively affected.)

• Many financial institutions develop and market these financial instruments to their clients. These arrangements are often called structured financings.

• Arranging information to get the results that you want not what has actually happened in the company.

T or F

Under ASPE, the primary source of GAAP is the CPA Canada Handbook, Part II

True

Appropriate characteristics

The qualitative characteristic being employed when companies in the same industry are using the same accounting policies.

• Comparability

Quality of information that confirms users earlier expectations

• feedback value

Necessary for providing comparisons of a company from period to period

• consistency

ignores the economic consequenc es of a standard

• neutrality

Requires a high degree of consensus among individuals on a given measurement

• verifiability

  Predictive value is an ingredient of this fundamental quality of information

• relevance

4 qualitative characteristics that are related to both relevance and faithful representation

1. comparability

2. timeliness

3. verifiability

4. understandability

Neutrality is an ingredient of this fundamental quality of accounting information

• representational faithfulness

2 fundamental qualities that make accounting information for decision making purposes

• relevance & representational faithfulness

Insurance of interim reports is an example of this enhancing quality of relevance

• timeliness

Elements examples

• arises from peripheral or incidental transactions - gains or losses

• obliges a transfer of resources because of enforceable obligation - liability

• increases in the ownership interest though insurance of shares - equity

• dividends declared and paid (ex to owners) - equity

• expenditure w future economic benefits - assets

• arises from income generating activities that are ongoing or central operations - revenues or expenses

• residual interest int he enterprises assets after deducting liabilities - equity

• increases assets during period though sale of inventory - revenue

• decreases assets during period by purchasing company’s own shares - equity

• bonds payable- liability

• accumulated dep - asset

Foundational principles and assumptions of accounting

Economic entity: indicates that personal and business record-keeping should be separately maintained

Control: related to the economic entity principle, defines the entities that should be consolidated in the financial statements

Revenue recognition and realization: requires passing of risks and rewards, measurability, and collectability before recording the transaction.

Matching: allocates expenses to revenues in the proper period

Going concern: is why plant assets are not reported at their value (do not use historical cast principle)

Historical cost: indicated that market value changes after the purchase are not recorded in the accounts unless impairment exists. (do not use revenue recognition principle)

Fair value and value in use: Permits the use of market valuation in certain specific situations.

Conceptual framework

Cccountants use conceptual frameworks for financial accounting and reporting.

• A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements.

why is it needed

• standard setting should build on an established body of concepts and objectives. Standard setters are then able to issue additional useful and consistent standards over time. The result is a coherent set of standards and rules, because they have all been built upon the same foundation. This increases user understanding and confidence in financial information.

• it should be possible to solve new and emerging practical problems more quickly. It is difficult, if not impossible, for standard setters to quickly state the proper accounting treatment for highly complex situations. Practising accountants, however, must solve such problems on a day‐to‐day basis. By using good judgement, and with the help of a universally accepted conceptual framework, it is hoped that accountants will be able to decide against certain alternatives quickly and to focus instead on a logical and acceptable treatment.

Conceptual framework for financial reporting levels

1. objectives (whys, goal and purpose of accounting)

   • information that is useful in making rational investment, credit and other decisions.

2. Qualitative characteristics of accounting information and elements of financial statements (bridges between 1 and 3) info must be useful for decision making and understandable

   A) i) qualitative characteristics: include fundamental relevance and representational faithfulness (free from error or bias)

   ii) enhancing: comparability, verifiability, timeliness, understandability

   B) Elements (assets, libabilities, equity, revenue, expense, gain/loss)

   • information to help in making resource allocation decisions

3. Foundational principles

   • information that is useful in assessing management stewardship(how well management is using entity resources to create and sustain value.)

   • control, revenue recognition, matching, periodically, going concern, fair value, full disclosure, ect

Triangle 1 at top

CHAPTER THREE

Historical Cost

What the company paid for the asset when they originally got it. EX) PPE and inventory

Fair value ….

of an asset is an exit price

Discounted cash flows model

Widely accepted tool for dealing with uncertainty and the time value of money.

2 approaches- traditional and expected

traditional vs expected cash flow models

Traditional: Rate reflects risks in the cash flow but the cash flows are assumed to be certain. (discounted rate adj technique)

Expected: risk-free disc rate is used to discount cash flows that have been adj for uncertainty. (expected pv technique)