CFA® Level I - Financial Reporting and Analysis

Financial Reporting Standards

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 Contents
1. Introduction
2. Objective of Financial Reporting
3. Standard-Setting Bodies and Regulatory Authorities
4. Convergence of Global Financial Reporting Standards
5. The International Financial Reporting Standards Framework
6. Effective Financial Reporting
7. Comparison of IFRS with Alternative Reporting Systems
8. Monitoring Developments in Financial Reporting Standards

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 1. Introduction

• Financial reporting standards provide principles for preparing

financial reports and determine the types and amounts of
information that must be provided.

• There are several standards but the two major ones are IFRS and
U.S. GAAP.

• This reading focuses on the framework within which these

standards are created.

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 2. Objective of Financial Reporting
The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to existing and potential
investors, lenders and other creditors in making decisions about providing
resources to the entity.
-- IASB’s Conceptual Framework 2010

Financial reporting standards facilitate comparison across companies (cross

sectional analysis) and over time (time series analysis) for a single company

Accounting standards must be flexible enough to recognize that differences exist in

the underlying economics between businesses

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 Example
• Consider two companies that buy similar equipment for long term use.
One company expenses and the other capitalizes. What is the challenge
and how do financial reporting standards address such challenges?

• Say one company will make extensive use of the equipment while the
other will not. How do financial reporting standards allow for such a
difference?

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 3. Standard-Setting Bodies and Regulatory Authorities

Standard Setting Bodies Regulatory Authorities

• Private sector, self-regulated
organizations
• Board members are experienced
accountants, auditors, analysts and
academics
• Major ones: FASB and IASB
• Set standards but do not have the
authority to enforce
• Government entities
• Country specific: SEC, FSA
• Authority to enforce financial
reporting requirements
• Can overrule private sector standard
setting bodies and establish standards
in their jurisdiction
• Regulate capital markets in general

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 International Organization of Securities Commissions (IOSCO)

IOSCO is not a regulatory authority but members (such as the SEC) regulate a
significant portion of the world’s financial markets. This organization has
established objectives and principles to guide securities and capital market
regulation.
Core Objectives
• Protect investors
• Ensure fairness, efficiency, transparency
• Reduce systematic risk
Principles
• There should be full, accurate and timely disclosure of financial results and risk
• Financial statements should be of a high and internationally acceptable quality

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 Example
Which of the following is least likely to be required by the SEC for a company which is
filing for registration?
A. Audited financial statements
B. Assessment of risk factors
C. Projected future cash flows

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 4. Convergence of Global Financial Reporting Standards
IFRS have been adopted in many countries. Other countries (U.S. being the major
one) maintain their own standards but are working with IASB on convergence.

Challenges related to a unified set of reporting standards (full convergence) still

remain because:
1. Standard setting bodies and regulators can have different views
2. Resistance to change from industry lobbying groups
3. For convergence to be meaningful standards should be applied consistently
and there needs to be effective enforcement

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5. The International Financial Reporting Standards Framework
Reporting Elements
Qualitative Characteristics

Objective
Provide financial information useful
in making decisions about providing
resources to the entity.
Relevance (materiality) Faithful Representation
Comparability Verifiability
Timeliness Understandability

Performance and Financial Position

Constraint: Cost/Benefit Consideration

Assumptions: Accrual Basis and Going Concern

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 General Requirements for Financial Statements (IASB)

Required Financial Statements General Features

Structure and Fair presentation
Content Balance Sheet Going concern
Classified balance sheet Income Statement Accrual basis
Minimum specified Comprehensive Income Materiality and aggregation
information on face Changes in Equity No offsetting
Minimum specified note Cash Flow Statement Frequency of reporting
disclosures Notes Comparative information
Comparative information Statements from earlier comparative Consistency of presentation
periods

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 Comparison of IFRS and U.S. GAAP
• In Exhibit 4 the curriculum shares the minimum required line items in
financial statements under IFRS
• In Section 5.6 there is a discussion on IFRS and U.S. GAAP convergence
• While there has been progress over the last decade, differences remain
between the two frameworks
• An analyst should be aware of these differences when comparing
financial reports based on the different frameworks
• Exhibit 6 summarizes the differences in December 2004
 Some of these differences no longer apply
 Relevant and current differences will be discussed in the readings

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 6. Effective Financial Reporting
• Characteristics of an effective framework:
 Transparency: reflect underlying economics
 Comprehensiveness: encompass full spectrum of transactions that
have financial consequences
 Consistency: similar transactions should be presented in a similar
manner across companies and time periods
• Difficult to satisfy all three characteristics simultaneously  tradeoffs are
required. At times different frameworks make different tradeoffs. This
becomes a barrier to a single coherent framework.
 Valuation: historical cost versus fair value
 Standard setting approach: principles-based versus rules-based
 Measurement: asset/liability versus revenue/expense approach

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7. Comparison of IFRS with Alternative Reporting Systems

• A significant percentage of listed companies report under IFRS or U.S.

GAAP
• Standards are moving toward convergence, but significant differences
remain
• An analyst must be cautions when comparing financial measures
between companies reporting under IFRS and companies reporting
under U.S. GAAP

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 8. Monitoring Developments in Financial Reporting Standards

• Reporting standards are evolving rapidly

• Analysts need to monitor developments in financial reporting and
assess their implication for security analysis
• A financial analyst can remain aware of developments in financial
reporting standards by monitoring three sources:
New products or transactions
Actions of standard setters and groups representing users of financial
statements
Company’s disclosures regarding critical accounting policies and estimates

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 Summary
• Objective of financial reporting: provide financial information that is useful to
investors in making decisions about providing resources to the entity
• Standard setting authorities, regulator bodies, and IOSCO
• IFRS framework
 Objective, qualitative characteristics, reporting elements, constraints and assumptions
• Effective financial reporting
 Transparency, Comprehensiveness and Consistency
• Barriers to a single coherent framework
 Valuation, standard-setting approach, measurement approach
• Comparison of IFRS and U.S. GAAP
• Monitor developments

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 Conclusion
• Read summary

• Review learning objectives

• Examples

• Practice problems: good but not enough

• Practice questions from other sources

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