Chapter 3: Financial

Reporting Standards
MR. ADAMA FATTY
UNIVERSITY OF THE GAMBIA
INTRODUCTION
Financial reporting standards provide principles for
preparing financial reports and determine the types
and amounts of information that must be provided to
users of financial statements, including investors and
creditors, so that they may make informed decisions.
Financial Reporting Standards
importance of financial reporting standards in
security analysis and valuation.
ensure that the financial information (financial
performance and financial position) is useful to a wide
range of users, including security analysts, by making
financial statements comparable to one another and
narrowing the range within which management’s
estimates can be seen as reasonable.
Financial Reporting Standards
Reporting standards limit the range of assumptions
management can make.
Assessing the financial prospects is the responsibility
of analysts.
Standard-Setting Bodies
Standard-setting bodies are professional organization
of accountants and auditors that establish financial
reporting standards.
FASB (Financial Accounting Standards Board) sets
forth the U.S. GAAP (Generally Accepted Accounting
Principles) in the U.S.
The IASB (International Accounting Standards
Board) establishes the IFRS (International Financial
Reporting Standards) outside of the U.S.
IASB (International Accounting
Standards Board)
The IASB has 4 stated goals
1. Develop global accounting standards requiring
transparency, comparability and high quality in
financial statements.
2. Promote the use of global accounting standards.
3. Account for the needs of emerging markets and
small firms when implementing global accounting
standards.
4. Achieve convergence between various national
accounting standards and global accounting
standards.
IASB (International Accounting
Standards Board)
The body of standards issued by the International
Accounting Standards Board (IASB) is referred to as
International Financial Reporting Standards.
FASB (Financial Accounting Standards
Board)
The FASB operates within a structure similar to that of
the IASB. The Financial Accounting Foundation
oversees, administers, and finances the organization.
The Foundation ensures the independence of the
standard-setting process and appoints members to the
FASB and related entities including the Financial
Accounting Standards Advisory Council.
Desirable Attributes of Accounting
Standards Boards
All parties involved in the standards-setting process
should observe high professional standards, including
standards of ethics and confidentiality.
The organization should have adequate authority,
resources, and competencies to fulfill its
responsibilities.
The processes that guide the organization and the
formation of standards should be clear and consistent.
Desirable Attributes of Accounting
Standards Boards
The accounting standards board should be guided by
a well-articulated framework with a clearly stated
objective.
The accounting standards board should operate
independently, seeking and considering input from
stakeholders but making decisions that are consistent
with the stated objective of the framework.
The decision-setting process should not be
compromised by pressure from external forces and
should not be influenced by self- or special interests.
Desirable Attributes of Accounting
Standards Boards
The decisions and resulting standards should be in the
public interest, and culminate in a set of high quality
standards that will be recognized and adopted by
regulatory authorities.
Although standards-setting bodies should not be
compromised by special interests, seeking input from
stakeholders is considered a desirable attribute.
Regulatory authorities
Regulatory authorities are government agencies that
have the legal authority to enforce compliance with
financial reporting standards. Regulatory authorities
such as the SEC (Securities and Exchange
Commission) in the U.S. and the FSA (Financial
Services Authority) in the U.K., are established by
national governments. Most national authorities
belong to the IOSCO (International Organization of
Securities Commission).
Regulatory authorities
i. Protect investors.
ii. Ensure the fairness, efficiency and
transparency of markets.
iii. Reduce systemic risk.
The SEC’s required filings
Form S-1: Registration statement filed prior to the sale
of new securities to the public.
Form 10-K: Required annual filing, includes
information about the business and its management,
audited financial statements and disclosures, and
disclosures about legal matters.
Form 10-Q: Required quarterly filing, with updated
financial statements (audit not required) and certain
events such as significant legal proceedings or changes
in accounting policies.
The SEC’s required filings
Form DEF-14 A: When a company prepares a proxy
statement for its shareholders prior to the annual
meeting or other shareholder vote, it also files the
statement with the SEC.
Form 8-K: Companies must file this form to disclose
material events including significant asset acquisitions
and disposals, changes in management or corporate
governance
The SEC’s required filings
Form 144: A company can issue securities to certain
qualified buyers without registering securities with the
SEC but must notify the SEC that it intends to do so.
Form 3, 4 & 5: Involve beneficial ownership of
securities by a company’s officers and directors.
CONVERGENCE OF GLOBAL FINANCIAL REPORTING
STANDARDS
Developing one universally accepted set of accounting
standards is referred to as ‘convergence’. The IASB is an
accounting-setting body involved in the process.
In September 2010, the IASB adopted the Conceptual
Framework for Financial Reporting in place of the
Framework for the Preparation and Presentation of
Financial Statements (1989).
The Conceptual Framework represents the partial
completion of a joint convergence project between the
IASB and FASB on an updated framework.
CONVERGENCE OF GLOBAL FINANCIAL REPORTING
STANDARDS
The Conceptual Framework (2010) contains two
updated chapters: The objective of financial reporting
and Qualitative characteristics of useful financial
information.
The remainder of the material in the Conceptual
Framework is from the Framework (1989) and will be
updated as the project is completed. Also in
September 2010, the FASB issued Concepts Statement
8, Conceptual Framework for Financial Reporting, to
replace Concepts Statements 1 and 2.
Barriers to Convergence
One barrier to this development is simply
that different standard-setting bodies of different
countries disagree on the best treatment of a
particular item or issue. Other barriers result
from political pressures from business groups and
others who will be affected by these charges.
THE INTERNATIONAL FINANCIAL REPORTING
STANDARDS FRAMEWORK
Qualitative characteristics that accounting
information must possess according to the IASB’s
Conceptual Framework are relevance and faithful
representation, which are enhanced by the
characteristics of timeliness, verifiability,
understandability and comparability.
THE INTERNATIONAL FINANCIAL REPORTING
STANDARDS FRAMEWORK
An item from the required reporting elements (asset,
liability, equity, income, expenses) should be
recognized in its financial statement element if a
future economic benefit from the item is probable and
the item’s value or cost can be measured reliably.
Measurement Bases
Historical cost (the amount originally paid for the
asset).
Amortized cost (historical cost adjusted for
depreciation, amortization, depletion and
impairment).
Current cost (the amount the firm would have to pay
for the same asset today).
Realizable value (the amount for which the firm could
sell the asset).
Measurement Bases
Present value (the discounted value of the assets’
expected future cash flows).
Fair value (the amount at which two parties in an arm’s
length transaction would exchange the asset).

The two underlying assumptions of financial

statements according to the conceptual framework
are accrual accounting and the going
concern assumptions.
Constraints
The benefit that users gain from the information
should be greater than the cost of presenting it.

Non-quantifiable information about a company

(reputation, brand loyalty...) cannot be captured
directly in financial statements.
Requirements for Financial Statements
under IFRS
IAS n°1 defines which financial statements are
required and how they must be presented.
The required financial statements are:
 Balance sheet.
 Statement of comprehensive income.
 Cash flow statement.
 Statement of changes in owner’s equity.
 Explanatory notes, including a summary of accounting

policies.
Features for Preparing Financial Statements
Fair presentation.
Going concern basis.
Accrual basis of accounting.
Consistency.
Materiality.
Aggregation.
Key concepts of financial reporting standards
under IFRS and U.S. GAAP reporting systems
The IASB and FASB frameworks are similar but are
moving towards convergence. Some of the remaining
differences are:

The IASB framework lists income and expenses as

elements related to performance, while the FASB
framework includes revenues, expenses, gains, losses
and comprehensive income.
The FASB defines an asset as a future economic
benefit, whereas the IASB defines it as a resource from
which a future economic benefit is expected to flow.
Also, the FASB uses the word ‘probable’ in its
definition of assets and liabilities.
The FASB does not allow the upward valuation of
most assets.
Firms that list their shares in the U.S. but do not use
U.S. GAAP or IFRS are required to reconcile their
financial statements with U.S. GAAP. For IFRS, firms
listing their shares in the U.S., reconciliation is no
longer required
Characteristics of coherent financial
reporting framework and barriers.
A coherent financial reporting framework should
exhibit transparency, comprehensiveness, and
consistency.

Barriers to creating a coherent framework include

issues of valuation, standard-setting, and
measurement.
Implications for Financial Analysis of
Differing Reporting Systems
An analyst should be aware of evolving financial
reporting standards and new products and
innovations that generate new types of transactions.
Company Disclosures of Significant
Accounting Policies
Under IFRS and U.S. GAAP, companies must disclose
their accounting policies and estimates in the
footnotes and MD&A. Public companies are also
required to disclose the likely impact of recently issued
accounting standards on their financial statements.