copyright © 2010 mcgraw-hill ryerson ltd slides prepared by ingrid mcleod-dick – finance...

Copyright © 2010 McGraw-Hill Ryerson Ltd

Slides prepared by Ingrid McLeod-Dick – Finance Department – Schulich School of Business

Intermediate Accounting 5Intermediate Accounting 5thth ed. ed.

Thomas H. BeechySchulich School of BusinessYork University

Joan E. D. ConrodFaculty of ManagementDalhousie University

Elizabeth FarrellSchulich School of BusinessYork University

Copyright © 2010 McGraw-Hill Ryerson Ltd 1-2

The Framework For Financial Reporting

Chapter 1


International Financial Reporting Standards

Motivation for Canada to move to IFRS Development of international financial markets Security exchanges wanted to attract foreign companies Companies listed on multiple exchanges were required to

prepare financial statements under various accounting standards

EU adopted IFRS as a single accounting standard in 2005 Canada adopts for 2011 India, Japan and China will adopt between 2011 and 2014 US is still considering (2017 at the earliest) but SEC will

accept IFRS prepared statements

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Accounting Standards in Canada

IFRS – Publicly accountable enterprises (PAE) must

comply with IFRS, effective for years beginning on or after January 1, 2011 (or earlier adoption is permitted)

“A PAE is an entity that has issued (or will be issuing) debt and/ or equity that is outstanding and traded in a public market; or holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses.”

- Investment funds, mutual funds, credit unions, saving institutions for example

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Accounting Standards in Canada (cont’d)

Public companies listed in USSEC will accept financial reports prepared under

IFRS with no reconciliation required to US GAAP; or

Some Canadian public companies that are heavily traded in US may prepare reports solely under US GAAP (which will be accepted by Canadian securities exchanges)

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Control Blocks

Control Blocks: A small number of related or affiliated shareholders who have the majority of the voting shares

Restricted shares: shares with limited or no voting rights

It is common Canadian practice for a public corporation to issue two or more classes of shares: one with multiple votes per share and another with little (one vote per share) or no voting rights called restricted shares

LO 1-2



Private enterprises (non PAE’s) – changeover effective for years beginning on or after January 1, 2011 (or earlier adoption is permitted)

Choices to adopt: IFRS; or Canadian accounting standards for private

enterprises ( ASPE); orA disclosed basis of accounting

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Why would a private enterprise choose IFRS? Is considering going public in the near futurePrivate capital providers may required IFRS

statements be preparedMay choose to be comparable with public

companies’ reports prepared under IFRS since competing for capital

Parent may report under IFRS

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Why would a private enterprise choose to adopt ASPE?No size test, or unanimous consent required and

no differential reporting options ASPE designed to reduce cost of preparation by:

reducing complexity in applying various standards reducing required disclosure many choices available for the more complex

standards in many areas consistent with pre-changeover GAAP

allowing for little disruption on January 1, 2011.

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In rare cases, a private enterprise may choose to follow a disclosed basis of accounting in order to:Make statements more useful for specific users –

to satisfy contractual requirements for bank loansMake statements coincide with income tax

treatment of specific items If this method is chosen, must disclose:

Description of the disclosed basis of accounting

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IFRS Comparability

Adopted by European Union, Australia, Japan, India and China and many other countries

Reason for IFRS is to promote multiple exchange listing and improve comparability

But there are still differences between countries due legal requirements, economic environment, political environment, regulations and ways of doing business.

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IFRS Comparability (cont’d)

Issues with comparability across countries: Many countries base income tax on reported earnings

Income tax minimization becomes the dominant objective

Countries may require more disclosure on social responsibility and environmental protection (i.e. Sweden)

Reporting may have strong emphasis on creditor protection resulting in income minimization (i.e. Germany)

More disclosure required on employee compensation and benefits

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Objectives of Financial Reporting

Objectives of financial reporting: the various users’ needs and management’s motivations that are basic criteria for making choices from among different possible accounting policies, accounting estimates, and note disclosures

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Objectives of Financial Reporting (cont’d)

Financial statements:Objective - “…is to provide information about the

financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions” (IASB)

External users – all non-management users – investors, creditors and employees

Preparers – managers and accountants who participate in decisions to prepare

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Financial statements:have direct economic impact on enterprise:

- Impact on profit sharing bonuses, company’s income tax liability, impact on financing available due to covenants

have direct economic impact on users:- Lenders decide on loan advances- Shareholders assess management’s ability- Security analysts make buy or sell recommendations

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LO 1-4

Facts

ConstraintsUser Power

User Needs Preparer Motivations

FINANCIAL REPORTING OBJECTIVES

Accounting Process Choices


External Users’ Objectives of Financial Reporting

Assessing & Predicting Cash Flows Income Tax Minimization Contract Compliance Stewardship Performance evaluation

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Assessing and Predicting Cash Flows • The consequences of adopting cash flow prediction as

a primary reporting objective include:Accounting policies are chosen that tend to reduce

inter-period allocations Full disclosure of future cash flow commitments is

given in the notes• provide the clearest indication of the cash flows

underlying reported earnings • Earnings quality – high degree of correlation between

operating cash flow and earnings

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Income Tax Minimization

Income Tax Minimization: Accounting policies that tend to:

delay the recognition of revenue to the extent permitted by the Income Tax Act, particularly for long earnings cycles

speed up the payment of expenses that can legitimately be deducted for tax purposes

Since there is a time value of money, why pay taxes this year if they can be delayed until next year?

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Contract Compliance

Financial statements basis for assessing whether an enterprise has complied with contract provisions Debt covenants or maintenance testsValuations for shareholder agreements

Impact of accounting choices on these ratios

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Stewardship

A steward : a person who is responsible for managing an enterprise on behalf of someone else

The stewardship objective is most clearly dominant in reporting for non-profit organizations, where donors and members need to see how managers used the resources at their disposal for the period

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Performance Evaluation

Managers are users of financial statements in order to: evaluate their own performance evaluate the performance of

managers of subsidiaries and other related companies in a corporate family of companies

Select policies to enhance their performance evaluation

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Preparer Motivations

Income maximization or minimization Income smoothing Minimum compliance Expanded disclosure

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Income Maximization

Income maximization stems from three powerful concerns: to make it easier to comply with debt

covenants to positively influence users’ judgments in

evaluating the performance of management to enhance managers’ compensation when

tied either to net income or to stock price performance, or both

“Big Bath” to maximize loss in one year to maximize earnings in subsequent years

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Income Minimization (cont’d) Income minimization:

to minimize income taxes to avoid public embarrassment by reducing

a high level of reported earnings to avoid attracting competitors

into a very lucrative business to discourage hostile take-over bids to avoid the scrutiny of regulators

or politicians to discourage large wage claims

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Minimum Compliance

Minimum compliance: the motivation of managers to reveal the least amount of information that is possible within the recommendations of GAAP

Provide little information to outsiders and maintain confidentiality

Minimum cost

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Expanded Disclosure

Management may wish to disclose a great deal of information that they are not required under GAAP

May demonstrate that management are ‘good citizens’ who have nothing to hide and wish to provide the most informative financial statements possible

May be motivated by expected concerns of shareholders

Additional disclosure required in other countries in which the company reports

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Objectives vs. Motivations

Users’ objectives and managers’ motivations often conflict

Managers may attempt to put the best picture on the corporation’s financial position and performance

The resolution of this conflict depends on:Fair presentation andProfessional judgment and ethics

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Required Financial Statements

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Publicly Accountable - IFRS Private Enterprises - ASPE

Statement of financial position Balance sheet

Statement of comprehensive income: - income statement- other comprehensive income

Income statements

Statement of changes in equity Statement of changes in retained earnings

Statement of cash flows Statement of cash flows

copyright © 2010 mcgraw-hill ryerson ltd slides prepared by ingrid mcleod-dick – finance...

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