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Republic of the Philippines

PALAWAN STATE UNIVERSITY
College of Business and Accountancy
Puerto Princesa City

FINANCIAL ANALYSIS AND REPORTING

CHAPTER 3: FINANCIAL REPORTING STANDARDS

THE OBJECTIVE OF FINANCIAL STANDARDS

The following are all qualitative characteristics of financial statements:

 Understandability
 Relevance
 Reliability
 Comparability
 Timeliness

Understandability
 The information must be readily understandable to users of the financial statements.
 This means that information must be clearly presented, with additional information supplied
in the supporting footnotes as needed to assist in clarification.

Relevance.
 The information must be relevant to the needs of the users, which is the case when the
information influences the economic decisions of users.
 This may involve reporting particularly relevant information, or information whose
omission or misstatement could influence the economic decisions of users.

Reliability.
 The information must be free of material error and bias, and not misleading.
 Thus, the information should faithfully represent transactions and other events, reflect the
underlying substance of events, and prudently represent estimates and uncertainties through
proper disclosure.

Comparability.
 The information must be comparable to the financial information presented for other
accounting periods, so that users can identify trends in the performance and financial
position of the reporting entity.

Timeliness
 All the information in the financial statements must be provided within a relevant span of
time.
 The disclosures must not be excessively late or delayed so that while making their economic
decisions the users of these statements posses all the relevant and up-to-date knowledge.
 Although this characteristic may take more resources but still it is a vital characteristic as
delayed information makes any corrective reactions irrelevant.

Objectives of Financial Reporting

 According to International Accounting Standard Board (IASB), the objective of financial

reporting is “to provide information about the financial position, performance and changes

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in financial position of an enterprise that is useful to a wide range of users in making
economic decisions.”

The following points sum up the objectives & purposes of financial reporting.

 Providing information to the management of an organization which is used for the purpose
of planning, analysis, benchmarking and decision making.

 Providing information to investors, promoters, debt provider and creditors which is used to
enable them to male rational and prudent decisions regarding investment, credit etc.

 Providing information to shareholders & public at large in case of listed companies about
various aspects of an organization.

 Providing information about the economic resources of an organization, claims to those

resources (liabilities & owner’s equity) and how these resources and claims have undergone
change over a period of time.

 Providing information as to how an organization is procuring & using various resources.

 Providing information to various stakeholders regarding performance management of an

organization as to how diligently & ethically they are discharging their fiduciary duties &
responsibilities.

 Providing information to the statutory auditors which in turn facilitates audit.

 Enhancing social welfare by looking into the interest of employees, trade union &
Government.

2.FINANCIAL REPOTING STANDARD-SETTING BODIES AND REGULATORY

AUTHORITIES

 Private sector standard - setting bodies and regulatory authorities plays significant but
different roles in standard - setting process.

 In general, standard - setting bodies nakes rules and regulatory authorities enforce the
rules.

 However, regulators typically retain legal authority to establish financial reporting standards
in their jurisdiction.

2.1 FINANCIAL ACCOUNTING STANDARDS BOARD

 FASB is non-governmental body that sets accounting standards for all companies issuing
audited financial statements.

2.2. INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)

 This is essentially the international equivalent of the FINANCIAL ACCOUNTING

STANDARDS BOARD (FASB).

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 It was preceded by INTERNATIONAL ACCOUNTING STANDARD COMMITTEE
(IASC), which was established in 1973.

 It is comprised of 14 members (12 full-time, 2 part-time)

 since the establishment of the IASB, the focus is on global standard setting.

INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (IOSCO)

 This is essentially the international equivalent of the U.S. SECURITIES AND EXCHANGE
COMMISSION (SEC).

 it works to achieve improved market regulation internationally.

 it works to facilitate cross-border listing.

 it advocates for the development and adoption of a single set for high-quality accounting
standards.

U.S. SECURITIES AND EXCHANGE COMMISSION (SEC)

 In the U.S., the form and content of the financial statements of companies whose securities
are publicity trade are governed by the Sec through it regulation.

 Although the SEC has delegated much of this responsibility to the FASB, it frequently adds
its own requirements.

3.CONVERGENCE OF GLOBAL FINANCIAL REPORTING STANDARDS

 IFRS in the process of being adopted in many cuntries.

 Other countries, U.S. being the major one, are maintaining their own standards but are
working with the IASB (International Accounting Standards Board) to coverge their
standars and IFRS.
 However, there are syill challenges in full covergence (adoption of a single set of global
standards).

THE MAIN CHALLEGES ARE AS FOLLOWS:

 Standards setting bodies are regulators can have different views.

 Resistance to change from industry lobbying groups.
 For convergence to be meaningful, standards need to applied consistently and tehre needs to
be effective enforecement. Otherwise, a single set of standards may only appear to exist and
desirable atrritutes such as comparability may be lacking.

4.THE INTERNATIONAL FINANCIAL REPORTING STANDARDS FRAMEWORK.

 International Financial Reporting Standards, usually called IFRS,[1] are standards issued by
the IFRS Foundation and the International Accounting Standards Board (IASB) to provide a
common global language for business affairs so that company accounts are understandable
and comparable across international boundaries.
 They are a consequence of growing international shareholding and trade and are particularly
important for companies that have dealings in several countries.
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 They are progressively replacing the many different national accounting standards.
 They are the rules to be followed by accountants to maintain books of accounts which are
comparable, understandable, reliable and relevant as per the users internal or external.

4.1 Objectives of Financial statement

 The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range
of users in making economic decisions."

Financial statements should be understandable, relevant, reliable and comparable.

 Providing information for economic decision

 Providing information about financial position

 Providing information about performance of enterprise

 Providing information about changes in financial position

4.2 Qualitative characteristics of financial statements

 Understandability

 Relevance

 Reliability

 Comparability

Understandability
 The information must be readily understandable to users of the financial statements.
 This means that information must be clearly presented, with additional information supplied
in the supporting footnotes as needed to assist in clarification.

Relevance
 The information must be relevant to the needs of the users, which is the case when the
information influences the economic decisions of users.
 This may involve reporting particularly relevant information, or information whose
omission or misstatement could influence the economic decisions of users.

Reliability
 The information must be free of material error and bias, and not misleading.
 Thus, the information should faithfully represent transactions and other events, reflect the
underlying substance of events, and prudently represent estimates and uncertainties through
proper disclosure.

Comparability
 The information must be comparable to the financial information presented for other
accounting periods, so that users can identify trends in the performance and financial
position of the reporting entity.

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4.3 Constraints of Financial Statement

 Constraints accounting (CA) allow some variations generally accepted accounting

principles(GAAP) when reporting financial statements of company and these variations do
not violate the GAAP in light of recognised CA.

 [1] CA contains explicit consideration of the role of constraints in accounting and

constraints relate to limitations when providing financial information.

 [2] The definition of a constraint is a regulation which belongs to prescribed bounds

 [3] and there are four main types of constraints which are the cost-benefit relationship,
materiality, industry practices, and conservatism,[4] and these constraints are also
accounting guidelines which border the hierarchy of qualitative information.

Constraint#1. Estimates and Judgments

 Certain measurements cannot be performed completely accurately, and must therefore

utilize conservative estimates and judgments.
 For example, a company cannot fully predict the amount of money it will not collect from
its customers, who having purchased goods from it on credit, ultimately decide not to pay.
 Instead, a company must make a conservative estimate based on its past experience with
bad customers.

Constraint#2. Materiality

 Inclusion and disclosure of financial transactions in financial statements hinge on their size
and effect on the company performing them.
 Note that materiality varies across different entities; a material transaction (taking out a
$1,000 loan) for a local lemonade stand is likely immaterial for General Electric, whose
financial information is reported in billions of dollars.

Constraint#3. Consistency

 For each company, the preparation of financial statements must utilize measurement
techniques and assumptions that are consistent from one period to another.

 Keep in mind that, companies can choose among several different accounting methods to
measure the monetary value of their inventories. What matters is that a company
consistently applies the same inventory method across different fiscal years.

Constraint#4. Conservatism

 Financial statements should be prepared with a downward measurement bias.

 Assets and revenues should not be overstated, while liabilities and expenses should not be
understated.

4.4 Elements of Financial statement

ASSETS

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 Assets are the property or legal rights owned by a business to which money value can be
attached.
 In other words, it is an item of economic value that is expected to yield a benefit in the
future.
 Assets can be classified into.
i. Tangible Assets
 Tangible Assets are those assets which have physical existence i.e. they can be seen and
touched.
 Examples of tangible assets are machinery, furniture, building, etc.
ii. Intangible Assets
 Intangible assets are those assets which do not have physical existence i.e. they cannot be
touched and seen. Examples of intangible assets are goodwill, patents, trademarks, etc.
iii. Fixed Assets Fixed Assets
 are those assets which are put to use for more than one accounting period and its benefit is
derived over a longer period.
 For example, computer, machinery, land, etc.
iv. Current assets
 Current assets are the assets which are readily convertible into cash and generally absorbed
within one accounting period.
 For example, debtors exist to convert them into cash, bills receivable, etc.

LIABILITIES
 According to IFRS Framework, “A liability is a present obligation of the enterprise arising
from past events, the settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits”.
 In other words, liability is the amount owed by the business to the proprietor and to the
outsiders.
 Liabilities are generally categorised into 2 broad categories i.e. Current Liabilities and Non
Current Liabilities.
i. Current Liabilities
 It refers to those obligations or payments which are repayable during the current financial
year.
 Examples of current liabilities are Creditors, bills payable.
ii. Non Current Liabilities
 It comprises of those payments which are due for payment over a long period of time and
there is no need to discharge it immediately.
 For example Debentures, long term loans, etc.

EQUITY
 Equity represents ownership interest in a firm in the form of stock.
 Being precise in the accounting terms, it is the difference between value of assets and cost
of liabilities of something owned.
 It is mainly a residual amount adjusted by the assets against liabilities.

INVESTMENT BY OWNERS
 It depicts an increase in equity resulting from transfer of resources in exchange of an
ownership interest .
 It basically describes any owner’s contribution to the firm.
 Issue of ownership shares of stock by a company in exchange for cash represents an
investment by owners.

DISTRIBUTION TO OWNERS
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 It represents a decrease in equity which results from transfer to owners.
 It determines the owners’ withdrawal from ownership interest of the firm.
 A cash dividend paid by a corporation to its shareholders is an example of distribution to
owners.

REVENUE
 Revenue is the income that a business earns from its normal business activities.
 It is an inflow of assets, which result in an increase in owner’s equity.
 Exchange of goods and services for money consideration is an example of revenue.

GAINS
 Gain is an increase in owner’s equity from peripheral transactions which are irregular and
non recurrent in nature.
 For example, Sale of machinery for an amount greater than its book value (original cost less
depreciation) would result in a gain for an enterprise which is engaged in the business other
than that of sale and purchase of machinery.

EXPENSES
 Are the gross outflows incurred by the business enterprise for generating revenues.
 An expense is charged to Profit and Loss Account.

LOSSES
 Loss is a decrease in owner’s equity from peripherals transactions which are irregular and
non recurrent in nature.
 For example, Sale of machinery for an amount lesser than its book value (original cost less
depreciation) would result in a gain for an enterprise which is engaged in the business other
than that of sale and purchase of machinery.

COMPREHENSIVE INCOME
 Comprehensive income is the change in equity of a business enterprise from transactions
from non-owner sources.
 It includes all changes in equity of an enterprise other than those resulting from investments
by owners and distributions to owners.

4.5GENERAL FEQUIREMENTS FOR FINANCIAL STATEMENTS

IAS No. 1 stipulates that a complete set of financial statements should include:
 A statement of financial position (balance sheet);
 A statement of comprehensive income;
 A statement of changes in equity;
 A statement of cash flows; and
 Notes comprising a summary of the significant accounting policies and other explanatory
notes which disclose information required by IFRS and information which will help with
understanding the financial statements. A company which applies IFRS must explicitly state
in these notes that it is in compliance with the standards.

IAS No. 1 also specifies several general features which should underlie the preparation of
financial statements. These features include:
 Fair Presentation: As described by the IAS, “fair presentation requires the faithful
representation of the effects of transactions, other events, and conditions in accordance with

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the definitions and recognition criteria for assets, liabilities, income, and expenses set out in
the Framework.”
 Going concern: A company’s financial statements should be prepared on a going concern
basis unless the company’s management intends to liquidate the company, cease trading, or
has no realistic alternative but to do so.
 Accrual basis: Accrual accounting should be used when preparing financial statements,
except where cash flow information is involved.
 Materiality and Aggregation: Material items are items which can influence the economic
decision-making of users of financial statements. Material classes of similar items are
presented separately, while dissimilar items are presented separately unless they are
immaterial.
 No offsetting: Unless required or permitted by IFRS, assets, liabilities, income and
expenses are not offset.
 Frequency of Reporting: Preparation of a company’s financial statements is required at
least annually.
 Comparative Information: Comparative information from prior periods should be
disclosed for all reported amounts on the financial statements unless IFRS requires or
permits otherwise.
 Consistency: The classification and presentation of items in the financial statements should
remain the same from one period to another.

5. EFFECTIVE FINANCIAL REPORTING

Characteristics of an Effective Financial Reporting Framework and the Barriers:

Transparent
 The framework should increase the transparency of the financial aspects of a business,
i.e., the users of the financial statements should be able to get a clear understanding of the
underlying economics by reading the financial statements.

Comprehensive
 The framework should be comprehensive, i.e., it should be able to capture all kinds of
transactions having financial consequences.

Consistent
 The framework should be able to bring consistency in financial reporting across companies
and time periods.
 This means that all companies in different time periods should measure and present
transactions in a similar manner.