Intermediate Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
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The Environment of Accounting
Thomas H. Beechy
Schulich School of Business,
York University
Chapter 1
Joan E. D. Conrod
Faculty of Management,
Dalhousie University
PowerPoint slides by:
Bruce W. MacLean,
Faculty of Management,
Dalhousie University
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1
INTRODUCTION



The purpose of financial accounting is to
communicate information to make decisions.
Accountants make financial reporting choices
that have the potential power to
influence someone’s or some
group’s behavior.
GAAP is a rather loosely defined
set of alternative approaches to
measuring and reporting
economic activities.
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The Difference between Accounting and
Bookkeeping
1
Bookkeeping is a recording process, much of
which statements
has been automated
Financial
are the end through the wideAssertions about economic
spread
of number
computers.
product
of ause
large
of :
actions and events
• accounting
policy
decisions
The accountant is responsible for telling the
• measurement
estimates
computer what
to do (not for the programming)
Footnotes
by management
(often with
– how to classify
andthe
record transactions,
Statement of Changes
advice of accountants), many of
– how
to disclose
those transactions
the
Incomeinstatement
which
are based
on expectations
statements,
Balance Sheet
about financial
future events.
– how toinvolves
measure
the value of assets and liabilities
Accounting
many
and choices.
of their related revenues and expenses, and
subjective
– what additional disclosures are appropriate.

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User Demand for Reliable Information
Users
Shareholders
Bond holders
Banks
Creditors
Employees
Auditors
Assurance
Demand
Companies
Complexity
Remoteness
Consequences
Directors
Management
(clients)
Accounting
Information
Provide
Balance Sheet
Income Statement
Financial Position
(conflict of
interest)
1
THE REALM OF FINANCIAL
ACCOUNTING
 Proprietorships
 Partnerships
all organizations,
the financial accounting
 Corporations
system produces
reports both
Charitable
Non-profit
organizations
 Incorporated
– at a point in time (point
statement) balance sheet and
 Unincorporated
Non-charitable
– for a period of time
(flow statements).
 Incorporated
 Unincorporated
 Flow statements vary
depending on the type of
Governments  Senior governments (federal, provincial, and
organization. All types
of organization normally
territorial)
Municipal governments (and school boards)
prepare three flow statements:
Exclusive use of management for decision-making,
Internal
Management
planning, employee motivation, and internal
Reports
Accounting
 statement
of operations
performance evaluation.
of changes
accumulates and reports information on the
thatcapital
System in
Economy
Macro  statement
economy
accounting
Financial
Accounting
 For
Businesses
 cash flow statement
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1
PUBLIC vs. PRIVATE CORPORATIONS



A public corporation is one that issues securities (either debt
or equity, or both) to the public that can be traded on the open
market, usually through an organized exchange such as the
Montreal Exchange or the Toronto Stock Exchange.
Public corporations must be registered with the securities
commissions in each province in which their securities are
traded and must comply with the reporting requirements of
the securities commissions.
A private corporation is one that does not issue securities to
the public.
– Private Placements McCain Foods Ltd., with annual revenues in excess
of $4 billion
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1




Accounting Implications
Public corporations must be audited and their
reporting generally must conform to generally
accepted accounting principles (GAAP).
The business corporations acts (CBCA) and
provincial acts usually state that an audit is
required for corporations that are above a
specified size threshold
Exemptions from the audit requirement
are readily available if all the shareholders
agree to waive the audit.
Wholly-owned subsidiaries of foreign parents
are likely to be audited but not reported publicly.
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Overview
of FS
Auditing
Assertions about Footnotes
economic
Statement of Changes
actions
and events Income statement
Balance Sheet
Other Communications
Objective
outsider
Independent
Auditor
Obtains and
evaluates evidence
Knowledge of client’s
business observation of
physical assets, enquiry
of managers,
confirmations from
outsider’s, inspection of
documents
Audit report
A certain degree
of correspondence
ISAC
FASB
SEC
CICA
EIC
OSC
GAAP
1
Control Blocks
Control block. Canadian public corporations most likely
will be
controlled
a small
number500
of related
Financial
Post’s
annual by
listing
of Canada’s
largest or affiliated
shareholders
have
the majority of the voting shares.
corporations,
knownwho
as the
FP500
 It is common Canadian practice for a public corporation
to companies
issue two or more classes of shares:
Public
50%
one with multiple
votes and
Public– companies
with control
blocks.
>50%
– another
with little
or no voting rights called
restricted shares.
“Widely
held” public
companies.
22%
 Restricted shares are used as a means of raising public
This capital
22% actually
overstates
the power
importance
of control
widely block.
without
losing the
of the
held
public companies in Canada, because the list does
 In Canada, the reporting objectives of the controlling
not include
a large may
number
private
companiesover
for those of the
shareholder
welloftake
precedence
which
no data
is available.
public
investor.

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WHAT IS GAAP?

Generally accepted accounting principles (GAAP)
represent the body of accounting practices that has
been built up over a long period of time through use.
– Pronouncements by designated authoritative bodies
that must be followed in all applicable cases
– Accounting practices developed by respected bodies
and industries or that have evolved over time
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1
WHAT IS GAAP?
CICA Handbook

Areas covered

liabilities
categories of assets
financial statement format
and presentation
problem areas that are
important mainly for large
corporations
a few disclosures that are
required for public
companies only




Copyright 1998 McGraw-Hill Ryerson Limited, Canada
examples
 pensions, leases,
income taxes
 R&D costs; capital assets;
long-term investments
 disclosure in the balance sheet,
income statement and the cash
flow statement
 business combinations;
foreign operations
 interim statements; segmented
reporting; earnings per share
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WHAT IS GAAP?
Other Areas - Sources of GAAP






Past accounting practice
Accounting Guidelines
AcSB’s Steering Committee
Abstracts of the
Emerging Issues Committee (EIC)
Research publications of
Canadian professional accounting bodies
Pronouncements by U.S.A.’s
Financial Accounting Standards Board or by the
International Accounting Standards Committee.
Textbooks and Other publications
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WHAT IS GAAP?
CICA Handbook - not Included


Revenue and expense recognition
Accounting practices in the specialized
industries (In Canada - A majority of the
economic activity of the country)
– Real property development,
– Financial services (e.g., insurance,
banking, and investment dealers
and funds),
– Resource companies (forest
products, mining, oil and gas), and
agriculture.
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AcSB - Accounting Standards Board
Nominations one each
CCFA Financial Analysts
CAAA Academics
FEAC Financial Executives
CGAAC CGA
SMAC CMA
CICA 8 members +
2 non-voting
Appoints AcSB members
Accounting Standards Board
Task Forces
Standards
Advisory
Board
Emerging Issues Committee
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The Accounting Standard Setting
Process in Canada






Write project proposal
Appoints task force
Develop issues paper
Create statement of
principles
Review with
associates
Develop exposure
draft
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Develop re-exposure
draft
 Make revisions
 Obtain AcSB approval
 CICA Handbook Section
 Accounting Guidelines

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Consensus
Groups
Professional
accounting
organizations
Provincial
Securities
Commissions
Industry
Groups
Other
professional
organizations
Public Accounting
firms
AcSB
Individuals
a broad
accounting issue is
identified
Financial
AcSB forms a task
Academics
force
AcSB prepares a
statement of
principles
AcSB prepares an
exposure draft
AcSB decision;
issues a standard
Analysts
Lawyers
Business
Leaders
Other
Interested
Parties
1
Click to Link to
Internet Site
FASB
Financial
Accounting
Foundation

Financial Accounting
Standards Board (FASB)
7 full-time,
independent
voting members
30 full
time staff
Two type of pronouncements
– Statements of Financial Accounting Concepts (SFACs)
– Statements of Financial Accounting Standards (SFASs)


Due process procedures followed
Conduct research where appropriate
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Virtues of the AcSB procedure:




It is a slow process, allows time for alternative accounting
and reporting treatments to be tested in practice before the
field of ‘acceptable’ practices is narrowed;
It prevents the proverbial ‘knee-jerk’ reaction to issues that
turn out to be temporary and of limited concern;
The members of the AcSB are all engaged in their regular
full-time employment elsewhere, so that they maintain an
outside perspective; and
The AcSB requires a two-thirds vote for approval of new
recommendations, which helps to ensure that the
recommendations have a reasonably wide base of support.
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
OTHER ORGANIZATIONS
Canadian Institute of Chartered Accountants (CICA)
– CA Magazine, Financial Accounting in Canada,CICA Research Studies,
Statements of Auditing Standards,Statements of Accounting Standards


Certified General Accountants’ Association
of Canada (CGAAC) CGA Magazine, GAAP Guide
Society of Management Accountants (SMA)
– Research Studies, Cost and Management




Securities and Exchange Commission (SEC)
Ontario Securities Commission (OSC)
Revenue Canada
Internal Revenue Service (IRS)
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OTHER ORGANIZATIONS





Academic Associations
– Canadian Academic Accounting Association (CAAA)
– American Accounting Association (AAA)
Executive Associations
– Canadian Council of Financial Analysts (CCFA)
– Financial Executives Association of Canada (FEAC)
American Institute of Certified Public Accountants (AICPA)
Governmental Accounting Standards Board (GASB)
Institute of Management Accountants (IMA)
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ETHICS



To be useful, accounting information
must be objective and reliable.
Management may be under pressure
to report desired results and ignore
or bend existing rules.
As professionals, we must be aware
of these pressures and sensitive to the
need to make appropriate decisions.
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

Revenue Canada
Agency of the federal government
Interpret and enforce the nation’s federal tax laws
Procedures and reporting requirements
– To collect money and,
– To attain specific social or economic objectives

Taxation principles:
– Emphasize cash flows - usually are
measurable quite clearly
– Exception reporting - Expenses Per Books (defer-and-amortize
approach) vs Tax Deductions (Capital Cost Allowance)
– Different Year Ends
– Book-tax conformity causes GAAP to be influenced
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Influence of Accounting Standards of
Other Countries
 Profound impact through two forms of accounting imperialism
– Political influence - families of accounting standards.
Capital flows
- close
economic
ties and more closely knit,
• The–Canadian
accounting
profession
is smaller
 Simplify life for the large number of U.S. subsidiaries
and
the ethical control
mechanism
is stronger
 Harmonize
Canadian
accounting
with that of the U.S
 Canadian-owned corporations (raise capital in USA) - would not
 has
AcSB’s
decide whetherlarger
or not mercantile
to
• U.S.
a proportionately
(i.e., retailing and
report
under
two
different
sets
adopt U.S.
accounting
wholesaling)
industry
and a standards.
far
accounting
 of
Few
Canadianstandards.
companies
larger
manufacturing
segment. are
registered
public
companies
in the US
 Securities
commissions
could
(Canada
- Resources
and services
based)
 share
SEC the
and regulatory
the Ontario burden
Securities
 U.S. has a large portion of economic
Commission (OSC) - cross-registered

International
audit
firms
activitycorporations
carried on in
by
public
each jurisdiction may file
could
transfer
staff
corporations
their financial statements in the host

using
home-country
GAAP
Debt country
financing
is much
higher in
Canadian business practice
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
International Accounting Standards
The International Accounting Standards Committee (IASC)
was established in 1973. The IASC consists of representatives
from professional accountancy bodies (i.e., auditors) from a
wide number of countries (107 bodies from 81 countries, in
1993), but is governed by a much smaller group.
– The objective of the IASC is to promote the world-wide harmonization of
accounting principles. IASC has been dominated by the Anglo-Saxon
approach to accounting
– There is little evidence to suggest that such harmonization is needed in
order to facilitate the international movement of capital.
– Restatement of GAAP is often not effective: Japanese financial
statements restated according to U.S. GAAP may be comparable to U.S.
financial statements in form, but not in substance
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Tailored Accounting Policies

When non-GAAP accounting policies are used, the
company is said to be using tailored accounting
policies (TAP) and to be reporting on a disclosed
basis of accounting (DBA). The CICA Handbook
recommends that:


A clear and concise description of the significant accounting
policies of the enterprise should be included as an integral
part of the financial statements. [CICA 1505.04]
In 1996, the CICA’s Auditing Standards Board (AuSB)
began deliberations on recommendations to clarify the
role of the auditor in engagements for companies in
which TAP are used.
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

Objectives Of
Financial Reporting
Preparers
(firms)
Communicate information for the decision
purposes to one or more groups or types of users. Published
Financial
Financial statements often have direct
Statements
economic impacts for either the enterprise
or its stakeholders, or both.
Auditors
– profit-sharing, income tax liability, financing provided
by a bank, permitted return in regulated industries,
covenants, financial rewards

Many of the decisions that users must make
are evaluative decisions that may not have
immediate economic impacts
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Users
Other
information
sources
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Objectives Of Financial Reporting





Assessing Predicting Cash Flows
Income Tax Minimization
Contract Compliance
Stewardship
Performance evaluation
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Assessing Predicting Cash Flows


The consequences of adopting cash flow
prediction as a primary reporting objective
include the following:
– Accounting policies are chosen that
tend to reduce inter-period allocations.
– Full disclosure of future cash flow
commitments is given in the notes
When cash flow assessment and prediction is the
primary objective, financial reporting policies are
chosen that provide the clearest indication of the cash
flows underlying reported earnings.
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Income Tax Minimization

A very common objective, particularly for private
companies, is that of income tax minimization.
– Since there is a time value of money, why pay taxes this
year if they can be delayed until next year?

It will adopt accounting policies that tend to
 delay the recognition of revenue to the
extent permitted by the Income Tax Act,
particularly for long earnings cycles, and
 speed up the payment of expenses that
can legitimately be deducted for tax
purposes.
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Contract Compliance



Financial statements often are the basis that external
users use for assessing whether an enterprise has
complied with contract provisions.
The most common type of financial
statement contracting is for debt,
particularly with bank loans and with
issues of bonds (both publicly issued
and privately placed).
Accounting policy choices and accounting
estimates can have a significant effect on
the ratios used in debt agreements and for share
valuation in shareholders’ agreements.
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Stewardship




A question commonly asked by business investors, by
taxpayers, and by donors to charitable organizations is:
“What did they do with my money?”
A steward is a person who is
responsible for managing an
enterprise on behalf of
someone else
The stewardship objective is most
clearly dominant in reporting for
non-profit organizations, where
donors and members need to see how managers used
the resources at their disposal for the period.
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Performance evaluation

Financial statement readers often use the
statements to evaluate management
performance.
– The common use of bonus schemes based on
reported earnings as means of compensating
senior executives

Managers are fully aware of the
performance evaluation objective of
financial statements,
– Therefore, managers have strong motivations to
select accounting policies that will enhance their
apparent performance.
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Management Motivations




Income Maximization or Minimization
Income Smoothing
Minimum Compliance
Expanded Disclosure
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Income Maximization or Minimization

The maximization of net income is one of the
commonest motivations of managers. This motivation
stems from three powerful concerns:
– to make it easier to comply with debt
covenants,
– to positively influence users’ judgements in
evaluating the performance of management
– to enhance managers’ compensation, in the
many corporations wherein management
compensation is tied either to net income or to
stock price performance, or both.
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Income Maximization or Minimization

In addition to the possible objective of minimizing income
taxes, management may strive to reduce earnings for any
of the following reasons:
– to avoid public embarrassment by reducing
a high level of reported earnings;
– to avoid attracting competitors
into a very lucrative business;
– to discourage hostile take-over bids;
– to avoid the scrutiny of regulators
or politicians; or
– to discourage large wage claims
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Income Smoothing

Canadian managers do seem to be fond of showing a
smooth record of earnings, free of disturbing peaks and
valleys.
– Widely fluctuating earnings are an indication of risk, and
managers often do not want investors or creditors to perceive the
company as being risky.
– Income can be smoothed by taking
advantage of the many opportunities
available (within GAAP) for spreading
both revenues and costs over several
periods.
– Accounting estimates provide a great
opportunity for income smoothing
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?
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Minimum Compliance



Minimum compliance refers to the motivation of
managers to reveal the least amount of information that is
possible within the recommendations of the CICA
Handbook and still receive a clean audit opinion
(assuming that a clean opinion is needed in the
circumstances).
Minimum compliance may be a motivation for managers
in a public company because management does not wish
to give outsiders any more information about the
company than is absolutely necessary.
Minimum compliance is usually equated with minimum
cost of providing accounting information.
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Expanded Disclosure




The opposite to minimum compliance may be called
expanded disclosure.
Management may wish to disclose a great deal of
information that they are not required to disclose under
GAAP.
The motivation for expanded disclosure may be simply to
indicate that the company and its management are ‘good
citizens’ who have nothing to hide and wish to provide the
most informative financial statements possible.
Sometimes, expanded disclosure is motivated by the
expected concerns of specific stakeholders.
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Objectives vs. Motivations

Users’ objectives and managers’
motivations often conflict.
– Being aware of users’ objectives, it is
not uncommon for managers to
attempt to put the best picture on the
corporation’s operations and financial position.
– The resolution of this conflict depends on general
concepts of fair presentation and often presents an
ethical dilemma for management, for the company’s
accountants, and for auditors (if any).
– Prioritizing conflicting objectives is part of the exercise
of professional judgement that is discussed further in
Chapter 2.
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1
WOW!
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