CHAPTER 1
The Financial Reporting Environment
Solutions
Questions
Q1-
1 Financial information is a much broader concept than simply the financial statements and foot
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
notes to the financial statements. Financial information includes items such as the President‘s lett
sw sw sw sw sw sw sw sw sw sw sw sw sw
er to the owners, management‘s discussion and analysis, the auditors‘ report, the management re
sw sw sw sw sw sw sw sw sw sw sw sw sw
port and press releases. Of course, the basic financial statements and footnotes are included in t
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
he term financial information. The basic financial statements are: the balance sheet (also referr
sw sw sw sw sw sw sw sw sw sw sw sw s w
ed to as the statement of financial position), the statement of comprehensive income (also referr
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ed to as the statement of net income and the statement of comprehensive income), the statement
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw s
of cash flows, and the statement of shareholders‘ equity. Financial information is not synonym
w sw sw sw sw sw sw sw sw sw sw sw sw sw
ous with the term financial statements because the financial statements are a subset of the differ
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ent types of financial information provided.
sw sw sw sw sw
Q1-
2 The purpose of generating financial statements is to provide useful information to users to eval
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
uate economic entities and make efficient resource allocation decisions based on the risks and r
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
eturns of a particular investment. The Financial Accounting Standards Board (FASB) identifies
sw sw sw sw sw sw sw sw sw sw sw s
investors, lenders and other creditors as the primary users of the financial statements. The finan
w sw sw sw sw sw sw sw sw sw sw sw sw sw sw
cial statements are the culmination of the financial reporting process.
sw sw sw sw sw sw sw sw sw
Q1-
3 Capital is a scarce resource. Investors and creditors have to make decisions as to how much ca
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
pital to invest in any given entity; therefore, they demand relevant and faithfully representative i
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
nformation about the economic performance and financial position of a company. This informat
sw sw sw sw sw sw sw sw sw sw sw sw
ion is provided in the financial statements.
sw sw sw sw sw sw
Q1-
4 External auditors ensure that the management of a company has prepared financial statements
sw sw sw sw sw sw sw sw sw sw sw sw sw
in accordance with Generally Accepted Accounting Principles and fairly present the financial p
sw sw sw sw sw sw sw sw sw sw sw sw sw
osition and economic performance of a company. In addition, external auditors must be an inde
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
pendent party and cannot be employees of the company they are auditing. External auditors pro
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
vide a significant amount of credibility to the financial statements.
sw sw sw sw sw sw sw sw sw
Q1-
5 Data analytics is the process of analyzing large data sets in order to draw useful conclusions.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
It involves converting raw data into useful knowledge. In financial reporting, data analytics can
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
be used to improve the quality of estimates and valuations.
sw sw sw sw sw sw sw sw sw
Q1-
6 Standard setters create accounting concepts, rules, and guidelines to ensure that financial state
sw sw sw sw sw sw sw sw sw sw sw sw sw
ments accurately present the economic performance and financial position of a firm. The standa
sw sw sw sw sw sw sw sw sw sw sw sw sw
rds encourage transparent and truthful reporting.
sw sw sw sw sw
,1-2
sw sw s w SO L UT IO NS
sw sw sw sw sw sw sw sw s w MANUALsw sw sw sw sw s w FOR sw sw s w INTERMED IATE
sw sw sw sw sw sw sw sw sw sw sw s w ACCO sw sw sw sw
U N T ING
sw sw sw sw
Q1-
7 U.S. companies listed on U.S. stock exchanges do not have the option to report under IFRS.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
However, foreign companies that trade in the U.S. exchanges can report under IFRS. The SEC p
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ermits the use of IFRS- sw sw sw sw
based financial statements by international companies with shares trading on U.S. stock exchan
sw sw sw sw sw sw sw sw sw sw sw sw
ges.
Q1-
8 The FASB seeks and welcomes comments from all parties in the financial reporting process i
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ncluding managers, investors, accountants, preparers, creditors, lenders, financial statement use
sw sw sw sw sw sw sw sw sw
rs, governmental agencies, financial analysts, industry groups, and auditors. FASB also receives
sw sw sw sw sw sw sw sw sw sw sw sw
feedback from public roundtable discussions, public meetings, the FASAC, the Private Compan
sw sw sw sw sw sw sw sw sw sw sw
y Council, and EITF.
sw sw sw
Q1-
9 Yes, the promulgation of financial accounting standards is a political process. There are sever
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
al groups that influence the standard setting process. The standard setting process is a political
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
process that is affected by the impact of several lobbying groups. The government, through the
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
SEC, influences accounting standards. The SEC has the authority to issue accounting standards
sw sw sw sw sw sw sw sw sw sw sw sw sw
but has assigned this responsibility to the private sector. Nonetheless, the SEC can exert pressur
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
e on the FASB to issue accounting standards and veto the standards promulgated by the FASB.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
Auditing firms, the corporate sector, creditors, financial analysts, the financial community, acco
sw sw sw sw sw sw sw sw sw sw sw
unting organizations, industry groups, and investors can influence the FASB by written commen
sw sw sw sw sw sw sw sw sw sw sw sw
ts about Exposure Drafts and participation in public meetings and public roundtables regarding
sw sw sw sw sw sw sw sw sw sw sw sw sw
a proposed financial reporting standard.
sw sw sw sw
Q1-10 A principles- sw sw
based standard is consistent with a theoretical framework. In contrast, a rules-
sw sw sw sw sw sw sw sw sw sw sw
based standard does not necessarily rely on a consistent theoretical framework. Rather, it cont
sw sw sw sw sw sw sw sw sw sw sw sw sw
ains more specific and prescriptive rules.
sw sw sw sw sw
Q1-
11 Recently, the FASB has taken an asset/liability approach in setting standards. With this appr
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
oach, a transaction is recorded based on whether an asset or liability is created. Another trend h
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
as been the movement toward the use of fair value measurements as an alternative to historical
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
cost. FASB has also focused on the promulgation of principles-based standards instead of rules-
sw sw sw sw sw sw sw sw sw sw sw sw sw
based standards. sw
Brief Exercises Solut sw sw
ion to BE1-1sw sw
General-
purpose financial statements provide general financial information about an entity that will be u
sw sw sw sw sw sw sw sw sw sw sw sw sw
seful to many types of users. General-
sw sw sw sw sw sw
purpose financial statements provide information to a wide spectrum of user groups: investors, c
sw sw sw sw sw sw sw sw sw sw sw sw sw
reditors, financial analysts, customers, employees, competitors, suppliers, unions, and governme
sw sw sw sw sw sw sw sw sw
nt agencies. Most financial information in general purpose financial statements is provided to sa
sw sw sw sw sw sw sw sw sw sw sw sw sw
tisfy users with limited ability or authority to obtain additional information, which includes inves
sw sw sw sw sw sw sw sw sw sw sw sw sw
tors and creditors. The Financial Accounting Standards Board (FASB) identifies investors, lend
sw sw sw sw sw sw sw sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
, C HAP TE R
sw sw sw sw sw sw s w 1s w THE sw sw s w FIN ANCI AL
sw sw sw sw sw sw sw sw s w RE PO RT IN G
sw sw sw sw sw sw sw sw s w EN VIR
sw sw sw sw s 1-3
sw sw s w
O N MENT
w sw sw sw sw sw
ers, and other creditors as the primary users of the financial statements.
sw sw sw sw sw sw sw sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
, 1-4
sw sw s w SO L UT IO NS
sw sw sw sw sw sw sw sw s w MANUAL
sw sw sw sw sw s w FOR sw sw s w INTERMED IATE
sw sw sw sw sw sw sw sw sw sw sw s w ACCO sw sw sw sw
U N T ING
sw sw sw sw
Solution to BE1-2 sw sw
Financial accounting is the process of identifying, measuring, and communicating financial info
sw sw sw sw sw sw sw sw sw sw sw
rmation about an economic entity to various user groups within the legal, economic, political, a
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
nd social environment. This definition contains four major elements: 1. Financial information;
sw sw sw sw sw sw sw sw sw s w sw sw
2.Economic entity; 3. User groups and 4. Legal, economic, political, and social environment
sw sw sw sw sw sw sw sw sw sw sw sw
Solution to BE1-3 sw sw
Financial Statement Users sw sw sw
and Other Parties sw sw Role
10. Are shareholders of the company. sw sw sw sw
sw 10 Equity Investors
sw sw
1. Are banks and other financial institutions that lend
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sw 1 Creditors
sw money to the company. w sw sw sw
5. Use financial information to review and analyz
s w sw sw sw sw sw sw
5 Financial Analysts
sw sw sw
e reported results of the companies they cover a
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nd make investment recommendations.sw sw sw
8 Employees and Labor Unions
sw sw sw sw sw
8. Use financial information during negotiation of ne
sw sw sw sw sw sw
2 Suppliers and Customers
sw sw sw sw
w labor agreements and compensation contracts.
sw sw sw sw sw
2. Use financial statements to determine whether to
sw sw sw sw sw sw s
7 Government Agencies
sw sw sw conduct business or purchase products from a c
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ompany.
sw 3 Competitors
sw
7. Review the financial statements of publicly traded c
s w sw sw sw sw sw sw sw
ompanies for a variety of reasons that are in the pu sw sw sw sw sw sw sw sw sw sw
4 External Auditors
sw sw sw
blic interest. sw
6 Internal Auditors
sw sw sw
3. Use financial information to determine their market
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position relative to the reporting entity and to atte
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sw 11 Regulatory Bodies
sw sw mpt to identify future strategies of the reporting ent
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ity.
9 Professional Organizations
sw sw sw
4. Are independent of the company and responsible
sw sw sw sw sw sw s
for ensuring that management prepares and issues
w sw sw sw sw sw sw
financial statements that comply with accountin
sw sw sw sw sw sw
g standards and fairly present the financial positi
sw sw sw sw sw sw sw
on and economic performance of the company.
sw sw sw sw sw sw
6. Are employees of the company serving in an advis
s w sw sw sw sw sw sw sw sw
ory role to management. They provide information
sw sw sw sw sw sw sw
to management regarding the company‘s operations
sw sw sw sw sw s
and proper functioning of its internal controls.
w sw sw sw sw sw sw
11. Protect investors and oversee the accounting and sw sw sw sw sw sw s
auditing standard setting processes.
w sw sw sw
9. Support accounting professionals throughout their sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
The Financial Reporting Environment
Solutions
Questions
Q1-
1 Financial information is a much broader concept than simply the financial statements and foot
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
notes to the financial statements. Financial information includes items such as the President‘s lett
sw sw sw sw sw sw sw sw sw sw sw sw sw
er to the owners, management‘s discussion and analysis, the auditors‘ report, the management re
sw sw sw sw sw sw sw sw sw sw sw sw sw
port and press releases. Of course, the basic financial statements and footnotes are included in t
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
he term financial information. The basic financial statements are: the balance sheet (also referr
sw sw sw sw sw sw sw sw sw sw sw sw s w
ed to as the statement of financial position), the statement of comprehensive income (also referr
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ed to as the statement of net income and the statement of comprehensive income), the statement
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw s
of cash flows, and the statement of shareholders‘ equity. Financial information is not synonym
w sw sw sw sw sw sw sw sw sw sw sw sw sw
ous with the term financial statements because the financial statements are a subset of the differ
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ent types of financial information provided.
sw sw sw sw sw
Q1-
2 The purpose of generating financial statements is to provide useful information to users to eval
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
uate economic entities and make efficient resource allocation decisions based on the risks and r
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
eturns of a particular investment. The Financial Accounting Standards Board (FASB) identifies
sw sw sw sw sw sw sw sw sw sw sw s
investors, lenders and other creditors as the primary users of the financial statements. The finan
w sw sw sw sw sw sw sw sw sw sw sw sw sw sw
cial statements are the culmination of the financial reporting process.
sw sw sw sw sw sw sw sw sw
Q1-
3 Capital is a scarce resource. Investors and creditors have to make decisions as to how much ca
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
pital to invest in any given entity; therefore, they demand relevant and faithfully representative i
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
nformation about the economic performance and financial position of a company. This informat
sw sw sw sw sw sw sw sw sw sw sw sw
ion is provided in the financial statements.
sw sw sw sw sw sw
Q1-
4 External auditors ensure that the management of a company has prepared financial statements
sw sw sw sw sw sw sw sw sw sw sw sw sw
in accordance with Generally Accepted Accounting Principles and fairly present the financial p
sw sw sw sw sw sw sw sw sw sw sw sw sw
osition and economic performance of a company. In addition, external auditors must be an inde
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
pendent party and cannot be employees of the company they are auditing. External auditors pro
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
vide a significant amount of credibility to the financial statements.
sw sw sw sw sw sw sw sw sw
Q1-
5 Data analytics is the process of analyzing large data sets in order to draw useful conclusions.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
It involves converting raw data into useful knowledge. In financial reporting, data analytics can
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
be used to improve the quality of estimates and valuations.
sw sw sw sw sw sw sw sw sw
Q1-
6 Standard setters create accounting concepts, rules, and guidelines to ensure that financial state
sw sw sw sw sw sw sw sw sw sw sw sw sw
ments accurately present the economic performance and financial position of a firm. The standa
sw sw sw sw sw sw sw sw sw sw sw sw sw
rds encourage transparent and truthful reporting.
sw sw sw sw sw
,1-2
sw sw s w SO L UT IO NS
sw sw sw sw sw sw sw sw s w MANUALsw sw sw sw sw s w FOR sw sw s w INTERMED IATE
sw sw sw sw sw sw sw sw sw sw sw s w ACCO sw sw sw sw
U N T ING
sw sw sw sw
Q1-
7 U.S. companies listed on U.S. stock exchanges do not have the option to report under IFRS.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
However, foreign companies that trade in the U.S. exchanges can report under IFRS. The SEC p
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ermits the use of IFRS- sw sw sw sw
based financial statements by international companies with shares trading on U.S. stock exchan
sw sw sw sw sw sw sw sw sw sw sw sw
ges.
Q1-
8 The FASB seeks and welcomes comments from all parties in the financial reporting process i
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
ncluding managers, investors, accountants, preparers, creditors, lenders, financial statement use
sw sw sw sw sw sw sw sw sw
rs, governmental agencies, financial analysts, industry groups, and auditors. FASB also receives
sw sw sw sw sw sw sw sw sw sw sw sw
feedback from public roundtable discussions, public meetings, the FASAC, the Private Compan
sw sw sw sw sw sw sw sw sw sw sw
y Council, and EITF.
sw sw sw
Q1-
9 Yes, the promulgation of financial accounting standards is a political process. There are sever
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
al groups that influence the standard setting process. The standard setting process is a political
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
process that is affected by the impact of several lobbying groups. The government, through the
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
SEC, influences accounting standards. The SEC has the authority to issue accounting standards
sw sw sw sw sw sw sw sw sw sw sw sw sw
but has assigned this responsibility to the private sector. Nonetheless, the SEC can exert pressur
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
e on the FASB to issue accounting standards and veto the standards promulgated by the FASB.
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
Auditing firms, the corporate sector, creditors, financial analysts, the financial community, acco
sw sw sw sw sw sw sw sw sw sw sw
unting organizations, industry groups, and investors can influence the FASB by written commen
sw sw sw sw sw sw sw sw sw sw sw sw
ts about Exposure Drafts and participation in public meetings and public roundtables regarding
sw sw sw sw sw sw sw sw sw sw sw sw sw
a proposed financial reporting standard.
sw sw sw sw
Q1-10 A principles- sw sw
based standard is consistent with a theoretical framework. In contrast, a rules-
sw sw sw sw sw sw sw sw sw sw sw
based standard does not necessarily rely on a consistent theoretical framework. Rather, it cont
sw sw sw sw sw sw sw sw sw sw sw sw sw
ains more specific and prescriptive rules.
sw sw sw sw sw
Q1-
11 Recently, the FASB has taken an asset/liability approach in setting standards. With this appr
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
oach, a transaction is recorded based on whether an asset or liability is created. Another trend h
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
as been the movement toward the use of fair value measurements as an alternative to historical
sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw sw
cost. FASB has also focused on the promulgation of principles-based standards instead of rules-
sw sw sw sw sw sw sw sw sw sw sw sw sw
based standards. sw
Brief Exercises Solut sw sw
ion to BE1-1sw sw
General-
purpose financial statements provide general financial information about an entity that will be u
sw sw sw sw sw sw sw sw sw sw sw sw sw
seful to many types of users. General-
sw sw sw sw sw sw
purpose financial statements provide information to a wide spectrum of user groups: investors, c
sw sw sw sw sw sw sw sw sw sw sw sw sw
reditors, financial analysts, customers, employees, competitors, suppliers, unions, and governme
sw sw sw sw sw sw sw sw sw
nt agencies. Most financial information in general purpose financial statements is provided to sa
sw sw sw sw sw sw sw sw sw sw sw sw sw
tisfy users with limited ability or authority to obtain additional information, which includes inves
sw sw sw sw sw sw sw sw sw sw sw sw sw
tors and creditors. The Financial Accounting Standards Board (FASB) identifies investors, lend
sw sw sw sw sw sw sw sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
, C HAP TE R
sw sw sw sw sw sw s w 1s w THE sw sw s w FIN ANCI AL
sw sw sw sw sw sw sw sw s w RE PO RT IN G
sw sw sw sw sw sw sw sw s w EN VIR
sw sw sw sw s 1-3
sw sw s w
O N MENT
w sw sw sw sw sw
ers, and other creditors as the primary users of the financial statements.
sw sw sw sw sw sw sw sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
, 1-4
sw sw s w SO L UT IO NS
sw sw sw sw sw sw sw sw s w MANUAL
sw sw sw sw sw s w FOR sw sw s w INTERMED IATE
sw sw sw sw sw sw sw sw sw sw sw s w ACCO sw sw sw sw
U N T ING
sw sw sw sw
Solution to BE1-2 sw sw
Financial accounting is the process of identifying, measuring, and communicating financial info
sw sw sw sw sw sw sw sw sw sw sw
rmation about an economic entity to various user groups within the legal, economic, political, a
sw sw sw sw sw sw sw sw sw sw sw sw sw sw
nd social environment. This definition contains four major elements: 1. Financial information;
sw sw sw sw sw sw sw sw sw s w sw sw
2.Economic entity; 3. User groups and 4. Legal, economic, political, and social environment
sw sw sw sw sw sw sw sw sw sw sw sw
Solution to BE1-3 sw sw
Financial Statement Users sw sw sw
and Other Parties sw sw Role
10. Are shareholders of the company. sw sw sw sw
sw 10 Equity Investors
sw sw
1. Are banks and other financial institutions that lend
sw sw sw sw sw sw sw s
sw 1 Creditors
sw money to the company. w sw sw sw
5. Use financial information to review and analyz
s w sw sw sw sw sw sw
5 Financial Analysts
sw sw sw
e reported results of the companies they cover a
sw sw sw sw sw sw sw sw
nd make investment recommendations.sw sw sw
8 Employees and Labor Unions
sw sw sw sw sw
8. Use financial information during negotiation of ne
sw sw sw sw sw sw
2 Suppliers and Customers
sw sw sw sw
w labor agreements and compensation contracts.
sw sw sw sw sw
2. Use financial statements to determine whether to
sw sw sw sw sw sw s
7 Government Agencies
sw sw sw conduct business or purchase products from a c
w sw sw sw sw sw sw sw
ompany.
sw 3 Competitors
sw
7. Review the financial statements of publicly traded c
s w sw sw sw sw sw sw sw
ompanies for a variety of reasons that are in the pu sw sw sw sw sw sw sw sw sw sw
4 External Auditors
sw sw sw
blic interest. sw
6 Internal Auditors
sw sw sw
3. Use financial information to determine their market
sw sw sw sw sw sw s
position relative to the reporting entity and to atte
w sw sw sw sw sw sw sw sw
sw 11 Regulatory Bodies
sw sw mpt to identify future strategies of the reporting ent
sw sw sw sw sw sw sw sw
ity.
9 Professional Organizations
sw sw sw
4. Are independent of the company and responsible
sw sw sw sw sw sw s
for ensuring that management prepares and issues
w sw sw sw sw sw sw
financial statements that comply with accountin
sw sw sw sw sw sw
g standards and fairly present the financial positi
sw sw sw sw sw sw sw
on and economic performance of the company.
sw sw sw sw sw sw
6. Are employees of the company serving in an advis
s w sw sw sw sw sw sw sw sw
ory role to management. They provide information
sw sw sw sw sw sw sw
to management regarding the company‘s operations
sw sw sw sw sw s
and proper functioning of its internal controls.
w sw sw sw sw sw sw
11. Protect investors and oversee the accounting and sw sw sw sw sw sw s
auditing standard setting processes.
w sw sw sw
9. Support accounting professionals throughout their sw sw sw sw
© 2021 Pearson Education, Inc
sw sw sw sw
.
