Accounts Theory PDF

**Accounts Theory** *[Conceptual Framework:]* purpose of the IASB Conceptual Framework: Framework aids preparers of financial statements in exercising professional judgements, especially where standards are silent or ambiguous. It provides a set of guiding principles that can be referenced when m...

**Accounts Theory** *[Conceptual Framework:]* purpose of the IASB Conceptual Framework: Framework aids preparers of financial statements in exercising professional judgements, especially where standards are silent or ambiguous. It provides a set of guiding principles that can be referenced when making accounting decisions, ensuring decisions align with overall objectives of financial reporting Why conceptual framework matters: - supports formulation of new standards - promotes consistency & comparability - guides professional judgment (especially in situations where standards are silent or ambiguous) Objective of Financial Reporting: to provide financial info. about the reporting entity that is useful to \[users\] in making decisions about providing resources to the entity. Users decisions: - Buying, selling or holding equity or debt instruments - Providing or settling loans and other forms of credit - Voting, or otherwise influencing management\'s actions To make decisions, users assess: - Prospects for future net cash inflows to the entity - Management\'s stewardship of the entity\'s economic resources Users need financial information about: - the entity\'s economic resources (assets) and claims (liabilities) against it \[info. about financial position\] - changes in economic resources and claims \[info. about entity\'s financial performance\] - how efficiently and effectively management has discharged its responsibilities to use the entity\'s economic resources \[stewardship\] Primary users (considered by IASB Framework): - Investors /shareholders -existing or potential -- buy/sell/hold equity instruments (shares) in the company - lenders - existing or potential - Provide / advance loans to the reporting entity - liquidity (short-term- CA \> CL) and solvency (long-term - TA \> TL) - other creditors -- understand entity\'s ability to settle obligations - current ratio to assess ST liquidity Why should there be primary user group? - Providers of resources & participants in the capital market - Have most critical & immediate need for information in financial reports - Cannot require entities to provide information directly to them - Information that meets needs of specific primary users is likely to meet needs of users, irrespective of whether corporate governance in jurisdictions is defined in the context of shareholders of all types of stakeholders regulators maintain country's financial stability -- entity might have to not report/delay changes in liabilities & assets Information about the entity's financial position: - nature & amount of resources available capable of generating cash flows - Liquidity & solvency of the company - need for additional financing & likelihood of obtaining it - priorities & payment requirements of existing claims to predict how future cash flow will be distributed Information about performance of an entity: - return entity has produced on the economic resources - whether efficient & effective use has been made of resources - predict entity's future returns on its economic resources - extent to which net cash inflows are generated from operating, investing, & financial activities Note: a reporting entity's economic resources & claims may change for reasons other than financial performance, such as issuing debt or equity instruments Regulations affecting Maltese Accounting profession: - Companies act - GAAP frameworks - General Accounting Principles for Small & Medium-Enterprises (GAPSME) - General Accounting Principles in respect of certain Eligible Entities (GAPEE) - IFRSs as adopted by the EU & SIC interpretations - Capital Markets Rules - Accountancy Profession Act - Malta Financial Services Authority Regulations - Income Tax Act Global Accounting Scandal ex. Dot-Com Bubble - Tech start-ups relied heavily on intangible assets, funded mainly by equity investors as many banks were hesitant to lend to high-risk, unproven tech ventures. Focused on revenue growth, leading to pressure on companies to demonstrate rapid growth to attract capital using aggressive measures, ex. fictitious barter transactions - Consequence financial statements led to investor losses & lack of trust in financial markets - Regulations introduced in response: - SIC 31 -- clarify accounting for barter transactions, addressing revenue recognition weaknesses - IFRS 15 -- establishes robust framework for revenue recognition, focusing on transfer of control, & enhancing transparency Purpose of accounting standards: ensure transparency & consistency in financial reporting Focus on large entities: designed for listed companies & multinationals due to their market impact Regulatory considerations for SMEs: - Trends in regulations: simplified regulations to accommodate limited resources - IASB encourages use of simpler frameworks ex. IFRS for SMEs - EU Exemptions: SMEs are exempt from the requirement to apply EU-IFRS - Regional frameworks - Malta: introduction of GAPSE & GAPSME, & ongoing discussions about exemptions for micro entities -- tailored approach - UK: various FRS address diverse reporting needs, ensuring regulations meet specific demands of different entity sizes Importance of regulation: - Crisis prevention emergence of regulations post-crises (ex. Sarbanes-Oxley) - Capital protection: safeguarding interests of investors - Standardization: enhances comparability & clarity in financial statements - Adaptation & complexity: updates needed for evolving business practices - Faithful representation: guide preparers on how to deal with intricate accounting topics, ensuring a T&F view of financial transactions Challenges of Regulation: - Cost of compliance: significant burden on smaller firms, potentially stifling innovation - Diminishing returns: complex regulations may not yield proportional benefits - Operational adjustments: necessitates updates to IT systems & processes - Interpretation risks: increased intricacy raises potential for misinterpretation - Market pressures: profitability expectations can increase fraud risks Regulations necessary however, must not be burdensome for the company Anti-regulation perspective (free market): - Accounting treated like other goods -- left in hands of market forces to generate optimal supply of information about entity - Private economics-based incentives for organisation to provide credible info. about its operations & performance otherwise cost of capital inc. - Lenders charge higher r - Shareholders reduce amount willing to pay for shares - Management voluntarily enter private agreements with interested parties ex. debt covenants (assuming they operate for own benefit) - Information related to such agreements obtained from financial reports - Company produces info. which will inc. confidence of stakeholders 2 safeguards: - Market for lemons: No news is bad news - Reputational-effects argument: reputational costs for managers - Market for managers: In absence of regulation managers still do the 'right thing' - Market for corporate takeovers: underperforming organizations taken over by another entity with existing management team subsequently replaced Pro-regulation perspective: - Regulation protects external users from fraudulent organizations publishing misleading information - Regulation leads to uniform methods adopted by different entities, enhancing comparability - Accounting info public good; 'free riders', true D understated. Underproduction of accounting info. Regulation reduces the impacts of market failure - Some institutions more powerful than others & can demand info. Regulation protects small investor & lender ('level playing field' argument) - Information produced to minimize cost of capital thereby increasing firm value - Assumes managers know marginal cost & marginal benefit of information *[Harmonization & Standardisation:]* environmental factors that influence accounting: - extent of economic development within a country - colonial inheritance - invasion - sources of aid/finance - religion - strength of the accounting profession +-----------------------+-----------------------+-----------------------+ | Variable | Anglo-American Model | Continental-European | | | | Model | +=======================+=======================+=======================+ | Business Ownership & | Shareholder | Creditor orientation | | Financing Systems | orientation | (Insiders) | | | (Outsiders) | | | | | Creditor protection | | | Higher quality | | | | external financing | | | | reporting | | +-----------------------+-----------------------+-----------------------+ | Existing Legal System | Common Law: limited | Codified Law: highly | | | regulation; preceding | influenced by legal | | | case law centre of | concepts (legal form | | | attention | prevails) | +-----------------------+-----------------------+-----------------------+ | Link between | Tax laws independent | Tax laws define | | Accounting & Taxation | from national | methods of evaluation | | | accounting | & methods of | | | requirements | recording business | | | (separate accounts | transactions & | | | filed for taxation | financial statement | | | purposes) | presentation | +-----------------------+-----------------------+-----------------------+ cultural differences: hypothesised relationships between Gray's accounting values & Hofstede's cultural values Advantages of standardisation: - lead to increase in cross-border finance (domestic investor protection; stock exchange regulators reluctant to allow international companies to list if they do not prepare financial statements according to local GAAP) - accounting procedures simplified - no need for international investor to understand numerous different sets of accounting assumptions, rules, regulations, & procedures - financial statements more comparable & understandable Limitations of Standardisation: - certain IASs/IFRSs still allow no. of options - differences in taxation systems - no. of countries may modify application of such IFRSs (IAS39 carve-out by EU) - differences in implementation, monitoring, & enforcement by different countries - standards ex. IAS 38 & IAS 36 require a lot of judgement - Fair Value prices in liquid vs illiquid capital markets EU Role in Standardisation: founding principle of EU: free of movement within the EU of people, goods, & capital EU required all listed groups to prepare consolidated financial statements in accordance with IFRSs adoption of IFRSs changed the way EU regulates accounting (previously through EU Directives on Company Law ex. 4th Directive, 7th Directive) EU adopted IASs/IFRSs as they are flexible to suit needs of users in dynamic business environment Ensure appropriate political oversight each IAS/IFRS would have to be legally endorsed by the EU before becoming mandatory for listed companies in EU Endorsement process involves the EFRAG (accounting experts from private sector of EU members) Carve out of IAS39 (on financial instruments) Basis of preparation: "These financial statements are prepared in accordance with IFRS as adopted by the European Union" US role in Standardisation: In 2002, FASB & IASB entered joint agreement (Norwalk Agreement) to converge & improve standards of both (The Convergence Project) In 2008, SEC removed requirement for a reconciliation between IFRS & US GAAP Tensions throughout the convergence project between IASB & FASB US place reliance on accounting standards issued by FASB Investors perceived 'rules-based' FASB standards to be superior to 'principles-based' IASB standards Enron collapse shattered the perception of high quality Sir David Tweedie criticised 'rules-based' standards of FASB when interviewed by the Senate Committee investigating Enron debacle *[Qualitative Characteristics:]* Financial info. which has predictive/confirmatory value/both can make a difference in decisions made by users even if some users choose not to take advantage of it or are already aware of it from other sources Predictive value: can be used as an input to processes employed by users to predict future outcomes -- not prediction/forecast ex. disclosure of continuing/discontinuing operations, disclosure of NCA held for sale, disclosure of material one-off items of income/exp., presentation of comparative info. for trend analysis Confirmatory value: provides feedback about (confirms or changes) previous evaluations. Ex. expected/budgeted revenue £5 billion vs actual revenue £4.9 billion (confirms if change necessary in budgeting or if its close enough when compared to actual figures) Materiality: users would come to a different conclusion if item isn't included or misstated Characteristics of Faithful representation: - Completeness: all info. user needs to understand phenomenon being depicted, including descriptions & explanations - Neutrality: depiction without bias in selection or presentation of financial info. -- not slanted, weighted, emphasized, de-emphasized or manipulated to inc. probability that financial info. will be received favourably/unfavourably by users (prudence) - Free from error: no errors or omissions in depiction of the phenomenon & process used to produce reported info. selected & applied with no errors Prudence: exercise of caution when making judgements under conditions of uncertainty; no understatement of assets/income or overstatement of liabilities/expenses Enhancing qualitative characteristics: enhance usefulness of info. relevant & faithfully represented: - Comparability: enables users to identify & understand similarities & differences among items (inter-firm vs intra-firm) - Verifiability - Timeliness - Understandability: classifying, characterizing, & presenting info. clearly & concisely - Excluding info. about inherently complex phenomena makes financial reports easier to understand however, would be incomplete & potentially misleading *[Elements of financial Statements]* Elements of financial statements: - Financial position - Assets -- present economic resource controlled by entity as result of past events - Liabilities -- present obligation to transfer economic resource as result of past event - Equity -- residual interest in assets of entity after deducing liabilities - Financial performance - Income -- inc. asset/dec. liabilities -- inc. equity other than contributions from holders of equity claims - Expenses -- dec. assets/inc. liabilities -- dec. equity other than contributions to equity claims Rights: potential to produce economic benefits (by contract, law, & other means) Control: present ability to prevent other parties from directing use of economic resource & obtaining economic benefits that may flow from it; usually ability to enforce legal right Obligation: duty/responsibility to another party that entity has no practical ability to avoid (contractual vs constructive) *[Measurement]* Historic cost (entry value): provides monetary info. about assets, liabilities, & related income & expenses using info. derived from price of transaction/event that gave rise to them. Does not reflect change in values except to extent that relate to impairment of asset/liability becoming onerous -- measured at amortised cost - Asset: consideration paid + transaction costs - Liability -- consideration received -- transaction costs Current value: provides monetary info. about assets, liabilities, & related income & expenses using info. updated to reflect conditions at measurement date -- reflect changes in values - Current cost (entry value): like HC but reflects conditions at measurement date - Fair value (exit value): price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at measurement date - Value in use (exit value): present value of cash flows or other economic benefits that entity expects to derive from use of asset & its disposal (no transaction cost) - Fulfilment value (exit value): present value of the cash or other economic resources that entity expects to be obligated to transfer as it fulfils a liability (no transaction cost) *[Companies Act]* Keeping of accounting records: - All sums of money received & expended & which receipt & expenditure takes place - Assets & liabilities - Stock statements, stocktaking statements, statements of goods sold & purchased Proper accounting records kept to: - Disclose with reasonable accuracy the financial position - Enable directors to ensure that balance sheets & P&L A/Cs complies with requirements Accounting records shall be kept at the registered office & shall be at all times open to public inspection by officers Directors' Report: approved by board & dated & signed by 2 directors - Names of directors - Principal activities & significant change during period - Review of business development & of financial position at period-end - description of principal risks & uncertainties faced - important subsequent events - likely future developments - indication of activities of R&D - amount recommended to pay dividend & amount they propose to carry to reserves - existence of branches Annual accounts shall be approved by board of directors & balance sheet shall be dated & signed by 2 directors. Copy of accounts shall be sent to shareholders, debenture holders, & all other persons entitled to receive notice of general meetings 14 days before GM Private company accounts need to be approved by 10 months after end of period whilst public 7 months Exemption for small companies which do not exceed: Small companies Private companies --------------------- ----------------- ------------------- Balance sheet total 4M 46,600 Turnover 8M 93,000 No. of employees 50 2 Private except from statutory audit Private company: - restricts right to transfer shares - limits no. of members to 50 - prohibits invitation to the public to subscribe for any shares/debentures *[Profession Act]* Regulates accountancy profession to ensure integrity, transparency, public trust, & protection of public interest APA role in safeguarding public interest: - protects public interest by prioritising public confidence in financial reporting while building & maintaining trust through accountability & transparency measures - establishes professional standards & ethical practices including code of ethics to promote competence, integrity, & independence - regulates entry into profession by setting clear qualification requirements & assessments - mandates CPD to keep professionals up-to-date with evolving standards - requires indemnity insurance to protect clients against professional negligence - aligns with international standards to maintain Malta's reputation in global financial market - addresses misconduct with clear procedures for accountability & disciplinary action - mandates transparency reports by auditors of PIEs to promote audit credibility no person shall practise profession of accountant unless they are warrant holders an audit may only be carried out by person holding practising certificate warrant eligibility criteria: - person must be of good conduct & repute - individual must be of full legal capacity - educational qualifications: UoM's professional accountancy degree/university entrance level or equivalent & Board-recognised course of theoretical instruction, otherwise pass examination of professional competence at university final or equivalent level - 3 yrs of practical experience, at least 1 yr after obtaining academic qualifications Practising certificate eligibility criteria: - Adequate qualifications in auditing at advanced level - Satisfies conditions of warrant - Has gained equivalent of 3yrs full time practical training in inter alia auditing of FS, at least 2 of which with an auditor approved in any MS, provided at least 18 months after obtaining degree or academic qualification relating to accountancy profession Work restricted to warrant holders: - Issuing reports on prospective financial info. prepared for promotion of investment to raise finance - Issuing of independent reports on share valuations or valuations of business - Acting as reporting accountants in prospectuses offering memoranda & similar documents intended for public subscription - Issuing of reports, including compilation of review of reports with respect to interim or annual financial statements of an entity excluding any reports on financial statements prepared for internal purposes Functions of Accountancy Board: - Decide on applications for issue of warrants or practising certificates - Deal with cases of professional misconduct & other disciplinary proceedings, including cases leading to suspension/withdrawal of warrant/practising certificate - Take measures necessary to protect public interest & integrity of profession, including placing restrictions, imposing fines, & other to warrant & practising certificate holders - Advise or make recommendations or express its views to the Minister - Operate appropriate system of quality assurance - Publish guidelines on interpretation of Act & regulations & directives issued under it - Maintain updated register (warrant holders, practising certificates, audit firms, accountancy firms, etc.)