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LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

● describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation;

● describe roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards, and describe the role of the International Organization of Securities Commissions;

● describe the status of global convergence of accounting standards and ongoing barriers to developing one universally accepted set of financial reporting standards;

● describe the International Accounting Standards Board's conceptual framework, including the objective and qualitative characteristics of financial statements, required reporting elements, and constraints and assumptions in preparing financial statements;

● describe general requirements for financial statements under International Financial Reporting Standards (IFRS);

● compare key concepts of financial reporting standards under IFRS and US generally accepted accounting principles (US GAAP) reporting systems;

● identify characteristics of a coherent financial reporting framework and the barriers to creating such a framework;

● describe implications for financial analysis of differing financial reporting systems and the importance of monitoring developments in financial reporting standards;

● analyze company disclosures of significant accounting policies.

SUMMARY OVERVIEW

● The Objective of Financial Reporting:

● The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling, or holding equity and debt instruments, and providing or settling loans and other forms of credit.1

● Financial reporting requires policy choices and estimates. These choices and estimates require judgment, which can vary from one preparer to the next. Accordingly, standards are needed to ensure increased consistency in these judgments.

● Financial Reporting Standard-Setting Bodies and Regulatory Authorities: Private sector standard-setting bodies and regulatory authorities play significant but different roles in the standard-setting process. In general, standard-setting bodies make the rules, and regulatory authorities enforce the rules. However, regulators typically retain legal authority to establish financial reporting standards in their jurisdiction.

● Convergence of Global Financial Reporting Standards: The IASB and FASB, along with other standard setters, are working to achieve convergence of financial reporting standards. Many countries have adopted or permit the use of IFRS, have indicated that they will adopt IFRS in the future, or have indicated that they are working on convergence with IFRS. Listed companies in many countries are adopting IFRS. Barriers and challenges to full convergence still exist.

● The IFRS Framework: The IFRS Framework sets forth the concepts that underlie the preparation and presentation of financial statements for external users, provides further guidance on the elements from which financial statements are constructed, and discusses concepts of capital and capital maintenance.

● The objective of fair presentation of useful information is the center of the Conceptual Framework (2010). The qualitative characteristics of useful information include fundamental and enhancing characteristics. Information must exhibit the fundamental characteristics of relevance and faithful representation to be useful. The enhancing characteristics identified are comparability, verifiability, timeliness, and understandability.

● The IFRS Framework identifies the following elements of financial statements: assets, liabilities, equity, income, expenses, and capital maintenance adjustments.

● The Conceptual Framework (2010) is constructed based on the underlying assumptions of accrual basis and going concern and acknowledges the inherent constraint of benefit versus cost.

● IFRS Financial Statements: IAS No. 1 prescribes that a complete set of financial statements includes a statement of financial position (balance sheet), a statement of comprehensive income (either two statements – one for net income and one for comprehensive income – or a single statement combining both net income and comprehensive income), a statement of changes in equity, a cash flow statement, and notes. The notes include a summary of significant accounting policies and other explanatory information.

● Financial statements need to reflect certain basic features: fair presentation, going concern, accrual basis, materiality and aggregation, no offsetting, and consistency.

● Financial statements must be prepared at least annually and must include comparative information from the previous period.

● Financial statements must follow certain presentation requirements including a classified balance sheet, minimum information on the face of the financial statements and in the notes.

● Characteristics of a Coherent Financial Reporting Framework: Effective frameworks share three characteristics: transparency, comprehensiveness, and consistency. Effective standards can, however, differ on appropriate valuation bases, the basis for standard setting (principle or rules based), and resolution of conflicts between balance sheet and income statement focus.

● Comparison of IFRS with Alternative Reporting Systems: A significant number of the world's listed companies report under either IFRS or US GAAP.

● Although these standards are moving toward convergence, there are still significant differences in the framework and individual standards.

● In most cases, a user of financial statements will lack the information necessary to make specific adjustments required to achieve comparability between companies that use IFRS and companies that use US GAAP. Instead, an analyst must maintain general caution in interpreting comparative financial measures produced under different accounting standards and monitor significant developments in financial reporting standards.

● Monitoring Developments: Analysts can remain aware of ongoing developments in financial reporting by monitoring three areas: new products or types of transactions; actions of standard setters, regulators, and other groups; and company disclosures regarding critical accounting policies and estimates.

PROBLEMS

1. Which of the following is most likely not an objective of financial statements?

A. To provide information about the performance of an entity.

B. To provide information about the financial position of an entity.

C. To provide information about the users of an entity's financial statements.

2. International financial reporting standards are currently developed by which entity?

A. The IFRS Foundation.

B. The International Accounting Standards Board.

C. The International Organization of Securities Commissions.

3. US generally accepted accounting principles are currently developed by which entity?

A. The Securities and Exchange Commission.

B. The Financial Accounting Standards Board.

C. The Public Company Accounting Oversight Board.

4. Which of the following statements about desirable attributes of accounting standards boards is most accurate? Accounting standards boards should:

A. concede to political pressures.

B. be guided by a well articulated framework.

C. be adequately funded by companies to which the standards apply.

5. A core objective of the International Organization of Securities Commissions is to:

A. eliminate systematic risk.

B. protect users of financial statements.

C. ensure that markets are fair, efficient, and transparent.

6. According to the Conceptual Framework for Financial Reporting (2010), which of the following is not an enhancing qualitative characteristic of information in financial statements?

A. Accuracy.

B. Timeliness.

C. Comparability.

7. Which of the following is not a constraint on the financial statements according to the Conceptual Framework (2010)?

A. Understandability.

B. Benefit versus cost.

C. Balancing of qualitative characteristics.

8. The assumption that an entity will continue to operate for the foreseeable future is called:

A. accrual basis.

B. comparability.

C. going concern.

9. The assumption that the effects of transactions and other events are recognized when they occur, not when the cash flows occur, is called:

A. relevance.

B. accrual basis.

C. going concern.

10. Neutrality of information in the financial statements most closely contributes to which qualitative characteristic?

A. Relevance.

B. Understandability.

C. Faithful representation.

11. Valuing assets at the amount of cash or equivalents paid or the fair value of the consideration given to acquire them at the time of acquisition most closely describes which measurement of financial statement elements?

A. Current cost.

B. Historical cost.

C. Realizable value.

12. The valuation technique under which assets are recorded at the amount that would be received in an orderly disposal is:

A. current cost.

B. present value.

C. realizable value.

13. Which of the following is not a required financial statement according to IAS No. 1?

A. Statement of financial position.

B. Statement of changes in income.

C. Statement of comprehensive income.

14. Which of the following elements of financial statements is most closely related to measurement of performance?

A. Assets.

B. Expenses.

C. Liabilities.

15. Which of the following elements of financial statements is most closely related to measurement of financial position?

A. Equity.

B. Income.

C. Expenses.

16. Which of the following is not a characteristic of a coherent financial reporting framework?

A. Timeliness.

B. Consistency.

C. Transparency.

17. Which of the following is not a recognized approach to standard-setting?

A. A rules-based approach.

B. An asset/liability approach.

C. A principles-based approach.

18. Which of the following disclosures regarding new accounting standards provides the most meaningful information to an analyst?

A. The impact of adoption is discussed.

B. The standard will have no material impact.

C. Management is still evaluating the impact.

1

Conceptual Framework for Financial Reporting (2010), International Accounting Standards Board, 2010, Chapter 1, OB2.