Reading 17: Financial Reporting Standards

Question 1

Describe the objective of financial reporting and the importance of financial reporting standards in security analysis and valuation.

Answer 1

The objective of financial statements is to provide economic decision makers with useful information about a firm’s financial performance and changes in financial position.

Reporting standards are designed to ensure that different firms’ statements are comparable to one another and to narrow the range of reasonable estimates on which financials statements are based. This aids users of the financial statements who rely on them for information about the company’s activities, profability, and creditworthiness.

Question 2

Describe the roles of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards.

Answer 2

Standar-setting bodies are private sector organization that establish financial reporting standards. The two primary standard-setting bodies are the International Accounting Standards Boards (IASB) and, in the United States, the Financial Accounting Board (FASB).

Regulatory authorities are government agencies that enforce compliance with financial reporting standards. Regulatory authorities include the Securities and Exchange Comission in the United States and the Financial Conduct Authority in the United Kingdom. Many national regulatory authorities belong to the International Organization of Securities Comissions.

Question 3

Describe the International Accounting Standards Board’s conceptual framework, including qualitative characteristics of financial reports, constraints on financial reports, and required reporting elements.

Answer 3

The IFRS “Conceptual Framework for Financial Reporting” defines the fudamental and enhancing qualitive characteritics of financial statements, specifies the required reporting elements, and notes the constraints and assumptions involved in preparing financial statements.

• The fundamental characteristics of financial statements are relevance and faithful representation. The enhancing characteristcs include comparability, verifitability, timeliness, and understandability.
• Elements of financial statements are assets, liabilities, and owners’ equity (for measuring financial position) and income and expenses (for measuring performance).
• Constraints on financial statement preparation include cost versus benefit and the difficulty of capturing non-quantifiable information in financial statements.
• The two primary assumptions that underline the preparation of financial statements are the accrual basis and the going concern assumption.

Question 4

Describe general requirements for financial statements under International Financial Reporting Standards (IFRS).

Answer 4

Required financial statements are the balance sheet, comprehensive income statements, cash flows statements, statement of changes in owners’ equity, and explanatory notes.

The general features of financial statements according to IAS No. 1:

• Fair presentation.
• Going concern.
• Accrual accounting
• Consistency.
• Materiality.
• Aggregation.
• No offsetting.
• Reporting frequency.
• Comparative information.

Other presentation requirements include a classified balance sheet and specific minimum information that must be reported in the notes and on the face of the financial statements.

Question 5

Describe implications for financial analysis of alternative financial reporting systems and the importance of monitoring developments in financial reporting standards.

Answer 5

An analyst should be aware of evolving financial reporting standards and new products that generate new types of transactions.