Financial Reporting Lecture 03 PDF

UPDATES ON FINANCIAL REPORTING =============== =========== Estimates in Financial Reporting Lecture 03 1 Our Heavenly Father,  We extend our heartful thanks to you Lord, for the new life, new beginnings and new hope.  While our faith remains the same, we a...

UPDATES ON FINANCIAL REPORTING =============== =========== Estimates in Financial Reporting Lecture 03 1 Our Heavenly Father,  We extend our heartful thanks to you Lord, for the new life, new beginnings and new hope.  While our faith remains the same, we are still asking for your divine protection – to spare us from whatever incidents that may happen, in our desire to live according to your words.  We ask for the new learnings Lord, to make us not only mentally and physically healthy, but likewise spiritually fit.  Our prayer is not limited to ourselves Father, but also to the less fortunate that needs more blessings and compassion. 2  IMPACT OF CRISIS IN FINANCIAL REPORTING SUMMARY OF PREVIOUS LESSON 1. The impact of Covid 19 in financial reporting 2. Financial reporting of entities affected by Covid 19 3. Information to be disclosed about the assumptions used 4. Other disclosures 3  ESTIMATES IN FINANCIAL STATEMENTS ESTIMATES DURING HEIGHTENED UNCERTAINTIES Estimates being done during heightened uncertainties is different from a normal situation. In this case, the following should be taken into account: Fair value estimate This is applicable if the company is evaluating the possible impairment of some assets affected by uncertainties. Examples of which are financial assets, intangible assets, in some cases, the property, plant and equipment. 4  ESTIMATES IN FINANCIAL STATEMENTS ESTIMATES DURING HEIGHTENED UNCERTAINTIES Avoid the possible occurrence of risk of material misstatement This is the risk in making estimates during the period of uncertainties - the possible abuse of providing approximated figures. To avoid this scenario, companies are creating an independent committee that will deliberate the estimates made by the controller or whoever is the responsible party for the purpose. To ensure its independence, the committee will 5  ESTIMATES IN FINANCIAL STATEMENTS ESTIMATES DURING HEIGHTENED UNCERTAINTIES Adapt the principle of professional skepticism Although, professional skepticism is applicable to auditors, it may apply in making estimates as to the figures in the financial statements. Professional skepticism is an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error. This attitude is applicable on the part of management whenever they see estimated 6  ESTIMATES IN FINANCIAL STATEMENTS ACCOUNTING ESTIMATES MAYBE SUBJECT TO MANAGEMENT BIAS This is the scenario that the stakeholders want to avoid in making estimates in times of uncertainties. Management may do estimation particularly accrual of revenues in its favor. In the same manner, accrual of expenses maybe lower to make it appear that management were able to lessen cost and expenses during the hard times. The role of the board of directors as an oversight body became very crucial in this estimation process. 7  ESTIMATES IN FINANCIAL STATEMENTS PROJECTIONS OF FUTURE CASH FLOWS One crucial area in making estimates is the projection of cash flows. Although the projected cash flow is not an actual financial report, it may create an impression at the beginning of the business period that the company maybe doing well, where in fact, it is not. To make the projected cash flows more reasonable and implementable, the following should be contemplated: 1. Projected cash inflows should be based on the possible amount to be collected the 8  ESTIMATES IN FINANCIAL STATEMENTS PROJECTIONS OF FUTURE CASH FLOWS 2. If the company is expecting that some assets are to be sold, the possible sale should be included. However, such transaction should be certain. The same principle shall apply in case of asset acquisition. 3. Estimates of cash inflow because of investments should likewise be certain. 4. Additional capital infusion of existing shareholders should be included if there is certainty on the additional fund. 9  ESTIMATES IN FINANCIAL STATEMENTS TESTING FOR IMPAIRMENT OF NON-FINANCIAL ASSETS 1. Goodwill Goodwill is not being amortized but rather being tested for possible impairment. In times of uncertainties, goodwill are most likely to be impaired. In this case, management is not supposed to overlook the impairment of this intangible asset. If there is a need to write-off, management 10  ESTIMATES IN FINANCIAL STATEMENTS TESTING FOR IMPAIRMENT OF NON-FINANCIAL ASSETS 2. Land and other affected assets Impairment in the value of land and other fixed assets happened if the uncertainties deeply affected the value of a particular asset. The typical example of this impairment in the value of land is the civil war that happened in Marawi City. When an earthquake hit Northern and Central11  ESTIMATES IN FINANCIAL STATEMENTS EFFECT OF UNCERTAINTIES IN GOING CONCERN ASSUMPTION In determining the going concern assumption, the following should be taken into consideration: 1. Salability of the products or services 2. Adequacy of capital to cover risk assets 3. Debt to equity ratio i.e. if the liabilities are greater than the capital, most of the assets are funded by borrowings. There could be a possibility that the company cannot sustain the challenges of the business environment in the future. 12  ESTIMATES IN FINANCIAL STATEMENTS MARKET BEHAVIOR IN THE PERIOD OF UNCERTAINTIES Market behavior in this context refers to the changes in the market price of investment instruments regardless whether debt or equity securities. Management should always on the lookout regarding changes in the market price of financial assets. In this period of uncertainties, a monthly monitoring and valuation is more appropriate. Focus should be on Trading Securities or 13  ESTIMATES IN FINANCIAL STATEMENTS SUMMARY OF TODAY’S LESSON 1. Estimates during heightened uncertainties 2. Fair value estimates 3. Possible existence of risk of material misstatements 4. Professional skepticism 5. Management bias on estimates 6. Projection of cash flows 7. Testing for impairment of non-financial assets 8. Effect of uncertainties in going concern assumption 9. Market behavior during uncertainties 14  ESTIMATES IN FINANCIAL STATEMENTS VALUES FORMATION “Start doing what is necessary, then, do what is possible; and suddenly (without knowing it), you are already doing the impossible.” 15 Our Heavenly Father,  We are grateful to you Lord, for the restoration of our broken soul, and such restoration gave us a golden opportunity to develop our hidden talents.  We acknowledge your omni-presence in our virtual classroom Father, for allowing us to absorb the wisdom that would create and develop professionals to be involved in nation building and economic prosperity.  Please continue your direction Lord, not only for ourselves but also for our beloved country. This we pray in the Mighty Name of your Beloved Son, Jesus Christ, AMEN. 16 17