M1 Financial Reporting Notes PDF

M1 – The Context and Purpose of Financial Reporting Contents Content and Purpose of Financial Reporting..................................................................................................... 3 DEFINITION AND PURPOSE OF FINANCIAL REPORTING:...............................................

M1 – The Context and Purpose of Financial Reporting Contents Content and Purpose of Financial Reporting..................................................................................................... 3 DEFINITION AND PURPOSE OF FINANCIAL REPORTING:................................................................................ 3 Types of Businesses.................................................................................................................................... 3 Users of financial reports........................................................................................................................... 5 Main elements of financial statements...................................................................................................... 5 Conceptual framework of financial reporting............................................................................................ 6 REGULATORY FRAMEWORK:.......................................................................................................................... 7 CORPORATE GOVERNANCE:........................................................................................................................... 8 Users' and Stakeholders' Needs....................................................................................................................... 10 INTERNAL AND EXTERNAL STAKEHOLDERS:................................................................................................ 10 1) Internal users........................................................................................................................................ 10 2) External users....................................................................................................................................... 10 The Main Elements of Financial Reports......................................................................................................... 12 STATEMENT OF FINANCIAL POSITION.......................................................................................................... 12 STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME................................................. 12 STATEMENT OF CHANGES IN EQUITY.......................................................................................................... 12 STATEMENT OF CASH FLOWS...................................................................................................................... 12 NOTES........................................................................................................................................................... 13 ELEMENTS OF THE STATEMENT OF FINANCIAL POSITION........................................................................... 13 ELEMENTS OF STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME......................... 15 The Regulatory Framework.............................................................................................................................. 16 1. THE INTERNATIONAL FINANCIAL REPORTING STANDARDS FOUNDATION............................................. 16 2. THE INTERNATIONAL ACCOUNTING STANDARDS BOARD....................................................................... 16 3. THE IFRS ADVISORY COUNCIL.................................................................................................................. 17 4. THE IFRS INTERPRETATIONS COMMITTEE............................................................................................... 17 THE ROLE OF INTERNATIONAL FINANCIAL REPORTING STANDARDS.......................................................... 18 1  INTERNATIONAL SUSTAINABILITY STANDARDS BOARD (ISSB).................................................................... 18 Duties and Responsibilities of those Charged with Governance..................................................................... 20 CORPORATE GOVERNANCE.......................................................................................................................... 20 PREPARATION OF THE FINANCIAL STATEMENTS......................................................................................... 20 THE DUTIES AND RESPONSIBILITIES OF DIRECTORS.................................................................................... 21 WHEN PREPARING THE FINANCIAL STATEMENTS....................................................................................... 21 THE DUTIES AND RESPONSIBILITIES OF AUDITORS...................................................................................... 22 2 Content and Purpose of Financial Reporting DEFINITION AND PURPOSE OF FINANCIAL REPORTING: Financial reports are produced for external use to record and summarise a company's financial performance during the previous accounting period. Types of Businesses There are three main types of businesses: 1. Sole trader – a single person trading on their own. They may have employees, but the sole trader runs and owns the business. A sole trader describes any business owned and controlled by one person. Although they may employ workers. Sole traders don't have a separate legal existence from their owners. As a result, the owners are personally liable for the firm's debts, called unlimited liability. The advantages of a sole trader are: 1) Easy to set up; 2) Small amount of capital needs to be invested; 3) Low wage bill; 4) Easier to keep overall control. The disadvantages of a sole trader are: 1) No one to share the responsibility; 2) Long hours; 3) Limited personal capital; 4) Risk of unlimited liability. 2. Partnership – two or more sole traders working together to run the business. The partners will share 3. in the profits and losses of the business, and they are all jointly liable for debts within the business. A partnership is a relationship which exists between partners carrying on a business together to profit. Partnerships can be created orally, but partners often draw up an agreement in writing called Articles of Partnership, Partnership agreement or Partnership Deed. The agreement can be changed at any time if all the partners agree. Some common features of partnership (from a legal perspective include): It can vary in size and formality Typically it is an informal association Many family businesses are a partnership in nature 3  This arrangement arises from a mutual consent All partners must consent to introduce a new partner This is not a separate entity and is not distinct from partners Partners are liable for loss The firm cannot acquire rights nor incur obligations, or property It is relatively less regulated as compared to companies All partners must consent to business decisions The limited liability of the partners means that they share joint responsibility for the entire debt and other liabilities. Unlimited liability is not capped at a maximum amount and exists regardless of the amount of investment each owner has personally made. If the business cannot meet financial obligations or settle outstanding liabilities, the owner's assets can be seized to satisfy the debts. Any change in a firm's membership, whether the withdrawal of a partner or the admission of a new partner, "destroys the firm's identity". The old firm is dissolved, and the new firm is created. This involves a contractual agreement between the partners of the old firm and the new firm. 4. Limited company – in this instance, the owners of the company, called shareholders, are not the people managing the company. The directors will manage the company on behalf of the shareholders. There are various types of companies which can be registered in terms of different liabilities: Formed without liability (unlimited companies) - Such companies receive all the benefits which flow from incorporation except limited liability. Limited by Guarantee (charities and education bodies) - It limits the members’ liability to an agreed amount. The sum guaranteed is usually nominal, so no real risk is involved. Limited by Shares (charities and education bodies) - The effect limits liability to the amount remaining unpaid on shares. If the shareholder has paid the full nominal value of shares, that is the end of responsibility for company debts. Limited liability is a type that does not exceed the amount invested in a limited partnership or limited liability company. It is one of the most significant advantages of investing in publicly listed companies. Shareholders can participate wholly in the company's growth while liability is restricted to the amount invested. In a limited partnership, the limited partners have limited liability, while the general partner has unlimited liability. The limited liability feature protects the investors' or partners' personal assets while allowing them to invest. The principle of separate legal personality states that a corporation has separate legal personality, rights and obligations distinct from those of its shareholders. 4 Users of financial reports A stakeholder is anyone interested in the company, so we need to think not only about the shareholders but also employees, customers, suppliers, investors, the company directors, the government and the general public. The key stakeholders are: 1. Shareholders: They are interested in the profit being generated, the capital growth being seen, and the dividends being paid out to them. 2. Employees: They will be interested in job security and any possibility of pay raises or healthy bonuses. 3. Customers: They will check that the company will still be trading in the future, ensuring that they can still buy from this company and do not risk losing a supplier. 4. Suppliers: They will be interested in ensuring that the company can pay any outstanding debts and will continue to buy from them. 5. Investors: They will check to see that future interest payments and capital repayments are assured. They will also examine the accounts in detail if there is a request for further investment in the company. 6. Directors: Like employees, they will be focusing on job security and potential bonus. 7. Government: The government will look at the company's financial reports to ensure they pay the proper taxes. 8. General public: They are interested in community involvement, charitable giving and any environmental impact of the company's work. Main elements of financial statements There are four main statements plus the notes to the accounts: 1. The statement of financial position (SFP) – reports on the company’s asset, liability and equity figures at the end of the reporting period; 2. The statement of changes in equity (SOCIE) – shows how the figures reported within the equity section of the SFP have changed from the end of the last reporting period to the end of the current reporting period; 3. The statement of profit or loss and other comprehensive income (P&L and OCI) – reports on the income and expenses generated during the reporting period; 4. The statement of cash flows – shows how cash has been utilised or generated during the reporting period. 5 Conceptual framework of financial reporting The conceptual framework for financial reporting is made up of four main areas: 1. Objectives: Key objective of financial reporting is to enable the readers of the accounts to make decisions. 2. Qualitative characteristics: The qualitative characteristics of financial information include: Fundamental characteristics Other characteristics _ Relevance _ Comparability _ Faithful representation _ Verifiability _ Timeliness _ Understandability 3. Fundamental accounting concepts: When preparing financial statements, there are several fundamental accounting concepts: a) The business entity concept tells us that the financial accounting information being reported must only relate to the activities of the business and not those of the owner. b) The accruals concept – means that all income and expenses are recorded when earned or incurred rather than when cash exchanges hands. c) The going concern assumption – means that the accounts are prepared to assume the business will continue to trade for the foreseeable future. d) Substance over form – means that we need to look at the substance or nature of the transaction as opposed to its legal form. e) The consistency concept – means that we need to be consistent with our accounting treatment from one period to the next to ensure that the accounts are comparable year on year. 6 4. Definition, recognition and measurement: There are four types of figures we will need to report on: Item Definition Recognition and measurement A resource owned by the business Assets → that Gives rise to future economic benefits. A present obligation as a result of a We should never overestimate past assets an event which will lead to the or underestimate liabilities Liabilities → economic (Prudence benefit passing from the business concept). to Another party. Income → Any increase in economic benefit (revenue and other gains). Income and expenses must be recognised in the accounting periods Decreases in economic benefits to which they relate rather than on during the accounting period (losses, Expenses → Cash basis (Accruals concept). impairment). NOTE: As a general rule, assets, liabilities, income and expenses are only recorded and reported when they can be measured reliably. REGULATORY FRAMEWORK: To ensure that all company accounts are prepared on the same basis and therefore achieve the objective of financial reporting (to allow the readers of the accounts to make decisions), accounting standards need to be followed. Accounting standards are being assessed and developed constantly, and as new standards are developed, these are published and enforced by various regulatory bodies. The most recent accounting standards to be published are the International Financial Reporting Standards (IFRS), developed and published by the International Accounting Standards Board (IASB) under the watchful eye of the IFRS Foundation. The IFRS Foundation is the supervisory body of the IASB, and its job is to monitor these enforceable and global financial reporting standards and promote their use. When the IASB was set up, they adopted the International Accounting Standards (IASs), then current accounting standards. To help the members of the IFRS Foundation and the IASB do their job, there is also an IFRS Advisory Council assisting them in their roles. This board comprises a wide range of representatives from groups 7 affected by and interested in the IASB's work and meets three times a year to discuss the development and implementation of IFRSs. In short, the regulatory framework (comprising of the mentioned three regulatory bodies) can be summed up in the following diagram: The regulatory framework CORPORATE GOVERNANCE: Corporate governance is the system by which companies are directed and controlled. This means that there are mechanisms to monitor and ensure that the company's directors manage the company's resources for the benefit of the shareholders and in the interests of all other stakeholders. A key objective of a corporate governance framework is to improve performance and accountability, to generate long-term shareholder value. This objective is supported by ensuring that: − The management of the company is effective; − The directors are appraised and paid relatively; − The resources of the company are being used as effectively as possible; − There are adequate internal controls in place, such that the control at the top of the management chain passes through the company. 8 Financial statements are audited by an independent external party to provide reasonable assurance that the financial statements are an accurate and fair reflection of the company's financial position. 9 Users' and Stakeholders' Needs INTERNAL AND EXTERNAL STAKEHOLDERS: As you probably already know, financial statements are prepared for a wide range of users who can be grouped into two groups: 1) Internal users a) Investors. Their main concern is their investment and its security. Reports prepared for them should show profitability and growth so they can appraise and value their investment; b) Owners. Often they are also the investors, so they have similar needs. Owners will also need the financial information for their tax returns; c) Managers. They should make decisions on the operations or observe any trends in the business. Management accounts break down the information by product or geographical location to see costs, profitability, etc.; d) Employees. They need the financial data to know if the company is stable and will continue and to see if it will be able to maintain employee pensions and salaries. Employee representatives such as trade unions will want to look at the profitability and use them to negotiate better wages and working conditions. 2) External users a) Future and potential investors. They need the information to decide whether they should invest their money in this company or another. They want to know the current and future returns and risks to an investment they make. Most of the information they need can be found in the financial statements or in a prospectus the company would prepare to attract investors; b) Financial institutions. Their main concern is the ability to repay loans for existing loans or ones the company applies for. They will want to look at current and previous profitability, and they need the information to decide if loans should be approved and if the company can pay them back; c) Suppliers. They need to know the ability of the company to pay its debts as they fall due. The bigger the client is for the supplier, the more critical their financial statements are. Suppliers will use a company's financial information to decide what credit terms to give if goods that were sold on credit will be paid and what priority their debt will have among the company's other creditors; d) Consumers. They want assurance over the stability of a company, particularly for large purchases like software systems. If an investment is made in software, the consumer would want to be sure that they can contact the company in the future for support and upgrades; 10 e) Government and other state agencies. They want to know a company's tax bill and will use their financial statements to calculate it. State bodies will also use the financial statements to ensure the organisation is compliant with other regulations and if they are eligible for grants; f) General public. It uses a company’s financial data to see the impact on the local economy. Knowing that there is a profitable local company is good for local confidence and indicates the economy’s health; g) Special interest groups (e.g., Greenpeace). They use financial information to check the company's impact on social and environmental issues. 11 The Main Elements of Financial Reports A complete set of financial statements has the following: A statement of financial position at the end of the period; A statement of profit or loss and other comprehensive income for the period; A statement of changes in equity for the period; A statement of cash flows (cash flow statement) for the period; and Notes to the accounts. STATEMENT OF FINANCIAL POSITION The statement of financial position is a statement of all the assets and liabilities of a business at a specific date. It is a picture of the organisation's position on a particular date. The statement of financial position is also called the: Balance sheet; or Statement of financial condition. STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME The statement of profit or loss and other comprehensive income records the income received and expenses incurred over a certain period. When the income is higher than expenditure, then the company is profitable. The statement of profit or loss and other comprehensive income is also known as: Income statement; Statement of comprehensive income; and Profit and loss. STATEMENT OF CHANGES IN EQUITY The statement of changes in equity presents an entity’s profit or loss for a period, items of income and expense recognised in other comprehensive income for the period, the effects of changes in accounting policies and corrections of errors recognised in the period, and the amounts of investments by, and dividends and other distributions too, equity investors during the period. STATEMENT OF CASH FLOWS The statement of cash flows for the period is the financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents. It breaks down this analysis into operating, investing and financing activities. It is also known as a cash flow statement. 12 NOTES Notes to the accounts provide additional information about the company's operations and financial position. They are an integral part of the financial statements. The full disclosure principle requires the notes. ELEMENTS OF THE STATEMENT OF FINANCIAL POSITION Following is a sample statement of financial position: STATEMENT OF FINANCIAL POSITION AS AT... STATEMENT OF FINANCIAL POSITION AS AT... ASSETS $ $ $ Non-current assets Cost Depreciation Property, plant and equipment x x x Total non-current assets x x x Current Assets x Inventories x Trade and other receivables x Prepayments x Cash x Total current assets x Total Assets x CAPITAL AND LIABILITIES Capital and reserves Capital brought forward x Profit or (loss) x Director's loans/Sole Traders Drawings x/(x) Capital carried forward x Non-current liabilities Long-term borrowings x Current liabilities Trade and other payables x Accrued expenses x Operating overdrafts x Total current liabilities x Total capital and liabilities x 13 The statement of financial position shows the breakdown of the assets and liabilities of a business. An asset is an economic resource controlled by an entity expected to have future economic benefits and is the result of a past financial transaction. In the statement of financial position, assets are divided into current and non-current. A non-current asset is an asset the business owns and will use for more than one year. It is not for resale— for example, a car or van. Non-current assets are depreciated on an annual basis. The depreciation rate reflects the annual usage of the asset. Current Assets are assets the company will benefit from for less than one year. In the statement of the financial position above, we see the current assets are inventories – these are expected to be sold within the year. A liability is a financial obligation that the company must pay at some time in the future. They are split into current and non-current liabilities. Current liabilities are amounts falling due within the year. In the statement of the financial position above, the company has trade payables, which are amounts owed to suppliers due for payment within the year. Accrued expenses are expenses incurred before the period end, but the invoice has not been received. Non-current liabilities fall due after one year, for example, long-term loans. The net assets in the statement of financial position equal the organisation's capital. Net assets are calculated as follows: (Non-current assets + current assets) – (non-current liabilities + current liabilities) The capital section represents the owner's interest in the business. This is also called net worth. Equity is the amount invested by an owner in a business. In a limited company, monies invested are usually shares, so share capital is also called equity capital. Capital brought forward from previous years is added to the current year’s profit or loss. Loans to or from the owners are added or deducted, respectively. 14 ELEMENTS OF STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME A BUSINESS INC STATEMENT OF PROFIT AND LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X7 $ Revenue X Cost of sales (X) Gross profit X Other expenses (X) Net profit/loss for the year X Other comprehensive income gains on buildings revaluation X Total comprehensive income for the year X Revenue, also known as turnover, is all sales made in the period, including those that haven't been paid for. Sales on credit are included in revenue, and the balance due to the company is shown under trade receivables in the statement of financial position. The cost of sales is the cost of the goods sold and includes all the costs linked with the production of the product. Gross profit is revenue less the cost of goods sold. Other expenses are expenses that do not go directly into producing the product or service but are business expenses. For example, in a chocolate shop, the cocoa would be included in the cost of sales, and the marketing expense would be included in other expenses. Other expenses are deducted from the gross profit to give the net profit. Other comprehensive income is where income from activities outside the normal activities of a business would go. It is income that doesn't appear in the profit and loss statement. It is often abbreviated to OCI. GROSS AND NET PROFIT MARGINS To compare gross and net profits, gross and net profit margins are used. Gross Profit Margin Net Profit Margin Gross Profit / Revenue x 100 Net Profit / Revenue x 100 These are expressed as percentages of revenue, and the higher the percentage, the better. Different companies and years can be compared, and the efficiency of converting revenues to profits is found. 15 The Regulatory Framework Users of financial statements use them to make crucial decisions, so it is essential that we can rely upon the rules that the financial statements are prepared by. The regulatory framework and the international financial standards were introduced due to this need for consistency. The central bodies involved in the setting of these standards are: The International Financial Reporting Standards Foundation; The International Accounting Standards Board; The IFRS Advisory Council; The IFRS Interpretations Committee. 1. THE INTERNATIONAL FINANCIAL REPORTING STANDARDS FOUNDATION The IFRS Foundation is the legal entity under which the International Accounting Standards Board (IASB) operates. 22 trustees govern the foundation, and its main objectives are: − To develop one set of financial reporting standards that are in the public’s interest; − To promote the use of these standards for a wide range of organisation types and sizes; and − To promote and facilitate the adoption of International Financial Reporting Standards (IFRSs) through the convergence of national accounting standards and IFRSs. 2. THE INTERNATIONAL ACCOUNTING STANDARDS BOARD The International Accounting Standards Board, or the IASB, is an independent, private-sector body that develops and approves sets of international financial reporting standards. International Financial Reporting Standards (IFRS Standards) is a single set of accounting standards that the IASB develops. The intention is that those standards should be capable of being applied on a globally consistent basis by investors and other users of financial statements with the ability to compare the financial performance of publicly listed companies on a like-for-like basis with their international peers. The goal of the IASB is to: − Raise the standard of financial reporting and harmonise accounting standards. − The IASB is responsible for all the technical matters of the IFRS Foundation. 16 3. THE IFRS ADVISORY COUNCIL The International Financial Reporting Standards Advisory Council is the formal advisory body to the International Accounting Standards Board (the IASB) and the trustees of the IFRS Foundation. It has a wide range of representatives from groups affected by and interested in the board's work. The Advisory Council acts as a sounding board for the International Accounting Standards Board and advises the IASB on its: − Technical agenda; − Project priorities; − Project issues related to the application and implementation of IFRSs; − Possible benefits and costs of specific proposals. The Advisory Council also provides advice on single projects, mainly looking at the practical application and implementation issues, including matters relating to existing standards that may need to be considered by the IFRS Interpretations Committee. Suppose the IASB ultimately takes a position on an issue different than the polled expression of the Advisory Council. In that case, the IASB gives the Advisory Council its reasons for coming to its position. 4. THE IFRS INTERPRETATIONS COMMITTEE The IFRS Interpretations Committee is the interpretative body for the IFRS Foundation. Its duty is to review widespread accounting issues arising within the context of current International Financial Reporting Standards (IFRSs) on a timely basis. The work of the Interpretations Committee is aimed at reaching an agreement on the appropriate accounting treatment (IFRIC Interpretations) and providing authoritative guidance on those issues. In developing interpretations, the Interpretations Committee works closely with similar national committees. The interpretations cover both: − Newly identified financial reporting issues not explicitly dealt with in IFRSs; − Issues where unsatisfactory or conflicting interpretations have developed or seem likely to develop in the absence of authoritative guidance. Their interpretations need to be approved by the IASB and have the same authority as a standard issued by the IASB. The Interpretations Committee has 14 voting members from various countries and professional backgrounds. The trustees of the IFRS Foundation appoint members. 17 THE ROLE OF INTERNATIONAL FINANCIAL REPORTING STANDARDS There is a level of subjectivity when preparing financial statements. By preparing accounts with IFRS, the level of subjectivity is controlled as the statements are prepared according to the assumptions of the standards. This allows greater comparability between companies. IFRSs have improved and harmonised financial reporting around the world. The IFRSs are used in the following ways: 1. As per national requirements, where the country has adopted the IFRS, financial statements must be presented according to IFRS. 2. Some countries will use the IFRS as the basis for all or some national requirements. 3. International and domestic regulatory authorities may insist that companies prepare their financial statements under IFRS, giving greater transparency and comparability. 4. Companies may adopt the standards as they are the highest financial reporting standard. GAAP GAAP = Generally Accepted Accounting Practices − These are a set of rules governing accounts preparation on a local level. − They vary by country and are usually set by local laws and statutory and stock exchange requirements. − These standards are being replaced or harmonised to be the same as IFRS in many countries. INTERNATIONAL SUSTAINABILITY STANDARDS BOARD (ISSB) The International Sustainability Standards Board (ISSB) was created by the IFRS Foundation in November 2021, with the main purpose to develop a worldwide standard for sustainability reporting. The main motivation for this was the growing interest in ESG (environmental, social, and governance) issues in the global capital and financial markets, and the need for a standardised reporting framework. The ISSB and the IASB, both are the standard-setting bodies under the umbrella of the IFRS Foundation. Where IASB is concerned with IFRS Accounting Standards for financial reporting, the ISSB is concerned with IFRS Sustainability Disclosure Standards. In simpler other words, ISSB does the same for sustainability disclosures, that the IASB has done for financial accounting. The IFRS Foundation states on their official website that ISSB has set out four key objectives: 1. to develop standards for a global baseline of sustainability disclosures; 2. to meet the information needs of investors; 18 3. to enable companies to provide comprehensive sustainability information to global capital markets; and 4. to facilitate interoperability with disclosures that are jurisdiction-specific and/or aimed at broader stakeholder groups. The ISSB is committed to delivering standards that are cost-effective, decision-useful and market informed. The standards are developed with efficiency in mind, helping companies to report what is needed globally to investors across markets globally. The standards are designed to provide the right information, in the right way, to support investor decision-making and facilitate international comparability to attract capital. A company can avoid double-reporting by applying the ISSB’s standards. When jurisdictional requirements build on the global baseline, companies are able to meet jurisdictional requirements while benefiting from the efficiency and comparability of the global baseline. 19 Duties and Responsibilities of those Charged with Governance CORPORATE GOVERNANCE Corporate governance is the system or process by which companies are directed and controlled. It is based on the principle that companies are accountable for their actions, and therefore broad-based systems of accountability need to be built into the government's structures of companies. Corporate governance has an external and internal sources. External sources are: − Laws − Mandatory and voluntary codes Internal corporate governance is external governance, so the laws and codes are complied with and integrated into the organisation's culture and values. The director is responsible for implementing and maintaining good corporate governance standards. They do this by actively putting systems in place and investigating and disciplining staff who don't comply. They must do this to ensure the company is adequately managed to protect the shareholders' interests. The shareholders own the company but appoint the directors to manage the company for them. Unfortunately, there is no shortage of corporate scandals where directors have acted in their interests and not with the shareholders. Over the years, many codes and standards have been issued and combined into "The Combined Code on Corporate Governance". All listed companies must report compliance with this code in their financial statements. PREPARATION OF THE FINANCIAL STATEMENTS Good corporate governance must be followed when preparing financial statements. The annual financial statements are the primary communication between the Board of Directors and the shareholders and must give the shareholders a clear picture of the company. For assurance over the company and the financial statements, the shareholders may have the company audited annually, if not already obliged to do so by law. 1. The financial statements must be prepared to give an accurate and fair view of the company's position. They must be prepared, using consistent and suitable accounting policies to reflect this. The requirement to produce financial statements that are true and fair is so essential that it is usually included in company legislation. Systems must be implemented to ensure that the financial statements reflect this. 20 2. All the business's principal risks must be assessed and shown what actions are being taken to reduce them. 3. All critical issues must be disclosed in the accounts. If not in the main body, they must be included in the notes. 4. The financial statements should assess the ability of the company to continue to exist. Its ability to meet its liabilities considering its current position and the risks the company faces. The financial statements must also state that if they are prepared on a going concern basis, they are prepared on the assumption that the company will continue. THE DUTIES AND RESPONSIBILITIES OF DIRECTORS The director's role is: To define the purpose of the company; To define the values by which the company will perform its daily duties; To identify the stakeholders relevant to the company; To develop a strategy combining these factors; To ensure the implementation of this strategy. As you can see, their role is significant. And they have many duties and responsibilities, such as: Complying with the company’s constitution; To act in the employee's best interests; To act in a way that is most likely to promote the success of a company; To exercise reasonable care, skill and due diligence; To exercise their independent judgement; To declare any personal interests in transactions; To avoid conflicts of interest. This is not an exhaustive list of directors’ duties. WHEN PREPARING THE FINANCIAL STATEMENTS The directors are responsible for the following: − Keeping proper accounting records; − Preparing financial statements for each financial year following the applicable reporting Financial Reporting Framework; − These financial statements must fairly present the activities of the business; 21  − The directors must establish and maintain a system of internal controls that ensures the financial statements are free from material error. These systems should also prevent and detect error and fraud; − The directors are also responsible for filing the company's financial statements and other returns with the relevant authorities, such as the tax collectors, on a timely basis. THE DUTIES AND RESPONSIBILITIES OF AUDITORS Auditors may test the financial statements to ensure they are correct on the shareholders' behalf. This is called an audit. The auditor gives an opinion to the shareholders on whether the statements comply with the financial reporting framework and if they give a true and fair view of the financial statements. The auditor must: − Be independent - so they must work independently of the directors and shareholders; − Be objective - so have no personal interest in the outcome of the audit; − Acting with integrity means being honest and truthful and dealing with all parties fairly. Suppose anything affects an auditor from being independent, objective or acting with integrity. In that case, it is the auditor's duty and responsibility to avoid such conflicts, even going as far as refusing the engagement and making the shareholders aware of the reasons. Auditors are external to the company. However, an audit committee may be formed. This committee should consist of independent non-executive directors, with at least one individual having expertise in financial management. The Audit Committee is responsible for the following: − Oversight of internal controls; approval of financial statements and other significant documents before the board's agreement. − Liaising with external auditors. − High level of compliance matters. − And reporting to the shareholders. Sometimes the committee may carry out investigations and deal with issues reported by whistleblowers. Not every company will have a specific audit committee. In these cases, the responsibilities lie with the board of directors. 22