Book 2: Chpater 17 Flashcards
According to the IASB’s conceptual framework for financial reporting what is the objective of financial reporting?
To provide information about the firm to current and potential investors and creditors to help them with their decisions about investing or lending to the firm
What is the conceptual framework for financial reporting used in?
The development of accounting standards
Why are financial reporting standards needed?
To provide consistency by narrowing the range of acceptable financial reports (think of the complexity of possible transactions and the estimates and assumptions a firm must make when presenting its performance)
What ensures that transactions are reported by firms similarly?
Reporting standards
Why must reporting standards remain flexible?
To allow discretion to management to properly describe the economics of the firm
What is the relationship between the design of financial reporting and valuation?
Financial reporting wasn’t designed specifically for valuation purposes but it does provide important inputs for it!
What is a standard setting body?
A professional organisation of accountants and auditors that establishes financial reporting standards
What is a regulatory authority?
Government agencies that have the legal authority to enforce compliance with financial reporting standards
Who are the two primary standard-setting bodies?
The financial accounting standards board (FASB) (US) and the international accounting standards board (IASB) (outside the US)
What does the FASB set?
Generally accepted accounting principles (GAAP)
What does the IASB establish?
International financial reporting standards (IFRS)
True or false, there are no other national standard-setting bodies other than the FASB and IASB?
False
What are some of the older IASB standards referred to as?
International accounting standards (IAS)
Name the regulatory authorities in the US and the UK established by their respective national governments
Securities and exchange commission (SEC) and the financial conduct authority (FCA)
What do most national authorities belong to?
The international organisation of securities commissions (IOSCO)
What % of the world’s financial markets does the international organisation of securities commissions (IOSCO) regulate?
95%
Is IOSCO a regulatory body?
No but its members work together to make national regulation and enforcement more uniform across the world
List the SEC’s requirements for financial reporting by US companies
Form S-1, form 10-K, form 10-Q, form DEF-14A, form 8-K, form 144, forms 3,4 and 5
Which act does the SEC have the responsibility of enforcing?
The Sarbanes-Oxley Act of 2002
What does the Sarbanes-Oxley Act of 2002 entail?
1) prohibits a company’s external auditor form providing additional paid services to the company (to avoid conflicts fo interest and to promote auditor independence)
2) executive management must certify that the financial statements are presented fairly and make a statement about the effectiveness of the company’s internal controls of financial reporting
3) the external auditor must provide a statement confirming the effectiveness of the company’s internal controls
What is a Form S-1?
Registration statement filed prior to the sale of new securities to the public, including audited financial statements, risk assessment,t underwriter identification and the estimated amount and use of the offering proceeds
What is a Form 10-K?
A required annual filing that includes info about the business and its management, audited financial statements and disclosures, disclosures about legal matters. Similar info so that in an annual report to shareholders but the annual report isn’t a substitute to the Form 10-K!
What are equivalent SEC forms to a Form 10-K for foreign issuers in US markets?
Form 40-F for Canadian companies
Form 20-F for other foreign issuers
What is a Form 10-Q?
US firms are required to file this form quarterly, with updated financial statements (but they don’t need to be audited) and disclosures about certain events eg significant legal proceedings or changes in accounting policy
What are non-US companies typically required to file semiannually that’s the equivalent of a Form 10-Q?
Form 6-K
What is a form DEF-14A?
When a firm prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, it files the statement with the SEC too (as a From DEF-14A)
What is a form 8-K?
Companies must file this form to disclose material events eg significant asset acquisitions and disposals, change in management or corporate governance or matters relating to accountants, financial statements or the markets in which its securities trade
What is a Form-144?
A company can issue securities to certain qualified buyers without registering the securities with the SEC, but it must notify the SEC that it intends to do so, with a Form-144
What are Forms 3, 4 and 5?
They involve the beneficial ownership of securities by a company’s officers and directors. Analysts use these forms to learn about the purchase and sales of company securities by corporate insiders
True or false, in the European Union each member state uses the same securities regulations and all countries are required to report using IFRS?
False, they all report using IFRS but each member state has its own securities regulations
Which 2 bodies did the European Commission set up and why?
1) the European Securities Commission which advises the European Commission on securities regulation issues
2) the European securities and market authority (ESMA) which coordinates regulation within the EU
Where are the ideas that the IASB (international accounting standards board) bases its standards on expressed?
In the conceptual framework for financial reporting
When did the IASB adopt the conceptual framework for financial reporting? And when was it revised?
In 2010, revised in 2018
What does the IASB framework detail?
The qualitative characteristics of financial statements and it specifies the required reporting elements
What is at the centre of the IASB conceptual framework?
The objective to provide financial information that is useful in making decisions about providing resources to an entity (these resource providers include investors, lenders and other creditors)
What do users of financial statements want to find out?
Information about the firm’s performance, financial position and cash flow
Which 2 fundamental characteristics make financial information useful?
Relevance and faithful representation
Define relevance of a financial statement
If the information can influence users’ economic decisions or affect their evaluations of past events or forecast future events.
Information should have predictive value, confirmatory value (confirm prior expectations) or both.
Materiality is also an aspect of relevance
Define faithful representation of a financial statement
The information contained is complete, neutral (no bias) and free from error
Which 4 characteristics enhance relevance and faithful representation?
Comparability, verifiability, timeliness and understandability
Define comparability
Financial statement presentation should be consistent among firms and across time periods
Define verifiability
Independent observers using the same methods obtain similar results
Define timeliness
Information is available to decision makers before the information is stale
Define understandability
Users with a basic knowledge of business and accounting and who make a reasonable effort to study the financial statements should be able to readily understand the information the statements present.
Useful information shouldn’t be omitted just because it’s complicated
What are the 5 required reporting elements of the conceptual framework for financial reporting?
Assets, liabilities, equity, income and expenses
What do assets, liabilities and owners’ equity get you to measure?
Financial position
What do income and expenses get you to measure?
Performance
How does the conceptual framework for financial reporting define assets?
Resources controlled as a result of past transactions that are expected to provide future economic benefits
How does the conceptual framework for financial reporting define liabilities?
Obligations as a result of past events that are expected to require an outflow of economic resources
How does the conceptual framework for financial reporting define equity
The owner’s residual interest in the assets after deducting the liabilities
How does the conceptual framework for financial reporting define income
An increase in economic benefits either increasing assets or decreasing liabilities in away that increases owner’s equity (but not including contributions by owners)
Includes revenues and gains
How does the conceptual framework for financial reporting define expenses?
A decrease in economic benefits either decreasing assets or increasing liabilities in a way that decreases owners’ equity (but not including distributions to owners)
Includes losses
What does the amount at which items are reported in the financial statement elements depend on?
Their measurement base
When should an item be recognised in its financial statement element?
If a future economic benefit (flowing to or from the firm) is probable pand the item’s value or cost can be measured reliably
Measurement bases include…
Historial cost
Amortised cost
Current cost
Net realizable value
Present value
Fair value
Define historical cost
The amount originally paid for the asset
Define amortised cost
Historial cost adjusted for depreciation, amortisation, depletion and impairment
Define current cost
The amount the firm would have to pay today for the same asset
Define net realisable value
The estimated selling price of the asset in the normal course of business minus the selling costs
Define present value
The discounted value of the asset’s expected future cash flows
Define fair value
The price at which the asset could be sold, or a liability transferred, in an orderly transaction between willing parties
According to the conceptual framework what has a cost-benefit trade off?
The 4 enhancing characteristics, so the benefit that users gain from the information should be greater than the cost of presenting it
What is a constraint not specifically mentioned in the conceptual framework for financial reporting?
That’s non-qualifiable information about a company (its reputation, brand loyalty, capacity for innovation etc) cant be captured directly in financial statements
What are 2 important underlying assumptions of financial statements
Accrual accounting and going concern
Define accrual accounting
It means financial statements should reflect transactions at the time they actually occur not necessarily when cash is paid
What is going concern
The assumption that the company will continue to exist for the foreseeable future
Which financial statements are required to be reported under IFRS?
Balance sheet (statement of financial position)
Statement of comprehensive income
Cash flow statement
Statement of changes in owners’ equity
Explanatory notes, including a summary of accounting policies
What are the general features for preparing financial statements under IFRS?
Fair presentation
Going concern basis
Accrual basis
Consistency
Materiality
Aggregation
No offsetting
Reporting frequency
Comparative information
Define fair presentation of financial statements according to the IFRS
Faithfully representing the effects of the entity’s transactions and events according to the standards for recognising assets, liabilities, revenues and expenses
Define going concern bias of financial statements according to the IFRS
The financial statements are based on the assumption that the firm will continue to exist unless its management intends to (or must) liquidate it
Define accrual bias of accounting according to the IFRS
This is used to prepare the financial statements other than the statement of cash flows
Define consistency of financial statements according to the IFRS
Consistency between periods in how items are presented and classified, with prior-period amounts disclosed for comparison
Define materiality of financial statements according to the IFRS
They should be free of misstatements or omissions that could influence the decisions of users of financial statements
Define aggregation of financial statements according to the IFRS
Aggregation of similar items and separation of dissimilar items
Define no offsetting of financial statements according to the IFRS
No offsetting of assets against liabilities or income against expenses unless a specific standards permits or requires it
Define the reporting frequency of financial statements according to the IFRS
Must be at least annually
Define comparative information of financial statements according to the IFRS
Comparative information for prior periods should be included unless a specific standard states otherwise
What are the 3 requirements for structure and content of financial statements according to the IFRS
Classified balance sheet
Minimum information
Comparative information
Define a classified balance sheet according tot he ISFR
Balance sheet includes current and non current assets and liabilities
Define minimum information according to IFRS
This si required on the face of each financial statement and in the notes.
Eg the face of the balance sheet must show specific items such as cash and cash equivalents, PP&E and inventories
The face of the comprehensive income statement needs to include revenue, profit or loss, tax expense, finance cost etc
Define comparative information according to the IFRS
This ensures that prior periods should be included unless a specific standard states otherwise
What should an analyst do about the fact that financial reporting standards continue to evolve?
Monitor how these developments will effect the financial statements they use.
Be aware or new products and innovations in the financial markets that generate new types of transactions because these might not fall neatly into the existing financial reporting standards
What can an analyst use as a guide for evaluating what effect new products or transactions might have on financial statements?
Financial reporting framework
What can an analyst use to keep up to date on the evolving financial reporting standards?
They can monitor professional journals and other sources such as IASB and FASB websites
Where does the CFA institute produce position papers on financial reporting issues?
The CFA institute centre for financial market integrity
What must analysts monitor company disclosures for?
Significant accounting standards and estimates
