10. The Regulatory Framework for Company Financial Statements

Question 1

Why are company financial statements prepared for external publication heavily regulated?

Answer 1

Company financial statements prepared for external publication are extensively regulated to protect investors who use information to make economic decisions, especially when comparing different companies.

Published financial statements are therefore prepared on the same basis by all companies so investors can make meaningful comparisons.

Question 2

In terms of financial statements, to what are rules and regulations applied to? (3)

Answer 2

Rules and regulations are applied to:
1. Content: What information the financial statements should contain, and what supporting information should go with them
2. Accounting concepts: how figures should be prepared
3. Presentation: how the financial statements should be presented

Question 3

What are the main sources of accounting regulations? (2)

Answer 3

The main sources of accounting regulations for companies are:
1. Accounting standards (IFRS Accounting Standards); and
2. Legislation, in particular the Companies Act 2006.

Question 4

What legislation/regulation covers the format of financial statements?

Answer 4

The formats of financial statements for unlisted companies under UK GAAP are specified by the Companies Act 2006.

Question 5

Why does IAS 1 include formats?

Answer 5

IAS 1 formats provide the minimum required presentation and disclosure requirements for company financial statements. The purpose of setting out formats for a statement of profit or loss and statement of financial position is to make it easier for the users of financial statements:

1. To find the items they are particularly interested in: companies are prevented from using complex layouts and formats that make the financial statements more difficult to understand.
2. To make comparisons of the results of different companies, or between the results of the same company from one reporting period to the next.

Question 6

Why does IAS 1 require comparative figures for the previous reporting period to be shown?

Answer 6

IAS 1 requires comparative figures for the previous reporting period to be shown, as well as the figures for the reporting period being reported to allow users to make comparisons between the results from one reporting period to the next.

Question 7

What two key pieces of information must be included in both the statement of financial position and the statement of profit or loss?

Answer 7

1. The name of the company
2. The date of the statement of financial position/reporting period covered - financial statements should not normally cover reporting periods longer than 12 months.

Question 8

What is the measurement basis and where should it be disclosed in the financial statements?

Answer 8

In the accounting policies note to the financial statements, the entity must disclose the measurement basis used in the their preparation (historical cost or net realisable value, for instance), and other accounting policies used that are relevant to an understanding of the financial statements.

Question 9

What is operating profit?

Answer 9

Operating profit is calculated as gross profit less distribution costs, administrative expenses and any other operating expenses.

Question 10

What is the UK GAAP requirement for changes of accounting policies?

Answer 10

The requirements of FRS 102 are the same as the IAS 8 requirements covered in ‘Accounting’.

Question 11

What does IAS 8 prescribe?

Answer 11

IAS 8 prescribes the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of errors.

Question 12

What are accounting policies?

Answer 12

Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting the financial statements’ (IAS 8: para. 5). The decision to value inventories using the first in, first out method, as opposed to the average cost method, is an example of an accounting policy choice.

Question 13

What is an accounting estimate? Give examples. (5)

Answer 13

Accounting estimates are judgements or assumptions used in applying an accounting policy when, because of estimation uncertainty, an item in financial statements cannot be measured with precision.

Give examples of areas that may require the use of accounting estimates:
1. Allowance for receivables
2. Inventory obsolescence
3. The fair value of assets and liabilities
4. The useful life of depreciable assets
5. Warranty obligations

Question 14

How does the application of IAS 8 enhance the usefulness of financial statements? (4)

Answer 14

The application of IAS 8 enhances the usefulness of the financial statements by ensuring that:
1. Information is available about the accounting policies adopted by different entities
2. Different entities adopt a common approach to the distinction between a change in accounting policy and a change in an accounting estimate
3. The scope for accounting policy change is constrained
4. Changes in accounting policies, changes in accounting estimates and corrections of errors are dealt with in a comparable manner by different entities

Question 15

What ethical values does the regulatory framework need to be underpinned by? (4)

Answer 15

The overall regulatory framework within a country or market can be very complex and needs to be underpinned by ethical values.

The process needs to be:
1. Honest and truthful
2. Transparent and adaptable
3. Legally complaint
4. Consistent