CHAPTER 1

Financial Reporting and Accounting

Standards
LEARNING OBJECTIVES
1. Describe the growing importance of global financial markets and its relation to
financial reporting.
2. Identify the major financial statements and other means of financial reporting.
3. Explain how accounting assists in the efficient use of scarce resources.
4. Explain the need for high-quality standards.
5. Identify the objective of financial reporting.
6. Identify the major policy-setting bodies and their role in the standard-setting
process.
7. Explain the meaning of IFRS.
8. Describe the challenges facing financial reporting.

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CHAPTER REVIEW
1. Chapter 1 describes the environment that has influenced both the development and use
of the financial accounting process. The chapter traces the development of financial
accounting standards, focusing on the groups that have had or currently have the
responsibility for developing such standards. Certain groups other than those with direct
responsibility for developing financial accounting standards have significantly influenced the
standard-setting process. These various pressure groups are also discussed in Chapter 1.

Global Markets

2. (L.O. 1) World markets are becoming increasingly intertwined. And, due to technological
advances and less onerous regulatory requirements, investors are able to engage in
financial transactions across national borders, and to make investment, capital allocation,
and financing decisions involving many foreign companies. As a result, an increasing
number of investors are holding securities of foreign companies, and a significant number
of foreign companies are found on national exchanges. The move toward adoption of
international financial reporting standards has and will continue to facilitate this movement.

3. (L.O. 2) Financial accounting is the process that culminates in the preparation of

financial reports on the enterprise for use by both internal and external parties.

4. Financial statements are the principal means through which a company communicates
its financial information to those outside it. The financial statements most frequently
provided are (1) the statement of financial position, (2) the income statement or statement
of comprehensive income, (3) the statement of cash flows, and (4) the statement of
changes in equity. Note disclosures are an integral part of each financial statement. Other
means of financial reporting include the president’s letter or supplementary schedules in
the corporate annual report, prospectuses, and reports filed with government agencies.

5. (L.O. 3) Accounting is important for markets, free enterprise, and competition because it
assists in providing information that leads to capital allocation. Reliable information leads
to a better, more effective process of capital allocation, which in turn is critical to a
healthier economy.

6. (L.O. 4) To facilitate efficient capital allocation, investors need relevant information and a
faithful representation of that information to enable them to make comparisons across
borders. A single, widely accepted set of high-quality accounting standards is a necessity
to ensure adequate comparability. In order to achieve this goal the following element
must be present:

a. A single set of high-quality accounting standards established by a single standard-

setting body.

b. Consistency in application and interpretation.

c. Common disclosures.

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 d. Common high-quality auditing standards and practices.

e. A common approach to regulatory review and enforcement.

f. Education and training of market participants.

g. Common delivery systems (e.g., eXtensible Business Reporting Language—XBRL).

h. A common approach to corporate governance and legal frameworks around the world.

7. The major standard-setters of the world, coupled with regulatory authorities, now
recognize that capital formation and investor understanding is enhanced if a single set of
high-quality accounting standards is developed.

Objective of Financial Reporting

8. (L.O. 5) The objective of general-purpose financial reporting is to provide financial

information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing resources to
the entity.

a. General-purpose financial statements provide at the least cost the most useful
information possible to a wide variety of users.

b. Equity investors and creditors are the primary user groups and have the most
critical and immediate needs for information in the financial statements. Investors and
creditors need this information to assess a company’s ability to generate net cash
inflows and to understand management’s ability to protect and enhance the assets of
a company.

c. The entity perspective means that the company is viewed as being separate and
distinct from its investors (both shareholders and creditors). Therefore, the assets of
the company belong to the company, not a specific creditor or shareholder. Financial
reporting focused only on the needs of the shareholder—the proprietary perspective
—is not considered appropriate.

d. Decision-usefulness means that information contained in the financial statements

should help investors assess the amounts, timing, and uncertainty of prospective cash
inflows from dividends or interest, and the proceeds from the sale, redemption, or
maturity of securities or loans. In order for investors to make these assessments, the
financial statements and related explanations must provide information about the
company’s economic resources, the claims to those resources, and the changes in
them.

9. Information generated using the accrual basis of accounting provides a better indication
of a company’s present and continuing ability to generate favorable cash flows than the
cash basis.

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Standard-Setting Organizations

10. (L.O. 6) The main international standard setting organization is the International
Accounting Standards Board (IASB), based in London, United Kingdom. The IASB
issues International Financial Reporting Standards (IFRS) which are used by most
foreign exchanges.

11. The two organizations that have a role in international standard-setting are the
International Organization of Securities Commissions (IOSCO) and the IASB. (A
detailed discussion of the U.S system is provided at the book’s companion website)

a. The IOSCO does not set accounting standards; it is dedicated to ensuring that the
global markets can operate in an efficient and effective basis.
b. The member agencies have agreed to:
(1) Cooperate together to promote high standards of regulation in order to maintain
just, efficient, and sound markets.
(2) Exchange information on their respective experiences in order to promote the
development of domestic markets.
(3) Unite their efforts to establish standards and an effective surveillance of
international securities transactions.
(4) Provide mutual assistance to promote the integrity of the markets by a rigorous
application of the standards and by effective enforcement against offenses.

12. IOSCO recommends that its members allow multinational issuers to use IFRS in cross-
folder offerings and listings, as supplemented by reconciliation, disclosure, and
interpretation where necessary, to address outstanding substantive issues at a national or
regional level.

13. The international standard-setting structure is composed of the following four

organizations:

a. The IFRS foundation (22 trustees) provides oversight to the IASB, IFRS Advisory
Council, and IFRS Interpretations Committee. It appoints members, reviews
effectiveness, and helps in fundraising efforts for these organizations.

b. The International Accounting Standards Board (IASB) consisting of 13 members,

develops in the public interest, a single set of high-quality, enforceable, and global
international financial reporting standards for general-purpose financial statements.

c. The IFRS Advisory Council (40 or more members) provides advice and council to
the IASB on major policies and technical issues.

d. The IFRS Interpretations Committee (14 members) assists the IASB through the
timely identification, discussion, and resolution of financial reporting issues within the
framework of IFRS.

14. In addition, as part of the governance structure, a Monitoring Board was created. It
establishes a link between accounting standard-setters and those public authorities that
generally oversee them (e.g. IOSCO). It also provides political legitimacy to the overall
organization.

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15. The IASB has a thorough, open and transparent due process in establishing financial
accounting standards. It consists of the following elements:
a. An independent standard-setting board overseen by geographically and professionally
diverse body of trustees.
b. A thorough and systematic process for developing standards.
c. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.
d. Collaborative efforts with the worldwide standard-setting community.
16. To implement its due process, the IASB follows specific steps to develop a typical IFRS.
a. Topics are identified and placed on the Board’s agenda.
b. Research and analysis is conducted and preliminary views of pros and cons are
issued.
c. Public hearings are held on the proposed standard.
d. The Board evaluates research and public responses and issues an exposure draft.
e. The Board evaluates the responses and changes the exposure draft, if necessary.
Then the final standard is issued.
17. The following characteristics of the IASB are meant to reinforce the importance of an
open, transparent, and independent due process.
a. Membership: The Board consists of 13 well-paid members, from different countries,
serving 5-year renewable terms.
b. Autonomy: The IASB is not part of any professional organization. It is appointed by
and answerable only to the IFRS Foundation.
c. Independence: Full-time IASB members must sever all ties with their former
employer. Members are selected for their expertise in standard-setting rather than to
represent a given country.
d. Voting: Nine of 16 votes are needed to issue a new IFRS.
18. The IASB issues three major types of pronouncements.
a. International Financial Reporting Standards: To date the IASB has issued 17
standards. In addition, the previous international standard-setting body, the
International Accounting Standards Committee (IASC) issued 41 International
Accounting Standards (IAS). Those that have not been amended or superseded are
considered under the umbrella of IFRS.

b. Conceptual Framework for Financial Reporting: The IASB issued the Framework

for the Preparation and Presentation of Financial Statements (referred to as the
Framework) with the intent to create a conceptual framework that would serve as a

Copyright © 2018 John Wiley & Sons, Inc.   Kieso Intermediate: IFRS 3e, Instructor’s Manual 1-5
 tool for solving existing and emerging problems in a consistent manner. However, the
Framework is not an IFRS and does not define standards for any particular
measurement or disclosure issue. Nothing in the Framework overrides any specific
IFRS.
c. International Financial Reporting Interpretations: Interpretations are issued by the
IFRS Interpretations Committee and are considered authoritative and must be
followed. Over twenty have been issued to date. These interpretations cover (1) newly
identified financial reporting issues not specifically dealt with in IFRS, and (2) issues
where unsatisfactory or conflicting interpretations have developed, or seem likely to
develop, in the absence of authoritative guidance.

19. (L.O. 7) The IASB has no regulatory mandate and no enforcement mechanism. It relies
on other regulators to enforce the use of its standards. For example, the European Union
requires publicly traded member country companies to use IFRS. Any company indicating
that it prepares its financial statements in conformity with IFRS must use all of the
standards and interpretations. The hierarchy of authoritative pronouncements is: IFRS, IAS,
Interpretations issued by either the IFRS Interpretation Committee or its predecessor the
IAS Interpretations Committee, the Conceptual Framework for Financial Reporting, and
pronouncements of other standard-setting bodies that use a similar conceptual framework
to develop accounting standards (e.g., U.S. GAAP).

Financial Reporting Challenges

20. (L.O. 8) Although IFRS are developed by using sound research and a conceptual
framework that has its foundation in economic reality, a certain amount of pressure and
influence is brought to bear by groups interested in or affected by IFRS. The IASB does
not exist in a vacuum, and politics and special-interest pressure remain a part of the
standard-setting process.

21 The expectations gap is the difference between what the public thinks accountants
should do and what accountants think they can do. It has been highlighted by the many
accounting scandals that have occurred. In order to meet the needs of society with highly
transparent, clean, and reliable systems, considerable costs will be incurred.

22. The significant financial reporting challenges facing the accounting profession are:

a. Non-financial measurements such as customer satisfaction indexes, backlog infor-

mation, and reject rates on goods purchased.

b. Forward-looking information.

c. Soft assets (intangibles).

d. Timeliness.

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23. In accounting, ethical dilemmas are encountered frequently. The whole process of ethical
sensitivity and selection among alternatives can be complicated by pressures that may
take the form of time pressure, job pressures, client pressures, personal pressures, and
peer pressures. And, there is no comprehensive ethical system to provide guidelines.

24. Convergence to a single set of high-quality global financial reporting standards is a real
possibility. For example, the IASB and the FASB (of the United States) have spent the
last 16 years working to converge their standards.

25. In addition, U.S. and European regulators have agreed to recognize each other’s standards
for listing on the various world securities exchanges. As a result, costly reconciliation re-
quirements have been eliminated and hopefully will lead to greater comparability and
transparency.

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LECTURE OUTLINE
The material in this chapter usually can be covered in one on two class sessions, depending
on whether the chapter appendix is discussed.

A. (L.O. 1) Global Markets and IFRS.

1. World markets are becoming more intertwined.

2. An increasing number of investors are holding securities in foreign companies.

3. An increasing number of foreign companies are found on national exchanges.

4. Companies have expanded choices of where to raise capital through debt or equity.

5. The move toward adoption of international financial reporting standards has and will
continue to facilitate this movement.

B. (L.O. 2) What are the major financial statements and other means of financial reporting?

Identification, measurement, and communication of financial information (discuss

difference between financial statements and financial reporting).

a. Financial statements:

(1) Income statement or statement of comprehensive income.

(2) Statement of financial position.

(3) Statement of cash flows.

(4) Statement of changes in equity.

(5) Note disclosures.

b. Financial reporting:
(1) President’s letter or supplementary schedules in the annual report.
(2) Prospectuses.

(3) Reports filed with government agencies.

(4) News releases and management forecasts.

(5) Social or environmental impact statements.

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C. (L.O. 3) How does accounting assist in the allocation of scarce resource?
1. A world of scarce resources. Accounting helps to identify efficient and inefficient users
of resources.

2. Capital allocation. Accounting assists in the effective capital allocation process by

providing financial reports to interested users.

3. Changing user needs. Accounting will continue to be faced with challenges to providing
information needed for an efficient capital allocation process.

D. (L.O. 4) Why the need for high-quality standards?

1. To facilitate efficient capital allocation.

2. In order to ensure adequate comparability across borders, a single, widely accepted

set of high-quality accounting standards is a necessity.

3. Identify the elements involved:

a. A single set of high-quality accounting standards established by a single standard-

setting body.

b. Consistency in application and interpretation.

c. Common disclosures.

d. Common high-quality auditing standards and practices.

e. Common approach to regulatory review and enforcement.

f. Education and training of market participants.

g. Common delivery systems.

h. Common approach to corporate governance and legal frameworks around the world.

4. Major standard-setters and regulatory authorities around the world recognize that
capital formation and investor understanding will be enhanced by a single set of high-
quality accounting standards.

E. (L.O. 5) Define the objective of financial reporting.

1. To provide financial information about the reporting entity that is useful to present and
potential equity investors, lenders, and other creditors in making decisions about
providing resources to the entity.

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 2. Describe the elements of the objective:

a. General-Purpose Financial Statements: provide the most useful information

possible to a wide variety of users for the least cost.

b. Equity Investors and Creditors: are the primary user group and have the most
critical and immediate need for information in financial reports, in order to:

(1) Assess an entity’s ability to generate net cash inflows, and

(2) Understand management’s ability to protect and enhance the assets of the
entity.

c. Entity Perspective: companies are viewed as separate and distinct from both
their shareholders and creditors.

(1) The assets of the entity are viewed as belonging to the entity, not any specific
creditor or shareholder.
(2) The proprietary perspective, which focuses solely on the needs of the
shareholders is not appropriate.

e. Decision-Usefulness: information contained in the financial statements should

be useful to investors in order to:

(1) Assess the amounts, timing, and uncertainty of prospective cash inflows from
dividends or interest, and

(2) The proceeds from the sale, redemption, or maturity of securities or loans.

(3) The accrual basis of accounting provides more useful information than the
cash basis.

F. (L.O. 6) Identify the major standard-setting bodies and their roles in the standard-setting
process.

1. International Organization of Securities Commissions (IOSCO):

(a) Does not set accounting standards.

(b) Dedicated to ensuring that global markets operate in an efficient and effective
basis.

(c) Regulates the world’s securities and futures markets.

(d) Supports development and use of IFRS as a set of high-quality international

standards in cross-border offerings and listings.

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2. International standard-setting structure.

a. International Financial Reporting Standards Foundation (IFRS Foundation):

(1) Selects members of the IASB, the IFRS Advisory Council, and the IFRS
Interpretations committee.

(2) Funds their activities.

(3) Oversees their activities.

(4) 22 Trustees

b. International Accounting Standards Board (IASB): Develops a single set of

high quality enforceable, and global IFRS for general-purpose financial
statements.

d. IFRS Advisory Council: Consults with the IASB on major policies and technical
issues.
e. IFRS Interpretations Committee:

(1) Assists the IASB in the timely identification, discussion and resolution of
financial reporting issues within the framework of IFRS.

(2) 14 members.

G. Discuss the elements comprising due process:

1. An independent standard-setting board overseen by a geographically and profession-

ally diverse body of trustees.

2. A thorough and systematic process for developing standards.

3. Engagement with investors, regulators, business leaders, and the global accountancy
profession at every stage of the process.

4. Collaborative efforts with the worldwide standard-setting community.

F. Describe the specific steps the IASB takes to implement due process:

1. Topics identified and placed on the Board’s agenda.

2. Research and analysis conducted and preliminary views of pros and cons issued
(Discussion Papers).

3. Public hearings on proposed standard.

4. Board evaluates research and public response and issues exposure draft.

5. Board evaluates responses and changes exposure draft, if necessary. Final standard
issued. Requires nine of 16 members to vote in favor of the new standard before
issuance.

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G. Discuss the characteristics of the IASB.

1. Membership

2. Autonomy

3. Independence

4. Voting

H. The IFRS issues 3 major types of pronouncements.

1. International Financial Reporting Standards (IFRS) (includes remaining Interna-

tional Accounting Standards (IAS))

2. Conceptual Framework for Financial Reporting

3. International Financial Reporting Standards Interpretations

I. (L.O. 7) IFRS hierarchy.

1. Hierarchy of pronouncements in the following order:

a. IFRS, International Accounting Standards (IAs) that have not been amended a
superseded by the IASB, IFRS Interpretations, and IAS Interpretations.

b. Conceptual Framework for Financial Reporting.

c. Pronouncements of other standard-setting bodies that use a similar conceptual

framework (e.g. U.S. GAAP).

J. (L.O. 8) Describe the challenges facing financial reporting.

1. IFRS in a Political Environment.

a. Describe pressure groups, their composition, and their interests.

b. Discuss the impact of accounting on the interests of each group.

2. The expectations gap: What people think accountants should be doing versus what
accountants think they can do.

3. Describe significant financial reporting issues:

a. Non-financial measurements

b. Forward-looking information

c. Soft assets

d. Timeliness

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 4. Discuss the steps to take in solving an ethical dilemma.

a. Recognize an ethical dilemma exists.

b. Identify and analyze the elements of the dilemma.

c. Identify and analyze the alternatives available.

d. Select the best or most ethical alternative.

5. Discuss some of the steps taken to date that demonstrate how international
convergence is occurring.

K. Global Accounting Insights

1. Why a single set of international accounting standards is needed.

a. Multinational corporations

b. Mergers and acquisitions

c. Information technology

d. Financial markets

2. U. S. GAAP versus IFRS

a. Similarities

b. Differences

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