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 financial 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 Data analytics is the process of analyzing large data sets in order to draw useful
conclusions. It involves converting raw data into useful knowledge. In financial reporting, data
analytics can be used to improve the quality of estimates and valuations.
Q1-6 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.
,1-2 S O L U T I O N S M A N U A L F O R I N T E R M E D I A T E A C C O U N T ING
Q1-7 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.
Q1-8 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, the
Private Company Council, and EITF.
Q1-9 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.
Q1-10 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.
Q1-11 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.
© 2021 Pearson Education, Inc.
, CH APTER 1 THE FIN ANC IAL RE PO RT IN G EN V IR ON MENT 1-3
Solution to BE1-2
Financial accounting is the process of identifying, measuring, and communicating financial
information about an economic entity to various user groups within the legal, economic,
political, and social environment. This definition contains four major elements: 1. Financial
information; 2.Economic entity; 3. User groups and 4. Legal, economic, political, and social
environment
Solution to BE1-3
Financial Statement Users
and Other Parties Role
10 Equity Investors 10. Are shareholders of the company.
1. Are banks and other financial institutions that lend
1 Creditors money to the company.
5. Use financial information to review and analyze
5 Financial Analysts reported results of the companies they cover and
make investment recommendations.
8 Employees and Labor Unions
8. Use financial information during negotiation of
2 Suppliers and Customers new labor agreements and compensation contracts.
2. Use financial statements to determine whether to
7 Government Agencies conduct business or purchase products from a
company.
3 Competitors 7. Review the financial statements of publicly traded
companies for a variety of reasons that are in the
4 External Auditors
public interest.
6 Internal Auditors 3. Use financial information to determine their market
position relative to the reporting entity and to
11 Regulatory Bodies attempt to identify future strategies of the reporting
entity.
9 Professional Organizations 4. Are 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. Are 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 their
© 2021 Pearson Education, Inc.
, 1-4 S O L U T I O N S M A N U A L F O R I N T E R M E D I A T E A C C O U N T ING
careers by providing training, professional skills
development, and other resources.
Solution to BE1-4
Financial statement users and why each would use the financial statements are summarized
below:
1. Equity investors - Equity investors buy stock in the company, that is, they purchase a
percentage of the company itself. The financial statements help them make investment
decisions.
2. Creditors - Creditors loan money to the company. The financial statements help them assess
the creditworthiness of the company, and whether principal and interest will be repaid.
3. Competitors - Competitors use financial statements to determine their market position
relative to the reporting entity.
© 2021 Pearson Education, Inc.
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 financial 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 Data analytics is the process of analyzing large data sets in order to draw useful
conclusions. It involves converting raw data into useful knowledge. In financial reporting, data
analytics can be used to improve the quality of estimates and valuations.
Q1-6 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.
,1-2 S O L U T I O N S M A N U A L F O R I N T E R M E D I A T E A C C O U N T ING
Q1-7 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.
Q1-8 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, the
Private Company Council, and EITF.
Q1-9 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.
Q1-10 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.
Q1-11 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.
© 2021 Pearson Education, Inc.
, CH APTER 1 THE FIN ANC IAL RE PO RT IN G EN V IR ON MENT 1-3
Solution to BE1-2
Financial accounting is the process of identifying, measuring, and communicating financial
information about an economic entity to various user groups within the legal, economic,
political, and social environment. This definition contains four major elements: 1. Financial
information; 2.Economic entity; 3. User groups and 4. Legal, economic, political, and social
environment
Solution to BE1-3
Financial Statement Users
and Other Parties Role
10 Equity Investors 10. Are shareholders of the company.
1. Are banks and other financial institutions that lend
1 Creditors money to the company.
5. Use financial information to review and analyze
5 Financial Analysts reported results of the companies they cover and
make investment recommendations.
8 Employees and Labor Unions
8. Use financial information during negotiation of
2 Suppliers and Customers new labor agreements and compensation contracts.
2. Use financial statements to determine whether to
7 Government Agencies conduct business or purchase products from a
company.
3 Competitors 7. Review the financial statements of publicly traded
companies for a variety of reasons that are in the
4 External Auditors
public interest.
6 Internal Auditors 3. Use financial information to determine their market
position relative to the reporting entity and to
11 Regulatory Bodies attempt to identify future strategies of the reporting
entity.
9 Professional Organizations 4. Are 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. Are 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 their
© 2021 Pearson Education, Inc.
, 1-4 S O L U T I O N S M A N U A L F O R I N T E R M E D I A T E A C C O U N T ING
careers by providing training, professional skills
development, and other resources.
Solution to BE1-4
Financial statement users and why each would use the financial statements are summarized
below:
1. Equity investors - Equity investors buy stock in the company, that is, they purchase a
percentage of the company itself. The financial statements help them make investment
decisions.
2. Creditors - Creditors loan money to the company. The financial statements help them assess
the creditworthiness of the company, and whether principal and interest will be repaid.
3. Competitors - Competitors use financial statements to determine their market position
relative to the reporting entity.
© 2021 Pearson Education, Inc.
