Financial Reporting Framework

Financial Reporting Framework

• Financial accounting involves classifying and recording an entity's monetary transactions in accordance with established concepts, principles, accounting standards, and legal requirements.
• This information is presented through income statements, balance sheets, and cash flow statements at the end of an accounting period.

Learning Objectives

• Evaluate the strengths, weaknesses, and applicability of the financial reporting framework.
• Discuss the impact of the financial reporting framework.

Structure of Financial Reporting

• Regulatory System for financial accounting
• Rules of accounting
• Accounting Standards
• Conceptual framework for financial reporting
• Objectives
• Elements
• Qualitative Characteristics
• Assumptions
• Principles of Accounting
• Constraints

Regulatory System

• The regulatory framework comprises national company legislation, such as the Companies Act, international financial reporting standards issued by the IASB for private companies and the International Public Sector Accounting Standards Board for public sector entities and Stock Exchange Rules.

Accounting Standards

• Accounting Standards (IASs) are authoritative pronouncements that provide guidance.
• They address specific accounting issues like valuing closing stocks and measuring property, plant, and equipment.
• Accounting Standards ensure a Common Form and Content of Accounts
• Using different methods of recording transactions can lead to substantial differences in financial accounts across businesses
• Over the years, standards for preparing accounts have been developed to assure users of the reliability of the information.
• Accounts are prepared based on a conceptual framework using common assumptions and principles.
• The IASB sets rules for recognition, measurement, presentation, and disclosure requirements when dealing with transactions and events in general purpose financial statements.
• The IASB has issued over 41 International Accounting Standards (IAS) and 9 International Financial Reporting Standards (IFRS) to obtain uniformity in international accounting practices.
• The IASB has over 150 member accounting organizations, representing more than 110 countries.
• The IASBs framework consists of shared elements used as the basis for developing accounting standards.
• The financial reporting framework serves as the foundation or model used by accounting standard setters in creating accounting standards.

Components of the Financial Reporting Framework

• Objectives of Financial Reporting
• Qualitative Characteristics of Accounting Information
• Elements of Financial Statements
• Recognition and Measurement Criteria
• Assumptions, Principles and Constraints

Qualitative Characteristics

• Qualitative characteristics of financial statements:
  • Understandability
    • This requires financial statements to be presented clearly so users can comprehend them.
    • Users are assumed to have some business, economic and accounting knowledge
    • Matters shouldn't be omitted solely due to complexity if the information is relevant.
  • Relevance
    • Information is relevant if it can influence decisions.
    • It is useful for forecasting future events (predictive value) and confirming or correcting prior expectations (feedback value).
    • Information must be available in a timely manner to influence decisions
  • Reliability
    • Reliability means information is free from error and bias and can be depended upon.
    • Accounting information must be verifiable and supported by evidence to prove accuracy.
    • Financial information must faithfully represents what it purports to be
  • Comparability
    • Requires accounting information to be comparable across different enterprises.
  • Consistency
    • Consistency dictates that the same accounting principles and methods should be consistently applied within a company from year to year.

Constraints

• Constraints allow companies to modify accounting principles without reducing the usefulness of reported information.
• The main constraints are cost-benefit and materiality.
  1. Cost-benefit
     • The value of information should outweigh the cost of providing it.
  2. Materiality
     • Materiality pertains to an item's impact on a firm's financial condition and operations.
  3. Industry Practice
     • Industry practice is considered when selecting accounting policies.
  4. Conservatism
     • Conservatism involves prudence to avoid overstating income or understating expenses.

Assumptions

• Economic Entity Assumption
  • The economic entity assumption establishes clear boundaries between the financial activities of a business and its owners.
  • A business is treated as a separate entity, distinct from its stakeholders' personal financial affairs.
• Going Concern Assumption
  • The going concern assumption assumes a company will continue operating indefinitely if it has sufficient resources, unless there is evidence to the contrary.
  • It also refers to a company's ability to sustain operations and avoid bankruptcy.
  • A company that is not a going concern is considered bankrupt and its assets are liquidated.
• Monetary Unit Assumption
  • All accounting records should be in terms of monetary units, also known as the money measurement concept.
  • The monetary unit is the currency typically used in a country.
• Periodicity Assumption
  • Oganizations can report its financial results within specific time periods.
  • Reporting is conducted consistently on a monthly, quarterly, or annual basis.
  • Consistent time periods ensure comparability, such as using calendar months for reporting results year to year.

Principles

• Cost Principle / Historical Cost
  • This follows the Going Concern Concept, assets are recorded at cost rather than net realizable or market value, assuming the business is ongoing.
  • Asset values are depreciated, but market values are not considered.
  • The cost concept prevents manipulation by focusing on historical cost, while it ignores inflation's effects, it is widely accepted for accounting.
• Matching Principle
  • The matching concept is based on the accounting period concept.
  • Expenditures for a period should be matched with revenues from the same period to calculate accurate profit or loss.
• Revenue Recognition
  • Revenue is typically recognized when critical events have occurred, products/services have been delivered, and the dollar amount is easily measurable to the company.
• Full Disclosure
  • All relevant and necessary information must be included in public company filings.
  • Financial analysts need data like inventory valuation methods, write-downs, depreciation calculations, and other critical details to understand financial statements.

Other Accounting Concepts

• Accrual Accounting
  • Accrual accounting records revenue before payment for goods/services and expenses as they are incurred.
  • Earned revenue and incurred expenses are entered in the company's journal, irrespective of when money exchanges hands.
  • Accrual accounting differs from cash basis accounting, which records revenue only when payments are received.
• Prudence
  • Prudence dictates that an entity should not overstate revenues, assets, or profits, and should not underestimate liabilities, losses, and expenses.
  • It ensures trustworthiness in financial reporting.
• Objectivity
  • Financial statements should be objective and free from internal and external influences.
  • Financial information should be based on solid evidence rather than opinions.
• Materiality
  • Materiality determines if a discrepancy (omission or misstatement) would impact a reasonable user's decision-making.
  • Material information must be accurately reported.
• Consistency
  • Consistency requires financial statements to follow the same accounting principles, methods, practices, and procedures from period to period.
  • It ensure consistent application of accounting methods and policies in subsequent financial periods.
  • Consistency provides meaningful comparisons between years and enables analyses and evaluations
• Reliability
  • Transactions/events in an entity's financial statements if they can be verified with objective evidence

Critiques of the Financial Reporting Framework

• Global standards face challenges in developing countries due to absent/inadequate capital markets, differing social/political/cultural/technological landscapes, and issues with competence, and training.

List of IFRS (IAS)

• IAS 1: Presentation of Financial Statements
• IAS 2: Inventories
• IAS 7: Statement of Cash Flows
• IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors
• IAS 10: Events after Reporting Periods
• IAS 11: Construction Contracts
• IAS 12: Income Taxes
• IAS 16: Property, Plant and Equipment
• IAS 17: Leases
• IAS 18: Revenue
• IAS 19: Employee Benefits
• IAS 20: Accounting for Government Grants and Disclosure of Government Assistance
• IAS 21: The Effect of Changes in Foreign Exchange Rates
• IAS 23: Borrowing Costs
• IAS 24: Related Party Disclosure
• IAS 26: Accounting and Reporting by Retirement Benefit Plans
• IAS 27: Consolidated and Separate Financial Statements
• IAS 28: Investment in Associates
• IAS 29: Financial Reporting in Hyperinflationary Economies
• IAS 31: Interests in Joint Ventures
• IAS 32: Financial Instruments: Presentation
• IAS 33: Earnings Per Share
• IAS 34: Interim Financial Reporting
• IAS 36: Impairment of Assets
• IAS 38: Intangible Assets
• IAS 39: Financial Instruments: Recognition and Measurement
• IAS 40: Investment Property
• IAS 41: Agriculture
• IFRS 1: First-Time Adoption of International Financial Reporting Standards
• IFRS 2: Share-based Payment
• IFRS 3: Business Combination
• IFRS 4: Insurance Contracts
• IFRS 5: Non-current Assets Held for Sale and Discontinued Operations
• IFRS 6: Exploration for and Evaluation of Mineral Resources
• IFRS 7: Financial Instruments: Disclosure
• IFRS 8: Operating Segments

Exercise

• Refer to the Companies Act, 2017, and answer the following questions:
  • What does the Companies Act require be included in the Annual Report of Companies?
    • Discuss whether the Companies Act requires auditors to attend the AGM.
  • Explain which Accounting Standards are required to be followed by companies in preparing financial statements.