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PREVIEW OF CHAPTER 1
CHAPTER 1
FINANCIAL REPORTING AND
ACCOUNTING STANDARDS

Financial Reporting and

1 Accounting Standards
REVIEW OF ACCOUNTING
What is Accounting?
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
Accounting = Language of business? Why?
1. Describe the growing 4. Explain the need for high-
importance of global financial quality standards. Process:
markets and its relation to 5. Identify the objective of financial
financial reporting. reporting.
2. Identify the major financial 6. Identify the major policy-setting
statements and other means of bodies and their role in the Ex. The Jay Co. purchases 300 units inventory at $20
financial reporting. standard-setting process. per unit on credit.
3. Explain how accounting assists 7. Explain the meaning of IFRS.
in the efficient use of scarce Purpose:
8. Describe the challenges facing
resources. financial reporting. Help users
 5 6
Imagine that you are going to open a shop selling
Accounting= Language of business? Why? music CDs.

What is the relation between 1. What is your purpose?

Business Activities and Accounting? 2. Where is the money?
From Business Activities to Financial Statements 3. What is the capital of profit creation?
(Bernard et. al. 1997)
4. How to make money?

1. What is your purpose?

2. Where is the money?

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Activities 3. What is the source of profit creation?

Investor = Partner
activities
(Shareholder)
You spend $16,000 in purchasing ten wooden
Creditor/Lender made CD racks.
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From Business Activities to Financial Statements (Bernard et.al. 1997)
4. How to make money? Business environment Business Strategy
Labor market Business Activities Cost leadership
Capital market Operating activities Differentiation
Product market investing activities
Business regulations financing activities
activities
You purchase 6,000 CDs with a unit cost of $60 on Accounting Accounting Strategy
credit. Accounting Environment System Choices of
Capital market structure accounting
Economic
Accounting conventions
consequences of policies/
and regulations
Third party auditing business activities accounting
estimates

Financial Statements
Managers’ superior information
on business activities
Estimation Errors

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Differences Between Financial and Financial Management

Managerial Accounting Accounting Accounting

Financial Management Time Span

Accounting Accounting
Information
Users quality

Subject
Decisions

Type of
Regulation reports
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Global Markets Significant number of foreign companies are
found on national exchanges.
World markets are becoming increasingly intertwined. Illustration 1-2
International Exchange
Statistics
Top 20 Global Companies In Terms Of Sales

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GLOBAL MARKETS GLOBAL MARKETS

Financial Statements and Financial Reporting Economic Entity Financial Statements Additional Information

Essential characteristics of accounting are: Financial Statement of • President’s letter

Information Financial Position • Prospectuses
1. the identification, measurement, and Accounting? Income Statement or • Reports filed with
communication of financial information about Statement of governmental
Identify Comprehensive agencies
and Income • News releases
2. economic entities to
Measure Statement of Cash • Forecasts
Flows • Environmental
3. interested parties. and
Statement of impact
Communicate
Changes in Equity statements
• Etc.
Note Disclosures
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Accounting and Capital Allocation High Quality Standards

Globalization demands a single set of high-quality international
• Resources are limited. accounting standards. Some elements:
• Efficient use of resources often determines whether Single set of high-quality accounting standards established
a business thrives. by a single standard-setting body.
Capital Allocation Process 1. Consistency in application and interpretation.
Financial Capital 2. Common disclosures.
Users
Reporting Allocation 3. Common high-quality auditing standards and practices.
The financial Investors, lenders, The process of 4. Common approach to regulatory review and enforcement.
information creditors, and determining how 5. Education and training of market participants.
provides to help other users use and at what cost
users with capital financial reports to money is allocated
7. Common delivery systems (e.g., eXtensible Business
allocation make their capital among competing
Reporting Language—XBRL).
decisions. allocation interests. 8. Common approach to corporate governance and legal
decisions frameworks around the world

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OBJECTIVE OF FINANCIAL ACCOUNTING General-Purpose Financial Statements
Provide financial reporting information to a wide
Objective: Provide financial information about variety of users.
the reporting entity that is useful to Provide the most useful information possible at
the least cost.
present and potential equity investors,
lenders, and other creditors Equity Investors and Creditors

in making decisions in their capacity as capital ► Investors and creditors are the primary user
group.
providers.
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Entity Perspective DON’T FORGET STEWARDSHIP
Companies are viewed as separate and distinct from
In addition to providing decision-useful information about future cash
their owners (shareholders). flows, management also is accountable to investors for the custody and
safekeeping of the company’s economic resources and for their
efficient and profitable use. For example, the management of Nestlé
Decision-Usefulness has the responsibility for protecting its economic resources from
Investors are interested in assessing the company’s unfavorable effects of economic factors, such as price changes, and
technological and social changes. Because Nestlé’s performance in
1. ability to generate net cash inflows^, and
discharging its responsibilities (referred to as its stewardship
2. management’s ability to protect and enhance the responsibilities) usually affects its ability to generate net cash inflows,
capital providers’ investments. financial reporting may also provide decision-useful information to
assess management performance in this role. [2]

[2] The Conceptual Framework for Financial Reporting, “Chapter 1, The Objective of General Purpose Financial
Reporting” (London, U.K.: IASB, September 2010), par. OB4.

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Two Major Standard-Setting STANDARD-SETTING ORGANIZATIONS

Organizations_International
International Organization of Securities
International Accounting Standards Board (IASB) Commissions (IOSCO)
Issues International Financial Reporting Standards
(IFRS). ► Does not set accounting standards.

Standards used on most foreign exchanges. ► Dedicated to ensuring that global

Standards used by foreign companies listing on U.S. markets can operate in an efficient
securities exchanges. and effective basis.
http://www.iosco.org/
IFRS used in over 115 countries. ► Supports the use of IFRS as the
Organizations that have a role in international standard- single set of international standards
setting are the International Organization of Securities in cross-border offerings and listings.
Commissions (IOSCO) and the IASB.
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HOW IS IT GOING?

How much progress has been made toward the goal of one single set of
global accounting standards? To answer this question, the IASB conducted
a major survey on IFRS adoption. The survey indicates that there is almost
universal support (95 percent) for IFRS as the single set of global
accounting standards. This includes those jurisdictions that have yet to
make a decision on adopting IFRS, such as the United States.
• More than 80 percent of the jurisdictions report IFRS adoption for all (or
in five cases, almost all) public companies.
• Most of the remaining 11 non-adopters have made significant progress
toward IFRS adoption.
• Those jurisdictions that have adopted IFRS have made very few
modifications to the standards.
• More than 40 percent of the IFRS adopters do so automatically, without
an endorsement process.
• Where modifications have occurred, they are regarded as temporary
(Continued
arrangements to assist in the migration from national accounting )
standards to IFRS.
Source: Adapted from Hans Hoogervorst, “Breaking the Boilerplate,” IFRS Foundation Conference (June 13, 2013).

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HOW IS IT GOING?
International Accounting Standards
How much progress has been made toward the goal of one single set
of global accounting standards? To answer this question, the IASB
Board (IASB)
conducted a major survey on IFRS adoption. The survey indicates that
there is almost universal support (95 percent) for IFRS as the single set Composed of four organizations—
of global accounting standards. This includes those jurisdictions that
have yet to make a decision on adopting IFRS, such as the United ► IFRS Foundation
States.
• A few large and important economies have not yet (fully) adopted ► International Accounting
IFRS.
Standards Board (IASB) http://www.iasb.org
• In such countries, more progress is being made than many people
are aware of. Japan already permits the use of full IFRS and has
recently widened the scope of companies that are allowed to adopt ► IFRS Advisory Council
it.
• In the United States, non-U.S. companies are allowed to use IFRS ► IFRS Interpretations Committee
for listings on their exchanges.
• Today, more than 450 foreign private issuers are reporting using
IFRS in U.S. regulatory filings, which represents trillions of dollars in
market capitalization.
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International Accounting Standards Board International Accounting Standards Board

ILLUSTRATION 1-4 International Standard-Setting Structure

Due Process
The IASB due process has the following elements:

1. Independent standard-setting board;

2. Thorough and systematic process for developing
standards;
3. Engagement with investors, regulators, business
leaders, and the global accountancy profession at
every stage of the process; and
4. Collaborative efforts with the worldwide standard-
setting community.

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ILLUSTRATION 1-5
International Standard-Setting Structure Standard-Setting Organizations _ USA
Research Discussion paper
2. Financial Accounting Standards Board (FASB)
Issues Statements of Financial Accounting
Standards (SFAS).
Exposure draft Standard Required for all U.S.-based companies.

Three Standard Setting Parties:

Securities and Exchange Commission (SEC)
American Institute of Certified Public Accountants
(AICPA)
Financial Accounting Standards Board (FASB)
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Types of Pronouncements Hierarchy of IFRS
Companies first look to:
Issued by the IASB: 1. International Financial Reporting Standards; International
Financial Reporting Standards, International Accounting
1. International Financial Reporting Standards. Standards (issued by the predecessor to the IASB), and
2. Framework for financial reporting. (Ch. 2) IFRS interpretations originated by the IFRS Interpretations
Committee (and its predecessor, the IAS Interpretations
3. International financial reporting interpretations. Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a
similar conceptual framework (e.g., U.S. GAAP).

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The Expectations Gap
Financial Reporting Challenges
What the public thinks accountants should do vs.
IFRS in a Political Environment Illustration 1-6
what accountants think they can do.
User Groups that Influence the
Formulation of Accounting Standards

Significant Financial Reporting Issues

Financial reports fail to provide:
Non-financial measurements: customer satisfaction,
defective rate…
Forward-looking information needed by present and
potential investors and creditors
Much information about sort assets: intangibles
Timeliness: little to no real-time F/S information was
available
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FAIR CONSEQUENCES?
Ethics in the Environment of Financial
No recent accounting issue better illustrates the economic consequences of
accounting than the current debate over the use of fair value accounting for Accounting
financial assets. The IASB has had long-standing standards requiring the use of
fair value accounting for financial assets, such as investments and other financial Companies that concentrate on “maximizing the
instruments. Fair value provides the most relevant and reliable information for
investors about these assets and liabilities. However, in the wake of the credit crisis bottom line,” “facing the challenges of competition,”
of 2008, some countries, their central banks, and bank regulators wanted to and “stressing short-term results” place accountants
suspend fair value accounting based on concerns that use of fair value accounting, in an environment of conflict and pressure.
which calls for recording significant losses on poorly performing loans and
investments, would scare investors and depositors and lead to a “run on the bank.” IFRS does not always provide an answer.
Most notable was the lobbying of then French President Nicolas Sarkozy in urging
his European Union counterparts to back changes to accounting rules and give Doing the right thing is not always easy or obvious.
banks and insurers some breathing space amid the market turmoil. Mr. Sarkozy
sought agreement to new regulations, including changes to the mark-to-market Technical competence is not enough when
accounting rules that have been blamed for aggravating the crisis. International encountering ethical decisions.
regulators also have conducted studies of fair value accounting and its role in the
credit crisis. It is unclear whether these political pressures will have an effect on fair
value accounting, but there is no question that the issue has stirred significant
worldwide political debate. In short, the numbers have consequences.
Source: Adapted from Ben Hall and Nikki Tait, “Sarkozy Seeks EU Accounting Change,” The LO 8
Financial Times Limited (September 30, 2008).

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International Convergence GLOBAL ACCOUNTING INSIGHTS
In 2002 the IASB and the FASB formalized their
INTERNATIONAL FINANCIAL REPORTING
commitment to the convergence of U.S. GAAP and
international standards. Most agree that there is a need for one set of international
Examples of how convergence is occurring: accounting standards. Here is why:
1.China’s goal is to eliminate differences between its standards • Multinational corporations
and IFRS. • Mergers and acquisitions
2.Japan now permits the use of IFRS for domestic companies. • Information technology
3.The IASB and the FASB have spent the last 12 years • Financial markets
working to converge their standards.
4.Malaysia helped amend the accounting for agricultural
assets.
5.Italy provided advice and counsel on the accounting for
business combinations under common control.
Relevant Facts 41 42
Relevant Facts
Following are the key similarities and differences between U.S. GAAP and Differences
IFRS related to the financial reporting environment.
Similarities •U.S. GAAP is more detailed or rules-based. IFRS tends to
•Generally accepted accounting principles (GAAP) for U.S. companies are simpler and more flexible in the accounting and disclosure
developed by the Financial Accounting Standards Board (FASB). The FASB requirements. The difference in approach has resulted in a
is a private organization. The U.S. Securities and Exchange Commission debate about the merits of principles-based versus rules-
(SEC) exercises oversight over the actions of the FASB. The IASB is also a
private organization. Oversight over the actions of the IASB is regulated by
based standards.
IOSCO. •Differences between U.S. GAAP and IFRS should not be
•Both the IASB and the FASB have essentially the same governance surprising because standard-setters have developed
structure, that is, a Foundation that provides oversight, a Board, an Advisory
standards in response to different user needs. In some
Council, and an Interpretations Committee.
•The FASB relies on the U.S. SEC for regulation and enforcement of its countries, the primary users of financial statements are
standards. The IASB relies primarily on IOSCO for regulation and private investors. In others, the primary users are tax
enforcement of its standards. authorities or central government planners. In the United
•Both the IASB and the FASB are working together to find common grounds States, investors and creditors have driven accounting-
for convergence. A good example is the recent issuance of a new standard
standard formulation.
on revenue recognition that both organizations support. Also, the Boards are
working together on other substantial projects such as the measurement
and classification of financial instruments.

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About The Numbers On the Horizon

The IASB has looked to the United States to determine the Both the IASB and the FASB are hard at work developing
structure it should follow in establishing IFRS. Presented is standards that will lead to the elimination of major differences
the FASB’s standard-setting structure. in the way certain transactions are accounted for and
reported. In fact, beginning in 2010, the IASB (and the FASB
on its joint projects with the IASB) started its policy of phasing
in adoption of new major standards over several years. The
major reason for this policy is to provide companies time to
translate and implement international standards into practice.
Much has happened in a very short period of time in the
international accounting environment. It now appears likely
that in a fairly short period of time, companies around the
world will be close to using a single set of high-quality
accounting standards.
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Review Question 2. The objective of financial reporting places most emphasis on:
1. What is the purpose of information presented in notes to a. reporting to capital providers.
the financial statements? b. reporting on stewardship.
a. To provide disclosure required by generally accepted c. providing specific guidance related to specific needs.
accounting principles. d. providing information to individuals who are experts in the
b. To correct improper presentation in the financial field.
statements.
c. To provide recognition of amounts not included in the
3. General-purpose financial statements are prepared primarily for:
totals of the financial statements.
a. internal users.
d. To present management’s responses to auditor
comments. b. external users.
c. auditors.
d. government regulators.

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4 An effective process of capital allocation is critical to a healthy 6. Accounting standard-setters use the following process in
economy, which establishing international standards:
a. Research, exposure draft, discussion paper, standard.
a. promotes productivity.
b. Discussion paper, research, exposure draft, standard.
b. encourages innovation.
c. Research, preliminary views, discussion paper, standard.
c. provides an efficient and liquid market for buying and d. Research, discussion paper, exposure draft, standard.
selling securities.
d. All of the above. 7. The expectations gap is:
a. what financial information management provides and
5. The major key players on the international side are the: what users want.
a. IASB and IFRS Advisory Council. b. what the public thinks accountants should do and what
b. IOSCO and the U.S. SEC. accountants think they can do.
c. London Stock Exchange and International Securities c. what the governmental agencies want from standard-
Exchange. setting and what the standard-setters provide.
d. IASB and IOSCO. d. what the users of financial statements want from the
government and what is provided.
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8. IFRS stands for:
a. International Federation of Reporting Services.
b. Independent Financial Reporting Standards.
c. International Financial Reporting Standards.
d. Integrated Financial Reporting Services.

9. IFRS is comprised of:

a. International Financial Reporting Standards and FASB
financial reporting standards.
b. International Financial Reporting Standards,
International Accounting Standards, and International
Accounting Standards Interpretations.
c. International Accounting Standards and International
Accounting Standards Interpretations.
d. FASB financial reporting standards and International
Accounting Standards.