CHAPTER 1 l
The Financial Reporting Environment
l l l
l Solutions
Questions
Q1-1 lFinancial linformation lis la lmuch lbroader lconcept lthan lsimply lthe lfinancial lstatements
land lfootnotes lto lthe lfinancial lstatements. lFinancial linformation lincludes litems lsuch las lthe
lPresident‘s lletter lto lthe lowners, lmanagement‘s ldiscussion land lanalysis, lthe lauditors‘ lreport, lthe
lmanagement lreport land lpress lreleases. lOf lcourse, lthe lbasic lfinancial lstatements land lfootnotes
lare lincluded lin lthe lterm lfinancial linformation. lThe lbasic lfinancial lstatements lare: lthe lbalance
lsheet l(also l referred lto las lthe lstatement lof lfinancial lposition), lthe lstatement lof lcomprehensive
lincome l(also lreferred lto las lthe lstatement lof lnet lincome land lthe lstatement lof lcomprehensive
lincome), lthe lstatement lof lcash lflows, land lthe lstatement lof lshareholders‘ lequity. lFinancial
linformation lis lnot lsynonymous lwith lthe lterm lfinancial lstatements lbecause lthe lfinancial
lstatements lare la lsubset lof lthe ldifferent ltypes lof lfinancial linformation lprovided.
Q1-2 lThe lpurpose lof lgenerating lfinancial lstatements lis lto lprovide luseful linformation lto lusers
lto levaluate leconomic lentities land lmake lefficient lresource lallocation ldecisions lbased lon lthe
lrisks land lreturns lof la lparticular linvestment. lThe lFinancial lAccounting lStandards lBoard
l(FASB) lidentifies linvestors, llenders land lother lcreditors las lthe lprimary lusers lof lthe lfinancial
lstatements. lThe lfinancial lstatements lare lthe lculmination lof lthe lfinancial lreporting lprocess.
Q1-3 lCapital lis la lscarce lresource. lInvestors land lcreditors lhave lto lmake ldecisions las lto lhow
lmuch lcapital lto linvest lin lany lgiven lentity; ltherefore, lthey ldemand lrelevant land lfaithfully
lrepresentative linformation labout lthe leconomic lperformance land lfinancial lposition lof la
lcompany. lThis linformation lis lprovided lin lthe lfinancial lstatements.
Q1-4 lExternal lauditors lensure lthat lthe lmanagement lof la lcompany lhas lprepared lfinancial
lstatements lin laccordance lwith lGenerally lAccepted lAccounting lPrinciples land lfairly lpresent lthe
lfinancial lposition land leconomic lperformance lof la lcompany. l In laddition, lexternal lauditors lmust
lbe lan lindependent lparty land lcannot lbe lemployees lof lthe lcompany lthey lare lauditing. lExternal
lauditors lprovide la lsignificant lamount lof lcredibility lto lthe lfinancial lstatements.
Q1-5 lData lanalytics lis lthe lprocess lof lanalyzing llarge ldata lsets lin lorder lto ldraw luseful
lconclusions. lIt linvolves lconverting lraw ldata linto luseful lknowledge. lIn lfinancial lreporting, ldata
lanalytics lcan lbe lused lto limprove lthe lquality lof lestimates land lvaluations.
Q1-6 lStandard lsetters lcreate laccounting lconcepts, lrules, land lguidelines lto lensure lthat lfinancial
lstatements laccurately lpresent lthe leconomic lperformance land lfinancial lposition lof la lfirm. lThe
lstandards lencourage ltransparent land ltruthful lreporting.
,1 l- l2 S lO lL lU lT lI lO lN lS l M lA lN lU lA lL l F lO lR l I lN lT lE lR lM lE lD lI lA lT lE l A lC
l
lC lO lU lN lT lING l
Q1-7 lU.S. lcompanies llisted lon lU.S. lstock lexchanges ldo lnot lhave lthe loption lto lreport lunder
l IFRS. lHowever, lforeign lcompanies lthat ltrade lin lthe lU.S. lexchanges lcan lreport lunder lIFRS.
lThe lSEC lpermits lthe luse lof lIFRS-based lfinancial lstatements lby linternational lcompanies lwith
lshares ltrading lon lU.S. lstock lexchanges.
Q1-8 lThe lFASB lseeks land lwelcomes lcomments lfrom lall lparties lin lthe lfinancial lreporting
lprocess lincluding lmanagers, linvestors, laccountants, lpreparers, lcreditors, llenders, lfinancial
lstatement lusers, lgovernmental lagencies, lfinancial lanalysts, lindustry lgroups, land lauditors.
lFASB lalso lreceives lfeedback lfrom lpublic lroundtable ldiscussions, lpublic lmeetings, lthe
lFASAC, lthe lPrivate lCompany lCouncil, land lEITF.
Q1-9 lYes, lthe lpromulgation lof lfinancial laccounting lstandards lis la lpolitical lprocess. lThere lare
lseveral lgroups lthat linfluence lthe lstandard lsetting lprocess. lThe lstandard lsetting lprocess lis la
lpolitical lprocess lthat lis laffected lby lthe limpact lof lseveral llobbying lgroups. lThe lgovernment,
lthrough lthe lSEC, linfluences laccounting lstandards. lThe lSEC lhas lthe lauthority lto lissue
laccounting lstandards lbut lhas lassigned lthis lresponsibility lto lthe lprivate lsector. lNonetheless,
lthe lSEC lcan lexert lpressure lon lthe lFASB lto lissue laccounting lstandards land lveto lthe lstandards
lpromulgated lby lthe lFASB. lAuditing lfirms, lthe lcorporate lsector, lcreditors, lfinancial lanalysts,
lthe lfinancial lcommunity, laccounting lorganizations, lindustry lgroups, land linvestors lcan
linfluence lthe lFASB lby lwritten lcomments labout lExposure lDrafts land lparticipation lin lpublic
lmeetings land lpublic lroundtables lregarding la lproposed lfinancial lreporting lstandard.
Q1-10 lA lprinciples-based lstandard lis lconsistent lwith la ltheoretical lframework. lIn lcontrast, la
lrules-based lstandard ldoes lnot lnecessarily lrely lon la lconsistent ltheoretical lframework. lRather,
lit lcontains lmore lspecific land lprescriptive lrules.
Q1-11 lRecently, lthe lFASB lhas ltaken lan lasset/liability lapproach lin lsetting lstandards. lWith lthis
lapproach, la ltransaction lis lrecorded lbased lon lwhether lan lasset lor lliability lis lcreated. lAnother
ltrend lhas lbeen lthe lmovement ltoward lthe luse lof lfair lvalue lmeasurements las lan lalternative lto
lhistorical lcost. lFASB lhas lalso lfocused lon lthe lpromulgation lof lprinciples-based lstandards
linstead lof lrules-based lstandards.
Brief lExercises
l Solution lto lBE1-1
General-purpose lfinancial lstatements lprovide lgeneral lfinancial linformation labout lan lentity lthat
lwill lbe luseful lto lmany ltypes lof lusers. lGeneral-purpose lfinancial lstatements lprovide
linformation lto la lwide lspectrum lof luser lgroups: linvestors, lcreditors, lfinancial lanalysts,
lcustomers, lemployees, lcompetitors, lsuppliers, lunions, land lgovernment lagencies. lMost
lfinancial linformation lin lgeneral lpurpose lfinancial lstatements lis lprovided lto lsatisfy lusers lwith
llimited lability lor lauthority lto lobtain ladditional linformation, lwhich lincludes linvestors land
lcreditors. lThe lFinancial lAccounting lStandards lBoard l(FASB) lidentifies linvestors, llenders, land
lother lcreditors las lthe lprimary lusers lof lthe lfinancial lstatements.
© l2021 lPearson lEducation, lInc.
, C lH lA lP lT lE lR l 1 l T lH lE l F lI lN lA lN lC lI lA lL l R lE lP lO lR lT lI lN lG l E lN 1 l- l3
l
lV lI lR lO lN lM lE lN lT
Solution lto lBE1-2
Financial laccounting lis lthe lprocess lof lidentifying, lmeasuring, land lcommunicating lfinancial
linformation labout lan leconomic lentity lto lvarious luser lgroups lwithin lthe llegal, leconomic,
lpolitical, land lsocial lenvironment. lThis ldefinition lcontains lfour lmajor lelements: l1. l Financial
linformation; l2.Economic lentity; l3. lUser lgroups land l4. lLegal, leconomic, lpolitical, land lsocial
lenvironment
Solution lto lBE1-3
Financial lStatement lUsers
land lOther lParties Role
10. Are lshareholders lof lthe lcompany.
l 10 lEquity lInvestors
1. Are lbanks land lother lfinancial linstitutions lthat llend
l 1 lCreditors lmoney lto lthe lcompany.
5. l Use lfinancial linformation lto lreview land
l 5 lFinancial lAnalysts lanalyze lreported lresults lof lthe lcompanies lthey
lcover land lmake linvestment lrecommendations.
l8 lEmployees land l Labor
l Unions 8. Use lfinancial linformation lduring lnegotiation lof
lnew llabor lagreements land lcompensation lcontracts.
l 2 lSuppliers land lCustomers 2. Use lfinancial lstatements lto ldetermine lwhether lto
lconduct lbusiness lor lpurchase lproducts lfrom la
7 lGovernment lAgencies
l lcompany.
7. l Review lthe lfinancial lstatements lof lpublicly ltraded
l 3 lCompetitors lcompanies lfor la lvariety lof lreasons lthat lare lin lthe
lpublic linterest.
l 4 lExternal lAuditors
3. Use lfinancial linformation lto ldetermine ltheir lmarket
l 6 lInternal lAuditors lposition lrelative lto lthe lreporting lentity land lto
lattempt lto lidentify lfuture lstrategies lof lthe
l 11 lRegulatory lBodies lreporting lentity.
4. Are lindependent lof lthe lcompany land
9 lProfessional lOrganizations
l
lresponsible lfor lensuring lthat lmanagement
lprepares land lissues lfinancial lstatements lthat
lcomply lwith laccounting lstandards land lfairly
lpresent lthe lfinancial lposition land leconomic
lperformance lof lthe lcompany.
6. l Are lemployees lof lthe lcompany lserving lin lan
ladvisory lrole lto lmanagement. lThey lprovide
linformation lto lmanagement lregarding lthe
lcompany‘s loperations land lproper lfunctioning lof lits
linternal lcontrols.
11. Protect linvestors land loversee lthe laccounting land
lauditing lstandard lsetting lprocesses.
9. Support laccounting lprofessionals lthroughout ltheir
© l2021 lPearson lEducation, lInc.
, 1 l- l4 S lO lL lU lT lI lO lN lS l M lA lN lU lA lL l F lO lR l I lN lT lE lR lM lE lD lI lA lT lE l A lC
l
lC lO lU lN lT lING l
careers lby lproviding ltraining, lprofessional lskills
ldevelopment, land lother lresources.
Solution lto lBE1-4
Financial lstatement lusers land lwhy leach lwould luse lthe lfinancial lstatements lare lsummarized
lbelow:
1. Equity linvestors l- lEquity linvestors lbuy lstock lin lthe lcompany, lthat lis, lthey lpurchase
la lpercentage lof lthe lcompany litself. lThe lfinancial lstatements lhelp lthem lmake
linvestment ldecisions.
2. Creditors l- lCreditors lloan lmoney lto lthe lcompany. lThe lfinancial lstatements lhelp lthem
lassess lthe lcreditworthiness lof lthe lcompany, land lwhether lprincipal land linterest lwill lbe
lrepaid.
3. Competitors l- lCompetitors luse lfinancial lstatements lto ldetermine ltheir lmarket
lposition lrelative lto lthe lreporting lentity.
© l2021 lPearson lEducation, lInc.
The Financial Reporting Environment
l l l
l Solutions
Questions
Q1-1 lFinancial linformation lis la lmuch lbroader lconcept lthan lsimply lthe lfinancial lstatements
land lfootnotes lto lthe lfinancial lstatements. lFinancial linformation lincludes litems lsuch las lthe
lPresident‘s lletter lto lthe lowners, lmanagement‘s ldiscussion land lanalysis, lthe lauditors‘ lreport, lthe
lmanagement lreport land lpress lreleases. lOf lcourse, lthe lbasic lfinancial lstatements land lfootnotes
lare lincluded lin lthe lterm lfinancial linformation. lThe lbasic lfinancial lstatements lare: lthe lbalance
lsheet l(also l referred lto las lthe lstatement lof lfinancial lposition), lthe lstatement lof lcomprehensive
lincome l(also lreferred lto las lthe lstatement lof lnet lincome land lthe lstatement lof lcomprehensive
lincome), lthe lstatement lof lcash lflows, land lthe lstatement lof lshareholders‘ lequity. lFinancial
linformation lis lnot lsynonymous lwith lthe lterm lfinancial lstatements lbecause lthe lfinancial
lstatements lare la lsubset lof lthe ldifferent ltypes lof lfinancial linformation lprovided.
Q1-2 lThe lpurpose lof lgenerating lfinancial lstatements lis lto lprovide luseful linformation lto lusers
lto levaluate leconomic lentities land lmake lefficient lresource lallocation ldecisions lbased lon lthe
lrisks land lreturns lof la lparticular linvestment. lThe lFinancial lAccounting lStandards lBoard
l(FASB) lidentifies linvestors, llenders land lother lcreditors las lthe lprimary lusers lof lthe lfinancial
lstatements. lThe lfinancial lstatements lare lthe lculmination lof lthe lfinancial lreporting lprocess.
Q1-3 lCapital lis la lscarce lresource. lInvestors land lcreditors lhave lto lmake ldecisions las lto lhow
lmuch lcapital lto linvest lin lany lgiven lentity; ltherefore, lthey ldemand lrelevant land lfaithfully
lrepresentative linformation labout lthe leconomic lperformance land lfinancial lposition lof la
lcompany. lThis linformation lis lprovided lin lthe lfinancial lstatements.
Q1-4 lExternal lauditors lensure lthat lthe lmanagement lof la lcompany lhas lprepared lfinancial
lstatements lin laccordance lwith lGenerally lAccepted lAccounting lPrinciples land lfairly lpresent lthe
lfinancial lposition land leconomic lperformance lof la lcompany. l In laddition, lexternal lauditors lmust
lbe lan lindependent lparty land lcannot lbe lemployees lof lthe lcompany lthey lare lauditing. lExternal
lauditors lprovide la lsignificant lamount lof lcredibility lto lthe lfinancial lstatements.
Q1-5 lData lanalytics lis lthe lprocess lof lanalyzing llarge ldata lsets lin lorder lto ldraw luseful
lconclusions. lIt linvolves lconverting lraw ldata linto luseful lknowledge. lIn lfinancial lreporting, ldata
lanalytics lcan lbe lused lto limprove lthe lquality lof lestimates land lvaluations.
Q1-6 lStandard lsetters lcreate laccounting lconcepts, lrules, land lguidelines lto lensure lthat lfinancial
lstatements laccurately lpresent lthe leconomic lperformance land lfinancial lposition lof la lfirm. lThe
lstandards lencourage ltransparent land ltruthful lreporting.
,1 l- l2 S lO lL lU lT lI lO lN lS l M lA lN lU lA lL l F lO lR l I lN lT lE lR lM lE lD lI lA lT lE l A lC
l
lC lO lU lN lT lING l
Q1-7 lU.S. lcompanies llisted lon lU.S. lstock lexchanges ldo lnot lhave lthe loption lto lreport lunder
l IFRS. lHowever, lforeign lcompanies lthat ltrade lin lthe lU.S. lexchanges lcan lreport lunder lIFRS.
lThe lSEC lpermits lthe luse lof lIFRS-based lfinancial lstatements lby linternational lcompanies lwith
lshares ltrading lon lU.S. lstock lexchanges.
Q1-8 lThe lFASB lseeks land lwelcomes lcomments lfrom lall lparties lin lthe lfinancial lreporting
lprocess lincluding lmanagers, linvestors, laccountants, lpreparers, lcreditors, llenders, lfinancial
lstatement lusers, lgovernmental lagencies, lfinancial lanalysts, lindustry lgroups, land lauditors.
lFASB lalso lreceives lfeedback lfrom lpublic lroundtable ldiscussions, lpublic lmeetings, lthe
lFASAC, lthe lPrivate lCompany lCouncil, land lEITF.
Q1-9 lYes, lthe lpromulgation lof lfinancial laccounting lstandards lis la lpolitical lprocess. lThere lare
lseveral lgroups lthat linfluence lthe lstandard lsetting lprocess. lThe lstandard lsetting lprocess lis la
lpolitical lprocess lthat lis laffected lby lthe limpact lof lseveral llobbying lgroups. lThe lgovernment,
lthrough lthe lSEC, linfluences laccounting lstandards. lThe lSEC lhas lthe lauthority lto lissue
laccounting lstandards lbut lhas lassigned lthis lresponsibility lto lthe lprivate lsector. lNonetheless,
lthe lSEC lcan lexert lpressure lon lthe lFASB lto lissue laccounting lstandards land lveto lthe lstandards
lpromulgated lby lthe lFASB. lAuditing lfirms, lthe lcorporate lsector, lcreditors, lfinancial lanalysts,
lthe lfinancial lcommunity, laccounting lorganizations, lindustry lgroups, land linvestors lcan
linfluence lthe lFASB lby lwritten lcomments labout lExposure lDrafts land lparticipation lin lpublic
lmeetings land lpublic lroundtables lregarding la lproposed lfinancial lreporting lstandard.
Q1-10 lA lprinciples-based lstandard lis lconsistent lwith la ltheoretical lframework. lIn lcontrast, la
lrules-based lstandard ldoes lnot lnecessarily lrely lon la lconsistent ltheoretical lframework. lRather,
lit lcontains lmore lspecific land lprescriptive lrules.
Q1-11 lRecently, lthe lFASB lhas ltaken lan lasset/liability lapproach lin lsetting lstandards. lWith lthis
lapproach, la ltransaction lis lrecorded lbased lon lwhether lan lasset lor lliability lis lcreated. lAnother
ltrend lhas lbeen lthe lmovement ltoward lthe luse lof lfair lvalue lmeasurements las lan lalternative lto
lhistorical lcost. lFASB lhas lalso lfocused lon lthe lpromulgation lof lprinciples-based lstandards
linstead lof lrules-based lstandards.
Brief lExercises
l Solution lto lBE1-1
General-purpose lfinancial lstatements lprovide lgeneral lfinancial linformation labout lan lentity lthat
lwill lbe luseful lto lmany ltypes lof lusers. lGeneral-purpose lfinancial lstatements lprovide
linformation lto la lwide lspectrum lof luser lgroups: linvestors, lcreditors, lfinancial lanalysts,
lcustomers, lemployees, lcompetitors, lsuppliers, lunions, land lgovernment lagencies. lMost
lfinancial linformation lin lgeneral lpurpose lfinancial lstatements lis lprovided lto lsatisfy lusers lwith
llimited lability lor lauthority lto lobtain ladditional linformation, lwhich lincludes linvestors land
lcreditors. lThe lFinancial lAccounting lStandards lBoard l(FASB) lidentifies linvestors, llenders, land
lother lcreditors las lthe lprimary lusers lof lthe lfinancial lstatements.
© l2021 lPearson lEducation, lInc.
, C lH lA lP lT lE lR l 1 l T lH lE l F lI lN lA lN lC lI lA lL l R lE lP lO lR lT lI lN lG l E lN 1 l- l3
l
lV lI lR lO lN lM lE lN lT
Solution lto lBE1-2
Financial laccounting lis lthe lprocess lof lidentifying, lmeasuring, land lcommunicating lfinancial
linformation labout lan leconomic lentity lto lvarious luser lgroups lwithin lthe llegal, leconomic,
lpolitical, land lsocial lenvironment. lThis ldefinition lcontains lfour lmajor lelements: l1. l Financial
linformation; l2.Economic lentity; l3. lUser lgroups land l4. lLegal, leconomic, lpolitical, land lsocial
lenvironment
Solution lto lBE1-3
Financial lStatement lUsers
land lOther lParties Role
10. Are lshareholders lof lthe lcompany.
l 10 lEquity lInvestors
1. Are lbanks land lother lfinancial linstitutions lthat llend
l 1 lCreditors lmoney lto lthe lcompany.
5. l Use lfinancial linformation lto lreview land
l 5 lFinancial lAnalysts lanalyze lreported lresults lof lthe lcompanies lthey
lcover land lmake linvestment lrecommendations.
l8 lEmployees land l Labor
l Unions 8. Use lfinancial linformation lduring lnegotiation lof
lnew llabor lagreements land lcompensation lcontracts.
l 2 lSuppliers land lCustomers 2. Use lfinancial lstatements lto ldetermine lwhether lto
lconduct lbusiness lor lpurchase lproducts lfrom la
7 lGovernment lAgencies
l lcompany.
7. l Review lthe lfinancial lstatements lof lpublicly ltraded
l 3 lCompetitors lcompanies lfor la lvariety lof lreasons lthat lare lin lthe
lpublic linterest.
l 4 lExternal lAuditors
3. Use lfinancial linformation lto ldetermine ltheir lmarket
l 6 lInternal lAuditors lposition lrelative lto lthe lreporting lentity land lto
lattempt lto lidentify lfuture lstrategies lof lthe
l 11 lRegulatory lBodies lreporting lentity.
4. Are lindependent lof lthe lcompany land
9 lProfessional lOrganizations
l
lresponsible lfor lensuring lthat lmanagement
lprepares land lissues lfinancial lstatements lthat
lcomply lwith laccounting lstandards land lfairly
lpresent lthe lfinancial lposition land leconomic
lperformance lof lthe lcompany.
6. l Are lemployees lof lthe lcompany lserving lin lan
ladvisory lrole lto lmanagement. lThey lprovide
linformation lto lmanagement lregarding lthe
lcompany‘s loperations land lproper lfunctioning lof lits
linternal lcontrols.
11. Protect linvestors land loversee lthe laccounting land
lauditing lstandard lsetting lprocesses.
9. Support laccounting lprofessionals lthroughout ltheir
© l2021 lPearson lEducation, lInc.
, 1 l- l4 S lO lL lU lT lI lO lN lS l M lA lN lU lA lL l F lO lR l I lN lT lE lR lM lE lD lI lA lT lE l A lC
l
lC lO lU lN lT lING l
careers lby lproviding ltraining, lprofessional lskills
ldevelopment, land lother lresources.
Solution lto lBE1-4
Financial lstatement lusers land lwhy leach lwould luse lthe lfinancial lstatements lare lsummarized
lbelow:
1. Equity linvestors l- lEquity linvestors lbuy lstock lin lthe lcompany, lthat lis, lthey lpurchase
la lpercentage lof lthe lcompany litself. lThe lfinancial lstatements lhelp lthem lmake
linvestment ldecisions.
2. Creditors l- lCreditors lloan lmoney lto lthe lcompany. lThe lfinancial lstatements lhelp lthem
lassess lthe lcreditworthiness lof lthe lcompany, land lwhether lprincipal land linterest lwill lbe
lrepaid.
3. Competitors l- lCompetitors luse lfinancial lstatements lto ldetermine ltheir lmarket
lposition lrelative lto lthe lreporting lentity.
© l2021 lPearson lEducation, lInc.
