Chapter

ChapterX3
Objective of financial statements, stakeholders and other reports
Chapter Title

An
Introduction to
Financial
Accounting
9th edition

Andrew Thomas & Anne Marie Ward

© McGraw-Hill Education 2019

 Objectives
By the end of the lecture (and with private study) students should
be able to:

• Explain the nature, purpose and scope of the conceptual framework of

accounting, including the main contents of the IASB’s Conceptual Framework
(2018)
• Discuss the objectives of general purpose financial statements
• Outline the limitations of general purpose financial statements
• Explain the relevance of the accounting entity concept in financial accounting
• Identify the users of annual reports and describe their information needs
• Explain corporate social responsibility (CSR) and discuss the type of
information included in a CSR report
• Discuss the type of information a company includes under environmental
reporting
• Describe the conceptual framework and standardisation debates and discuss
related issues
• Describe the main©types of accounting
McGraw-Hill Education 2019theory and their implications for a
Conceptual Framework: Definition and
Purpose
Definition
• Describes the objective of, and concepts for, general
purpose financial statements
Purpose
• Practical tool to assist the IASB (International
Accounting Standard Board) when developing that
IFRSs (International Financial Reporting Standards)
are base don consistent concepts
• To help preparers to develop consistent accounting
policies that are not covered by a Standard or where
there is choice in accounting policy.
• To assist all parties to understand and interpret the
Standards.
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 Areas the Conceptual Framework (CF)
addresses (chapters)

1. The objective of financial statements

2. The qualitative characteristics of useful financial
information
3. Financial statements and the reporting entity
4. The elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance

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 Objectives of general purpose financial
reporting

• A key function of financial accounting is

Financial Reporting

• Chapter 1 (CF) states that general purpose

financial reports should provide financial
information about the reporting entity that is
useful to existing and potential investors,
lenders and other creditors in making
decisions relating to providing resources to
the entity (IASB, 2018).

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 Limitations of financial statements

• Investors are taken as being the defining class of

user – general purpose vs. specific purpose financial
reports.

• The statements involve a substantial degree of

classification (accountant needs to exercise their
professional judgement), aggregation and allocation.

• They do not focus on non-financial effects or

information.

• They provide largely historical/past information.

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 The Reporting Entity
• ‘An entity (sole trader, partnership &
company) that is required, or chooses, to
prepare financial statement’ (IASB, 2018).

• Boundaries are created to separate out the

accounting entity (entity concept).

• The boundaries are necessary even though

they may be artificial (for example between a
sole trader and the sole trader’s business).

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 Worked example 3.1
• Should the following be entered in a sole
trader businesses accounting system? (p.44)
– Direct debit paying the shops rent
– Direct debit paying the owner’s house rates
– Debit care payment for a washing machine for the
owner’s house
– Cash payment for stationery – the owner takes 10%
for his kids school bags
– Credit card payment for overalls for cleaning the shop
– Credit card payment for a new outfit which he can
wear to the shop

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Primary users of financial statements
and their key information needs
Investors (and their advisors)
They are concerned with evaluating the ‘risk in, and
return provided by their investment’

‘Investors require information to help them determine

whether they should buy, hold or sell. Shareholders are
also interested in information which enables them to
assess the ability of the entity to pay dividends and to
vote, or otherwise influence, managements actions
that affect the use of the entity’s economic resources’

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Primary users of financial statements
and their key information needs
Lenders
Require information to decide whether to lend money to an
entity, and assess whether loans and interest will be paid when
due.

Other creditors: suppliers and other trade creditors

Require information to decide whether to sell goods to an entity
and assess the likelihood of being paid when due.

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 Accountability
There is an argument that companies are accountable to
stakeholders other than investors and financiers

• ‘There is an implicit responsibility to report publicly . . .

incumbent on every entity whose size or format renders it
significant; . . . we consider the responsibility to report publicly
(referred to . . . as public accountability) is separate from and
broader than the legal obligation to report and arises from the
custodial role played in the community by economic entities; . . .
they are involved in the maintenance of standards of life and
the creation of wealth for and on behalf of the community.’

Hence other user needs are typically catered for.

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Other users of financial statements and their
key information needs
Employees
Require information to assess an entity’s stability
and profitability, and its ability to provide
remuneration, employment opportunities and
retirement benefits.

Customers
Require information about the continuance of an
entity because of long-term involvement,
warranties and replacement parts.

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 Users of financial statements and their key
information needs
Governments and their agencies
Require information to regulate the activities of
entities, assess taxation and provide a basis for
national statistics.

The public
Require information about trends and recent
developments in an entity’s prosperity and its
activities.

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Users of financial statements and their key
information needs
• The analyst–adviser group (assumed covered by
investors)
• Competitors and takeover bidders (potential
investors so covered by investors)
• Management - Management are users of financial
statements; however, it is assumed that financial
statements (external) should not be prepared with
management’s (internal) information needs in
mind as they have access to all the information
that is available and can use this to tailor reports
to their specific decision needs.

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 CSR Report - examples
Steps taken by companies as part of their CSR might include:

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 Environmental accounting
• Also known as green accounting or social accounting

• Government – tries to highlight the contribution that

the natural environment makes to the economy
(economic contribution earned from the environment’s
resources and benefits from social well-being)
• Government is also interested on recording expenditure
on protecting the environment
• Companies aim to make stakeholders aware of the steps
an entity is taking to protect the environment (social
conscious)
• Reporting may not necessarily be in monetary terms,
for example an environment report may discuss gas
emissions in terms of millions of times of carbon
dioxide. © McGraw-Hill Education 2019
 Arguments against a conceptual framework

• The costs of a conceptual framework are not justified in terms of

its benefits.

• A conceptual framework will not lead to improvements in

standard setting.

• Standardisation leads to uniformity, which creates rigidity, a lack

of flexibility, and thus less innovation.

• Standardisation results in consistency but does not enhance

comparability. There are ‘circumstantial variables’ or ‘differences
in circumstances’ between companies which necessitate the
exercise of managerial choice in the selection of accounting
policies that are appropriate to a company’s circumstances.

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 Types of accounting theories
Normative theories - true income/profit, financial statements are
like maps (conceptual frameworks are necessary).

Deductive theories - accounting methods should be deduced from

identifying the objectives of financial statements, users
information needs, etc (conceptual frameworks are necessary).

Empirical theories - accounting methods should be selected on the

basis of which gives the best predictions of economic/ financial
variables such as profits, insolvency, etc. (not necessary)

Positive theories - accounting in general, and standard setting in

particular, is a political process based on class interests. (not
necessary)

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 Summary – some key points
• The conceptual framework details the objective/point of accounting.

• It provides guidance on the principles underlying accounting and

presenting information.

• It defined general purpose financial statements and sets out what a

reporting entity is.

• It focuses on providing information for investors and creditors

• However, companies are deemed to be accountable to a wider

range of stakeholders including employees, the government and the
public and specialised reports such as CSR and environmental
reporting have emerged to provide tailored information that are
deemed to be of interest to a wide range of stakeholders.

• Finally, though generally accepted, there are several arguments

against the creation of a conceptual framework.
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 Student - study action
• Read chapter 3
• Then - try to explain the key terms and concepts (check
your answer with the chapter and the online glossary)
• Try the review questions (check your answers with the
chapter)
• Try the exercise questions with an asterisk (solutions
are available in the appendix)
• Try the exercise questions required by your tutor
(solutions to be provided by the tutor at their
discretion)
• Try the learning activities on the student online
learning centre (
www.mcgraw-hill.co.uk/textbooks/thomas)
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