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