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Financial

Reporting
and
Accounting
Standards

CHAPTER 1

Financial Statements and Financial Reporting


Essential characteristics of accounting are:
(1)

the identification, measurement, and communication


of financial information about

(2)

economic entities to

(3)

interested parties.

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Financial Statements and Financial Reporting


Identification

To identify economic events, a company selects the economic events


that can be expressed in financial terms and relevant to its business.

An economic event is any event that directly affects the financial


position of the company.

Financial position comprises assets, liabilities, and owners equity.

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Financial Statements and Financial Reporting


Measurement

It means quantification (include estimates) of business transactions into


financial terms by using monetary unit, i.e. Euro, Dollar, as a measuring
unit.

If an event cannot be quantified in monetary terms, it is not considered


for recording in financial accounts.

That is why important items like the appointment of a new managing


director, signing of contracts or changes in personnel are not shown in
the books of accounts.

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Financial Statements and Financial Reporting


Communication

Financial statements are the principal means through which financial


information is communicated to those outside an enterprise.

The financial statements most frequently provided are:


1)
2)
3)
4)

Statement of financial position,


The income statement or statement of comprehensive income,
The statement of cash flows, and
The statement of changes in equity

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Financial Statements and Financial Reporting


Economic Entity

Under the economic entity assumption, an economic activity can be


identified to a separate entity accountable for that activity.

In other words, this assumption states that businesses must keep their
transactions separate from their owners, business units or other
businesses transactions.

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Financial Statements and Financial Reporting


Interested parties

In general, all parties interested in all the financial health of a


company are called stakeholders.

Stakeholder users of accounting information are normally divided


into two major classifications:

Internal users, who make decisions directly affecting the


internal operations of the enterprise.

External users, who make


relationship to the enterprise.

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decisions

concerning

their

Financial Statements and Financial Reporting


Interested
parties

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Economic Entity

Financial Statements

Additional Information

Financial
Information

Statement
Statement of
of
Financial
Financial Position
Position

Presidents
Presidents letter
letter

Accounting?

Income
Income Statement
or
or Statement
Statement of
of
Comprehensive
Comprehensive
Income
Income

Reports
Reports filed
filed with
with
governmental
governmental
agencies
agencies

Statement
Statement of
of Cash
Cash
Flows
Flows

Forecasts
Forecasts

Identify
and
Measure
and
Communicate

Statement
Statement of
of
Changes
Changes in
in Equity
Note
Note Disclosures
Disclosures

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Prospectuses
Prospectuses

News
News releases
releases
Environmental
Environmental
impact
impact statements
statements
Etc.
Etc.

Accounting and Capital Allocation


Resources are limited. Efficient use of resources often
determines whether a business thrives.

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Objective: 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.


Those decisions involve buying, selling, or holding equity and debt
instruments, and providing or settling loans and other forms of credit.

OBJECTIVE OF FINANCIAL ACCOUNTING

General-Purpose Financial Statements

Provide financial reporting information to a wide variety


of users.

Provide the most useful information possible at


least cost the most useful information possible.

Equity Investors and Creditors

Investors and creditors are the primary user group.

OBJECTIVE OF FINANCIAL ACCOUNTING

the

Equity Investors and Creditors

Identifying investors and creditors as the primary user group


because they have the most critical and immediate need for
information in financial reports.

Investors and creditors need this financial information to assess an


entitys ability to generate net cash inflows and to understand
managements ability to protect and enhance the assets of the
company, which will be used to generate future net cash inflows.

OBJECTIVE OF FINANCIAL ACCOUNTING

Entity Perspective

Under the entity perspective, the entity is assumed to have


substance of its own, separate and distinct from that of its owners.

Economic resources provided by capital providers (including equity


capital) become resources of the entity and cease to be resources
of the capital providers.

In exchange for the resources provided, capital providers,


including equity capital providers, are granted claims to the
economic resources of the reporting entity.

OBJECTIVE OF FINANCIAL ACCOUNTING

Entity Perspective
Therefore, financial reporting from the perspective of the entity
involves reporting on the economic resources of that entity and the
claims to those resources held by its capital providers.

OBJECTIVE OF FINANCIAL ACCOUNTING

Decision-Usefulness
Investors are interested in assessing
1. the companys ability to generate net cash inflows and
2. managements ability to protect and enhance the capital
providers investments.
Financial reporting should therefore 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.

OBJECTIVE OF FINANCIAL ACCOUNTING

Decision-Usefulness
The emphasis on assessing cash flow prospects does not
mean that the cash basis is preferred over the accrual basis of
accounting.
Information based on accrual accounting generally better
indicates a companys present and continuing ability to generate
favorable cash flows than does information limited to the
financial effects of cash receipts and payments.

OBJECTIVE OF FINANCIAL ACCOUNTING

International Accounting Standards Board (IASB)


Financial Accounting Standards Board (FASB)

STANDARD-SETTING ORGANIZATIONS

International Accounting Standard Board (IASB)

The International Accounting Standards Board (IASB) was established on


April 01, 2001 to replace the International Accounting Standards Committee
(IASC).

The IASB is head-quartered in London, England and is an independent and


privately-funded accounting standard-setter.

Its mission is to develop, in public interest, a single set of high-quality and


understandable IFRS for general-purpose financial statements.

STANDARD-SETTING ORGANIZATIONS

International Accounting Standard Board (IASB)


Issues International Financial Reporting Standards (IFRS).
Standards used on most foreign exchanges.
IFRS used in over 115 countries.

STANDARD-SETTING ORGANIZATIONS

International Accounting Standard Board (IASB)


In establishing financial accounting standards, the IASB has a thorough,
open, and transparent due process.
The IASB due process has the following elements:
1.

Independent standard-setting board (Full-time members sever


employment relationships);

2.

Thorough and systematic process for developing standards;

3.

Engagement with investors, regulators, business leaders, and the


global accountancy profession at every stage of the process; and

4.

Collaborative efforts with the worldwide standard-setting community


(e.g FASB).

STANDARD-SETTING ORGANIZATIONS

STANDARD-SETTING ORGANIZATIONS

ILLUSTRATION 1-5
International
Standard-Setting
Structure

Issued by the IASB:


International Financial Reporting Standards.
Framework for financial reporting.
International financial reporting interpretations.

TYPES OF PRONOUNCEMENTS

Types
Types of
of Pronouncements
Pronouncements
International Financial Reporting Standards

The accounting standards produce by the IASB are referred to as


International Financial Reporting Standards (IFRS) and International
Accounting Standards (IAS).

The difference between these two sets of standards is merely one of timing;
the IASB standards issued before 2001 are called IAS (issued by
International Accounting Standards Committee IASC was the
predecessor of IASB) and those issued since 2001 are called IFRS (issued
by International Accounting Standards Board - IASB).

TYPES OF PRONOUNCEMENTS

TYPES OF PRONOUNCEMENTS

International financial reporting interpretations


Are considered authoritative and must be
followed.
Cover newly identified financial reporting issues
not specifically addressed by the IASB.
Cover issues where unsatisfactory or conflicting
interpretations have developed.

TYPES OF PRONOUNCEMENTS

Companies first look to:


1. International Financial Reporting Standards, International
Accounting Standards (issued by the predecessor to the
IASB), and IFRS interpretations originated by the IFRS
Interpretations Committee (and its predecessor, the IAS
Interpretations Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a
similar conceptual framework (e.g., U.S. GAAP).

HIERARCHY OF IFRS

Financial Accounting Standards Board (FASB)


The FASB was organized in 1973 and is currently recognized
as the private-sector body responsible for the establishment
of U.S. accounting standards.
Issues generally accepted accounting principles (GAAP) .
Required for all U.S.-based companies.

STANDARD-SETTING ORGANIZATIONS

Generally accepted accounting principles (GAAP) for U.S.


companies are developed by the Financial Accounting Standards
Board (FASB). The FASB is a private organization.
The U.S. Securities and Exchange Commission (SEC) exercises
oversight over the actions of the FASB.
The IASB is also a private organization. Oversight over the actions
of the IASB is regulated by International Organization of Securities
Commissions (IOSCO).

STANDARD-SETTING ORGANIZATIONS

High Quality Standards


Globalization demands a single set of high-quality
international accounting standards. Some elements:
1. Single set of high-quality accounting standards established by
a single standard-setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants.

FINANCIAL REPORTING CHALLENGES

Both the IASB and the FASB are hard at work developing
standards that will lead to the elimination of major differences in the
way certain transactions are accounted for and reported.

Much has happened in a very short period of time in the


international accounting environment. It now appears likely that in a
fairly short period of time, companies around the world will be close
to using a single set of high-quality accounting standards.

On the Horizon

International Convergence
Examples of how convergence is occurring:
1. Chinas goal is to eliminate differences between its standards and
IFRS.
2. Japan now permits the use of IFRS for domestic companies.
3. The IASB and the FASB have spent the last 12 years working to
converge their standards.

FINANCIAL REPORTING CHALLENGES

IFRS in a Political Environment


The political environment includes all laws, government agencies, and lobbying groups that
influence or restrict IASB in the society.

FINANCIAL REPORTING CHALLENGES

IFRS in a Political Environment


These user groups often target the IASB, to pressure it to influence
changes in the existing rules and the development of new ones so
as to get what they want.

FINANCIAL REPORTING CHALLENGES

The Expectations Gap


What the public thinks accountants should do vs. what
accountants think they can do.
Due to the size and the number of accounting scandals at
companies like Enron, WorldCom, Standard Chartered Bank,
some question whether the accounting profession is doing
enough.

FINANCIAL REPORTING CHALLENGES

Significant Financial Reporting Issues


Non-financial measurements
Financial reports failed to provide some key performance measures
widely used by management, such as customer satisfaction,
backlog information, and reject rates on goods purchased.

FINANCIAL REPORTING CHALLENGES

Significant Financial Reporting Issues


Forward-looking information

Forward-looking
information
includes
the
information concerning possible or assumed
future results of operations of the Company.

These statements represent the Companys


expectations, estimates and projections regarding
future events and are not historical facts.

Forward-looking information is not a guarantee of future performance and


involves risks and uncertainties that are difficult to predict.

Financial reports failed to provide forward-looking information needed by present


and potential investors and creditors.

FINANCIAL REPORTING CHALLENGES

Significant Financial Reporting Issues


Soft assets
Financial reports focused on hard assets (inventory, plant assets)
but failed to provide much information about a companys soft
assets (intangibles).
The best assets are often intangible. Consider Microsofts (USA)
know-how and market dominance, Sonys (JPN) or Samsung
expertise in electronics.

FINANCIAL REPORTING CHALLENGES

Significant Financial Reporting Issues


Timeliness

Timeliness means having information available to decision-makers in time


to be capable of influencing their decisions.

Generally, the older the information is, the less useful it is (e.g. fair value
measures for property, plant, and equipment

Therefore, financial reports should be published as soon as possible after


the end of the accounting period.

The usefulness of financial statements is impaired if they are not made


available to users within a reasonable period after the reporting date.

FINANCIAL REPORTING CHALLENGES

Significant Financial Reporting Issues


Trade-Off Between Timeliness and Accuracy
The information also becomes less relevant over time. The
balance between using current but inaccurate information or
accurate but outdated information we call the accuracy-timeliness
tradeoff.
The main reason is that improving timeliness forces the producer
to compile the financial reports from incomplete source data.

FINANCIAL REPORTING CHALLENGES

Ethics in the Environment of Financial Accounting


Ethics is the practice of behavior that does not allow for
intentionally inaccurate or false accounting practices.
This pertains not only to following the law, but also to interpreting
financial data as clearly and honestly as possible in all situations.

FINANCIAL REPORTING CHALLENGES

Ethics in the Environment of Financial Accounting

Companies that concentrate on maximizing the bottom line, facing the


challenges of competition, and stressing short-term results place
accountants in an environment of conflict and pressure.

IFRS do not always provide an answer.

Technical competence is not enough when encountering ethical decisions.

FINANCIAL REPORTING CHALLENGES