Answers to Got It? - All Rights Reserved. May not be scanned, copied...

1-7 © 2024 Cengage Learning.All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Answers to Got It?1-1 The objective of financial accounting is to identify, measure, record, and report relevant and reliable financial information about companies to present and potential future stakeholders. Financial reporting is the process of communicating financial accounting information about a company to existing and potential future investors, creditors, and other external decision makers and stakeholders. An important way a company’s financial accounting information is reported is in its quarterly and annual reports. The role of financial reporting is to inform investors, creditors, and other stakeholders. Financial reporting also provides information to mitigate agency problems which stem from the separation of ownership and control of resources.1-2 The primary stakeholders that are important users of financial information include investors, creditors, banks, suppliers, customers, employees, executives, labor unions, pension funds, government regulatory authorities, tax authorities, local communities, and many others (see Exhibit 1.1). In class we discuss how these stakeholders can be divided into two major categories: external users and internal users. These two groups do not have the same decision-making information needs because of their differing relationships with the company providing economic information. Of these groups, FASB has stated the primary purpose of financial reporting is to inform investors and creditors.1-3 Investors and creditors take different downside risks and enjoy different potential upside gains from investing or lending. Equity investors are the residual risk bearers of corporations but stand to enjoy potentially greater upside if the company is successful and profitable. Creditors face less risk of loss of their investments because they have superior claim in bankruptcy over equity investors. But creditors do not share in the same upside potential as equity investors. As a result of these differences, their information needs differ. Equity investors are more concerned with profitability, whereas creditors tend to be more focused on cash flows.1-4 Information asymmetry arises from the separation of ownership and control of resources.Financial reporting helps reduce (but not eliminate) information asymmetry problems by enabling managers (agents) to provide relevant and faithfully represented information to investors and creditors (principals), thereby reducing information asymmetry.1-5 The demand for financial accounting information, as an economic good in society, arises from the needs of equity shareholders, creditors, and various other stakeholders for information to make resource allocation decisions. This demand arises because businesses have to compete for and attract scarce economic resources, such as equity and debt capital, productive resources, employees, supplier and customer relationships, and so forth. In order to compete for these valuable resources, companies must provide relevant and faithfully represented information to those who can provide the resources.1-6 To solve the problems that would arise from biases in a self-reporting accounting system, a natural demand arises for accounting standards and audits. The demand for accounting information drives the demand for professionally established accounting standards that provide authoritative guidance on how to measure and report economic activities in financial statements. In addition, the demand for accounting information also drives the demand for auditing— independent verification and attestation of whether the financial statements have been fairly presented in accordance with professional accounting standards.Chapter 1 Intermediate Accounting Reporting and Analysis, 4e James Wahlen, Jefferson Jones, Donald Pagach (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) Supplement files download link at the end of this file. 1 / 4

1-8 © 2024 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.1-7 Generally Accepted Accounting Principles (GAAP) are the principles, concepts, guidelines, procedures, and practices that U.S. companies that are listed in the United States and subject to SEC regulation are required to use in recording and reporting the accounting information in audited financial statements.

1-8 The supply of accounting information that companies report to external stakeholders is

determined primarily by the interactions between two sets of forces:

 The authoritative professional accounting standards that govern in the company’s country of incorporation, such as U.S. GAAP or IFRS, and  the many choices, methods, estimates, and judgments that the company must make in order to apply those accounting standards to measure and report their financial statements.

1-9 The stated mission of the U.S. Securities and Exchange Commission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The U.S. Congress created the SEC to administer the Securities Act of 1933 and the Securities Exchange Act of 1934. Under these Acts, the SEC has the legal authority to prescribe accounting principles and reporting practices for all corporations issuing publicly traded securities within the U.S. capital markets. The SEC has mandated that the information communicated to external users in financial reporting be based on professionally established accounting principles, such as GAAP for U.S. companies and IFRS for non-U.S. companies.

The SEC delegates the authority over standard setting to private standard-setting bodies within the accounting profession, such as the Financial Accounting Standards Board (FASB) establishing GAAP for U.S. companies and the International Accounting Standards Board (IASB) establishing IFRS for companies from many other countries around the world.The SEC monitors closely and oversees the standards being developed by these standard setters. From time to time, the SEC exerts pressure on the standard setters to adopt, or not adopt, specific standards.

1-10 The FASB is responsible for identifying financial accounting issues, conducting research to address these issues, and resolving them by issuing new accounting standards applicable to U.S. companies.

The FASB fulfills its responsibility by:

 establishing standards that are the most acceptable, given the various affected constituencies, and  continually monitoring the consequences of its actions so that revised standards can be issued where appropriate.

1-11 In assisting the FASB, the primary objectives of the EITF are:

 to identify significant emerging accounting issues (i.e., unique transactions and accounting problems) that it feels the FASB should address. to develop consensus positions on the implementation issues involving the application of standards. In some cases, these consensus positions may be viewed as the ‘‘best available guidance’’ on GAAP, particularly as they relate to new accounting issues.

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1-9 © 2024 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.1-12 The Codification is an electronic database that integrates and topically organizes the U.S. GAAP into one coherent body of literature. There are six levels in the framework of Codification: Areas, Topics, Subtopics, Sections, Subsections, and Paragraphs. The Topics level contains a collection of related guidance on a particular subject Area. The Subtopics level includes subsets of a Topic. The Sections level characterizes the nature of the content in a Subtopic (e.g., Recognition, Measurement, Disclosure). The Subsections level provides finer breakdown of the content in a Section. Paragraphs contain the guidance that constitutes GAAP.

The FASB developed the Codification to achieve three goals:

 Simplify user access by codifying all authoritative U.S. GAAP in one spot. Ensure the codified content accurately represented all authoritative U.S. GAAP. Create a codification research system that is up to date, including the most recently released standards.

1-13 Before issuing an Accounting Standards Update, the FASB generally completes a

multistage process as follows:

(1) identifies topic (2) appoints task force (3) conducts research (4) issues Discussion Memorandum or Invitation to Comment (5) holds public hearings (6) deliberates on findings (7) issues Exposure Draft (8) holds public hearings (9) modifies Exposure Draft (10) votes

After a supermajority vote (at least five votes out of seven) is attained, the FASB issues an Accounting Standards Update.

1-14 The FASB and IASB are overseen and supported by Foundations comprised of Boards of Trustees and supported by large staffs of professional and technical experts and administrative support. Similarly, both Boards have Advisory Councils as resources for input. Unlike the Financial Accounting Foundation, the IFRS Foundation Trustees are overseen by the IFRS Foundation Monitoring Board, which consists of capital markets authorities from jurisdictions around the world that require or allow the use of IFRS. Both Boards follow similar open, careful due processes in deliberating new accounting standards. Whereas the FASB is a seven-member Board consisting of only U.S. members, the IASB is larger, with 14 full-time members. The composition of the IASB is structured to contain a balanced representation from different countries and regions of the world. The IASB issues International Financial Reporting Standards (IFRS). To do so, its operating procedures include study of the topic, issuance of an Exposure Draft, evaluation of comments, and consideration of a revised draft. If approved by at least nine members of the IASB, the International Financial Reporting Standard is issued.

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1-10 © 2024 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.1-15 They are the principles, concepts, guidelines, procedures, and practices that companies from the roughly 140 countries that have adopted IFRS are required to use in recording and reporting the accounting information in audited financial statements. In the United States, the SEC has decided to allow non-U.S. companies that are listed in the United States and subject to SEC regulation to use IFRS for preparation of financial statements filed with the SEC.

1-16 The FASB and the IASB have completed most of their major joint projects, which have helped achieve greater convergence between U.S. GAAP and IFRS. The collaborative efforts of the FASB and the IASB are on a path to both improve U.S. GAAP and IFRS and eliminate or minimize the differences between them.

1-17 Because of the substantial economic consequences of new standards, key constituents often disagree about the objectives for new standards. Because the Boards hold public hearings and open meetings, various external user groups (e.g., investors and creditors) and other interested parties (e.g., affected corporations and CPA firms) exert pressure to influence the new standards, continue existing standards, or change existing standards in their own best interests. In addition, research results about the likely effects of new standards are sometimes conflicting, and only “best guesses” can be made of the future consequences of current standards. A particular difficulty is that costs of complying with new standards are often significant and measurable, whereas the benefits of new information to decision makers are diffuse and hard to quantify. As a consequence, the FASB and the IASB often make decisions about new accounting standards that sometimes require compromise between conflicting views and interests.

1-18 The balance sheet, or statement of financial position, presents a snapshot of the resources of a firm (assets) and the claims on the company (liabilities and shareholders’ equity) as of a specific date (usually the last day of the fiscal quarter or the fiscal year). The balance sheet reports the following equality:

Assets = Liabilities + Shareholders’ Equity

Most stakeholders in a company, particularly investors and creditors, will be interested in balance sheet information because it reports the financial position (resources and obligations) of the company.

1-19 The income statement measures and reports the financial results of a firm’s performance for a period of time, usually a quarter or a year. The income statement provides information about the profits (or losses) the firm has generated during the period by conducting operating, investing, and financing activities. Most stakeholders in a company, particularly equity investors, will be interested in income statement information because it reports the profits and losses that accrue to the common equity shareholders of the company. The chapter shows empirical research evidence on how changes in earnings are associated with changes in stock prices.

1-20 The statement of cash flows reports for a period of time the net cash flows (inflows minus outflows) from the three principal categories of business activities: operating, investing, and financing. The purpose of the statement of cash flows is important but simple: to provide useful information about how a firm is generating and using cash. The statement of cash flows provides information to complement the income statement, demonstrating how cash flows differ from accrual-based income.

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