Part 2: Financial Reporting Standards

Question 1

Financial Reporting

Answer 1

The objective is to provide information about the firm to current and potential investors and creditors that are useful for making their decisions about investing in or lending to the firm.

Used in the development of accounting standards, which aim to ensure consistency, flexibility, and allow discretion to management to properly describe the economics of the firm.

Question 2

Standard setting bodies

Answer 2

A professional organisation of accountants and auditors that establish financial reporting standards.

e.g. Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB)

Question 3

Regulatory authorities

Answer 3

Government agencies who have the legal authority to enforce compliance with financial reporting standards.

e.g. FCA, SEC

Question 4

International Organisation of Securities Commissions (IOSCO)

Answer 4

• Their members regulate more than 95% of the financial markets.
• Not a regulatory body
• Its members work together to make national regulations and enforcement more uniform around the world.

Question 5

Securities and Exchange Commission

Answer 5

The responsibilty of enforcing the Sarbanes-Oxley Act of 2002:

• Prohibits a companys external auditor from providing certain additional paid services to the company, to avoid conflict of interest involved, and promote auditor independence.
• The act requires company’s executive management and external auditor to certify the financial statements are presented fairly, including statement about effectiveness of internal controls.

Question 6

Form S-1

Answer 6

Registration statement filed prior to the sale of new securities to the public, includes audited financial statements, risk assessment, underwriter identification and estimated amount and use of offering proceeds.

Question 7

Form 10-K

Answer 7

• Required annual filing includes information about the business and its management, audited financial statements and disclosures, and disclosures about legal matter involving the firm.
• Similar to which a firm typically provides its annual report to shareholders.

Form 40-F for Canadian companies
Form 20-F for other foreign issuers

Question 8

Form 10-Q

Answer 8

US firms are required to file this form quarterly, with updated financial statements, and disclosures about certain events such as significant legal proceedings or changes in accounting policy.

Form 6-K semiannually for non-US companies.

Question 9

Form DEF-14A

Answer 9

When a company prepares a proxy statement for shareholders prior to the annual meeting or other shareholder votes,

Question 10

Form 8-K

Answer 10

• Companies file this form to disclose material events including significant asset acquisitions and disposals, changes in management, and corporate governance, or matters related to accountants, financial statements, or markets in which securities trade.

Question 11

Form 144

Answer 11

A company can issue securities to certain qualified buyers without registering securities with SEC, but must notify SEC prior.

Question 12

Forms 3, 4, 5

Answer 12

This involves the beneficial ownership of securities by company officers and directors, using these filings to learn about purchases and sales of company securities by corporate insiders.

Question 13

International Accounting Standards Board (IASB)

Answer 13

The objective is to provide financial information that is useful in making decisions about providing resources to an entity.

These include investors, lenders, and other creditors, providing information on a firm’s performance, financial position, and cash flow.

Question 14

Two fundamental characteristics make financial information useful:

Answer 14

1. Relevance - Influence user’s economic decisions or affect user’s evaluations of past events or forecasts of future events, with predictive, or confirmatory value to information.
2. Faithful representation - information that is faithfully representative is complete, neutral (absence of bias), and free from error.

Question 15

4 characteristics enhancing relevance and faithful representation:

Answer 15

1. Comparability - financial statement presentation consistent among firms and across time periods.
2. Verifiability - independent observers, using the same methods to obtain similar results.
3. Timeliness - information available to decision-makers before the information is stale.
4. Understandability - users with basic knowledge of business and accounting, who make a reasonable effort to study financial statements who readily understand information present.

Question 16

Conceptual Framework

Answer 16

The elements of financial statements are by now familiar groupings of assets, liabilities and owners equity, income and expenses.

Question 17

Elements of Conceptual Framework:

Answer 17

Assets - resources controlled by past transactions expected to provide future economic benefits.

Liabilities - Obligations of past events are expected to require an outflow of economic resources.

Equity - The owner’s residual interest in assets after deducting the liabilities.

Income - An increase in economic benefits by increasing assets or decreasing liabilities in a way that increases owners’ equity; including revenue and gains.

Expenses - A decrease in economic benefits, either decreasing assets or increasing liabilities in a way that decreases owners’ equity; includes losses.

Question 18

Measurement base

Answer 18

The amounts at which items are reported in financial statement elements are dependent on.

These include:

• Historical cost = the amount originally paid for the asset.
• Amortized cost = historical cost adjusted for depreciation, amortization, depletion, and impairment.
• Current cost = the amount the firm would have to pay today for the same asset.
• Net realizable value = the estimated selling price of the asset in the normal course of business minus selling cost.
• Present value = the discounted value of assets’ expected future cash flows.
• Fair value = the price at which an asset could be sold, or liability transferred in an orderly transaction between willing parties.

Question 19

Constraints and assumptions of Conceptual Framework

Answer 19

• The benefits users gain from information should be greater than the cost of presenting it.
• Non-quantifiable information about a company (reputation, brand loyalty, capacity for innovation etc.) cannot be captured directly in financial statements.
• Accrual accounting assumption - financial transactions should reflect transactions at the time they actually occur, not necessarily when cash is paid.
• Going concern assumption - this assumes the company will continue to exist for the foreseeable future.

Question 20

The required financial statements are:

Answer 20

1. Balance sheet (statement of financial position)
2. Statement of comprehensive income
3. Cash flow statement
4. Statement of changes in owners equity
5. Explanatory notes, including summary of accounting policies

Question 21

Features for preparing financial statements

Answer 21

1. Fair presentation
2. Going concern basis - financial statements based on the assumption the firm will continue to exist unless management intends to liquidate it.
3. Accrual basis - used to prepare financial statements other than statements of cash flows.
4. Consistency - between periods in how items are presented and classified, with prior-period amounts disclosed for comparison.
5. Materiality - financial statements free of misstatements or omissions that could influence the decisions of users of financial statements.
6. Aggregation of similar or dissimilar items.
7. No offsetting - of assets against liabilities or income against expenses unless a specific standard permits or requires it.
8. Reporting frequency - at least annually
9. Comparative information - prior periods should be included unless specific standard states otherwise.

Question 22

Structure and content of financial statements:

Answer 22

1. Most entities present a classified balance sheet showing current and noncurrent assets and liabilities.
2. Minimum information - required in face of each financial statement and in notes, e.g. the face of the balance sheet must show specific items such as cash, cash equivalents, plant, property and equipment, and inventories, with a comprehensive income statement including revenue, profit or loss, tax expense, and finance costs.
3. Comparative information - for prior periods should be included unless specific standards state otherwise.