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Solution Manual for Intermediate Accounting Volume 1, Tenth Canadian Edition

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 1 Chapter 1 CHAPTER 1 THE CANADIAN FINANCIAL REPORTING ENVIRONMENT ASSIGNMENT CLASSIFICATION TABLE Topic Brief Exercises Writing Assignments 1. Financial statements and financial reporting. 2. Capital allocation. 1 4 3. Stakeholders. 2 4 4. Objectives of financial reporting. 3 5. Management bias in financial reporting. 1 6. Importance of user needs in financial reporting. 1, 2, 7 7. Need for accounting standards. 6 , 7 1, 2, 7 8. Parties involved in standard - setting. 8 , 9 , 1 0 , 1 1 , 1 2 , 1 3 , 1 4 , 1 5 3, 6 9. GAAP. 1 6 , 1 7 , 1 8 6, 10. Professional judgement. 19 , 20 6 11. Ethical issues. 21 , 22 , 23 5 12. Challenges facing financial accounting 2 0 , 24 , 25 5, 7 13. Information Assymetry 4, 5

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 2 Chapter 1 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1 - 1 Accounting has the responsibility of measuring company performance accurately and fairly on a timely basis. This enables investors and creditors to assess the relative risks and returns of investment opportunities and channel resources more effectively. If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right managers and companies are able to attract investment capital. Unreliable and irrelevant information leads to poor capital allocation, which adversely affects the securities market and ultimately the performance of the economy as a whole . BRIEF EXERCISE 1 - 2 Some stakeholders using financial accounting information and financial statement s include: Investor s – These stakeholder s are interested in the performance of their investment in the company. They will use the financial statements to evaluate management stewardship and effectiveness . Creditor s – These stakeholder s are interested in evaluating the company to decide whether to lend money to it. They will use the statements to evaluate the risk that will be taken in making the loan. For example, lenders want to know whether the company will be able to repay its loans when due and service interest and principal on a timely basis .

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 3 Chapter 1 BRIEF EXERCISE 1 - 2 (CONTINUED) Canada Revenue Agency (CRA) – These stakeholders establish the rules for how taxable income will be measured. They are interested in the fair measurement of the financial position and financial performance of the company so that the appropriate amount of tax will be paid. Note that i n preparing the tax return, the financial statements net income is the starting point and is then adjusted to arrive at taxable income , which is used to calculate the amount of taxes payable . The CRA is principally interested in compliance with the I ncome T ax A ct . Financial Analysts – These stakeholder s provide investment advice to their c lient s. They are interested in evaluating the investment opportunities and potential of various companies. Note: This is only a suggested list of stakeholders and their possible uses of the financial accounting information. T here are many other stakeholders as discussed in the chapter that would be acceptable answers to this question . Different stakeholders make different decisions that require different information. For example, lenders want to know whether the company will be able to repay its loans but the Canada Revenue Agency (CRA) wants to know the amount of taxes that should be paid for the current year. Much of the information that the lenders would request, such as who are the company’s major customers and the amounts they owe the company, would be of no interest to the CRA for income tax purposes yet may be of relevance in a GST/HST review .

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 4 Chapter 1 BRIEF EXERCISE 1 - 3 The overall objective is to provide financial information that is useful to users (primarily capital providers such as investors and lenders) that is decision relevant (i.e., will help them make decisions about allocating capital). The statements should communicate information about : 1. the entity’s economic resources and claims to those resources and 2. changes in those resources and claims. ( IASB/FASB jointly published Exposure Draft ). Note the emphasis on resource (or capital) allocation decisions , which is a balance sheet focus . The assessment of management stewardship is also important since users need to know whether management is doing their job to maximize shareholder value (which is also called fiduciary duty) . As a general rule, it is assumed that management stewardship is already taken into account in the resource allocation decision . BRIEF EXERCISE 1 - 4 Information asymmetry exists when one stakeholder in the financial reporting process has more or different information than another. For example, management generally has more information about the company than external investors or creditors. While it is not practical nor optimal for perfect information symmetry to exist, f inancial reporting serves the role of ensuring that relevant information is properly communicated to external parties such as investors, and others. BRIEF EXERCISE 1 - 5 There is a risk where information asymmetry exists, that the party with the additional information will act in their own self - interest to the detriment of the other party and/ or the capital maket in general. For instance, management might withhold negative information about the company for fear that it will hurt the manager’s bonus. This would not be optimal for external parties such as creditor s and investors who may

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 5 Chapter 1 BRIEF EXERCISE 1 - 5 (Continued) need that information before they invest or lend the company money. The risk that the party with t h e additional information may act in their own self - interest is known as moral hazard. If people understand that this behaviour is tolerated in the marketplace, the marketplace may attract people and companies that accept and tolerate this behaviour (known as adverse selection). This will degrade the capital marketplace as there will be less transparency and information sharing and thus suboptimal capital allocation . BRIEF EXERCISE 1 - 6 A common set of standards applied by all businesses and entities provides financial statements which are reasonably comparable. Without a common set of standards, each enterprise could, and would, develop its own theory structure and set of practices, resulting in a lack of comparability among enterprises. BRIEF EXERCISE 1 - 7 General - purpose financial statements are not likely to satisfy the specific needs of all interested parties. Since the needs of interested parties such as creditors, managers, owners, governmental agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements would be equally appropriate for these varied uses. The level of detail in financial statements is based on specific requirements in accounting standards and management’s perception of users’ needs, balanced against the cost of providing this additional information.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 6 Chapter 1 BRIEF EXERCISE 1 - 8 Accounting was affected and changed between 1900 and 1930 by the growth of the corporate form of enterprise , the growing separation of management from ownership , the imposition of tax on business and individual income, and the stock market crash (attributed in part to lax accounting standards and oversight), and the subsequent great depression. BRIEF EXERCISE 1 - 9 The International Accounting Standards Board (IASB) has in recent years become the dominant standard setting body in the world. B y 2005, over 7,000 companies had adopted IFRS, with m or e than 100 countries now requiring or permit ting the use of IFRSs , or in the process of c onverging with the International Accounting Sta ndards Board's (IASB) standards, at present and in the near future this means that hundreds of thousands of companies throughout the world will use either the full IFRS or the version for small and medium size enterprises. The goal of the IASB is to develop, in the public interest, a single set of high quality global accounting standards. See www.iasb.org for further details. BRIEF EXERCISE 1 - 10 The Accounting Standards Board (AcSB) of the CICA has primary responsibility for setting GAAP in Canada. This is accomplished through a lengthy and complex process. Two basic premises underlie the process of establishing financial accounting standards: (1) the AcSB should respond to the needs and viewpoints of the entire economic community, not just the public accounting profession, and (2) it should operate in full public view through a “due process” system that gives interested persons enough opportunity to make their views known. The Accounting Standards Oversight Council (AcSOC)

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 7 Chapter 1 BRIEF EXERCISE 1 - 10 (Continued) oversees AcSB activities: its activities include setting the agenda and reporting to the public, among other things. The AcSB is responsible for setting standards for non - publicly accountable private enterprises (ASPE) , not - for - profit entities, and pension plans only. Standards for publicly accountable entities are set by the International Accounting Standards Board. It is important to note that non - publicly accountable entities will also have the option to use IFRS . BRIEF EXERCISE 1 - 1 1 The Provincial Securities Commissions (including the Ontario Securities Commission ) collectively are one of the stakeholders in standard - setting. Standard - setting is the responsibility of the Accounting Standards Board (AcSB) (for ASPE) and the International Accounting Standards Board (for IFRS) . The Accounting Standards Oversight Council (AcSOC) sets the strategic direction and priorities of the AcSB. AcSOC membership consists of regulators and representatives of the financial analyst communities, amongst others. The OSC issue s its own disclosure requirements. These additional requirements are applicable only to companies registered with the OSC . BRIEF EXERCISE 1 - 1 2 One of the functions of the Ontario Securities Commission (OSC) and the Securities and Exchange Commission (SEC) is to represent and protect the interests of investors. They do not represent the interests of different users of financial information. The CICA has since the early 1970s had the sole legislative and regulatory authority to set national private sector accounting standards in Canada. It delegates this to the AcSB. Starting in 2011, the AcSB is responsible for ASPE and the IASB has is

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 8 Chapter 1 BRIEF EXERCISE 1 - 12 (Continued) responsible for IFRS. This ensures that accounting standards have a high degree of acceptance from its broad community of constituents. BRIEF EXERCISE 1 - 1 3 The sources of pressure are innumerable, but the most intense and continuous pressure to change or influence accounting principles or standards comes from individual companies, industry associations, governmental agencies, securities commissions, practicing accountants, academicians, professional accounting organizations, and public opinion. As we move towards international harmonization, the U.S. accounting standards will have a continuing influence on IFRS due to the significant capital pool and flows associated with U.S. markets. BRIEF EXERCISE 1 - 1 4 ”Economic consequences” means the impact of accounting reports on the wealth positions of issuers and users of financial information and the decision - making behaviour resulting from that impact. In other words, accounting information impacts various users in many different ways, which leads to wealth transfers among these various groups. If politics plays too much of a role in the development of accounting standards, standards could become subject to manipulation for the purpose of furthering whatever policy prevails at the moment. No matter how well intentioned the standard setters may be, if information is designed to indicate that investing in a particular enterprise or industry involves less risk than it actually does, or is designed to encourage investment in a particular segment of the economy, financial reporting will suffer an irreplaceable loss of credibility.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 9 Chapter 1 BRIEF EXERCISE 1 - 1 5 The users of financial information from public companies have different needs than the users of financial information from private companies. Public corporations need the opportunity to present financial information using consistent accounting rules as those used globally. To accomplish this , public companies need to follow the International Financial Reporting Standards (IFRS). Doing so helps Canadian companies compete in a global market. F ollowing this set of policies and standards is not essential to privately owned businesses who may have less complex business models and /or fewer number of financial statement users who do not expect as extensive measurement and disclosure requirements as those required under IFRS. BRIEF EXERCISE 1 - 1 6 No one particular proposal is expected in answer to this question. The students’ proposals, however, should be defensible 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 insulated from pressure groups. 3. The method must have legislative authority or otherwise command widespread support. 4. The method must produce sound yet practicable accounting principles or standards. The students’ proposals might take the form of alterations of the existing methodology, an accounting court, or governmental device.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 10 Chapter 1 BRIEF EXERCISE 1 - 1 7 The explanation should note that generally accepted accounting principles have “substantial authoritative support.” They consist of accounting practices, procedures, theories, and broad principles and conventions of general application, including underlying concepts and methods , which are recognized by a large majority of practicing accountants as well as other members of the business and financial community. GAAP is divided into primary and other sources. Primary sources must be looked to first for how to treat an issue . Where primary sources do not deal with the issue, the accounting policy selected must be consistent with the primary sources as well as developed through use of professional judgement in accordance with the conceptual framework. BRIEF EXERCISE 1 - 1 8 For public companies, GAAP incorporates IFRS, IAS, and Interpretations. For private companies, pension plans, and not - for - profit entities primary sources of GAAP include (in descending order of authority) the Accounting Handbook sections 1400 to 3870 , Accounting Guidelines, background information and illustrative material related to the previous items and implementation guides. An entity should apply every primary source of GAAP that deals with the accounting and reporting of transactions encountered by an entity. This means that primary sources must be looked to first. Where primary sources do not deal with a specific issue, the entity should then adopt accounting policies that are consistent with the primary sources as well as the Conceptual Framework.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 11 Chapter 1 BRIEF EXERCISE 1 - 19 The chairman of the FASB was indicating that too much attention is put on the bottom line and not enough on the development of quality products. Managers should be less concerned with short - term results and be more concerned with the long - term results. In addition, short - term tax benefits often lead to long - term problems. The second part of his comment relates to accountants being overly concerned with following a set of rules, so that if litigation ensues, they will be able to argue that they followed the rules exactly. The problem with this approach is that accountants often seem to want more and more rules with less reliance on professional judgment. Less professional judg e ment leads to inappropriate use of accounting procedures in difficult situations. In the accountants’ defense, recent legal decisions have imposed vast new liability on accountants. The concept of accountant’s liability that has emerged in these cases is broad and expansive; the number of classes of people to whom the accountant is held responsible are almost limitless. BRIEF EXERCISE 1 - 2 0 Principles - based standards are considered to be based on a conceptual framework and the accounting principles t hat result may require significant professional judgement in interpreting and applying the standards to ensure compliance. Rules - based standards are generally quite detailed, and in many instances follow a “check - box” mentality that some contend may shield accountants, auditors and companies from legal liability. IFRS and ASPE tend to follow the principles - based standard - setting system, while U.S. GAAP is generally considered more rules - based (even though it is based on principles). This is because it is more prescriptive and detail - oriented .

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 12 Chapter 1 BRIEF EXERCISE 1 - 2 1 Concern exists about fraudulent financial reporting because it can undermine the entire financial reporting process. Failure to provide information to users that is accurate can lead to inappropriate allocations of resources in our economy. In addition, failure to detect massive fraud can lead to additional governmental oversight of the accounting profession and financial reporting more generally . Even though GAAP (including IFRS and ASPE) provides structured information that is relevant and represents underlying business transactions and events, it may be manipulated. This is because the various stakeholders in the process o f ten act in their own self - interest. For instance, management may seek to optimize their own bonus or the value of their stock options. BRIEF EXERCISE 1 - 22 Some of the reasons for difference include : 1. The objectives of financial reporting often differ among countries. 2. The institutional structures are often not comparable. 3. Strong national ist tendencies may be pervasive and therefore there is reluctance to adopt any one country’s approach. BRIEF EXERCISE 1 - 23 Accountants must perceive the moral dimensions of some situations because GAAP does not define or cover all specific features that are to be reported in financial statements. In these instances accountants must choose among alternatives. These accounting choices influence whether particular stakeholders may be harmed or benefited. Ethical decision - making involves awareness of potential harm or benefit and taking responsibility for the choices which should always consider the public interest.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 13 Chapter 1 BRIEF EXERCISE 1 - 24 Some major challenges facing the accounting profession relate to the following items: Credibility – how to regain public confidence in the aftermath of corporate fraud and poor reporting practices. Globalization of companies and capital markets – Canadian companies are operating and trading securities in global markets and are subject to accounting regulations in other jurisdictions. Canadian investors are investing in the global marketplace. Non - financial measurement – how to report significant key performance indicators such as customer satisfaction indexes, backlog information and reject rates on goods purchased. Soft assets – how to report on intangible assets, such as market know - how, intellectual capital, market dominance, and well - trained employees. Timeliness – how to report more reliable real - time information in the Internet age. BRIEF EXERCISE 1 - 25 The 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 and establishes auditing, quality control, and independence standards and rules for Auditors .  Implements stronger independence rules for auditors. Audit partners, for example, are required to rotate every five years and auditors are prohibited from offering certain types of consulting services to corporate clients.

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 14 Chapter 1 BRIEF EXERCISE 1 - 25 (Continued)  Requires CEOs and CFOs to personally certify that financial statements and disclosures are accurate and complete and requires CEOs and CFOs to forfeit bonuses and profit s haring when there is an accounting restatement.  Company management must report on the effectiveness of the financial reporting internal control system and the auditors must assess and report on these internal controls .  Requires audit committees of Boards of Directors to be comprised of independent members and members with financial expertise.  Companies must disclose whether they have a code of ethics for their senior financial officers. In Canada, m any of the SOX requirements have now been put in place, or are soon to be put in place , in part by pronouncements by Canadian securities administrators such as the OSC

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    Kieso, Weygandt, Warfield, Young, Wiecek , McConomy Intermediate Accounting, Tenth Canadian Edition Solutions Manual 1 - 15 Chapter 1 CASES See the Case Primer on the Student Website as well as the summary case primer in the front of the text. Note that the first few chapters of the text lay the foundation for financial reporting decision - making. Therefore the cases in the first few chapters (1 – 5) are shorter with less depth. As such, they may not cover all aspects of a full - blown case analysis. CA 1 - 1 POPOVICH Overview : - Reported net income a key focus for management – represents a reporting bias. - Controller (Paula) is concerned about doing the right thing – not just doing what is required under GAAP. Analysis and Recommendation : - GAAP constrained companies must adopt new standards as prescribed in the CICA Handbook (publicly accountable entities follow IFRS which is included as Part I to the CICA Handbook and private entities follow ASPE which is Part II to the CICA Handbook). Normally the standard setters give companies some lead time so that they may ensure that they have all the appropriate information needed to present the information. - Thus – they are not required to change to a new standard until GAAP requires it (the date is written into each standard). - The issue is whether to adopt a change earlier even though not required or later when required. Adopt new standard as required Adopt new standard earlier than required - GAAP requirements are met. - Need additional time to ensure that the company has all the information needed to prepare the financial statements under the new standard i.e. to ensure reliable. - Other. - Provides greater comparability between years earlier if adopted earlier. - If this is the better presentation , why not share it with users as soon as possible. - Consideration of the impact on net income should not be a motivator for making the financial reporting decision (unbiased ). - Other.

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