Test Bank (Downloadable Files) for Intermediate Accounting, Volume 1 & 2, 12th Canadian Edition, Donald E. Kieso

CHAPTER 1 THE CANADIAN FINANCIAL REPORTING ENVIRONMENT CHAPTER STUDY OBJECTIVES 1. Understand the financial reporting environment. Accounting provides reliable, relevant, and timely information to managers, investors, and creditors so that resources are allocated to the most efficient enterprises. Accounting also provides measurements of efficiency (profitability) and financial soundness. Investors, creditors, management, securities commissions, stock exchanges, analysts, credit rating agencies, auditors, and standard setters are some of the major stakeholders. Illustration 1-4 explains what is at stake for each one. The objective of financial reporting is to communicate information that is useful to key decision makers such as investors and creditors in making resource allocation decisions (including assessing management stewardship) about the resources and claims to resources of an entity and how these are changing. Ideally, all stakeholders should have access to the same information in order to ensure that good decisions are made in the capital marketplace. (This is known as information symmetry.) However, this is not the case—there is often information asymmetry. Of necessity, management has access to more information so that it can run the company. It must also make sure that it does not give away information that might harm the company, such as in a lawsuit where disclosure might cause the company to lose. Aside from this, information asymmetry exists because of management bias whereby management acts in its own self-interest, such as wanting to maximize management bonuses. This is known as moral hazard in accounting theory. Information asymmetry causes markets to be less efficient. It may cause stock prices to be discounted or costs of capital to increase. In addition, it might detract good companies from raising capital in the particular market where relevant information is not available (referred to as adverse selection in accounting theory). The efficient markets hypothesis is felt to exist only in a semi-strong form, meaning that only publicly available information is assimilated into stock prices. 2. Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting. The accounting profession has tried to develop a set of standards that is generally accepted and universally practised. This is known as GAAP (generally accepted accounting principles). Without this set of standards, each enterprise would have to develop its own standards, and readers of financial statements would have to become familiar with every company’s particular accounting and reporting practices. As a result, it would be almost impossible to prepare statements that could be compared. In addition, accounting standards help deal with the information asymmetry problem. The Canadian Accounting Standards Board (AcSB) is the main standard-setting body in Canada for private companies, pension plans, and not-for-profit entities. Its mandate comes from the Canada Business Corporations Act and Regulations as well as provincial acts of incorporation. For public companies, GAAP is International Financial Reporting Standards (IFRS) as established by the International Accounting Standards Board (IASB). Public companies are required to follow GAAP in order to access capital markets, which are monitored by provincial securities commissions. The Financial Accounting Standards Board (FASB) is also important as it influences IFRS standard setting. Private companies may choose to follow IFRS. Public companies that list on U.S. stock exchanges may choose to follow U.S. GAAP. 3. Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP. Generally accepted accounting principles are either principles that have substantial authoritative support, such as the CPA Canada Handbook, or those arrived at through the use of professional judgement and the conceptual framework. Professional judgement plays an important role in Accounting Standards for Private Enterprises (ASPE) and IFRS since much of GAAP is based on general principles, which need to be interpreted. 4. Discuss some of the challenges and opportunities for accounting. Some of the challenges facing accounting are oversight in the capital markets, centrality of ethics, standard setting in a political environment, principles- versus rules-based standard setting, the impact of technology, and integrated reporting. All of these require the accounting profession to continue to strive for excellence and to understand how accounting adds value in the capital marketplace. MULTIPLE CHOICE QUESTIONS Answer No. Description d 1. Accounting characteristics a 2. Nature of financial accounting c 3. Definition of financial accounting b 4. Definition of management accounting d 5. Efficient use of resources c 6. Capital allocation process d 7. Importance of accounting information d 8. Primary exchange mechanism(s) for allocating resources c 9. Changing financial reporting environment b 10. Stakeholders in the financial reporting environment d 11. Preparation of audited financial statements a 12. Auditor’s responsibility c 13. Causes of subprime lending crisis a 14. Management’s primary responsibility with respect to financial statements c 15. Primary responsibility of security and exchange commissions b 16. Objectives of financial reporting b 17. Appropriate objectives of general-purpose financial reporting b 18. Accrual-basis accounting c 19. Preparation of biased information c 20. Existence of information asymmetry b 21. Efficient markets hypothesis d 22. Management bias a 23. Moral hazard d 24. Conservative accounting b 25. Reduction of information asymmetry b 26. Development of GAAP c 27. Financial reporting before 1900 c 28. Responsibility of the AcSB a 29. Oversight of AcSB c 30. Authority over accounting standards in the U.S d 31. Development of financial reporting standards in Canada b 32. Adoption of IFRS d 33. Activities and authority of the Ontario Securities Commission (OSC) b 34. Use of ASPE a 35. IASB’s standard-setting process c 36. Primary sources of GAAP under ASPE c 37. Sources of GAAP d 38. Exercise of professional judgement c 39. Rules-based vs. principles-based approach c 40. Comparison of Canadian GAAP and U.S. GAAP b 41. SOX a 42. Advancement of technology on financial reporting a 43. IASB principles regarding funding c 44. Rules-based GAAP body of knowledge EXERCISES Item Description E1-45 Effective capital allocation E1-46 Financial statements in practice and theory E1-47 Stakeholders in the financial reporting environment E1-48 Sources of capital and stages of company growth E1-49 Objectives of financial reporting E1-50 Traditional users vs. others E1-51 Imperfection of the stakeholder ecosystem E1-52 Entity vs. proprietary perspective E1-53 User needs E1-54 The decision-usefulness approach to financial reporting E1-55 Merits of accrual- vs. cash-basis accounting E1-56 Information asymmetry E1-57 Maintaining competitive advantage E1-58 Management bias in financial statement presentation E1-59 Financial versus managerial accounting E1-60 Role of securities commissions and stock exchanges E1-61 Standard setting E1-62 Purpose of accounting standards E1-63 ASPE vs. IFRS E1-64 IFRS Discussion Group E1-65 Sources of GAAP E1-66 Sources of GAAP E1-67 Professional judgement E1-68 SOX and standard setting E1-69 Challenges facing financial reporting E1-70 Role of executives and management in a post-SOX world E1-71 Technology and financial information E1-72 Extensible business reporting E1-73 IFRS taxonomy E1-74 Principles- versus rules-based approaches PROBLEMS Item Description P1-75 U.S. GAAP impact on Canadian GAAP P1-76 Shortcomings of rules-based approach MULTIPLE CHOICE 1. The essential characteristic(s) of accounting is (are) a) communication of financial information to interested internal parties only. b) communication of economic information to external parties. c) identification and measurement of financial information only. d) identification, measurement, and communication of financial information. Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Communication 2. Financial accounting is concerned with the process that culminates in a) the preparation of financial reports. b) specialized reports for inventory management and control. c) specialized reports for income tax calculation and recognition. d) reports on changes in stock prices and future estimates of market position. Answer: a Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 3. Financial accounting can be broadly defined as the area of accounting that prepares financial statements to be used a) by parties internal to the business enterprise only. b) by investors only. c) by parties both internal and external to the business enterprise. d) primarily by external users and Canada Revenue Agency. Answer: c Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 4. Management accounting can be broadly defined as the area of accounting that communicates financial information a) to investors only. b) to parties internal to the business enterprise only. c) to parties both internal and external to the business enterprise. d) primarily to external users and Canada Revenue Agency. Answer: b Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting CPA: Management Accounting Bloomcode: Knowledge AACSB: Analytic 5. Whether a business is successful and thrives is determined by a) free enterprise or competition. b) competition and markets only. c) markets and free enterprise only. d) markets, competition, and free enterprise. Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting CPA: Strategy & Governance Bloomcode: Knowledge AACSB: Analytic 5. Whether a business is successful and thrives is determined by a) free enterprise or competition. b) competition and markets only. c) markets and free enterprise only. d) markets, competition, and free enterprise. Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting CPA: Strategy & Governance Bloomcode: Knowledge AACSB: Analytic 6. Which of the following is correct? a) Reported accounting numbers do not affect the transfer of resources. b) Credit rating agencies use accounting information to assess only assets. c) Efficient capital markets promote productivity and encourage innovation. d) Efficient capital markets promote productivity but do not encourage innovation. Answer: c Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting CPA: Strategy & Governance Bloomcode: Knowledge AACSB: Analytic 7. Information provided by accounting is important because it enables investors and creditors to a) compare income and assets of companies. b) assess the relative risks and returns of investment opportunities. c) channel their resources more effectively. d) all of the above Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting CPA: Strategy & Governance Bloomcode: Knowledge AACSB: Analytic 8. In Canada, the primary exchange mechanism(s) for allocating resources is (are) a) debt and equity markets. b) financial Institutions such as banks. c) government authorities such as the Canada Revenue Agency (CRA). d) both a and b Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 9. Which of the following is/are major factors in the rapidly changing financial reporting environment in Canada? a) increased demand for accountants and the impact of technology b) globalization and the unethical actions of accountants c) the growing number of institutional investors who want more information regarding environmental and social issues d) increased use of the Internet Answer: c Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting Learning Objective: Discuss some of the challenges and opportunities for accounting. Section Reference: Challenges and Opportunities for the Accounting Profession CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 10. Stakeholders who help in the efficient allocation of resources include a) investors and creditors. b) financial analysts and regulators. c) creditors and auditors. d) management and auditors. Answer: b Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 11. Audited financial statements are prepared by a) auditors. b) financial analysts. c) Canada Revenue Agency. d) management. Answer: d Difficulty: Easy Learning Objective: Understand the financial reporting environment. Section Reference: Financial Statements and Financial Reporting CPA: Financial Reporting Bloomcode: Knowledge AACSB: Analytic 12. The auditor’s primary responsibility is to a) review financial statements and discuss them with management. b) prepare financial statements. c) report to Canada Revenue Agency. d) report to standard setters. Answer: a