Test Bank For Intermediate Accounting Volume 1, 11th Canadian Edition By Keiso

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Test Bank For Intermediate Accounting Volume 1, 11th Canadian Edition By Keiso

Description

WITH ANSWERS

 

Intermediate Accounting Volume 1, 11th Canadian Edition Test Bank

CHAPTER 1

 

THE CANADIAN FINANCIAL REPORTING ENVIRONMENT

CHAPTER STUDY OBJECTIVES

 

 

  1. 1. Explain how accounting makes it possible to use scarce resources more efficiently. Accounting provides reliable, relevant, and timely information to managers, investors, and creditors so that resources are allocated to the most efficient enterprises. Accounting also provides measurements of efficiency (profitability) and financial soundness.

 

 

  1. Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one. Investors, creditors, management, securities commissions, stock exchanges, analysts, credit rating agencies, auditors, and standard setters are some of the major stakeholders. Illustration 1-4 explains what is at stake for each one.

 

 

  1. Identify the objective of financial reporting. The objective of financial reporting is to communicate information that is useful to key decision makers such as investors and creditors in making resource allocation decisions (including assessing management stewardship) about the resources and claims to resources of an entity and how these are changing.

 

 

  1. Explain how information asymmetry and bias interferes with the objective of financial reporting. Ideally, all stakeholders should have access to the same information in order to ensure that good decisions are made in the capital marketplace. (This is known as information symmetry.) However, this is not the casethere is often information asymmetry. Of necessity, management has access to more information so that it can run the company. It must also make sure that it does not give away information that might harm the company, such as in a lawsuit where disclosure might cause the company to lose. Aside from this, information asymmetry exists because of management bias whereby management acts in its own self-interest, such as wanting to maximize management bonuses. This is known as moral hazard in accounting theory. Information asymmetry causes markets to be less efficient. It may cause stock prices to be discounted or costs of capital to increase. In addition, it might detract good companies from raising capital in the particular market where relevant information is not available (referred to as adverse selection in accounting theory). The efficient markets hypothesis is felt to exist only in a semi-strong form, meaning that only publicly available information is assimilated into stock prices.

 

 

  1. Explain the need for accounting standards & identify the major entities that influence standard setting and financial reporting. The accounting profession has tried to develop a set of standards that is generally accepted and universally practised. This is known as GAAP (generally accepted accounting principles). Without this set of standards, each enterprise would have to develop its own standards, and readers of financial statements would have to become familiar with every companys particular accounting and reporting practices. As a result, it would be almost impossible to prepare statements that could be compared. In addition, accounting standards help deal with the information asymmetry problem.

The Canadian Accounting Standards Board (AcSB) is the main standard-setting body in Canada for private companies, pension plans, and not-for-profit entities. Its mandate comes from the Canada Business Corporations Act and Regulations as well as provincial acts of incorporation. For public companies, GAAP is International Financial Reporting Standards (IFRS) as established by the International Accounting Standards Board (IASB). Public companies are required to follow GAAP in order to access capital markets, which are monitored by provincial securities commissions. The Financial Accounting Standards Board (FASB) is also important as it influences IFRS standard setting. Private companies may choose to follow IFRS. Public companies that list on U.S. stock exchanges may choose to follow U.S. GAAP.

 

 

  1. Explain the meaning of generally accepted accounting principles (GAAP) & the significance of professional judgement in applying GAAP. Generally accepted accounting principles are either principles that have substantial authoritative support, such as the CPA Canada Handbook, or those arrived at through the use of professional judgement and the conceptual framework.

Professional judgement plays an important role in Accounting Standards for Private Enterprises (ASPE) and IFRS since much of GAAP is based on general principles, which need to be interpreted.

 

 

  1. Discuss some of the challenges and opportunities for accounting. Some of the challenges facing accounting are oversight in the capital markets, centrality of ethics, standard setting in a political environment, principles versus rules-based standard setting, the impact of technology, and integrated reporting. All of these require the accounting profession to continue to strive for excellence and to understand how accounting adds value in the capital marketplace.

 

 

Multiple Choice QUESTIONS

 

Answer          No.       Description

d                1.        Accounting characteristics

a                2.        Nature of financial accounting

c                3.        Definition of financial accounting

b                4.        Definition of management accounting

d                5.        Efficient use of resources

c                6.        Capital allocation process

d                7.        Importance of accounting information

d                8.        Primary exchange mechanism(s) for allocating resources

c                9.        Changing financial reporting environment

b               10.       Stakeholders in the financial reporting environment

d               11.       Preparation of audited financial statements

a               12.       Auditors responsibility

c               13.       Causes of subprime lending crisis

a               14.       Managements primary responsibility with respect to financial statements

c               15.       Primary responsibility of security and exchange commissions

b               16.       Objectives of financial reporting

b               17.       Appropriate objectives of general-purpose financial reporting

b               18.       Accrual-basis accounting

c               19.       Preparation of biased information

c               20.       Existence of information asymmetry

b               21.       Efficient markets hypothesis

d               22.       Management bias

a               23.       Moral hazard

d               24.       Conservative accounting

b               25.       Reduction of information asymmetry

b               26.       Development of GAAP

c               27.       Financial reporting before 1900

c               28.       Responsibility of the AcSB

a               29.       Oversight of AcSB

c               30.       Authority over accounting standards in the U.S

d               31.       Development of financial reporting standards in Canada

b               32.       Adoption of IFRS

d               33.       Activities and authority of the Ontario Securities Commission (OSC)

b               34.       Use of ASPE

a               35.       IASBs standard setting process

c               36.       Primary sources of GAAP under ASPE

c               37.       Sources of GAAP

d               38.       Exercise of professional judgement

c               39.       Rules-based vs. principles-based approach

c               40.       Comparison of Canadian GAAP and U.S. GAAP

b               41.       SOX

a               42.       Advancement of technology on financial reporting

a               43.       IASB principles regarding funding

c               44.       Rules-based GAAP body of knowledge

 

 

Exercises

 

Item                 Description

E1-45              Effective capital allocation

E1-46              Financial statements in practice and theory

E1-47              Stakeholders in the financial reporting environment

E1-48              Sources of capital and stages of company growth

E1-49              Objectives of financial reporting

E1-50              Traditional users vs. others

E1-51              Imperfection of the stakeholder ecosystem

E1-52              Entity vs. proprietary perspective

E1-53              User needs

E1-54              The decision-usefulness approach to financial reporting

E1-55              Merits of accrual- vs. cash-basis accounting

E1-56              Information asymmetry

E1-57              Maintaining competitive advantage

E1-58              Management bias in financial statement presentation

E1-59              Role of securities commissions and stock exchanges

E1-60              Standard setting

E1-61              Purpose of accounting standards

E1-62              ASPE vs. IFRS

E1-63              Source of GAAP

E1-64              Sources of GAAP

E1-65              Professional judgement

E1-66              SOX and standard setting

E1-67              Challenges facing financial reporting

E1-68              Role of executives and management in a post-SOX world

E1-69              Technology and financial information


MULTIPLE CHOICE QUESTIONS

 

 

  1. The essential characteristic(s) of accounting is (are)
  2. a) communication of financial information to interested internal parties only.
  3. b) communication of economic information to external parties.
  4. c) identification and measurement of financial information only.
  5. d) identification, measurement, and communication of financial information.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Financial accounting is concerned with the process that culminates in
  2. a) the preparation of financial reports.
  3. b) specialized reports for inventory management and control.
  4. c) specialized reports for income tax calculation and recognition.
  5. d) reports on changes in stock prices and future estimates of market position.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Financial accounting can be broadly defined as the area of accounting that prepares financial statements to be used
  2. a) by parties internal to the business enterprise only.
  3. b) by investors only.
  4. c) by parties both internal and external to the business enterprise.
  5. d) primarily by external users and Canada Revenue Agency.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Management accounting can be broadly defined as the area of accounting that communicates financial information
  2. a) to investors only.
  3. b) to parties internal to the business enterprise only.
  4. c) to parties both internal and external to the business enterprise.
  5. d) primarily to external users and Canada Revenue Agency.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Management Accounting

Bloomcode: Knowledge

 

 

  1. Whether a business is successful and thrives is determined by
  2. a) free enterprise or competition.
  3. b) competition and markets only.
  4. c) markets and competition only.
  5. d) markets, competition and free enterprise.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Which of the following is correct?
  2. a) Reported accounting numbers do not affect the transfer of resources.
  3. b) Credit rating agencies use accounting information to assess their assets.
  4. c) Efficient capital markets promote productivity and encourage innovation.
  5. d) Efficient capital markets promote productivity but do not encourage innovation.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Information provided by accounting is important because it enables investors and creditors to
  2. a) compare income and assets of companies.
  3. b) assess the relative risks and returns of investment opportunities.
  4. c) channel their resources more effectively.
  5. d) all of the above

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. In Canada, the primary exchange mechanism(s) for allocating resources is (are)
  2. a) debt & equity markets.
  3. b) financial Institutions such as banks.
  4. c) government authorities such as the Canada Revenue Agency (CRA).
  5. d) both a & b

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is/are major factors in the rapidly changing financial reporting environment in Canada?
  2. a) increased demand for accountants and the impact of technology
  3. b) globalization and the unethical actions of accountants
  4. c) the growing number of institutional investors who want more information regarding environmental and social issues
  5. d) increased use of the Internet

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Stakeholders who help in the efficient allocation of resources include
  2. a) investors and creditors.
  3. b) financial analysts and regulators.
  4. c) creditors and auditors.
  5. d) management and auditors.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Audited financial statements are prepared by
  2. a) auditors.
  3. b) financial analysts.
  4. c) Canada Revenue Agency.
  5. d) management.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The auditors primary responsibility is to
  2. a) review financial statements and discuss them with management.
  3. b) prepare financial statements.
  4. c) report to Canada Revenue Agency.
  5. d) report to standard setters.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The widely publicized subprime lending crisis was NOT caused by
  2. a) capital market participants who acted in their own self-interest.
  3. b) a lack of transparency.
  4. c) the practice of securitizing assets.
  5. d) a lack of investor understanding of the investments true risk.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Finance

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Managements primary responsibility with respect to financial statements is to
  2. a) prepare them, as they have the best insight and know what should be included.
  3. b) audit them, as they are distant enough from daily operations.
  4. c) rely on them to make decisions.
  5. d) None of the above are true.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. The primary responsibility of security and exchange commissions with respect to financial statements is to
  2. a) set generally accepted accounting principles (GAAP), which must be followed in their preparation.
  3. b) review accounting choices made by companies in their financial statements to ensure decision-making logic is sound.
  4. c) monitor financial statements to ensure full and plain disclosure of material information thus maintaining compliance with listing requirements.
  5. d) monitor and analyze the information looking for signs of an improved or weakened financial condition.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Objectives of financial reporting do NOT include
  2. a) providing information that is useful to users in making resource allocation decisions.
  3. b) providing information about the liquidation value of an enterprise.
  4. c) providing information about an entitys economic resources, obligations, and equity/net assets.
  5. d) providing information about changes in an entitys economic resources, obligations, and equity/net assets.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. As part of the objective of general-purpose financial reporting, which of the following perspectives are considered appropriate?
  2. a) proprietary perspective
  3. b) entity perspective
  4. c) stakeholder perspective
  5. d) None of the above perspectives are considered appropriate.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is NOT true regarding accrual-basis accounting?
  2. a) A company records events that change its financial statements in the periods in which the events occur.
  3. b) Revenues and expenses are recognized in the periods in which the company receives or pays cash.
  4. c) It has greater potential to depict meaningful trends in revenues and expenses.
  5. d) Revenues and expenses can be more easily related to the economic environment of the period in which they occurred.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The preparation by some companies of biased information is sometimes referred to as
  2. a) conservative financial reporting.
  3. b) full disclosure of all material facts.
  4. c) aggressive financial reporting.
  5. d) stewardship.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Where information asymmetry exists, the capital market may attract the wrong kind of company. This is known as
  2. a) moral hazard.
  3. b) conservative accounting.
  4. c) adverse selection.
  5. d) an inefficient marketplace.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

CPA: Professional & Ethical Behaviour

Bloomcode: Knowledge

 

 

  1. The efficient markets hypothesis proposes that
  2. a) market prices reflect information known only to internal stakeholders.
  3. b) market prices reflect all information about a company.
  4. c) market prices reflect information known only to external stakeholders.
  5. d) information asymmetry is required.

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Finance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT describe a cause of management bias?
  2. a) the need to comply with contracts, such as debt covenants
  3. b) the desire to meet financial analysts expectations
  4. c) the tendency to downplay negative events
  5. d) the desire for all stakeholders to have access to all information

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Where people think that no one is watching, they will often shirk their responsibilities. This is known as
  2. a) moral hazard.
  3. b) conservative accounting.
  4. c) adverse selection.
  5. d) an inefficient marketplace.

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Conservative accounting refers to
  2. a) a managers tendency to shirk his stewardship responsibilities.
  3. b) a managers engagement in greater risk taking.
  4. c) a decision to downplay the negative and focus on the positive.
  5. d) a decision to downplay the positive and focus on the negative.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

Feedback: a, b, & c describe aggressive accounting.

 

 

  1. The problem of information asymmetry can be reduced by
  2. a) aggressive accounting.
  3. b) accounting standards.
  4. c) adverse selection.
  5. d) only focusing on positive events.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

  1. Which of the following sources of generally accepted accounting principles (GAAP) are NOT developed by the Canadian Accounting Standards Board (AcSB)?
  2. a) Accounting Standards for Private Enterprises (ASPE)
  3. b) International Financial Reporting Standards (IFRS)
  4. c) GAAP for Pension Plans
  5. d) GAAP for Not-for-Profit entities

 

Answer: b

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Before 1900, which of the following accurately describes financial reports?
  2. a) They emphasized the need for standardized and increased corporate disclosures.
  3. b) They were for widespread use and distribution.
  4. c) They emphasized solvency and liquidity.
  5. d) None of the above accurately describe financial reports pre-1900.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. As of 2011, the responsibilities of the Accounting Standards Board (AcSB) in Canada relate to setting standards for
  2. a) publicly accountable entities only.
  3. b) both publicly accountable entities and private enterprises.
  4. c) private enterprises, not-for-profit entities and pension plans.
  5. d) not-for-profit entities and pension plans only.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Audit & Assurance

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In Canada, the body that has the responsibility of overseeing the Accounting Standards Board (AcSB) is the
  2. a) Accounting Standards Oversight Council (AcSOC).
  3. b) International Accounting Standards Board (IASB).
  4. c) Canadian Institute of Chartered Accountants (CICA).
  5. d) Financial Accounting Standards Board (FASB).

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In the United States, the body that has the final authority over accounting standards is the
  2. a) Financial Accounting Standards Board (FASB).
  3. b) International Accounting Standards Board (IASB).
  4. c) Securities Exchange Commission (SEC).
  5. d) Accounting Standards Oversight Council (AcSOC).

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In Canada, the body which is NOT instrumental in the development of financial reporting standards is the
  2. a) Accounting Standards Board (AcSB).
  3. b) Financial Accounting Standards Board (FASB).
  4. c) International Accounting Standards Board (IASB).
  5. d) American Institute of Certified Public Accountants.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The adoption of International Financial Reporting Standards in Canada is an example of
  2. a) the impact of technology on users needs.
  3. b) the impact of globalization on capital markets.
  4. c) ethical behaviour.
  5. d) the desire of most private companies to expand internationally.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following statements does NOT describe the activities and authority of the Ontario Securities Commission (OSC)?
  2. a) The OSC reviews and monitors the financial statements of companies whose shares are listed on the Toronto Stock Exchange.
  3. b) The OSC issues its own disclosure requirements for listed companies.
  4. c) The OSC has the ability to fine or delist companies.
  5. d) The OSC issues financial accounting standards for Canadian companies.

 

Answer: d

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT support the use of Accounting Standards for Private Enterprises (ASPE)?
  2. a) Private enterprises usually have less complex business models.
  3. b) Private enterprises that are going public.
  4. c) Private enterprises usually have fewer users.
  5. d) Private enterprises financial statement users tend to have first-hand information.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following does NOT describe a step in the IASBs standard setting process?
  2. a) appointing trustees to the IFRS Foundation
  3. b) development of an exposure draft
  4. c) provision of strategic advice by the IFRS Advisory Council
  5. d) public consultation

 

Answer: a

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Under ASPE, the primary sources of GAAP include
  2. a) accounting textbooks and journals.
  3. b) International Financial Reporting Standards.
  4. c) the CICA Handbook and appendices.
  5. d) research studies.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the need for accounting standards and identify the major entities that influence standard setting and financial reporting.

Section Reference: Standard Setting

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Under ASPE, the other (as opposed to primary) sources of GAAP include
  2. a) the CICA Handbook and appendices.
  3. b) Accounting Guidelines, including appendices.
  4. c) pronouncements by accounting standard-setting bodes in other jurisdictions.
  5. d) All of these are primary sources of GAAP.

 

Answer: c

 

Difficulty: Easy

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The exercise of professional judgement does NOT involve
  2. a) the use of knowledge gained through education.
  3. b) the application of knowledge gained through experience.
  4. c) the use of ethical decision making.
  5. d) aggressive accounting.

 

Answer: d

 

Difficulty: Easy

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In a rules-based approach (such as U.S. GAAP), compared to a principles-based approach (such as Canadian GAAP),
  2. a) the body of knowledge is smaller.
  3. b) the importance of communicating the best information to users is emphasized.
  4. c) since it is more prescriptive, it may be easier to defend how to account for a particular item.
  5. d) companies frequently do not interpret the rules literally.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. In a principles-based standard-setting system (such as Canadian GAAP), compared to a rules-based approach (such as U.S. GAAP),
  2. a) since it is more prescriptive, it may be easier to defend how to account for a particular item.
  3. b) there is a rule for every situation.
  4. c) accountants either apply specific standards based on the conceptual framework, or, professional judgement consistent with the framework.
  5. d) it is expected that professional accountants might encounter situations where they are unable to apply the principles appropriately.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Explain the meaning of generally accepted accounting principles (GAAP) and the significance of professional judgement in applying GAAP.

Section Reference: Generally Accepted Accounting Principles

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. The Sarbanes-Oxley Act (SOX) was NOT enacted to
  2. a) help prevent fraud and poor financial reporting practices.
  3. b) ensure the act was applied internationally.
  4. c) enable the SEC to increase its policing efforts.
  5. d) introduce new independence rules for auditors.

 

Answer: b

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. Which of the following is likely to be an advantage of the advancement of technology on financial reporting?
  2. a) Users of financial information will have access to more information.
  3. b) The quality and reliability of the information may be compromised.
  4. c) Equal and fair access may be at issue.
  5. d) Internet reporting will increase costs.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

  1. One political factor influencing the standard setting process is how the standard-setting bodies are financed. Which of the following is NOT an IASB principle regarding the nature and amount of funding?
  2. a) Closed-loop: Financial commitments for funding should be contingent upon particular outcomes.
  3. b) Broad-based: It should not rely on one or a few sources.
  4. c) Compelling: Constituents should not be allowed to benefit from the standards without contributing to the process of standard setting.
  5. d) Country-specific: Funding should be shared by the major economies on a proportionate basis.

 

Answer: a

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

Feedback: Funding must be open-ended.

 

 

  1. Which of the following is an argument in favour of a GAAP body of knowledge that is more prescriptive, or rules-based?
  2. a) It always emphasizes communicating the best information for users.
  3. b) The body of knowledge becomes significantly smaller and therefore easier to manage.
  4. c) It may be easier to defend how to account for a particular item.
  5. d) There is a tendency for companies to interpret guidelines loosely, and thus account for items inconsistently.

 

Answer: c

 

Difficulty: Medium

Learning Objective: Discuss some of the challenges and opportunities for accounting.

Section Reference: Challenges and Opportunities for the Accounting Profession

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Exercises

 

 

Ex. 1-45 Effective capital allocation

Explain the advantages of an effective capital allocation process.

 

Solution 1-45

An effective capital allocation process encourages innovation, promotes productivity, and            provides a platform for buying and selling securities and obtaining and granting credit.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Management Accounting

Bloomcode: Knowledge

 

 

Ex 1-46 Financial statements in practice and theory

What are the four most frequently provided financial statements? Provide two terminologies used to refer to each statement.

 

Solution 1-46

  1. Statement of financial position/Balance sheet
  2. Statement of income/comprehensive income/Income statement/ Profit & loss statement
  3. Statement of cash flows/ Cash flow statement
  4. Statement of changes in equity/ Statement of retained earnings

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-47 Stakeholders in the financial reporting environment

Briefly describe the much-publicized subprime lending crisis in the United States, and identify the stakeholders and how they were affected.

 

Solution 1-47

At the centre of this issue were securitized mortgage assets that were sold to investors. These assets were based on mortgages that had been extended to high-risk borrowers who could no longer afford their mortgage payments once interest rates rose. This led to a flooding of the housing market as borrowers walked away from their houses (and debt). The primary stakeholders were the lenders, borrowers and investors. Lenders (acting in their own self-interest) sold these investments to investors who may not have fully understood the high-risk nature of their investment. Borrowers lost their homes they could no longer afford, and investors suffered large losses due to the defaulted loans.

 

Difficulty: Medium

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Finance

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-48 Sources of capital and stages of company growth

Briefly describe how the sources of capital a company relies upon for funding might vary according to their stage of growth.

 

Solution 1-48

As per Illustration 1-2, in the early project/idea stages a company will acquire its initial capital from founders, family, and friends. As they progress to the research & development or prototype stage, private and public venture capital may be introduced, and includes capital provided by angel investors, venture capitalists, and public exchanges such as the TSX Venture Exchange or TSX. Venture capitalists and these public exchanges become the dominant capital sources as greater amounts of capital are required and as a company progresses through commercialization and into stable production.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Finance

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-49 Objectives of financial reporting

What are the objectives of financial reporting by business enterprises?

 

Solution 1-49

The objectives of financial reporting are to provide information

  1. that is useful to investors, members, contributors, creditors and other users in making their resource allocation decisions and/or assessing management stewardship.
  2. to help users in evaluating an entitys economic resources, obligations and equity/net assets and the changes to these items.
  3. to help users evaluate the economic performance of an entity.

 

Difficulty: Easy

Learning Objective: Explain how accounting makes it possible to use scarce resources more efficiently.

Section Reference: Accounting and Capital Allocation

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex 1-50 Traditional users vs. others

Beyond users relying directly on financial information for resource allocation, such as investors and creditor, identify at least two categories of stakeholders included in the broader definition of users who help in the efficient allocation of resources. For each category, indicate what is at stake.

 

Solution 1-50

Refer to Illustration 1-4.

Stakeholder What is at Stake
Securities commissions and stock exchanges Reputation, effective and efficient capital marketplace
Analysts and credit rating agencies Reputation, profits
Auditors Reputation, profits (companies and their clients)
Standard setters Reputation

 

Difficulty: Medium

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-51 Imperfection of the stakeholder ecosystem

The stakeholder ecosystem (depicted in Illustration 1-3) provides checks and balances to ensure that the people with capitalinvestors and creditorshave good information to use when deciding where best to invest and allocate capital. The system does not always work, however. Explain why this is the case.

 

Solution 1-51

The stakeholder ecosystem does not always provide perfect information for people with capital because it involves people, and human behaviour is an unpredictable variable. People often act in their own self-interest rather than in the best interest of the capital marketplace, and by extension, the economy.

 

Difficulty: Medium

Learning Objective: Explain the meaning of stakeholder and identify key stakeholders in financial reporting, explaining what is at stake for each one.

Section Reference: Stakeholders

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-52 Entity vs. proprietary perspective

Explain the difference between the entity perspective and the proprietary perspective.

 

Solution 1-52

The entity perspective views companies as separate and distinct from their owners. e.g., corporate assets are viewed as assets of the company and not of a specific creditor or shareholder. Investors and creditors have liability or equity claims. On the other hand, the proprietary perspective holds that financial reporting should focus only on the needs of the shareholders, and is not considered appropriate. The entity perspective is adopted as part of the objective of general-purpose financial reporting.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-53 User needs

Explain why providing information to users is a challenging task.

 

Solution 1-53

First, users have very different knowledge levels. Some users have accounting designations or have worked in the finance industry for several years. Others have limited knowledge of how the information is gathered and reported. Secondly, users have very different needs. Some users are institutional investors who hold a large percentage of equity shareholdings and generally devote significant resources to managing their investment portfolios. Others are credit managers at banks or credit unions who deal mainly with small business or personal loans. Still others are labour negotiators whose knowledge of financial reporting is limited to periodic reviews of financial information for the purpose of negotiations.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-54 The decision-usefulness approach to financial reporting

Explain what is meant by the decision-usefulness approach to financial reporting. Who will this information be useful to, and why?

 

Solution 1-54

The decision-usefulness approach to financial reporting dictates that financial statements provide information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. It may also be useful to those who are not providers of capital such as analysts, regulators, and competitors.

 

Difficulty: Easy

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

Bloomcode: Knowledge

 

 

Ex. 1-55 Merits of accrual- vs. cash-basis accounting

Investors are interested in assessing a companys ability to generate net cash inflows, as well as its ability to protect and enhance capital investments. Briefly explain how each of the accrual- and cash-basis methods, respectively, might enhance these objectives.

 

Solution 1-55

Cash-basis accounting provides better information for assessing timing and amounts of cash flows, which assist with objective 1. Objective 2, concerning long-term performance of the company, may be better served by accrual-based accounting, which generally provides better information about future ability to generate favourable cash flows. It also ties operations to events and the surrounding environment, which are better indicators of performance, and the companys ability to continue operating as a going concern.

 

Difficulty: Medium

Learning Objective: Identify the objective of financial reporting.

Section Reference: Objective of Financial Reporting

CPA: Communication

CPA: Financial Reporting

CPA: Management Accounting

Bloomcode: Knowledge

 

 

Ex. 1-56 Information asymmetry

In markets where information asymmetry exists, there can be adverse selection and moral hazard. Explain what these terms mean.

 

Solution 1-56

Adverse selection refers to hidden knowledge, where the capital marketplace may attract the wrong type of company, such as companies who have the most to gain from not disclosing information. Given this situation, companies who do fully disclose all information may choose not to enter the marketplace if they are aware of the presence of adverse selection.

Moral hazard refers to hidden actions, and occurs as a result of human nature. People or companies may shirk their responsibilities if they think they can get away with it, e.g., not disclose negative information since they know it may be detrimental to their share price. This is a form of management bias.

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Communication

CPA: Financial Reporting

CPA: Strategy & Governance

Bloomcode: Knowledge

 

 

Ex. 1-57 Maintaining competitive advantage

In the most efficient and effective marketplace possible, all stakeholders would have equal access to all relevant information. However, a company may feel that complete disclosure may hurt their competitive advantage or position. Offer an example of a circumstance where this may be the case. What do you think the company should do?

 

Solution 1-57

An example where disclosure may hurt the companys competitive advantage or position would be a legal battle. If the company were in the middle of a lawsuit, the company would want to be careful about how much information was disclosed because it might affect the outcome of the lawsuit. This is an ethical dilemma. The company must weigh the costs and benefits of sharing information. If the financial impact of the lawsuit is expected to be material, they should, at minimum, disclose its existence in the notes to the financial statements. If amount and timing of any financial impact are sufficiently known and certain, an accrual of these amounts may be necessary.

 

Difficulty: Medium

Learning Objective: Explain how information asymmetry and bias interfere with the objective of financial reporting.

Section Reference: Information Asymmetry

CPA: Communication

CPA: Professional & Ethical Behaviour

CPA: Strategy & Governance

Bloomcode: Knowledge

Bloomcode: Evaluation

 

 

Ex. 1-58 Management bias in financial statement presentation

There are many reasons why management may present biased information in the financial statements. Identify at least three (3) such motivations.

 

Solution 1-58

Refer to Illustration 1-5. Possible motivations include:

  • evaluation of management performance
  • compensation structures
  • access to capital markets and meeting financial analyst expectations
  • contractual obligations

 

Difficulty: Easy

Learning Objective: Explain how information asymmetry and bias interfere with the objective of fina

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