Chapter 1
The Canadian Financial Reporting Environment
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
2
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
3
Characteristics of Accounting
•
•
•
Accounting identifies, measures, analyses, and
communicates financial information to various
users (decision makers)
Accounting has two broad classifications:
1. Financial accounting
2. Managerial accounting
Accounting theory and practice have evolved and
will continue to evolve to meet changing demands
and influences
4
Characteristics of Accounting
1. Identification, measurement, and
communication of financial information
about;
2. Economic entities to;
3. Interested persons.
5
Financial Reporting
• Financial accounting provides historical information
• Financial reporting is used by both internal and
external users
• External users include such decision makers as
investors, creditors, unions, and government
agencies
• Managerial accounting provides both historical and
forecast information
• Managerial reporting information is used by
management (internal users only)
6
Financial Statements and Other
Means of Financial Reporting
•
Major financial statements include:
• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Statement of Shareholders’ (Owners’)
Equity
+ Note Disclosures
7
Financial Reporting
•
Other forms of financial reporting include:
• President’s letter
• Prospectuses
• Government reporting
• News releases
• Management forecasts
8
Flow of Information through the
Financial Statements
Income
Statement
Reports Net
Income
Statement of
Equity
Balance
Sheet
Ending
balance
reported
Change in cash as
reported displays the
change in cash
position
Statement of
Cash Flows
9
Accounting and Capital Allocation
Financial reporting aids users in the
allocation of scarce resources
(capital)
10
Accounting and Capital Allocation
• The accounting profession has the
responsibility of measuring a company’s
performance accurately, fairly, and on a
timely basis
• These measurements enable investors and
creditors to compare the income and assets
employed by companies
• Investors can then assess the relative risks
and returns associated with companies
11
Capital Allocation Process
12
Accounting and Capital Allocation
Financial
Reporting
aids
Financial
statements and
other forms of
financial
reporting
Users
(present and
potential)
Users include:
investors,
creditors,
unions,
government
agencies, and
other
Capital
Allocation
decisions
Involves
determining
how funds are
allocated among
competing
interests
13
Accounting and Capital Allocation
• In Canada, the primary exchange mechanisms
for allocating resources are:
– Debt and equity markets (e.g. TSX)
– Financial institutions (e.g. banks)
14
Sources of Capital
15
Accounting and Capital Allocation
• An effective process of capital allocation is
critical to a healthy economy
• Unreliable information leads to poor capital
allocation
• Credit rating agencies use accounting to rate
companies’ financial stability
• This gives investors and creditors additional
independent information
16
Stakeholders in Financial Reporting
• Stakeholders: parties who have
something at risk (stake) in the financial
reporting environment
• Key stakeholders include traditional
users of financial information
17
Stakeholders in Financial Reporting
• Broader definition of users is: anyone who
prepares, relies on, reviews, audits, or
monitors financial information
• Includes both internal and external parties
• Key stakeholders include:
– investors, creditors, auditors, regulators,
analysts, management, standard setters,
and others
18
Stakeholders in Financial Accounting
• Investors and creditors rely on the financial
statements to make decisions
• Standard setters set Generally Accepted
Accounting Principles (GAAP) for direction on
accounting
• GAAP is used to help reduce management
bias and to ensure the information is useful to
users
19
What is at Stake for Each Stakeholder
Stakeholder
What is at Stake?
• Investors &
creditors
• Investment / loan
• Management
• Job, bonus, reputation, salary
increase, access to capital markets
by company
• Securities
commissions
and stock
exchanges
• Reputation, effective and efficient
capital marketplace
20
What is at Stake for Each Stakeholder
Stakeholder
What is at Stake?
• Analysts & credit
rating agencies
• Reputation and profits
• Auditors
• Reputation and profits (companies
are their clients)
• Standard setters
• Reputation
21
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
22
Objective of Financial Reporting
• The overall objective of financial reporting is to provide
information that is:
1. useful to users, and
2. decision relevant
• Financial statements should provide information about:
1. the entity’s economic resources and claims to those
resources, and
2. changes in those resources and claims
• Resource allocation decisions are assumed to include
assessment of management stewardship (i.e. management
role in maximizing shareholder value)
23
Objectives of Financial Reporting
Resource Allocation Decisions
Was income
earned to
generate
future cash?
Yes
Able to meet obligations
and pay a return on
investment
Assess Management Stewardship
Did management’s decisions
on resource acquisition and
allocation increase
shareholder wealth?
Yes
Capital
continues
to be
available
Investor and creditor
confidence continues
24
Management Bias
• Preparation of the financial statements are the
responsibility of internal management
• May lead to preparing statements that report the
enterprise in its best light
• Motives include:
– to reflect positive management stewardship (job,
compensation)
– meet financial analysts’ expectations, resulting in
a positive reaction in the capital markets
• What safeguards are in place to protect financial
users from management bias?
25
Understanding User Needs in the
Financial Reporting Process
Management
Prepare the
reports
Users
Use the reports
to acquire capital
Use the reports for
investment/lending
decisions
Financial
Statements
Aggressive financial reporting has a direct impact on
the user’s decision-making process
26
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
27
The Need to Develop Standards
• Standards are set to aid preparers and users of
financial statements
• They allow the preparers of the financial
statements to present fairly the operations of the
company
• A single set of financial statements is prepared
to meet the majority of the users’ needs
• Standards are not rules, regulations, or laws
• Standards are intended to be generally
accepted and universally practised
28
The Standard Setting Process in
Canada – Parties Involved
•
Canadian Accounting Standards Board (AcSB)
– Primarily responsible for setting GAAP in Canada
•
From 2011, this will be limited to standards for private
enterprises, not-for-profit entities, and pension plans
only (standards for publicly accountable entities will be
set by the International Accounting Standards Board)
– Two underlying premises for development of
standards
• Be responsive to the needs and viewpoints of the
entire economic community
• Operate in full public view through due process
29
The Standard Setting Process in
Canada – Parties Involved
• International Accounting Standards Board (IASB)
– Major international standard setting body
– Mission “to develop, in the public interest, a single
set of high quality, understandable and international
reporting standards (IFRSs) for general purpose
financial statements”
30
The Standard Setting Process in
Canada — Parties Involved
• Financial Accounting Standards Board (FASB) and
the Securities and Exchange Commission (SEC)
– FASB is the major standard setting body in the
U.S.
– SEC has the final authority over accounting
standards in the U.S
• Provincial Securities Commission
(e.g. Ontario Securities Commission)
– To oversee and monitor capital marketplace
– Ensure strict adherence to securities
law/legislation
31
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
32
Generally Accepted Accounting
Principles (GAAP)
• For private companies, pension plans, and not-forprofit entities, GAAP consists of :
– Primary sources
• CICA Handbook Sections 1400 to 3870
• Accounting guidelines
– Other sources
• Background documents and implementation guidance issued by
AcSB
• Pronouncements in other jurisdictions
• Research studies, accounting textbooks, journals, etc.
Must be consistent with primary sources and in accordance
with the conceptual framework (i.e. CICA Handbook Section
1000)
33
Generally Accepted Accounting
Principles (GAAP)
• For public companies (reporting under IFRS),
GAAP includes:
–
–
–
–
IFRS
International Accounting Standards (IAS)
Interpretations (IFRIC or SIC)
If above sources do not specifically apply, other
sources may be considered:
• Pronouncements of other standard-setting bodies
• Other accounting literature
• Accepted industry practices
34
Professional Judgement
• There cannot be a rule for every situation
• Standards in Canada are based primarily on
principles rather than specific rules
• Therefore, must use professional judgement
• The United States uses a rules-based
approach
35
Role of Ethics
• Ethical dilemmas are common in accounting
and other areas of business
• It is not always easy to do the right thing or
make the right decision
• Ethical decisions often go beyond applying
GAAP or rules of the profession
36
The Canadian Financial Reporting
Environment
Role of
Financial
Reporting
• Financial
statements
and financial
reporting
• Accounting
and capital
allocation
•Stakeholders
Objective of
Financial
Reporting
•Management
bias
•Users’ needs
Standard
Setting
• Need to
develop
standards
• Parties
involved in
standard
setting
• Standard
setting in a
political
environment
GAAP
• GAAP
hierarchy
•Professional
judgement
• Role of
ethics
Challenges
Facing Financial
Reporting
• Globalization of
companies and
capital markets
• Impact of
technology
• Changing nature
of the economy
• Increased
requirement for
accountability
37
Sarbanes-Oxley Act (SOX)
• The Sarbanes-Oxley Act (SOX) was enacted in
2002 (in the United States)
• Some of the legislation’s key provisions:
– Public Company Accounting Oversight Board
(PCAOB)
– Independence rules
– Bonus/profit forfeiture
– CEO/CFO certification
– Management report on effectiveness of internal
controls over financial reporting
– Independent audit committees
– Codes of ethics
38
Canadian Response
• The Canadian Public Accountability Board
(CPAB)
• Additional rules issued by Canadian Securities
Administrators (CSA) including:
– Management responsibility for appropriateness
and fairness of financial statements
– Independent audit committees
– Increased disclosures
39
Challenges Facing Accounting
Need for international
harmonization of standards
Globalization
Technology
New economy
Accountability
Ability to produce and access
timely information
A move from the traditional
‘resource-based’ to a
‘knowledge-based’ economy
Driven by more sophisticated
and varied investors
40
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41