FR - Module 1 (part 1) PDF

# Module 1: The Role and Importance of Financial Reporting ## Learning Objectives After completing this module, you should be able to: - Explain the role and importance of financial reporting - Explain the role of the IASB Conceptual Framework in financial reporting and accounting standards - Des...

# Module 1: The Role and Importance of Financial Reporting ## Learning Objectives After completing this module, you should be able to: - Explain the role and importance of financial reporting - Explain the role of the IASB Conceptual Framework in financial reporting and accounting standards - Describe the objective and limitations of general purpose financial reporting as identified in the Conceptual Framework - Explain the definitions of the elements of financial statements and recognition criteria adopted by the Conceptual Framework - Explain the application of the standards to the financial reporting process and apply specific standards - Discuss and demonstrate the importance of professional judgment in the financial reporting process - Explain the implications of using cost and fair value accounting - Explain how materiality is assessed and determine the materiality of transactions ## Assumed Knowledge It is assumed that, before commencing your study in this module, you are able to: - Explain the four primary financial statements, including their purpose and interrelationship - Prepare each of the four primary financial statements using the accrual method of accounting - Read and interpret International Financial Reporting Standards (IFRSs) ## Learning Resources International Financial Reporting Standards (IFRSs), with a particular focus on the IASB Conceptual Framework for Financial Reporting: - IASB Conceptual Framework for Financial Reporting (2018) - IFRS 2 Share-based Payment - IFRS 5 Non-current Assets Held for Sale and Discontinued Operations - IFRS 9 Financial Instruments - IFRS 13 Fair Value Measurement - IFRS 16 Leases - IAS 1 Presentation of Financial Statements - IAS 2 Inventories - IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors - IAS 16 Property, Plant and Equipment - IAS 19 Employee Benefits - IAS 36 Impairment of Assets - IAS 37 Provisions, Contingent Liabilities and Contingent Assets - IAS 40 Investment Property ## Preview Financial reporting is the process of documenting an entity's status in the form of financial reports/statements. The entity uses the prepared reports as a communication tool to assist users with their decision making. There is a broad range of users, including shareholders, banks, and other creditors, competitors, employees, and financial analysts - and they may have different information needs. Therefore, to assist users in their decision making, it is critical that financial statements are prepared in accordance with a financial reporting framework that recognizes and endeavours to satisfy the needs of these users. This module considers the role and importance of financial reporting, particularly the need for general purpose financial statements (GPFSs) and discusses the application of financial reporting in an international context. It then discusses the role that the IASB Conceptual Framework for Financial Reporting (Conceptual Framework) plays in financial reporting, including a discussion on the objective and limitations of GPFSs as identified in the Conceptual Framework. The module discusses the qualitative characteristics of financial information and the definitions, recognition criteria, and measurement of financial reporting items as outlined in the Conceptual Framework. The concept of materiality and how it is applied to financial reporting is also addressed. This module also examines the application of the measurement principles in International Financial Reporting Standards (IFRSs) in the context of selected issues. IFRSs are developed based on the Conceptual Framework as a consistent language for reporting that ensures that financial statements are understandable and can be compared among entities. IFRSs are the global language of accounting standards. Measurement is a complex and controversial aspect of accounting. In this module, alternative measurement bases are studied, and the application of the mixed measurement model (based on cost and fair value) is examined. Measurement issues are considered in the context of leases, employee benefits, share-based payments, and investment properties. The module also explores the importance of professional judgment in the reporting process. ## 1.1 The Role and Importance of Financial Reporting Financial reporting is a process that provides entities with an important communication tool to reach out to external stakeholders (users) interested in their financial information for decision making. The communication tool is represented by the GPFSs prepared in accordance with the Conceptual Framework and the accounting standards developed based on the framework. These financial statements provide users with financial information about the entity, including its financial position, financial performance, and cash flows. ### The Role of Financial Reporting The role of financial reporting is to provide users with information to enable them to achieve effective decision making. It also provides a stewardship or accountability role by requiring managers to give an account of how they have used the resources provided by those users. The stewardship role is particularly important when there is a separation between ownership and management in an entity. Effective financial reporting communicates the "story" of the entity during the period so that the users can understand what the entity has achieved and how it has achieved it. Improving the communication effectiveness of financial statements is one of the central themes of the IASB's standard-setting work (IFRS Foundation 2016). The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to its primary users for making decisions about providing resources to the entity. These decisions include: - Buying, selling, or holding equity and debt instruments; - Providing or settling loans and other forms of credit; or - Exercising rights to vote on or otherwise influence management's actions that affect the use of the entity's resources (Conceptual Framework, Para. 1.2). Identification of the primary users of financial reports is crucial in determining the information that should be disseminated through the financial reports to effectively satisfy their decision-making needs. The IASB identifies primary users as those that provide equity or debt finance to the entity. Specifically, the primary users rely on an entity's financial information are existing and potential investors, lenders, and other creditors that must rely on general purpose financial reports for much of the information they need as they may be unable to command information from an entity directly (Conceptual Framework, Paras. 1.2 and 1.5). General purpose financial reports are directed to those primary users to provide information about the economic resources of the entity, claims against the entity, and changes in those resources and claims, which is necessary for these users to assess the entity for their decision making (Conceptual Framework, Para. 1.4). Financial reports provide information about an entity's financial position at a point in time. They also provide information about an entity's financial performance as a result of transactions and other events that change the financial position during a reporting period (Conceptual Framework, Paras. 1.12-1.16). More specifically, the statement of financial position (or balance sheet) provides information about the financial position (i.e. the assets, liabilities, and equity) of the entity at a point in time. The statement of profit or loss and other comprehensive income (the statement of P/L and OCI) (also referred to as the "statement of financial performance" or just "profit or loss statement") reports on the financial performance (i.e. the income, expenses, and profitability) for a reporting period on an accrual basis. The statement of cash flows reports on the cash inflows and outflows of the entity for a reporting period on a cash basis. Changes in the net assets, or equity, are reported in the statement of changes in equity. All individual financial reports are prepared by an entity as at a particular point in time or for a particular reporting period, but the presentation of financial reports is prescribed to ensure that they are comparable with the entity's previous financial statements and with the financial statements of other entities (IAS 1, Para. 1). Financial reporting via general purpose financial statements should not be seen as the only way for an entity to communicate to external users. Other types of reporting, including investor updates, sustainability reporting, corporate governance reporting, and other prospective, or forward-looking, information, should be considered as well. For example, when an entity is intending to list on a stock exchange, it would normally be required to provide some forward-looking information to potential investors to help them make their investment decision. Technology advancements provide opportunities for various other methods of information dissemination that, together with financial reporting via GPFSs, can be incorporated into a whole suite of reporting tools to properly and efficiently address the information needs of users. ### The Importance of Financial Reporting Financial reporting is important because of the often significant level of resources under the responsibility of managers and the financial impact of the decisions that users make from relying on the information provided in financial reports. This importance is reflected in company regulators and stock exchanges around the world requiring financial statements to be prepared by entities as part of their reporting obligations. The types of decisions that financial statements might be used for are highlighted in Figure 1.1: **Figure 1.1: Financial statement user decisions** | User | Decision | |---|---| | Shareholders | Should I invest money in the company? | | Competitors | How has the company performed in comparison to its competitors? | | Suppliers | Should I sell goods to the company? | | Banks | Should I lend money to the company? | **Source: CPA Australia 2022.** ### Information Needs of the User As previously mentioned, the primary users of financial information are existing and potential investors, lenders, and other creditors (Conceptual Framework, Para. 1.5). Management of an entity also require financial information for decision making but they can obtain whatever information they need internally and do not need to rely on general purpose financial reports (Conceptual Framework, Para. 1.9). Other users of financial information include regulators and members of the public, such as community groups and potential employees; however, general purpose financial reports are not primarily directed to these users (Conceptual Framework, Para. 1.10). In the Conceptual Framework, it is the primary users that are the focus of general purposes financial reports. Entities are required to prepare general purpose financial reports specifically to assist their primary users in their decision making. However, the decisions facing the primary users may give rise to varying or even conflicting information needs. Consider, for example, lenders as users of financial statements. Lenders are interested in making an assessment of an entity's capacity to meet its interest and principal repayment obligations and the level of risk associated with a loan. As investors invest equity, they are also interested in the assessment of risk and the ability of the entity to service its debt, so that the entity can continue its operations and provide a return to investors. These varying information needs and the resulting information demands may give rise to different preferences for the measurement of assets or the timing of the recognition of revenue. For example, lenders may prefer a measure of the net realisable value of certain assets provided as security to assess whether the security is sufficient in the event that the entity defaults on repayment. However, investors may prefer measurement of those assets based on their value in use, which provides a better indication of the expected benefits to be derived from the continued use of the assets. The IASB's approach to resolving conflicting user information needs is to provide the information that will meet "the needs of the maximum number of primary users" (Conceptual Framework, Para. 1.8). However, according to the IASB, focusing on common information needs does not prevent an entity from providing additional information that may be useful to another sub-group of primary users (Conceptual Framework, Para. 1.8). It should also be noted that trying to meet the needs of the maximum number of primary users may have different implications depending on the context. For example, for some entities, investors may be the largest group of primary users, but for other entities, the largest group of primary users may be lenders. Conflicting information needs are shown in Figure 1.2. **Figure 1.2: Maximising the number of primary users whose information needs are met** [Insert Figure 1.2 Here] **Source: Adapted from IFRS Foundation 2022, Conceptual Framework for Financial Reporting, Paras. 1.5-1.8, IFRS Foundation, London, p. A18. CPA Australia 2022.** ## Question 1.1 According to the Conceptual Framework, who are the primary users of general purpose financial reports, and why do you think they are regarded as the primary users? ## Question 1.2 Consider the following statement: By focusing on the information needs of investors, lenders, and other creditors, financial reporting will not be useful for other users. Do you agree or disagree? Give reasons for your answer. ## Understanding International Financial Reporting Standards In this module, the terms "financial reports" and "financial reporting" refer to general purpose financial reports and general purpose financial reporting unless otherwise noted. GPFSs such as the statement of P/L and OCI, statement of financial position, statement of changes in equity, and the statement of cash flows and the notes make up the body of general purpose financial reports that are prepared for external users. The information included in GPFSs must comply with the International Financial Reporting Standards (IFRSs) and achieve fair presentation in accordance with the definition and recognition criteria in the Conceptual Framework. The Conceptual Framework is not a standard itself; therefore, it will not override any IFRSs. If a conflict is identified between provisions of an IFRS and the Conceptual Framework, the IFRS will take precedence. If any new provisions in the IFRSs depart from the Conceptual Framework, the IASB will explain the departure in the Basis for Conclusions of the relevant standard. The IFRSs are an internationally recognised set of accounting standards "that bring transparency, accountability and efficiency to financial markets around the world" (IFRS Foundation 2022a). IFRSs are used by most publicly listed companies in over 140 jurisdictions. The Australian Accounting Standards Board adopted the IFRSs for Australian entities required to report under the Corporations Act 2001 (Cwlth) (Corporations Act) for annual reporting periods beginning on or after 1 January 2005. There are two series of international accounting standards. The first series, the International Accounting Standards (IASs), are those standards issued from 1973 to 2001, before the new International Accounting Standards Board (IASB) was formed. The second series, the International Financial Reporting Standards (IFRSs), are those standards issued under the IASB since 2001 and reflect the changes in accounting and business practices since that date. Some IASs are still relevant today and have therefore remained under their original IAS heading. An example is IAS 1 Presentation of Financial Statements. AASB standards are the accounting standards developed by the Australian Accounting Standards Board for all economic sectors in Australia. A specific numbering system has been used for the AASBs to identify their connection to the international accounting standards. AASB standards numbered by using one or two digits (from 1 to 99) are the equivalent of IFRSs. AASB standards numbered by using three digits (from 101 to 999) are the equivalent of IASs; and AASB standards numbered with four digits (from 1001 onwards) have no international equivalent (AASB 2021). The AASBs, whilst complying with the IFRSs, sometimes include additional paragraphs where reporting requirements differ for specific entities such as Australian not-for-profit entities. These paragraphs have the prefix "AUS" and generally begin with words that highlight their limited applicability. For example: "Notwithstanding paragraphs xx, in respect of not-for-profit entities...". Each standard includes a statement at the beginning referring to its structure, main principles and terms, and the context in which the standard should be read. Example 1.1 shows this statement as is included at the beginning of IFRS 16 Leases. **Example 1.1** **Statement from IFRS 16 Leases** "International Financial Reporting Standard 16 Leases (IFRS 16) is set out in paragraphs 1-106 and Appendices A-D. All the paragraphs have equal authority. Paragraphs in bold type state the main principles. Terms defined in Appendix A are in italics the first time that they appear in the Standard. Definitions of other terms are given in the Glossary for International Financial Reporting Standards. The Standard should be read in the context of its objective and the Basis for Conclusions, the Preface to IFRS Standards and the Conceptual Framework for Financial Reporting. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides a basis for selecting and applying accounting policies in the absence of explicit guidance." **Source: IFRS Foundation 2022, IFRS 16 Leases, IFRS Foundation, London, p. A821.** Each standard begins with statements on its Objective and Scope and includes a section for its Effective Date (ED) and whether earlier adoption is permitted. Additional sections such as the Basis for Conclusions (BC) and the Illustrative Examples (IE) accompany the standard but are not considered to be a part of the standard. The BC section provides detailed explanations of the IASB's considerations when developing and/or updating the standard. The IE section is included for those standards requiring practical explanations and may provide examples to demonstrate the application of the main principles of the standard. The IEs are not meant to represent the only application of a particular aspect and are not intended to be industry-specific. Example 1.2 is taken from the Illustrative Examples section of IFRS 16 Leases - it is Example 5 from that standard which works through identifying whether or not a lease exists for a truck rental contract. When a member (or members) of the IASB does not approve the publication of a standard, that standard will include a section called Dissenting Opinion (DO) which states the reasons for any member objections. **Example 1.2** **IFRS 16 Leases, Illustrative Example 5 - Truck Rental** "Customer enters into a contract with Supplier for the use of a truck for one week to transport cargo from New York to San Francisco. Supplier does not have substitution rights. Only cargo specified in the contract is permitted to be transported on this truck for the period of the contract. The contract specifies a maximum distance that the truck can be driven. Customer is able to choose the details of the journey (speed, route, rest stops, etc.) within the parameters of the contract. Customer does not have the right to continue using the truck after the specified trip is complete. The cargo to be transported, and the timing and location of pick-up in New York and delivery in San Francisco, are specified in the contract. Customer is responsible for driving the truck from New York to San Francisco. The contract contains a lease of a truck. Customer has the right to use the truck for the duration of the specified trip. There is an identified asset. The truck is explicitly specified in the contract, and Supplier does not have the right to substitute the truck. Customer has the right to control the use of the truck throughout the period of use because: (a) Customer has the right to obtain substantially all of the economic benefits from use of the truck over the period of use. Customer has exclusive use of the truck throughout the period of use. (b) Customer has the right to direct the use of the truck because the conditions in B24(b)(i) exist. How and for what purpose the truck will be used (i.e. the transportation of specified cargo from New York to San Francisco within a specified timeframe) is predetermined in the contract. Customer directs the use of the truck because it has the right to operate the truck (for example, speed, route, rest stops) throughout the period of use. Customer makes all of the decisions about the use of the truck that can be made during the period of use through its control of the operations of the truck. Because the duration of the contract is one week, this lease meets the definition of a short-term lease." **Source: IFRS Foundation 2022, IFRS 16 Leases, IFRS Foundation, London, part B, illustrative examples.** **Explore Further** If you wish to explore this topic further, you should refer to IFRS 16 Leases, reading from the title page up to and including paragraphs 1-4 of the standard. Also refer to IFRS 16 IE section for further illustrative examples on the application of the standard. ## Interaction Between Financial Reporting and the Regulatory Environment - Who Must Prepare General Purpose Financial Reports? ### International Accounting Standards Board General purpose financial reporting applies to reporting entities. The question of who must prepare general purpose financial reports is a matter for governments and regulatory agencies of each jurisdiction that adopts IFRS to decide. The Conceptual Framework therefore sets out a general definition of a reporting entity at paragraph 3.10 as follows: "A reporting entity is an entity that is required, or chooses, to prepare financial statements. A reporting entity can be a single entity or a portion of an entity or can comprise more than one entity. A reporting entity is not necessarily a legal entity." The IFRSs do not further clarify who must prepare general purpose financial reports. In jurisdictions adopting IFRSs, legislation and other regulatory requirements usually require general purpose financial reports from entities that have issued debt or equity securities traded in a public market. The IASB does not, however, limit general purpose financial reporting to these entities. In this regard, the Conceptual Framework indicates that a reporting entity can be any entity that has existing and potential investors, lenders, and other creditors who must rely on general purpose financial reports for much of the information they need to make decisions about providing resources to the entity. A reporting entity can be a for-profit entity or a not-for-profit entity. A reporting entity can operate in the private sector or the public sector. Examples of for-profit private sector entities include companies, partnership, and trading trusts. Examples of not-for-profit entities include registered clubs, associations, charities, and government departments. A reporting entity can be one entity or a group of entities comprising a parent and its subsidiaries (Conceptual Framework, Para. 3.11). Whilst the IFRSs and the Conceptual Framework are also applied in the not-for-profit sector in some jurisdictions, emphasis throughout this subject is generally on for-profit private sector entities whose equity and/or debt securities are publicly listed in financial markets. ### Australian Accounting Standards Board In Australia, for-profit private sector entities are subject to the Conceptual Framework and must prepare financial statements that comply with Australian Accounting Standards (i.e. prepare general purpose financial statements) when required to do so by either: 1. Legislation that requires the entity to prepare financial statements in accordance with Australian accounting standards or "accounting standards"; 2. Their constituting or other document requires the entity to prepare financial statements in accordance with Australian Accounting Standards, provided that the relevant document was created or amended on or after 1 July 2021. Other for-profit private sector entities may nonetheless elect to apply the Conceptual Framework and prepare general purpose financial reports (AASB Conceptual Framework, Para. Aus1.1). The predecessor of the Conceptual Framework, titled the Framework for the Preparation and Presentation of Financial Statements, continues to apply to not-for-profit entities. **Legislation** Part 2M.3 (Financial Reporting) of the Corporations Act requires an entity that is a disclosing entity, public company, large proprietary company or registered scheme to prepare an annual financial report (s. 292). The financial report must comply with Australian Accounting Standards when they are applicable (s. 296). A disclosing entity is an entity with enhanced disclosure securities on issue, which is similar to the notion of public accountability (s. 111AC). A proprietary company is usually limited by shares and can have no more than 50 shareholders. A large proprietary company is based on qualifying for two out of three size thresholds for revenue, gross assets, and number of employees (s. 45A). The thresholds are revenue of $50 million or more, gross assets of $25 million or more, and employees of 100 or more. A public company is a company other than a proprietary company (s. 9). The financial reporting obligations of other types of entities are included in other federal or state-based legislation. For example, for associations, the appropriate legislation is the relevant state-based Incorporated Associations Act. **Constituting or Other Document** "A for-profit private sector entity may be founded on a constituting or other document, such as a partnership agreement, trust deed or joint arrangement (AASB 2020). If that document was created or amended after 1 July 2021 and requires the entity to prepare financial statements in accordance with Australian Accounting Standards, the entity must prepare general purpose financial reports. If the document was created before, and has not been amended since, 1 July 2021, and requires the entity to prepare financial statements in accordance with Australian Accounting Standards, presuming the entity does not have a legislative requirement to prepare general purpose financial reports, it may prepare special purpose financial reports instead. As part of its special purpose financial reports, the entity will be required to provide additional disclosures, including the following: * why the entity is preparing special purpose financial reports * the material accounting policies applied in the special purpose financial reports and details on any changes in these policies, including the nature and reasons for the change and its financial statement impact * whether the special purpose financial reports comply with the consolidation and/or equity accounting requirements in Australian Accounting Standards where the entity has interest in other entities * where a material accounting policy applied in the special purpose financial reports does not comply with all recognition and measurement requirements in Australian Accounting Standards, an indication of how it does not comply, and * a statement as to whether the special purpose financial reports, overall, comply with all recognition and measurement requirements in Australian Accounting Standards (AASB 1054, Para. 9A)." ### Two Tiers of General Purpose Financial Reporting The Australian Accounting Standards Board has a two-tier model of general purpose financial reporting. The two tiers are as follows (refer AASB 1053, Para. 7): (a) Tier 1 *Australian Accounting Standards*; and (b) Tier 2 *Australian Accounting Standards Simplified Disclosures*. **Tier 1** general purpose financial reporting means an entity must satisfy all the recognition, measurement, and disclosure requirements in Australian Accounting Standards, which incorporates IFRSs (AASB 1053, Para. 8). Tier 1 applies to for-profit private sector entities with public accountability that are required by legislation to prepare financial statements that comply with Australian Accounting Standards, and Australian Governments either at the federal, state, territory or local level (AASB 1053, Para. 11). A for-profit private sector entity has public accountability if: * it has debt or equity instruments (i.e. securities) that are traded in a public market or it is in the process of issuing securities for such trading; or * "it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses", for example banks, insurance companies, securities brokers/dealers and mutual funds (AASB 1053, Appendix A). **Tier 2** general purpose financial reporting means an entity must satisfy all the recognition and measurement requirements in Australian Accounting Standards but has substantially simplified disclosures relative to Tier 1 (AASB 1053, Para. 9). The disclosure requirements for Tier 2 entities are set out in a separate standard, AASB 1060 *General Purpose Financial Statements - Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities*. As such, Tier 2 entities complying with the simplified disclosure requirements of AASB 1060 are exempt from the disclosure requirements specified within other Australian Accounting Standards. AASB 1060 is available to a wide range of entities that are required to prepare general purpose financial statements in both the private and public sectors (refer AASB 1053, Para. 13): (a) for-profit private sector entities that do not have public accountability; (b) not-for-profit private sector entities; and (c) public sector entities ... other than the Australian Government and State, Territory and Local Governments. Notwithstanding that Tier 2 is available to an entity required to prepare a general purpose financial report, it may still elect to apply Tier 1 and the full requirements of Australian Accounting Standards. **Refer to Note 1 "Summary of significant accounting policies" in the notes to financial statements of Techworks Ltd (see appendix). What type of financial statements have been prepared by Techworks Ltd? What factors might explain the type of financial statements that have been prepared?** ### External Reporting Board of New Zealand The External Reporting Board (XRB) of New Zealand also has a multi-tiered accounting standards framework in which the nature of the entity determines the level of disclosure and compliance requirements. Entities are categorised as either "for-profit" entities or "public-benefit" (not-for-profit) entities. Then entities are subclassified based on whether they are publicly accountable for their financial reports, and/or their size. This multi-tiered approach is summarized in Table 1.1: **Table 1.1: External Reporting Board Accounting Standards Framework - tiered approach** | Tier | For-profit Entities | Public Benefit Entities (PBEs) | |---|---|---| | 1 | Publicly accountable (as defined below); or public sector entities with total expenses >$30 million (termed "large") | Publicly accountable (as defined below); or PBEs with total expenses > $30 million (termed "large") | | 2 | Non-publicly accountable and non-large for-profit public sector entities which elect to be in Tier 2 | Not publicly accountable, not large, have total expenses < $30 million but > $2 million, which elect to be in Tier 2 | | 3 | Non-publicly accountable with total expenses < $2 million which elect to be in Tier 3 | Non-publicly accountable with total expenses < $2 million which elect to be in Tier 3 | | 4 | Entities allowed by law to use cash accounting which elect to be in Tier 4 | Entities allowed by law to use cash accounting which elect to be in Tier 4 | **Source: External Reporting Board (New Zealand) 2019, “Accounting Standards Framework,” accessed July 2022, https://www.xrb.govt.nz/standards/accounting-standards/accounting-standards-framework.** The definition of public accountability is similar to that provided above, except it also includes an entity deemed to have public accountability by the Financial Markets Authority under s. 461K and s. 461L(1)(a) of the Financial Markets Conduct Act 2013. ### Other Jurisdictions In other jurisdictions, the appropriate legislation includes the Singapore Companies Act (Chapter 50) 2006 (Singapore) and the Companies Act 2016 (Malaysia). This legislation will specify the content of the financial statements, the regularity of reporting and the basis on which the financial statements are prepared. Not all entities from jurisdictions that adopted IFRSs are required to prepare financial reports in accordance with the IFRSs. An entity may use alternative bases for accounting if this is required or permitted. For example, in Malaysia, eligible private entities comply with the Malaysian Private Entities Reporting Standard (MPERS) rather than with the IFRSs. Alternatively, an entity that is not required to report separately in accordance with the IFRSs may still need to provide information that must comply with the IFRSs to a parent entity for inclusion in a set of consolidated financial statements. This module and this subject will only address an entity's obligations under the IFRSs. ## International Initiatives to Decrease Financial Reporting Complexity An ongoing criticism of financial reporting is the complexity of financial reports. Improving the communication effectiveness of disclosures in financial statements is a current focus of many accounting setters, including the IASB, and there are a growing number of initiatives to help combat the issue, including: - Reducing differences in reporting standards among countries - Reducing reporting requirements of small and medium-sized entities - Catering to the information needs of multiple stakeholders - Improving the content and structure of the primary financial statements - Clarifying disclosure requirements and improving the usefulness of disclosures - Improving understanding of the existing requirements and helping entities make better materiality judgements - Considering how management commentary outside the financial statements could better complement and support the financial statements - Improving communication between preparers and users by enabling information to be delivered in an electronic format. IASB and other standard setters across the world made significant progress on the first three initiatives listed - the following section provides further details. ### Reducing Differences in Reporting Standards Among Countries Overall, the complexity in financial reporting has decreased due to increased acceptance of the IFRSs in many parts of the world. More than 140 jurisdictions worldwide require the use of the IFRSs for their publicly listed companies. The global acceptance of the IFRSs led to the commitment of the US Financial Accounting Standards Board (FASB) to work with the IASB to explore the possibilities of the convergence of US *Generally Accepted Accounting Principles* (GAAP) with the IFRSs. In 2007, the US Securities and Exchange Commission (SEC) eliminated the requirement for foreign companies registered with the US SEC to reconcile their IFRS-based financial statements to US GAAP. However, the US SEC does not permit domestic issuers to adopt the IFRSs (SEC 2007). ### Reducing Reporting Requirements of Small and Medium-sized Entities The complexity of the full IFRSs led the IASB and accounting standards-setting bodies to specify less complex standards for some entities. Examples of such reductions are as follows: **International Accounting Standards Board** To reduce the complexity of following the full IFRSs for small and medium-sized entities (SMEs), the IASB has introduced the *IFRS for SMEs*. The IFRS for SMEs is described as being less complex than the "full" IFRSs because: - Topics not relevant to SMEs, such as earnings per share, interim financial reporting, and segment reporting, are omitted; - Many principles for recognizing and measuring assets, liabilities, income, and expenses in the full IFRSs are simplified - for example, amortising goodwill; expensing all borrowings and development costs; allowing the cost model for associates and jointly controlled entities; and providing undue cost or effort exemptions for specific requirements; - Significantly fewer disclosures are required (about a 90 per cent reduction); - The standards are written in clear, easily understandable language (IFRS Foundation 2022c). The IFRS for SMEs was first issued in 2009 and amended in 2015 following a comprehensive review. At the time of writing, the IASB was undertaking its second comprehensive review to determine how the IFRS for SMEs should be amended to take account of new IFRSs and amendments to existing IFRSs. The IASB is preparing an exposure draft outlining the proposed amendments to the IFRS for SMEs which may be released after publication (IFRS Foundation 2022d). **Australian Accounting Standards Board** The AASB has not adopted *IFRS for SMEs* to date, but AASB 1060 is based on the disclosure requirements of *IFRS for SMEs*. In Australia, for-profit private sector entities may prepare special purpose financial reports rather than GPFSs if legislation or their constituting or other document does not require them to prepare GPFSs. Special purpose financial statements (SPFSs) are prepared and presented in accordance with the specific information needs of the entity's financial statement users. A few selected entities can lodge SPFSs with ASIC. An entity that lodges SPFSs with the Australian Securities and Investments Commission (ASIC) must ensure that they comply with a minimum set of Australian Accounting Standards as follows: * AASB 101 Presentation of Financial Statements * AASB 107 Statement of Cash Flows * AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors * AASB 1048 Interpretation of Standards * AASB 1053 **Application of Tiers of Australian Accounting Standards** * AASB 1054 **Australian Additional Disclosures** Entities that lodge SPFSs with ASIC are also required to ensure that the financial statements give "a true and fair" view (s. 297 of the Corporations Act). In ASIC's opinion, SPFSs can only present a true and fair view if they apply all recognition and measurement requirements in Australian Accounting Standards (e.g. depreciation, tax-effect accounting, leases, inventories, employee benefits) (ASIC Regulatory Guide 85). ASIC's Regulatory Guide does not have any legal status. Whilst some entities that lodge SPFSs follow ASIC's advice, others do not. In practice, there are many large proprietary companies that choose to lodge SPFSs with ASIC based on the minimum standards approach listed in this section. ### Catering to the Information Needs of Multiple Stakeholders One aspect of the current complexity in financial reporting, which has attracted the attention of accounting standards-setting bodies worldwide, has resulted from the need to measure "performance" from multiple perspectives. This requirement cannot be met simply by the reporting of financial statements. A company's performance is a multifaceted measure. Therefore, there is a need for information such as the progress of the company in terms of strategy and plan - rather than financial measures such as profit, assets, and liabilities. Although the reporting of the strategy and plan is material to investors, lenders, and other stakeholders, there is no requirement to report this information in the IFRSs. The increase in the reporting of non-mandatory information in annual reports (relative to the mandated financial information) makes financial reporting seem like a mere compliance exercise rather than an exercise that communicates the information needs of multiple stakeholders. To address this concern, some of the present research projects in progress across the world are as follows: **International Accounting Standards Board** To assist entities to communicate their disclosures more effectively, the IASB engaged in a research project around a so-called "Disclosure Initiative" to develop better disclosure requirements in accounting standards, around accounting policies and in general. Following feedback from stakeholders used to inform the IASB's research, in March 2021 the IASB published an *Exposure Draft Disclosure Requirements in IFRS Standards - A Pilot Approach*, which sets out a proposed new approach to developing and drafting disclosure requirements in all standards starting with IAS 19 *Employee Benefits* and IFRS 13 *Fair Value Measurement* (IFRS Foundation 2022e). This project is part of the Board's wider series of initiatives under the theme "Better Communication in Financial Reporting" (IFRS Foundation 2022b). **Technology Advancements**