Solution Manual for Intermediate Accounting Volume 1, Tenth Canadian Edition

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-1Chapter 1CHAPTER 1THE CANADIAN FINANCIAL REPORTINGENVIRONMENTASSIGNMENT CLASSIFICATION TABLETopicBrief ExercisesWritingAssignments1.Financial statements and financial reporting.2.Capital allocation.143.Stakeholders.244.Objectives of financial reporting.35.Management bias in financial reporting.16.Importance of user needs in financial reporting.1, 2,77.Need for accounting standards.6,71, 2,78.Parties involved in standard-setting.8,9, 10, 11, 12,13, 14, 153, 69.GAAP.16, 17, 186,10.Professional judgement.19,20611.Ethical issues.21,22,23512.Challenges facing financial accounting20,24,255,713.Information Assymetry4, 5

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-2Chapter 1SOLUTIONS TO BRIEF EXERCISESBRIEF EXERCISE 1-1Accountinghastheresponsibilityofmeasuringcompanyperformanceaccuratelyandfairlyonatimelybasis.Thisenables investors and creditors to assess the relative risks andreturns of investment opportunities and channel resources moreeffectively. If a company’s financial performance is measuredaccurately, fairly, and on a timely basis, the right managers andcompanies are able to attract investment capital.Unreliable andirrelevantinformation leadstopoorcapitalallocation,whichadverselyaffectsthesecuritiesmarketandultimatelytheperformance of the economy as a whole.BRIEF EXERCISE 1-2Some stakeholders using financial accounting information andfinancial statementsinclude:Investors–Thesestakeholdersareinterestedintheperformance of their investment in the company. They will usethe financial statements to evaluatemanagement stewardshipand effectiveness.Creditors–Thesestakeholders are interested in evaluating thecompany to decide whether to lend money to it. They will usethe statements to evaluate the risk that will be taken in makingtheloan.Forexample,lenderswanttoknowwhetherthecompany will be able to repay its loanswhen due and serviceinterest and principal on a timely basis.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-3Chapter 1BRIEF EXERCISE 1-2(CONTINUED)Canada Revenue Agency (CRA)–Thesestakeholdersestablishthe rules for how taxable income will be measured. They areinterested in the fair measurement of the financial positionandfinancial performanceof the company so that the appropriateamount oftax will be paid.Note that in preparing the tax return,the financial statements net income is the starting point and isthen adjusted toarriveat taxableincome,which is used tocalculate the amount of taxes payable.The CRA isprincipallyinterested in compliance with theIncomeTaxAct.FinancialAnalysts–Thesestakeholdersprovideinvestmentadvice to their clients. They areinterested in evaluating theinvestmentopportunities andpotential of various companies.Note:This is only a suggested list of stakeholders and theirpossible uses of the financial accounting information.There aremanyotherstakeholders asdiscussed in the chapter that wouldbe acceptable answers to this question.Differentstakeholdersmakedifferentdecisionsthatrequiredifferentinformation.Forexample,lenderswanttoknowwhether the company will be able to repay its loans but theCanada Revenue Agency (CRA) wants to know the amount oftaxes that should be paid for the current year. Much of theinformation that the lenders would request, such as who are thecompany’smajorcustomersandtheamountstheyowethecompany, would be of no interest to the CRAfor income taxpurposes yet may be of relevance in a GST/HST review.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-4Chapter 1BRIEF EXERCISE 1-3The overall objective is to provide financial information that isuseful to users (primarilycapital providers such as investorsand lenders) that is decision relevant (i.e., will helpthem makedecisions about allocating capital). The statements shouldcommunicate informationabout:1.theentity’seconomicresourcesandclaimstothoseresources and2.changes in those resources and claims.(IASB/FASBjointlypublished Exposure Draft).Note the emphasis on resource (or capital) allocation decisions,which is a balance sheet focus. The assessment ofmanagementstewardship is also important since users need to know whethermanagementis doing their job to maximize shareholder value(which is also called fiduciary duty). As a general rule, it isassumed thatmanagement stewardship is already taken intoaccount in the resource allocation decision.BRIEF EXERCISE 1-4Information asymmetry exists when one stakeholder in thefinancial reporting process has more or different informationthan another. For example, management generally has moreinformation about the company than external investors orcreditors. While it is not practical nor optimal for perfectinformation symmetry to exist, financial reporting serves therole of ensuring that relevant information is properlycommunicated to external parties such as investors, and others.BRIEF EXERCISE 1-5There is a risk where information asymmetry exists, that theparty with the additional information will act in their ownself-interestto the detriment of the other partyand/or the capitalmaket in general. For instance, management might withholdnegative information about the company for fear that it will hurtthe manager’s bonus. This would not be optimal for externalparties such as creditorsand investors who may

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-5Chapter 1BRIEF EXERCISE 1-5 (Continued)need that information before they invest or lend the companymoney. The risk that the party with the additional informationmay act in their own self-interest is known as moral hazard. Ifpeople understand that this behaviour is tolerated in themarketplace, the marketplace may attract people and companiesthat accept and tolerate this behaviour(known as adverseselection). Thiswill degrade the capital marketplaceas there willbe less transparency and information sharing and thussuboptimal capital allocation.BRIEF EXERCISE 1-6Acommonsetofstandardsappliedbyallbusinessesandentitiesprovidesfinancialstatementswhicharereasonablycomparable.Withoutacommonsetofstandards,eachenterprise could, and would, develop its own theory structureand set of practices, resulting ina lack of comparabilityamongenterprises.BRIEF EXERCISE 1-7General-purpose financial statements are not likely to satisfy thespecificneedsof all interestedparties.Sincetheneeds ofinterestedpartiessuchascreditors,managers,owners,governmentalagencies,andfinancialanalystsvaryconsiderably, it is unlikely that one set of financial statementswould beequally appropriate for these varied uses. The level ofdetail in financial statements is based onspecific requirementsin accounting standards andmanagement’s perception of users’needs, balanced against the cost of providing this additionalinformation.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-6Chapter 1BRIEF EXERCISE 1-8Accounting was affected and changed between 1900 and 1930by the growth of the corporate form of enterprise, the growingseparation of management from ownership, the imposition of taxon business and individual income, and the stock market crash(attributed in part to lax accounting standards and oversight),andthesubsequent great depression.BRIEF EXERCISE 1-9The InternationalAccounting Standards Board(IASB)hasinrecent years become the dominant standard setting body in theworld.By 2005, over 7,000 companies had adopted IFRS, withmore than 100 countries now requiringor permittingthe use ofIFRSs,orin the process of converging with the InternationalAccounting Standards Board's (IASB)standards, at present andin the near future this means thathundreds of thousands ofcompanies throughout the worldwilluse either the full IFRS orthe version for small and medium size enterprises.The goal of the IASB is to develop, in the public interest, a singlesetofhighqualityglobalaccountingstandards.Seewww.iasb.orgfor further details.BRIEF EXERCISE 1-10TheAccountingStandardsBoard(AcSB)oftheCICAhasprimaryresponsibilityforsettingGAAPinCanada.Thisisaccomplished through a lengthyand complexprocess.Twobasic premises underlie the process of establishing financialaccountingstandards:(1)theAcSBshouldrespondtotheneeds and viewpoints of the entire economiccommunity, notjust the public accounting profession, and (2) it should operateinfull public view through a “due process” system that givesinterestedpersonsenoughopportunitytomaketheirviewsknown. The Accounting Standards Oversight Council(AcSOC)

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-7Chapter 1BRIEF EXERCISE 1-10 (Continued)overseesAcSBactivities:itsactivitiesincludesettingtheagenda and reportingto the public, among other things.TheAcSBisresponsible for settingstandards fornon-publiclyaccountableprivate enterprises(ASPE), not-for-profit entities,andpensionplansonly.StandardsforpubliclyaccountableentitiesaresetbytheInternationalAccountingStandardsBoard.It is important to note thatnon-publicly accountableentitieswill alsohave the option to use IFRS.BRIEF EXERCISE 1-11The Provincial Securities Commissions(includingthe OntarioSecurities Commission)collectively areone of thestakeholdersin standard-setting. Standard-setting is the responsibility of theAccountingStandardsBoard(AcSB)(forASPE)andtheInternationalAccountingStandardsBoard(forIFRS).TheAccountingStandardsOversightCouncil(AcSOC)setsthestrategicdirectionandprioritiesoftheAcSB.AcSOCmembership consists of regulators andrepresentatives of thefinancial analyst communities, amongst others.TheOSCissuesitsowndisclosurerequirements.Theseadditionalrequirementsareapplicableonlytocompaniesregistered with the OSC.BRIEF EXERCISE 1-12OneofthefunctionsoftheOntarioSecuritiesCommission(OSC) and the Securities and Exchange Commission (SEC) is torepresent and protect the interests of investors. They do notrepresent the interests of different users of financial information.The CICA hassince the early 1970s hadthe sole legislative andregulatory authority to set nationalprivate sectoraccountingstandards in Canada.It delegates this to the AcSB.Starting in2011, theAcSB is responsible forASPEand the IASB hasis

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-8Chapter 1BRIEF EXERCISE 1-12 (Continued)responsiblefor IFRS.This ensures that accounting standardshave a high degree of acceptance from its broad community ofconstituents.BRIEF EXERCISE 1-13The sources of pressure are innumerable, but the most intenseandcontinuouspressuretochangeorinfluenceaccountingprinciplesorstandardscomesfromindividualcompanies,industryassociations,governmentalagencies,securitiescommissions,practicingaccountants,academicians,professional accounting organizations, and public opinion.Aswemovetowardsinternationalharmonization,theU.S.accounting standards will have a continuing influence onIFRSdue to the significant capital pooland flowsassociated withU.S.markets.BRIEF EXERCISE 1-14”Economicconsequences”meanstheimpactofaccountingreports on the wealth positions of issuers and users of financialinformation and the decision-making behaviour resulting fromthat impact.In other words, accounting information impactsvarious users in many different ways, which leads to wealthtransfers among these various groups.Ifpoliticsplaystoomuchofaroleinthedevelopmentofaccountingstandards,standardscouldbecomesubjecttomanipulationforthepurposeoffurtheringwhateverpolicyprevails at the moment.No matter how well intentioned thestandard setters may be, if information is designed to indicatethat investing in a particular enterprise or industry involves lessriskthanitactuallydoes,orisdesignedtoencourageinvestment in a particular segment of the economy, financialreporting will suffer an irreplaceable loss of credibility.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-9Chapter 1BRIEF EXERCISE 1-15The users of financial information from public companies havedifferentneedsthantheusersoffinancialinformationfromprivate companies. Public corporations need the opportunity topresent financial information using consistent accounting rulesas those used globally. Toaccomplishthis,public companiesneed to follow the International Financial Reporting Standards(IFRS). Doing so helps Canadian companies compete in a globalmarket.Followingthissetofpoliciesandstandardsisnotessential toprivatelyowned businesseswhomay havelesscomplexbusinessmodelsand/orfewernumberoffinancialstatement userswhodo not expect as extensive measurementand disclosurerequirementsas those requiredunderIFRS.BRIEF EXERCISE 1-16Nooneparticularproposalisexpectedinanswertothisquestion.Thestudents’proposals,however,shouldbedefensible relative to the following criteria:1.The method must be efficient, responsive, and expeditious.2.The method must be free of bias and be above or insulatedfrom pressure groups.3.The method musthave legislative authority or otherwisecommand widespread support.4.Themethodmustproducesoundyetpracticableaccounting principles or standards.The students’ proposals might take the form of alterations of theexistingmethodology,anaccountingcourt,orgovernmentaldevice.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-10Chapter 1BRIEF EXERCISE 1-17The explanation should note that generally accepted accountingprinciples have “substantial authoritative support.” They consistofaccountingpractices,procedures,theories,andbroadprinciplesandconventionsofgeneralapplication,includingunderlying conceptsand methods, which are recognized by alargemajorityofpracticingaccountantsaswellasothermembers of the business and financial community. GAAP isdivided into primary and other sources. Primary sources mustbe lookedto firstfor howto treat an issue.Where primarysourcesdonotdealwiththeissue,theaccountingpolicyselected must be consistent with the primary sources as well asdeveloped through use of professional judgement in accordancewiththe conceptual framework.BRIEF EXERCISE 1-18Forpubliccompanies,GAAPincorporatesIFRS,IAS,andInterpretations.For private companies, pension plans, and not-for-profitentitiesprimarysourcesofGAAPinclude(indescendingorderofauthority)theAccountingHandbooksections1400to3870,AccountingGuidelines,backgroundinformation and illustrative material related to the previous itemsand implementation guides.An entity should apply every primary source of GAAP that dealswith the accounting and reporting of transactions encounteredby an entity. This means that primary sources must be looked tofirst.Where primary sources do not deal with a specific issue, theentity should then adopt accounting policies that are consistentwith the primary sources as well as the Conceptual Framework.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-11Chapter 1BRIEF EXERCISE 1-19ThechairmanoftheFASBwasindicatingthattoomuchattentionisputonthebottomlineandnotenoughonthedevelopmentofqualityproducts.Managersshouldbelessconcerned with short-term results and be more concerned withthe long-term results.In addition, short-term tax benefits oftenlead to long-term problems.The second part of his comment relates to accountants beingoverly concerned with following a set of rules, so that if litigationensues, they will be able to argue that they followed the rulesexactly.The problem with this approach is that accountantsoften seem towant more and more rules with less reliance onprofessional judgment.Less professional judgement leads toinappropriateuseofaccountingproceduresindifficultsituations.Intheaccountants’defense,recentlegaldecisionshaveimposed vast newliabilityonaccountants.Theconceptofaccountant’s liability that has emerged in these cases isbroadand expansive; the number of classes of people to whom theaccountant is held responsible are almost limitless.BRIEF EXERCISE 1-20Principles-basedstandards are considered to be based on aconceptual frameworkandtheaccounting principlesthatresultmay requiresignificant professional judgement in interpretingand applying the standardsto ensure compliance.Rules-basedstandards are generally quite detailed, and in many instancesfollow a “check-box” mentality that some contend may shieldaccountants,auditors and companies from legal liability.IFRSandASPEtend tofollow the principles-based standard-settingsystem, while U.S. GAAPis generally considered morerules-based(even though it is based on principles). This is because itis more prescriptive and detail-oriented.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-12Chapter 1BRIEF EXERCISE 1-21Concern exists about fraudulent financial reporting because itcan undermine the entire financial reporting process.Failure toprovideinformationtousersthatisaccuratecanleadtoinappropriateallocationsofresourcesinoureconomy.Inaddition, failure to detect massive fraud can lead to additionalgovernmentaloversightoftheaccountingprofessionandfinancial reporting more generally.EventhoughGAAP(includingIFRSandASPE)providesstructuredinformationthatisrelevantandrepresentsunderlyingbusinesstransactionsandevents,itmaybemanipulated. This is because the various stakeholders in theprocessoftenactintheirownself-interest.Forinstance,management may seek to optimize their own bonus or the valueof their stock options.BRIEF EXERCISE 1-22Some of the reasons for differenceinclude:1.The objectives of financial reporting often differamongcountries.2.The institutional structures are often not comparable.3.Strongnationalisttendenciesmaybepervasiveandtherefore there is reluctance to adopt any one country’sapproach.BRIEF EXERCISE 1-23Accountantsmustperceivethemoraldimensionsofsomesituations because GAAP does not define or cover all specificfeatures that are to be reported in financial statements.In theseinstances accountants must choose among alternatives.Theseaccounting choices influence whether particular stakeholdersmay be harmed or benefited.Ethicaldecision-making involvesawareness of potential harm or benefit and taking responsibilityforthechoiceswhichshouldalwaysconsiderthepublicinterest.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-13Chapter 1BRIEF EXERCISE 1-24Some major challenges facing the accounting profession relateto the following items:Credibility–howtoregainpublicconfidenceintheaftermath of corporate fraud and poor reporting practices.Globalizationofcompaniesandcapitalmarkets–Canadian companies are operating and trading securitiesinglobalmarketsandaresubjecttoaccountingregulations in other jurisdictions. Canadian investors areinvesting in the global marketplace.Non-financial measurement–how to report significant keyperformanceindicatorssuchascustomersatisfactionindexes, backlog information and reject rates on goodspurchased.Soft assets–how to report on intangible assets, such asmarket know-how, intellectual capital, market dominance,and well-trained employees.Timeliness–howtoreportmorereliablereal-timeinformation in the Internet age.BRIEF EXERCISE 1-25The following are some of the key provisions of the Sarbanes-Oxley Act(SOX), enacted in 2002:Establishes an oversight board for accounting practices.The Public Company Accounting Oversight Board(PCAOB) has oversight and enforcement authority andestablishes auditing, quality control, and independencestandards and rulesfor Auditors.Implements stronger independence rules for auditors.Audit partners, for example, are required to rotate everyfive years and auditors are prohibited from offering certaintypes of consulting services to corporate clients.

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-14Chapter 1BRIEF EXERCISE 1-25 (Continued)Requires CEOs and CFOs to personally certify thatfinancial statements and disclosures are accurate andcomplete and requires CEOs and CFOs to forfeit bonusesand profitsharingwhen there is an accountingrestatement.Company management must report on the effectiveness ofthe financial reporting internal control system and theauditors must assess and report on these internal controls.Requires audit committeesof Boards of Directorsto becomprised of independent members and members withfinancial expertise.Companies must disclose whether they have a codeofethics fortheirsenior financial officers.In Canada, many of the SOX requirements have now beenput inplace, or are soon to be put in place, in part by pronouncementsby Canadian securities administrators such as the OSC

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Kieso, Weygandt, Warfield, Young, Wiecek, McConomyIntermediate Accounting,TenthCanadian EditionSolutions Manual1-15Chapter 1CASESSee the Case Primer on the Student Website as well as the summary caseprimer in the front of the text. Note that the first few chapters of the text lay thefoundation for financial reporting decision-making. Therefore the cases in the firstfew chapters (1–5) are shorter with less depth. As such, they may not cover allaspects of a full-blown case analysis.CA 1-1 POPOVICHOverview:-Reportednetincomeakeyfocusformanagement–representsareporting bias.-Controller (Paula) is concerned about doing the right thing–not just doingwhat is required under GAAP.Analysis and Recommendation:-GAAP constrained companies must adopt new standards as prescribed inthe CICA Handbook (publicly accountable entities follow IFRS which isincluded as Part I to the CICA Handbook and private entities follow ASPEwhich is Part II to the CICA Handbook). Normally the standard setters givecompanies some lead time so that they may ensure that they have all theappropriate information needed to present the information.-Thus–they are not required to change to a new standard until GAAPrequires it (the date is written into each standard).-The issue is whether to adopt a change earlier even though not requiredor later when required.Adopt new standard as requiredAdoptnewstandardearlierthanrequired-GAAP requirements are met.-Need additional time to ensurethatthecompanyhasalltheinformationneededtopreparethefinancialstatementsunderthe new standard i.e. to ensurereliable.-Other.-Providesgreatercomparabilitybetweenyearsearlierifadoptedearlier.-If this is thebetter presentation,why not share it with users as soonas possible.-Consideration of the impact on netincome should not be a motivatorfor making the financial reportingdecision(unbiased).-Other.

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