CHAPTER 1 t
The Financial Reporting Environment t t t
t Solutions
Questions
Q1-1 Financial information is a much broader concept than simply the financial statements and
t t t t t t t t t t t t t
footnotesto the financialstatements. Financial information includes items such as the President‘s letter
t t t t t t t t t t t t t t
to the owners, management‘s discussion and analysis, the auditors‘ report, the management report and
t t t t t t t t t t t t t t
press releases. Of course, the basic financial statements and footnotes are included in the term
t t t t t t t t t t t t t t t
financial information. The basic financial statements are: the balance sheet (also referred to as the
t t t t t t t t t t t t t t t
statement of financial position), the statement of comprehensive income (also referred to as the
t t t t t t t t t t t t t t
statement of net income and the statement of comprehensive income), the statement of cash flows, and
t t t t t t t t t t t t t t t t
the statement of shareholders‘ equity. Financial information is not synonymous with the term
t t t t t t t t t t t t t
financial statements because the financial statements are a subset of the different types of financial
t t t t t t t t t t t t t t t
information provided.
t t
Q1-2 The purpose ofgenerating financialstatements is to provide usefulinformation to usersto
t t t t t t t t t t t t t t
evaluate economic entities and make efficient resource allocation decisions based on the risks and
t t t t t t t t t t t t t t
returns of a particular investment. The Financial Accounting Standards Board (FASB) identifies
t t t t t t t t t t t t
investors, lenders and other creditors as the primary users of the financial statements. The financial
t t t t t t t t t t t t t t t
statements are the culmination of the financial reporting process.
t t t t t t t t t
Q1-3 Capitalis a scarce resource. Investors and creditors have to make decisions as to how much capital
t t t t t t t t t t t t t t t t t
to invest in anygiven entity; therefore, they demand relevant and faithfully representative information
t t t t t t t t t t t t t t
about the economic performance and financial position of a company. This information is provided in
t t t t t t t t t t t t t t t
the financial statements.
t t t
Q1-4 External auditors ensure that the management of a company has prepared financial statements in
t t t t t t t t t t t t t t
accordance with Generally Accepted Accounting Principles and fairlypresent the financialposition
t t t t t t t t t t t t
and economic performance ofa company. In addition, external auditors must be an independent party
t t t t t t t t t t t t t t t
and cannot be employees of the company they are auditing. External auditors provide a significant
t t t t t t t t t t t t t t t
amount of credibility to the financial statements.
t t t t t t t
Q1-5 Data analytics is the process of analyzing large data sets in order to draw useful conclusions. It
t t t t t t t t t t t t t t t t t
involves converting raw datainto usefulknowledge. In financial reporting, data analytics can be used
t t t t t t t t t t t t t t t
to improve the quality of estimates and valuations.
t t t t t t t t
Q1-6 Standard setters createaccounting concepts, rules, and guidelines to ensure that financial
t t t t t t t t t t t t
statements accurately present the economic performance and financial position of a firm. The
t t t t t t t t t t t t t
standards encourage transparent and truthful reporting.
t t t t t t
,1 -2t t t SOLUTIONS MAN UAL FO R IN TERMED IATE AC COU NT ING
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t
Q1-7 U.S. companies listed on U.S. stock exchanges do not have the option to report under IFRS.
t t t t t t t t t t t t t t t t
However, foreign companies that trade inthe U.S. exchanges can report under IFRS. The SEC permits
t t t t t t t t t t t t t t t t
the use ofIFRS-based financial statements by international companies with shares trading on U.S.
t t t t t t t t t t t t t t
stock exchanges.
t t
Q1-8 The FASB seeks and welcomes comments from all parties in the financial reporting process
t t t t t t t t t t t t t t
including managers, investors, accountants, preparers, creditors, lenders, financial statement users,
t t t t t t t t t t
governmentalagencies, financial analysts, industrygroups, and auditors. FASB also receives
t t t t t t t t t t t
feedback from public roundtable discussions, public meetings, the FASAC, the Private Company
t t t t t t t t t t t t
Council, and EITF.
t t t
Q1-9 Yes, the promulgation of financial accounting standards is a political process. There are several
t t t t t t t t t t t t t t
groups that influence the standard setting process. The standard setting process is a political process
t t t t t t t t t t t t t t t
that is affected by the impact of several lobbying groups. The government, throughthe SEC, influences
t t t t t t t t t t t t t t t t
accounting standards. The SEC has the authorityto issue accounting standards but has assigned this
t t t t t t t t t t t t t t t
responsibility to the private sector. Nonetheless, the SEC can exert pressureon the FASB to issue
t t t t t t t t t t t t t t t t
accounting standards and veto the standards promulgated by the FASB. Auditing firms, the corporate
t t t t t t t t t t t t t t
sector, creditors, financial analysts, the financial community, accounting organizations, industry
t t t t t t t t t t
groups, and investors can influence the FASB by written comments about Exposure Drafts and
t t t t t t t t t t t t t t
participation in public meetings and public roundtables regarding a proposed financial reporting
t t t t t t t t t t t t
standard.
t
Q1-10 A principles-based standard is consistent with a theoretical framework. In contrast, a rules-
t t t t t t t t t t t t t
based standard does not necessarilyrelyon a consistent theoretical framework. Rather, it contains
t t t t t t t t t t t t t
more specific and prescriptive rules.
t t t t t
Q1-11 Recently, the FASB has taken an asset/liability approach in setting standards. With this
t t t t t t t t t t t t t
approach, a transaction is recorded based on whether an asset or liability is created. Another trend has
t t t t t t t t t t t t t t t t t
been the movement toward the use of fair value measurements as an alternative to historical cost.
t t t t t t t t t t t t t t t t
FASB has also focused on the promulgation ofprinciples-based standards instead of rules-based
t t t t t t t t t t t t t
standards.
t
Brief Exercises t
t SolutiontoBE1-1 t t
General-purpose financial statements provide general financial information about an entity that will t t t t t t t t t t t
be useful to many types of users. General-purpose financial statements provide information to a wide
t t t t t t t t t t t t t t t
spectrumofuser groups: investors, creditors, financial analysts, customers, employees, competitors,
t t t t t t t t t t t
suppliers, unions, and government agencies. Most financial information in general purpose financial
t t t t t t t t t t t t
statements is provided to satisfy users with limited abilityor authorityto obtain additional information,
t t t t t t t t t t t t t t t
which includes investors and creditors. The Financial Accounting Standards Board (FASB) identifies
t t t t t t t t t t t t
investors, lenders, and other creditors as the primary users of the financial statements.
t t t t t t t t t t t t t
© 2021 Pearson Education, Inc. t t t t
, CHAPTER 1 THE FIN ANC IAL REPO RT IN G EN VIR ON MENT
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t 1 -3
t t t
Solution to BE1-2 t t
Financial accounting is the process of identifying, measuring, and communicating financial
t t t t t t t t t t
information about an economic entity to various user groups within the legal, economic, political, and
t t t t t t t t t t t t t t t
socialenvironment. This definitioncontains four major elements: 1. Financial information;
t t t t t t t t t t t
2.Economic entity; 3. User groups and 4. Legal, economic, political, and social environment
t t t t t t t t t t t t t
Solution to BE1-3 t t
FinancialStatementUsers t t
and Other Parties
t t t Role
t 10 EquityInvestors
t t
10. Are shareholders ofthe company. t t t t
1. Arebanksand otherfinancial institutionsthat lend t t t t t t t
t 1 Creditors
t
money to the company. t t t t
5. Use financial information to review and analyze
t t t t t t t
5 Financial Analysts
t t t
reported results of the companies they cover and
t t t t t t t t
make investment recommendations.
t t t
8 Employees and Labor Unions
t t t t t
8. Use financial information during negotiation of new t t t t t t
2 Suppliers and Customers
t t t t
laboragreementsand compensationcontracts.
t t t t t
2. Use financialstatementsto determinewhetherto t t t t t t
7 Government Agencies
t t t conduct business or purchase products from a
t t t t t t t
company. t
t 3 Competitors
t
7. Review the financial statements ofpubliclytraded
t t t t t t t
companies for a variety of reasons that are in the public
4 External Auditors
t t t t t t t t t t t
t t t
interest. t
t 6 Internal Auditors
t t
3. Use financialinformationto determinetheir market t t t t t t
position relative to the reporting entity and to attempt
t t t t t t t t t
t 11 Regulatory Bodies
t t to identify future strategies ofthe reporting entity.
t t t t t t t t
4. Are independent of the company and responsible for t t t t t t t
9 Professional Organizations
t t t
ensuringthatmanagement preparesand issues
t t t t t t
financial statements that comply with accounting
t t t t t t
standards and fairly present the financial position
t t t t t t t
and economic performance of the company.
t t t t t t
6. Are employees of the company serving in an advisory
t t t t t t t t t
role to management. They provide information to
t t t t t t t
management regarding the company‘soperationsand
t t t t t t
properfunctioning ofits internal controls.
t t t t t t
11. Protect investorsand overseethe accounting and t t t t t t
auditing standard setting processes.
t t t t
9. Support accounting professionals throughout their t t t t
© 2021 Pearson Education, Inc.
t t t t
, 1 -4
t t t SOLUTIONS MAN UAL FO R IN TERMED IATE AC COU NT ING
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t
careersbyproviding training, professionalskills t t t t t
development, and other resources.
t t t t
Solution to BE1-4 t t
Financialstatement users and whyeachwould use the financial statements are summarized below:
t t t t t t t t t t t t t
1. Equity investors - Equity investors buy stock in the company, that is, they purchase a
t t t t t t t t t t t t t t
percentage ofthe company itself. The financialstatements help themmake investment
t t t t t t t t t t t t
decisions.t
2. Creditors- Creditors loan moneyto the company. The financial statements help themassess the
t t t t t t t t t t t t t t
creditworthiness of the company, and whether principal and interest will be repaid.
t t t t t t t t t t t t
3. Competitors- Competitorsuse financial statements to determine their market position
t t t t t t t t t t
relative to the reporting entity.
t t t t t
© 2021 Pearson Education, Inc.
t t t t
The Financial Reporting Environment t t t
t Solutions
Questions
Q1-1 Financial information is a much broader concept than simply the financial statements and
t t t t t t t t t t t t t
footnotesto the financialstatements. Financial information includes items such as the President‘s letter
t t t t t t t t t t t t t t
to the owners, management‘s discussion and analysis, the auditors‘ report, the management report and
t t t t t t t t t t t t t t
press releases. Of course, the basic financial statements and footnotes are included in the term
t t t t t t t t t t t t t t t
financial information. The basic financial statements are: the balance sheet (also referred to as the
t t t t t t t t t t t t t t t
statement of financial position), the statement of comprehensive income (also referred to as the
t t t t t t t t t t t t t t
statement of net income and the statement of comprehensive income), the statement of cash flows, and
t t t t t t t t t t t t t t t t
the statement of shareholders‘ equity. Financial information is not synonymous with the term
t t t t t t t t t t t t t
financial statements because the financial statements are a subset of the different types of financial
t t t t t t t t t t t t t t t
information provided.
t t
Q1-2 The purpose ofgenerating financialstatements is to provide usefulinformation to usersto
t t t t t t t t t t t t t t
evaluate economic entities and make efficient resource allocation decisions based on the risks and
t t t t t t t t t t t t t t
returns of a particular investment. The Financial Accounting Standards Board (FASB) identifies
t t t t t t t t t t t t
investors, lenders and other creditors as the primary users of the financial statements. The financial
t t t t t t t t t t t t t t t
statements are the culmination of the financial reporting process.
t t t t t t t t t
Q1-3 Capitalis a scarce resource. Investors and creditors have to make decisions as to how much capital
t t t t t t t t t t t t t t t t t
to invest in anygiven entity; therefore, they demand relevant and faithfully representative information
t t t t t t t t t t t t t t
about the economic performance and financial position of a company. This information is provided in
t t t t t t t t t t t t t t t
the financial statements.
t t t
Q1-4 External auditors ensure that the management of a company has prepared financial statements in
t t t t t t t t t t t t t t
accordance with Generally Accepted Accounting Principles and fairlypresent the financialposition
t t t t t t t t t t t t
and economic performance ofa company. In addition, external auditors must be an independent party
t t t t t t t t t t t t t t t
and cannot be employees of the company they are auditing. External auditors provide a significant
t t t t t t t t t t t t t t t
amount of credibility to the financial statements.
t t t t t t t
Q1-5 Data analytics is the process of analyzing large data sets in order to draw useful conclusions. It
t t t t t t t t t t t t t t t t t
involves converting raw datainto usefulknowledge. In financial reporting, data analytics can be used
t t t t t t t t t t t t t t t
to improve the quality of estimates and valuations.
t t t t t t t t
Q1-6 Standard setters createaccounting concepts, rules, and guidelines to ensure that financial
t t t t t t t t t t t t
statements accurately present the economic performance and financial position of a firm. The
t t t t t t t t t t t t t
standards encourage transparent and truthful reporting.
t t t t t t
,1 -2t t t SOLUTIONS MAN UAL FO R IN TERMED IATE AC COU NT ING
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t
Q1-7 U.S. companies listed on U.S. stock exchanges do not have the option to report under IFRS.
t t t t t t t t t t t t t t t t
However, foreign companies that trade inthe U.S. exchanges can report under IFRS. The SEC permits
t t t t t t t t t t t t t t t t
the use ofIFRS-based financial statements by international companies with shares trading on U.S.
t t t t t t t t t t t t t t
stock exchanges.
t t
Q1-8 The FASB seeks and welcomes comments from all parties in the financial reporting process
t t t t t t t t t t t t t t
including managers, investors, accountants, preparers, creditors, lenders, financial statement users,
t t t t t t t t t t
governmentalagencies, financial analysts, industrygroups, and auditors. FASB also receives
t t t t t t t t t t t
feedback from public roundtable discussions, public meetings, the FASAC, the Private Company
t t t t t t t t t t t t
Council, and EITF.
t t t
Q1-9 Yes, the promulgation of financial accounting standards is a political process. There are several
t t t t t t t t t t t t t t
groups that influence the standard setting process. The standard setting process is a political process
t t t t t t t t t t t t t t t
that is affected by the impact of several lobbying groups. The government, throughthe SEC, influences
t t t t t t t t t t t t t t t t
accounting standards. The SEC has the authorityto issue accounting standards but has assigned this
t t t t t t t t t t t t t t t
responsibility to the private sector. Nonetheless, the SEC can exert pressureon the FASB to issue
t t t t t t t t t t t t t t t t
accounting standards and veto the standards promulgated by the FASB. Auditing firms, the corporate
t t t t t t t t t t t t t t
sector, creditors, financial analysts, the financial community, accounting organizations, industry
t t t t t t t t t t
groups, and investors can influence the FASB by written comments about Exposure Drafts and
t t t t t t t t t t t t t t
participation in public meetings and public roundtables regarding a proposed financial reporting
t t t t t t t t t t t t
standard.
t
Q1-10 A principles-based standard is consistent with a theoretical framework. In contrast, a rules-
t t t t t t t t t t t t t
based standard does not necessarilyrelyon a consistent theoretical framework. Rather, it contains
t t t t t t t t t t t t t
more specific and prescriptive rules.
t t t t t
Q1-11 Recently, the FASB has taken an asset/liability approach in setting standards. With this
t t t t t t t t t t t t t
approach, a transaction is recorded based on whether an asset or liability is created. Another trend has
t t t t t t t t t t t t t t t t t
been the movement toward the use of fair value measurements as an alternative to historical cost.
t t t t t t t t t t t t t t t t
FASB has also focused on the promulgation ofprinciples-based standards instead of rules-based
t t t t t t t t t t t t t
standards.
t
Brief Exercises t
t SolutiontoBE1-1 t t
General-purpose financial statements provide general financial information about an entity that will t t t t t t t t t t t
be useful to many types of users. General-purpose financial statements provide information to a wide
t t t t t t t t t t t t t t t
spectrumofuser groups: investors, creditors, financial analysts, customers, employees, competitors,
t t t t t t t t t t t
suppliers, unions, and government agencies. Most financial information in general purpose financial
t t t t t t t t t t t t
statements is provided to satisfy users with limited abilityor authorityto obtain additional information,
t t t t t t t t t t t t t t t
which includes investors and creditors. The Financial Accounting Standards Board (FASB) identifies
t t t t t t t t t t t t
investors, lenders, and other creditors as the primary users of the financial statements.
t t t t t t t t t t t t t
© 2021 Pearson Education, Inc. t t t t
, CHAPTER 1 THE FIN ANC IAL REPO RT IN G EN VIR ON MENT
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t 1 -3
t t t
Solution to BE1-2 t t
Financial accounting is the process of identifying, measuring, and communicating financial
t t t t t t t t t t
information about an economic entity to various user groups within the legal, economic, political, and
t t t t t t t t t t t t t t t
socialenvironment. This definitioncontains four major elements: 1. Financial information;
t t t t t t t t t t t
2.Economic entity; 3. User groups and 4. Legal, economic, political, and social environment
t t t t t t t t t t t t t
Solution to BE1-3 t t
FinancialStatementUsers t t
and Other Parties
t t t Role
t 10 EquityInvestors
t t
10. Are shareholders ofthe company. t t t t
1. Arebanksand otherfinancial institutionsthat lend t t t t t t t
t 1 Creditors
t
money to the company. t t t t
5. Use financial information to review and analyze
t t t t t t t
5 Financial Analysts
t t t
reported results of the companies they cover and
t t t t t t t t
make investment recommendations.
t t t
8 Employees and Labor Unions
t t t t t
8. Use financial information during negotiation of new t t t t t t
2 Suppliers and Customers
t t t t
laboragreementsand compensationcontracts.
t t t t t
2. Use financialstatementsto determinewhetherto t t t t t t
7 Government Agencies
t t t conduct business or purchase products from a
t t t t t t t
company. t
t 3 Competitors
t
7. Review the financial statements ofpubliclytraded
t t t t t t t
companies for a variety of reasons that are in the public
4 External Auditors
t t t t t t t t t t t
t t t
interest. t
t 6 Internal Auditors
t t
3. Use financialinformationto determinetheir market t t t t t t
position relative to the reporting entity and to attempt
t t t t t t t t t
t 11 Regulatory Bodies
t t to identify future strategies ofthe reporting entity.
t t t t t t t t
4. Are independent of the company and responsible for t t t t t t t
9 Professional Organizations
t t t
ensuringthatmanagement preparesand issues
t t t t t t
financial statements that comply with accounting
t t t t t t
standards and fairly present the financial position
t t t t t t t
and economic performance of the company.
t t t t t t
6. Are employees of the company serving in an advisory
t t t t t t t t t
role to management. They provide information to
t t t t t t t
management regarding the company‘soperationsand
t t t t t t
properfunctioning ofits internal controls.
t t t t t t
11. Protect investorsand overseethe accounting and t t t t t t
auditing standard setting processes.
t t t t
9. Support accounting professionals throughout their t t t t
© 2021 Pearson Education, Inc.
t t t t
, 1 -4
t t t SOLUTIONS MAN UAL FO R IN TERMED IATE AC COU NT ING
t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t t
careersbyproviding training, professionalskills t t t t t
development, and other resources.
t t t t
Solution to BE1-4 t t
Financialstatement users and whyeachwould use the financial statements are summarized below:
t t t t t t t t t t t t t
1. Equity investors - Equity investors buy stock in the company, that is, they purchase a
t t t t t t t t t t t t t t
percentage ofthe company itself. The financialstatements help themmake investment
t t t t t t t t t t t t
decisions.t
2. Creditors- Creditors loan moneyto the company. The financial statements help themassess the
t t t t t t t t t t t t t t
creditworthiness of the company, and whether principal and interest will be repaid.
t t t t t t t t t t t t
3. Competitors- Competitorsuse financial statements to determine their market position
t t t t t t t t t t
relative to the reporting entity.
t t t t t
© 2021 Pearson Education, Inc.
t t t t
