Test Bank for Intermediate Accounting, Twelfth Canadian Edition

CHAPTER 1

THE CANADIAN FINANCIAL REPORTING ENVIRONMENT

CHAPTER STUDY OBJECTIVES

1. Understand the financial reporting environment. 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.
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. 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. 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 case—there 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.

2. Explain the need for accounting standards and 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 company’s 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.

3. Explain the meaning of generally accepted accounting principles (GAAP) and the significance of
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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.

4. 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

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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. Auditor’s responsibility
c 13. Causes of subprime lending crisis
a 14. Management’s 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. IASB’s 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
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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 Financial versus managerial accounting
E1-60 Role of securities commissions and stock exchanges
E1-61 Standard setting
E1-62 Purpose of accounting standards
E1-63 ASPE vs. IFRS
E1-64 IFRS Discussion Group
E1-65 Sources of GAAP
E1-66 Sources of GAAP
E1-67 Professional judgement
E1-68 SOX and standard setting
E1-69 Challenges facing financial reporting
E1-70 Role of executives and management in a post-SOX world
E1-71 Technology and financial information
E1-72 Extensible business reporting
E1-73 IFRS taxonomy
E1-74 Principles- versus rules-based approaches

PROBLEMS
Item Description
P1-75 U.S. GAAP impact on Canadian GAAP
P1-76 Shortcomings of rules-based approach

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

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

2. Financial accounting is concerned with the process that culminates in

a) the preparation of financial reports.
b) specialized reports for inventory management and control.
c) specialized reports for income tax calculation and recognition.
d) reports on changes in stock prices and future estimates of market position.

Answer: a

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: b

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Management Accounting
Bloomcode: Knowledge
AACSB: Analytic

5. Whether a business is successful and thrives is determined by

a) free enterprise or competition.
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

b) competition and markets only.

c) markets and free enterprise only.
d) markets, competition, and free enterprise.

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

5. Whether a business is successful and thrives is determined by

a) free enterprise or competition.
b) competition and markets only.
c) markets and free enterprise only.
d) markets, competition, and free enterprise.

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

6. Which of the following is correct?

a) Reported accounting numbers do not affect the transfer of resources.
b) Credit rating agencies use accounting information to assess only assets.
c) Efficient capital markets promote productivity and encourage innovation.
d) Efficient capital markets promote productivity but do not encourage innovation.

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

7. Information provided by accounting is important because it enables investors and creditors to

a) compare income and assets of companies.
b) assess the relative risks and returns of investment opportunities.
c) channel their resources more effectively.
d) all of the above
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

8. In Canada, the primary exchange mechanism(s) for allocating resources is (are)

a) debt and equity markets.
b) financial Institutions such as banks.
c) government authorities such as the Canada Revenue Agency (CRA).
d) both a and b

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
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
AACSB: Analytic

10. Stakeholders who help in the efficient allocation of resources include

a) investors and creditors.
b) financial analysts and regulators.
c) creditors and auditors.
d) management and auditors.

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Answer: b

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

11. Audited financial statements are prepared by

a) auditors.
b) financial analysts.
c) Canada Revenue Agency.
d) management.

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

12. The auditor’s primary responsibility is to

a) review financial statements and discuss them with management.
b) prepare financial statements.
c) report to Canada Revenue Agency.
d) report to standard setters.

Answer: a

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Audit & Assurance
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

13. The widely publicized subprime lending crisis was NOT caused by
a) capital market participants who acted in their own self-interest.
b) a lack of transparency.
c) the practice of securitizing assets.
d) a lack of investor understanding of the investment's true risk.

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

CPA: Finance
CPA: Professional & Ethical Behaviour
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

14. Management’s primary responsibility with respect to financial statements is to

a) prepare them, as they have the best insight and know what should be included.
b) audit them, as they are distant enough from daily operations.
c) rely on them to make decisions.
d) None of the above are true.

Answer: a

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

16. Objectives of financial reporting do NOT include

a) providing information that is useful to users in making resource allocation decisions.
b) providing information about the liquidation value of an enterprise.
c) providing information about an entity’s economic resources, obligations, and equity/net assets.
d) providing information about changes in an entity’s economic resources, obligations, and equity/net
assets.

Answer: b

Difficulty: Easy
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Learning Objective: Understand the financial reporting environment.

Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: b

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

18. Which of the following is NOT true regarding accrual-basis accounting?

a) A company records events that change its financial statements in the periods in which the events occur.
b) Revenues and expenses are recognized in the periods in which the company receives or pays cash.
c) It has greater potential to depict meaningful trends in revenues and expenses.
d) Revenues and expenses can be more easily related to the economic environment of the period in which
they occurred.

Answer: b

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

19. The preparation by some companies of biased information is sometimes referred to as

a) conservative financial reporting.
b) full disclosure of all material facts.
c) aggressive financial reporting.
d) stewardship.

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

AACSB: Analytic

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

Answer: c

Difficulty: Easy
Learning Objective: Understand the financial reporting environment. .
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Professional & Ethical Behaviour
Bloomcode: Knowledge
AACSB: Analytic

21. The “efficient markets hypothesis” proposes that

a) market prices reflect information known only to internal stakeholders.
b) market prices reflect all information about a company.
c) market prices reflect information known only to external stakeholders.
d) information asymmetry is required.

Answer: b

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Finance
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Audit & Assurance
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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

Answer: a

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Analytic

24.Conservative accounting refers to

a) a manager’s tendency to shirk his stewardship responsibilities.
b) a manager’s engagement in greater risk taking.
c) a decision to downplay the negative and focus on the positive.
d) a decision to downplay the positive and focus on the negative.

Answer: d

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
Feedback: a, b, and c describe aggressive accounting.
AACSB: Analytic

25. The problem of information asymmetry can be reduced by

a) aggressive accounting.
b) accounting standards.
c) adverse selection.
d) only focusing on positive events.

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
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Analytic

26. Which of the following sources of generally accepted accounting principles (GAAP) are NOT
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

developed by the Canadian Accounting Standards Board (AcSB)?

a) Accounting Standards for Private Enterprises (ASPE)
b) International Financial Reporting Standards (IFRS)
c) GAAP for pension plans
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
AACSB: Analytic

27.Before 1900, which of the following accurately describes financial reports?

a) They emphasized the need for standardized and increased corporate disclosures.
b) They were for widespread use and distribution.
c) They emphasized solvency and liquidity.
d) None of the above accurately describe financial reports pre-1900.

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
AACSB: Analytic

28. As of 2011, the responsibilities of the Accounting Standards Board (AcSB) in Canada relate to setting
standards for
a) publicly accountable entities only.
b) both publicly accountable entities and private enterprises.
c) private enterprises, not-for-profit entities, and pension plans.
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
AACSB: Analytic

29. In Canada, the body that has the responsibility of overseeing the Accounting Standards Board (AcSB)
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

is the
a) Accounting Standards Oversight Council (AcSOC).
b) International Accounting Standards Board (IASB).
c) Canadian Institute of Chartered Accountants (CICA).
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
AACSB: Analytic

30. In the United States, the body that has the final authority over accounting standards is the
a) Financial Accounting Standards Board (FASB).
b) International Accounting Standards Board (IASB).
c) Securities Exchange Commission (SEC).
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
AACSB: Analytic

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

Answer: d

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
AACSB: Analytic

32. The adoption of International Financial Reporting Standards in Canada is an example of

a) the impact of technology on user's needs.
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

b) the impact of globalization on capital markets.

c) ethical behaviour.
d) the desire of most private companies to expand internationally.

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
AACSB: Analytic

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

Answer: d

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
AACSB: Analytic

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

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
AACSB: Analytic

35. Which of the following does NOT describe a step in the IASB’s standard-setting process?
a) appointing trustees to the IFRS Foundation
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

b) development of an exposure draft

c) provision of strategic advice by the IFRS Advisory Council
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
AACSB: Analytic

36. Under ASPE, the primary sources of GAAP include

a) accounting textbooks and journals.
b) International Financial Reporting Standards.
c) the CICA Handbook and appendices.
d) research studies.

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
AACSB: Analytic

37. Under ASPE, the other (as opposed to primary) sources of GAAP include
a) the CICA Handbook and appendices.
b) Accounting Guidelines, including appendices.
c) pronouncements by accounting standard-setting bodes in other jurisdictions.
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
AACSB: Analytic

38. The exercise of professional judgement does NOT involve

a) the use of knowledge gained through education.
b) the application of knowledge gained through experience.
c) the use of ethical decision making.
d) aggressive accounting.
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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
AACSB: Analytic

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

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
AACSB: Analytic

40. In a principles-based standard-setting system (such as Canadian GAAP), compared to a rules-based

approach (such as U.S. GAAP),
a) which is more prescriptive, it may be easier to defend how to account for a particular item.
b) there is a rule for every situation.
c) accountants either apply specific standards based on the conceptual framework, or, professional
judgement consistent with the framework.
d) it is expected that professional accountants might encounter situations where they are unable to apply
the principles appropriately.

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
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
AACSB: Analytic

41. The Sarbanes-Oxley Act (SOX) was NOT enacted to

a) help prevent fraud and poor financial reporting practices.
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

b) ensure the act was applied internationally.

c) enable the SEC to increase its policing efforts.
d) introduce new independence rules for auditors.

Answer: b

Difficulty: Easy
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
AACSB: Analytic

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

Answer: a

Difficulty: Easy
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
AACSB: Technology

43. 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?
a) Closed-loop: Financial commitments for funding should be contingent upon particular outcomes.
b) Broad-based: It should not rely on one or a few sources.
c) Compelling: Constituents should not be allowed to benefit from the standards without contributing to
the process of standard setting.
d) Country-specific: Funding should be shared by the major economies on a proportionate basis.

Answer: a

Difficulty: Easy
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.
AACSB: Analytic

44. Which of the following is an argument in favour of a GAAP body of knowledge that is more
prescriptive, or rules-based?
a) It always emphasizes communicating the best information for users.
b) The body of knowledge becomes significantly smaller and therefore easier to manage.
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

c) It may be easier to defend how to account for a particular item.

d) There is a tendency for companies to interpret guidelines loosely, and thus account for items
inconsistently.

Answer: c

Difficulty: Easy
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
AACSB: Analytic

EXERCISES
Ex. 1-45
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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Management Accounting
Bloomcode: Knowledge
AACSB: Communication

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 and loss statement
3. Statement of cash flows/ Cash flow statement
4. Statement of changes in equity/ Statement of retained earnings

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-47 Stakeholders in the financial reporting environment

Briefly describe the much-publicized subprime lending crisis in the United States, and identify the

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Finance
CPA: Strategy & Governance
Bloomcode: Comprehension
AACSB: Communication

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 and 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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Finance
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Communication

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 entity’s economic resources, obligations, and equity/net assets, and the
changes to these items.

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

3. to help users evaluate the economic performance of an entity.

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex 1-50 Traditional users vs. others

Beyond users relying directly on financial information for resource allocation, such as investors and
creditors, 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 are their clients)
Standard setters Reputation

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Comprehension
AACSB: Communication

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 capital—investors and creditors—have good information to use when deciding where best to
invest and allocate capital. However, the system does not always work. 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: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Comprehension
AACSB: Communication

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

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

Investors are interested in assessing a company’s 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 the timing and amounts of cash flows,
which assist with the first objective. The second objective, 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 company’s ability to continue operating
as a going concern.

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
CPA: Management Accounting
Bloomcode: Comprehension
AACSB: Communication

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: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-57 Maintaining competitive advantage

In the most efficient and effective marketplace possible, all stakeholders would have equal access to all
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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 company’s 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 the amount and timing of any financial impact are sufficiently known and
certain, an accrual of these amounts may be necessary.

Difficulty: Hard
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Professional & Ethical Behaviour
CPA: Strategy & Governance
Bloomcode: Evaluation
AACSB: Communication

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: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Communication
CPA: Professional & Ethical Behaviour
CPA: Strategy & Governance
Bloomcode: Comprehension
AACSB: Communication

Ex. 1-59 Financial versus managerial accounting

Distinguish between financial and managerial accounting.

Solution 1-59
Financial accounting (financial reporting) is the process that culminates in the preparation of financial
reports that cover all of the enterprise’s business activities and that are used by both internal and
external parties. Users of these financial reports include investors, creditors, and others.

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

In contrast, managerial accounting is the process of identifying, measuring, analyzing, and

communicating financial information to internal decision-makers. This information may take varied
forms, such as cost-benefit analyses and forecasts that management uses to plan, evaluate, and control an
organization’s operations.

Difficulty: Easy
Learning Objective: Understand the financial reporting environment.
Section Reference: Financial Statements and Financial Reporting
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-60 Role of securities commissions and stock exchanges

Explain the role of securities commissions and stock exchanges in financial reporting.

Solution 1-60
The securities commissions and stock exchanges monitor the financial statements of companies whose
shares are publicly traded to ensure that they provide full and plain disclosure of material information,
and to ensure that the companies may continue to list shares on the stock exchanges. Securities
commissions oversee and monitor the capital marketplace.

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: Communication
CPA: Management Accounting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Communication
Ex. 1-61 Standard setting
Explain the relationship between Canadian GAAP and International Financial Reporting Standards
(IFRS).

Solution 1-61
Since the decision to adopt IFRS was made, Canadian GAAP has been continuously adjusted (converged)
to mirror IFRS. Even prior to that convergence, both standards were principles-based (rather than rules-
based).

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: Communication
CPA: Management Accounting
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-62 Purpose of accounting standards

Accounting professions in various countries have tried to develop a set of standards that are generally
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

accepted and universally practised. Explain the motivation for creating such a set of standards.

Solution 1-62
Creating standards facilitates comparability across companies and periods. Without standards, each
enterprise would develop its own standards, and readers of financial statement would have to become
familiar with every company’s particular accounting and reporting practices. It would be almost
impossible to prepare statements that could be compared.

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: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-63 ASPE vs. IFRS

Accounting standards for Private Enterprises (ASPE) are geared towards fewer users who have access to
additional information about the company. The need for common language and comparability as
facilitated by IFRS is less necessary among private enterprises. Explain why, despite this, a private
company might choose to voluntarily adopt IFRS.

Solution 1-63
A private company that is looking to go public might find it easier to follow IFRS right from the
beginning. Other motivations might include specific requests from users, or ease of adoption if the small
enterprise is a subsidiary of a larger company with IFRS reporting already in place.

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: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-64 IFRS Discussion Group

Explain the purpose of the IFRS Discussion Group.

Solution 1-64

The IFRS Discussion Group (IFRS DG) is a sub-committee created by the AcSB mandated to raise
awareness of issues arising in Canada as a result of implementing IFRS, and to make recommendations to
the AcSB for referral to the International Accounting Standards Board and its subcommittees.

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
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Bloomcode: Knowledge
AACSB: Analytic

Ex. 1-65 Sources of GAAP

International Financial Reporting Standards (IFRS) are the primary source of GAAP for public
enterprises in Canada. They are, however, insufficient to address all of the accounting issues facing
accountants. Explain why this is so and outline some other sources of GAAP that accountants use.

Solution 1-65
Although IFRS outline the specific accounting treatment for a multitude of items, for some items the
guidelines are very general. Also, the business environment is complex and constantly changing and,
therefore, some items may not be discussed at all. Thus, accountants must use IFRS in conjunction with
other sources like professional judgement, pronouncements of other standard-setting bodies, accounting
literature, and accepted industry practices.

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: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-66 Sources of GAAP

The Canadian principles-based GAAP does not offer specific standards for every transaction. When
specific guidance cannot be found in primary sources such as the Handbook and Accounting guidelines,
what process should the accountant follow in their consultation of other sources?

Solution 1-66
If primary sources do not deal with the specific issue, the entity should use accounting policies that are
consistent with primary sources. The policies should be developed through use of professional judgement
in accordance with the conceptual framework. The accountant might consider pronouncements of other
standard setters, accepted industry practices, and other literature, with the goal of producing information
that is as relevant and reliable.

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: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-67 Professional judgement

Explain the principle of professional judgement. When or why might it be necessary to employ
professional judgement, even in a rules-based system?

Solution 1-67
Professional judgement is the process by which professional accountants with significant education and
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

experience apply general principles appropriately as they see fit. This is important in Canada because
IFRS and ASPE are based primarily on general principles rather than on specific rules. It may also be
useful in a rules-based system, as novel circumstances and transactions are bound to arise for which a rule
does not yet exist. In these scenarios, the professional accountant must make use of professional
judgement to decide which treatment/record-keeping approach to a transaction will provide the most
relevant, reliable, and timely information to financial statement stakeholders.

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: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
AACSB: Communication

Ex. 1-68 SOX and standard setting

After several highly publicized accounting scandals in the U.S. such as Enron, Sunbeam, and WorldCom,
all of whom, coincidentally, were clients of the former public accounting firm of Arthur Andersen, the
U.S. regulators enacted the Sarbanes-Oxley Act (SOX). Pressure was put on Canada to follow a similar
course. Explain what Canada has done to make public companies more accountable.

Solution 1-68
First, the Canadian Public Accountability Board (CPAB) was created to supervise accounting issues
similar to those addressed by SOX. 2These included establishing auditing, quality control, and
independence standards and rules.
The Canadian Securities Administrators (CSA) has issued guidelines/rules that require (among other
things)
1. company management to take responsibility for the appropriateness and fairness of the financial
statements
2. public enterprises to have independent audit committees
3. public accounting firms to be subject to CPAB
4. greater disclosures including ratings from rating agencies, legal proceedings, payments to stock
promoters, and details about corporate directors.

Difficulty: Easy
Learning Objective: Discuss some of the challenges and opportunities for accounting.
Section Reference: Challenges and Opportunities for the Accounting Profession
CPA: Communication
CPA: Financial Reporting
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-69 Challenges facing financial reporting

In North America, the financial reporting environment is changing at a very rapid pace. Briefly describe
four challenges facing the accounting profession today.

Solution 1-69
1. Oversight in the capital marketplace. The Sarbanes-Oxley Act (SOX) instituted the Public Company
Accounting Oversight Board (PCAOB), stronger independence rules for auditors, reporting on the
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

effectiveness of the financial reporting internal control system, and disclosure of a code of ethics for
senior financial officers.
Canada has followed suit and developed the Canadian Public Accountability Board (CPAB). As
well, the Canadian Securities Administrators (CSA) requires company management to take
responsibility for the appropriateness and fairness of the financial statements, public companies to
have independent audit committees, and public accounting firms to be subject to the CPAB. The
CSA also requires much greater disclosures. The overall impact of these financial reforms has been
to put more emphasis on government regulation and less on self-regulation.
2. Centrality of ethics. Accountants are central in making the capital marketplace efficient and
effective. However, ethical dilemmas are common, often precipitated by management bias. It is not
always easy to “do the right thing.” Pressure to “bend the rules,” “play the game,” or “just ignore it”
are often there. There is no consensus (yet) among accounting professionals as to what a
comprehensive ethical system is, and so it is up to the individual accountant to maintain a high
standard of ethics at all times.
3. Standard setting in a political environment. Since standard setting is part of the real world,
accounting standards often arise from political action. The stakeholders who lobby the hardest may
unduly influence new or revised accounting standards. This is not surprising since many accounting
standards have economic consequences. Thus standard setters such as the IASB must consider the
needs of all stakeholders when creating or changing standards. The challenge is to find a balance
between letting stakeholders have a say while not bowing to undue political pressure.
4. Principles vs. rules. Rules-based, prescriptive systems (such as U.S. GAAP or the Canadian income
tax system) have a significantly larger body of knowledge than a principles-based approach such as
IFRS and ASPE. However, there is a tendency to interpret the rules literally with a rules-based
approach, possibly because it may be easier to defend the accounting for a particular item. A
disadvantage of the rules-based approach is that it may not always communicate the best information
to the user. The principles-based approaches are based on professional judgement, resulting in
carefully reasoned application of the principle to the business facts. Since the body of knowledge is
smaller with principles-based approaches, the standard setters must ensure it rests on a cohesive set
of principles and conceptual framework, which is sufficiently flexible, and sufficiently detailed to
provide good guidance.
Other challenges are the impact of technology and integrated reporting.

Difficulty: Easy
Learning Objective: Discuss some of the challenges and opportunities for accounting.
Section Reference: Challenges and Opportunities for the Accounting Profession
CPA: Communication
CPA: Financial Accounting
CPA: Management Accounting
CPA: Professional & Ethical Behaviour
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-70 Role of executives and management in a post-SOX world

SOX introduced sweeping changes to the institutional structure of the accounting profession. What key
provision was introduced relating to the role of management and executive officers, and their relationship
to financial reporting? Why?

Solution 1-70
Chief executive officers (CEOs) and chief financial officers (CFOs) are required to certify that the
financial statements and company disclosures are appropriate and fairly presented. In many cases, they
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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

must forfeit bonuses and profits if there is a restatement of their companies’ accounting disclosures.
Management must report on the effectiveness of financial reporting internal control systems. Requiring
management and executives to make these attestations holds them accountable, and creates a greater
sense of ownership over the financial statements. When this is done, management and executives are
unable to claim ignorance if intentional misrepresentations or frauds present in the financial reports are
uncovered, as many were in the pre-SOX era.

Difficulty: Easy
Learning Objective: Discuss some of the challenges and opportunities for accounting.
Section Reference: Challenges and Opportunities for the Accounting Profession
CPA: Audit & Assurance
CPA: Communication
CPA: Financial Reporting
CPA: Professional & Ethical Behaviour
CPA: Strategy & Governance
Bloomcode: Knowledge
AACSB: Communication

Ex. 1-71 Technology and financial information

Explain how technology impacts the accountants’ role as providers of information.

Solution 1-71
Technology impacts the process of identifying, measuring, and communicating useful information to
users in profound ways. Information is increasingly abundant and available through technology.
Companies are required to file disclosures electronically through securities commissions. Investors have
access to a greater abundance of information as well. This includes earnings calls, analyst briefings,
interviews with management and regulators, and much more. The Internet allows disclosure of and access
to a much larger group of users while reducing the cost of said communication. As technology advances
at a rapid pace, information may even be available in real time. This raises the concern of equal access to
information, as it exposes companies to additional risks as they pertain to information security.

Difficulty: Hard
Learning Objective: Discuss some of the challenges and opportunities for accounting.
Section Reference: Challenges and Opportunities for the Accounting Profession
CPA: Audit & Assurance
CPA: Communication
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Evaluation
AACSB: Technology

Ex. 1-72 Extensible business reporting

What is extensible business reporting language and how is it used?

Solution 1-72

Extensible business reporting language (XBRL) is a system that allows a company to tag its information
so that users can more easily extract it for analyzing and other use. The CSA have launched a voluntary
filing program, encouraging companies to use XBRL when filing their financial information with
securities regulators.

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Difficulty: Easy
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
AACSB: Technology

Ex. 1-73 IFRS taxonomy

What is the IFRS taxonomy and how is it used?

Solution 1-73

The IASB has created the IFRS taxonomy, which is a system for classifying things such as financial
statement elements and amounts. In 2014, the IASB put together the IFRS Taxonomy Consultative
Group, which provides a technical advisory and review forum to keep abreast of the issues and keep the
IFRS taxonomy up to date and relevant.

Difficulty: Easy
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
AACSB: Analytic

Ex. 1-74 Principles- versus rules-based aproaches

Explain the difference between the principles- versus rules-based approaches regarding GAAP.

Solution 1-74
In a rules-based approach—much like the Canadian tax system—there is a rule for most things (even
though the rule may be based on a principle). The result is that the body of knowledge in a rules-based
approach is significantly larger than that in a principles-based approach.

IFRS and ASPE are more principles-based. The body of knowledge is smaller and the idea is that one or
more principles form the basis for decision-making in many differing scenarios. In addition, professional
judgement is fundamental. There is less emphasis on right and wrong answers. Rather, the financial
reporting is a result of carefully reasoned application of the principle to the business facts.

Difficulty: Easy
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
AACSB: Analytic

PROBLEMS
P1-75 U,S. GAAP on Canadian GAAP
Explain why U.S. GAAP has and will continue to have a significant impact on GAAP in Canada.

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

Solution 1-75
U.S. GAAP has and will continue to have a significant impact on GAAP in Canada for three reasons:

Given that Canadian GAAP is based on principles and is fairly open to interpretation, accounting
professionals have often (in past) relied on the more prescriptive, specific guidance provided in U.S.
GAAP.
1. Many public Canadian companies are also listed on U.S. stock markets and exchanges and to be
listed on a U.S. exchange, these companies must follow U.S. GAAP or IFRS. As we move
toward international harmonization in accounting standards, the U.S. standards will continue to
influence Canadian and international standards due to the significant capital pool of these
markets.
2. The United States has not adopted IFRS. In October 2002, the FASB and IASB signed an
agreement (the Norwalk Agreement) that formalized their commitment to converge U.S. and
international accounting standards. In 2008, the FASB and IASB reaffirmed their commitment to
continue to work together, although it is not clear whether this relationship will continue. In
addition, the SEC issued a document known as the “Roadmap,” outlining issues regarding the
convergence initiative. More recently, the United States has been examining just how moving to
IFRS might work from a practical perspective, if at all. It is uncertain as to how the FASB will
proceed in terms of IFRS.

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
AACSB: Analytic

P1-76 Shortcomings of rules-based approcah

Discuss the shortcomings of the rules-based approach regarding GAAP.

Solution 1-76

In a rules-based approach there is a tendency for companies to interpret the rules literally and many
companies take the view that, if there is no rule for a particular situation, they are free to choose whatever
treatment they think is appropriate (within reason). Similarly, many believe that as long as they comply
with a rule, even in a narrow sense, they are in accordance with GAAP. Consequently, the rules-based
approach does not always emphasize the importance of communicating the best information for users.
Just because a practice is defensible does not mean it provides the best information. This particular issue
is a significant one for the United States as it continues to debate whether to adopt IFRS which is
principles-based rather than rules-based.

Difficulty: Easy
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
AACSB: Analytic

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Test Bank for Intermediate Accounting, Twelfth Canadian Edition

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