Reading 23 - Financial Reporting Standards

Question 1

The International Accounting Standards Board’s (IASB’s) objective of general purpose financial reporting:

Answer 1

The International Accounting Standards Board’s (IASB’s) objective of general purpose financial reporting, as stated in its Conceptual Framework for Financial Reporting 2010 (Conceptual Framework 2010), 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

Question 2

The process of developing financial reporting standards is quite complicated. Explain.

Answer 2

The process of developing financial reporting standards is quite complicated. Some transactions do not necessarily have one correct treatment, so standards are set with the aim of achieving some degree of consistency in the treatment of these transactions. Therefore, the IASB and U.S. Financial Accounting Standards Board (FASB) have developed similar frameworks for financial reporting.

Question 3

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

Answer 3

Financial statements are not designed only to facilitate asset valuation; they provide information to a host of users (e.g., creditors, employees, and customers). At the same time, they do provide important inputs for the asset-valuation process. For analysts, it is extremely important to understand how and when judgments and subjective estimates affect the financial statements. Such an understanding is important to evaluate the wisdom of business decisions, and to make comparisons between companies.

Question 4

The role of standard-setting bodies and regulatory authorities.

Answer 4

Standard‐setting bodies, such as the IASB and FASB, are private sector organizations of accountants and auditors that develop financial reporting rules, regulations, and accounting standards. Regulatory authorities, like the Securities and Exchange Commission (SEC) in the United States, and Financial Standards Authority (FSA) in the United Kingdom have legal authority to enforce financial reporting requirements, and can overrule private sector standard-setting bodies. Standard-setting bodies have no authority unless their standards are recognized by regulatory authorities.

Question 5

What are the two standard-setting bodies

Answer 5

• International accounting standards board (IASB)
• Financial accounting standards board (FASB)

Question 6

International accounting standards board (IASP)

Answer 6

The IASB is the independent standard-setting body of the IFRS Foundation, which is an independent, not-for-profit private sector organization. The principal objectives of the IFRS Foundation are to develop and promote the use and adoption of a single set of high-quality financial standards; to ensure the standards result in transparent, comparable, and decision, useful information while taking into account the needs of a range of sizes and types of entities in diverse economic settings; and to promote the convergence of national accounting standards and IFRS.

Question 7

IFRS Interpretations Committee

Answer 7

The IFRS Interpretations Committee is responsible for reviewing accounting issues that arise in the application of IFRS and are not specifically addressed by IFRS.

Question 8

IFRS Advisory Council

Answer 8

The IFRS Advisory Council provides advice to the IASB on agenda decisions and priorities among other items. 


Question 9

Financial accounting standards board (FASB)

Answer 9

The FASB issues new and revised standards with the aim of improving standards of financial reporting so that information provided to users is useful for decision‐making. The FASB standards are contained in the FASB Accounting Standard CodificationTM (Codification). The Codification is the source of all authoritative U.S. generally accepted accounting principles (U.S. GAAP) for nongovernmental entities. U.S. GAAP is officially recognized as authoritative by the Securities and Exchange Commission (SEC). However, the SEC retains the authority 
to establish standards.

Question 10

What are the desirable attributes of an Accounting Standards Board?

Answer 10

• The responsibilities of all parties involved in the standard‐setting process should be clearly defined. 

• All parties involved in the standard‐setting process should observe high professional and ethical standards, including standards of confidentiality. 

• The organization should have adequate authority, resources, and competencies. 

• There should be clear and consistent processes to guide the organization and 
formation of standards. 

• There should be a well‐articulated framework with a clearly stated objective to 
guide the board. 

• The board should seek and consider input from all stakeholders. However, it 
should operate independently and make decisions that are in line with the stated 
objective of the framework. 

• The board should not succumb to pressure from external forces. 

• Final decisions should be in public interest, and should lead to a set of high‐quality 
standards that will be recognized and adopted by regulatory authorities. 


Question 11

Define regulatory authorities

Answer 11

Regulatory authorities are governmental entities that have the legal authority to enforce the financial reporting requirements set forth by the standard-setting bodies, and to exert control over entities that participate in capital markets within their jurisdiction.

Question 12

IOSCO (International Organization of Securities Commission) basic overview

Answer 12

IOSCO (International Organization of Securities Commission) is not a regulatory authority, but its members regulate a large portion of the world’s financial capital markets.

Question 13

IOSCO sets out three core objectives of securities regulation:

Answer 13

• Protection of investors. 

• Ensuring that markets are fair, efficient, and transparent. 

• Reducing systematic risk. 


Question 14

Describe the IOSCO (International Organization of Securities Commission) in detail.

Answer 14

IOSCO’s principles are grouped into nine categories, including principles for regulators, for enforcement, for issuers, and for auditors. With increasing globalization, the organization aims to assist its members in the development of internationally comparable financial reporting standards. Further, it assists in attaining uniform regulation and cross‐border cooperation in combating violations of securities and derivatives laws. Finally, it provides guidance regarding the use of Self-Regulatory Organizations (SROs) in overseeing their respective areas of expertise.

Question 15

Any company issuing securities in the United States, or otherwise involved in U.S. capital markets is subject to the rules of the SEC. The SEC requires companies to submit numerous forms periodically. These filings, which are available on the SEC website (www.sec.gov), are a key source of information for analysis of listed firms. The forms most relevant for financial analysts include:

Answer 15

Securities Offering Registration Statement

Forms 10-K, 20-F, and 40-F

Forms 10-Q and 6-K

Proxy Statement/Form DEF-14A

Form 8-K

Form 144

Forms 3, 4, 5, and 11-K

Question 16

Define the SEC form Securities Offerings Registration Statement

Answer 16

All companies that issue new securities are required to file a Securities Offerings Registration Statement. Required information includes disclosures about the securities, the relationship of these new securities to the issuer’s other capital securities, the information typically provided in annual filings, recent audited financial statements, and risk factors involved in the business. 


Question 17

Define the SEC forms 10-K, 20-F, and 40-F

Answer 17

Forms 10‐K, 20‐F, and 40‐F must be filed annually. In these forms, companies provide a comprehensive business overview and disclose important financial data (historical overview of performance, management discussion & analysis (MD&A) report, and audited financial statements). This information is also available in a company’s annual report. However, annual reports are prepared for shareholders and are not required by the SEC. 


Question 18

Define the SEC forms 10-Q and 6-K

Answer 18

Forms 10‐Q and 6‐K: U.S. companies file form 10‐Q quarterly while non‐U.S. firms file form 6‐K semiannually. These submissions require unaudited financial statements, MD&A reports, and disclosure of any nonrecurring events. 


Question 19

Define the SEC form Proxy Statement/Form DEF-14A

Answer 19

Proxy Statement/ Form DEF‐14A: The SEC requires that shareholders of a company be sent a proxy statement before any shareholder meeting. A proxy is an authorization from a shareholder granting another party the right to vote on her behalf. The following information is contained in a proxy statement:

• Details of proposals that require shareholder vote. 

• Ownership stakes of senior management and principal owners. 

• Director biographies. 

• Executive compensation disclosures. 
The proxy statement that is filed with the SEC is known as Form DEF‐14A.

Question 20

Define the SEC form 8-K

Answer 20

Form 8‐K: This form must be filed for significant events that include the acquisition or disposal of corporate assets, changes in management or corporate governance, changes in securities and trading markets, and matters related to accountants and financial statements. 


Question 21

Define the SEC form 144

Answer 21

Form 144: This form is filed to announce a possible sale of restricted securities or the sale of securities held by affiliates of the issuer. 


Question 22

Define the SEC form 3, 4, 5, and 11-K

Answer 22

Forms 3, 4, 5, and 11‐K: These forms are used to examine purchases and sales of securities by management, directors, employees, and other affiliates of the company. 


Question 23

How do the Capital Market Regulations work in Europe?

Answer 23

Capital Market Regulation in Europe: Each country in the European Union (EU) regulates its own capital market. However, certain regulations have been adopted at the EU level to achieve some consistency in securities regulation among the different member states. In 2002 the EU agreed that from January 1, 2005, listed companies would prepare their consolidated accounts in accordance with the IFRS. 


Question 24

The IASB and FASB, along with other standard setters, are working to achieve convergence of financial reporting standards, name some significant dates.

Answer 24

• In 2002, the IASB and FASB both acknowledged their commitment to develop high quality, compatible accounting standards that can be used for both domestic as well as cross‐border financial reporting. 

• In 2004, both the boards agreed to align their conceptual frameworks and to work together in developing any significant accounting standards in the future. In the short term they aimed to remove selected differences, while in the medium term they agreed to issue joint standards in areas where significant improvements were required. 

• In 2009, both the boards affirmed their commitment to achieve convergence in selected major projects by June 2011. This date was later revised to late 2011. 


Question 25

Define the convergence efforts between U.S. GAAP and the IFRS.

Answer 25

Convergence between U.S. GAAP and IFRS is underway. Time and again, the SEC has reiterated its commitment to global accounting standards and is looking into incorporating IFRS into the financial reporting system for U.S. issuers. Convergence between IFRS and other local GAAP (e.g., Japanese GAAP) is also underway. 


Question 26

However, the move toward developing one set of universally accepted financial reporting standards is impeded by two factors:

Answer 26

• Standard‐setting bodies and regulators have different opinions regarding appropriate accounting treatments due to differences in institutional, regulatory, business, and cultural environments. 

• Powerful lobbyists and business groups, whose reported financial performance would be affected adversely by changes in reporting standards, exert pressure against the adoption of unfavorable standards. 


Question 27

Who uses the Conceptual Framework for Financial Reporting 2010? How is it used?

Answer 27

The IASB uses the Conceptual Framework for Financial Reporting 2010 (Conceptual Framework 2010) to develop reporting standards. The framework assists standard setters in developing and reviewing standards, assists preparers of financial statements in applying standards, helps auditors in forming an opinion on financial statements, and aids users 
in interpreting financial statement information.

Question 28

IFRS Framework for the Preparation and Presentation of Financial Reports: Describe graphic.

Answer 28

Question 29

IFRS Framework for the Preparation and Presentation of Financial Reports: Objective of Financial Statements

Answer 29

Under the Conceptual Framework, the objective of general purpose financial reporting is to provide financial information that is useful in making decisions about providing resources to the entity to existing and potential providers of resources (e.g., investors, lenders, and creditors) to the entity.

Question 30

The Conceptual Framework identifies two fundamental qualitative characteristics that make financial information useful, what are they?

Answer 30

Relevance

Faithful representation

Question 31

The Conceptual Framework identifies two fundamental qualitative characteristics that make financial information useful: Define relevance.

Answer 31

Relevance: The information presented in the financial statements should be useful in making forecasts (have predictive value) and/or be useful to evaluate past decisions or forecasts (have confirmatory value). Further, the criterion of materiality states that information
should be timely and sufficiently detailed with no material omissions or misstatements of information that could make a difference to users’ decisions.

Question 32

The Conceptual Framework identifies two fundamental qualitative characteristics that make financial information useful: Define faithful representation.

Answer 32

Faithful Representation: This requires that the information presented is:

• Complete (i.e., all the information necessary to understand the phenomenon is 
included); 

• Neutral (i.e., information presented is free from any bias); and 

• Free from error (i.e., there are no errors of commission or omission in the 
description of the economic phenomenon). Further, an appropriate process is adhered to, without error, in order to arrive at the reported information. 


Question 33

The Conceptual Framework also identifies four supplementary qualitative characteristics that increase the usefulness of relevant and faithfully represented financial information. These are: 


Answer 33

• Comparability: The presentation of financial statements should be consistent over time and across firms to facilitate comparisons. 

• Verifiability: Different knowledgeable and independent observers should be able to verify that the information presented faithfully represents the economic phenomena that it is supposed to represent. 

• Timeliness: Information should be available to users in a timely manner. 

• Understandability: Users with basic business and accounting knowledge, who are 
willing to make reasonable efforts to study the information presented, should be able to easily understand the information presented. 


Question 34

While it would be ideal for financial statements to exhibit all the desirable characteristics listed earlier, there are several constraints to achieving this goal:

Answer 34

Tradeoff

Cost

Intangible aspects

Question 35

While it would be ideal for financial statements to exhibit all the desirable characteristics listed earlier, there are several constraints to achieving this goal: define tradeoff.

Answer 35

There may be a tradeoff between certain desirable characteristics. For example, companies must estimate bad debts (amount of credit sales that the company
will not be able to collect) when presenting financial information so that financial statements can be released in a timely manner. However, the fact estimated expenses must be included reduces the verifiability of the statements.

Question 36

While it would be ideal for financial statements to exhibit all the desirable characteristics listed earlier, there are several constraints to achieving this goal: define cost.

Answer 36

There is a cost of providing useful financial information. The benefits from information should exceed the costs of providing it. 


Question 37

While it would be ideal for financial statements to exhibit all the desirable characteristics listed earlier, there are several constraints to achieving this goal: define intangible aspects.

Answer 37

Intangible aspects (e.g., company reputation, brand name, customer loyalty, and corporate culture) cannot be quantified and reflected in financial statements. Unfortunately, nonquantifiable information is omitted from financial statements. 


Question 38

IFRS Framework for the Preparation and Presentation of Financial Reports, in reporting elements, the elements of financial statements that are related to the measurement of financial position are: 


Answer 38

• Assets: Resources owned and controlled by a company from which it expects to realize future benefits. 

• Liabilities: Obligations of a company that are expected to result in future outflow of resources. 

• Equity: The residual claim of owners on assets of the company after subtracting all liabilities. 


Question 39

IFRS Framework for the Preparation and Presentation of Financial Reports, in reporting elements, Elements related to the measurement of financial performance are: 


Answer 39

Income

Expenses

Question 40

IFRS Framework for the Preparation and Presentation of Financial Reports, in reporting elements, Elements related to the measurement of financial performance are: 
Define income.

Answer 40

Income: Increases in economic benefits in the form of inflows or enhancement of 
assets or reductions in liabilities that result in increases in equity (other than increases resulting from contributions by owners). Income includes revenues and gains. Revenue refers to income generated through ordinary activities of the business (e.g., sale of products). Gains may result from ordinary activities or other activities (e.g., sale of surplus machinery). 


Question 41

IFRS Framework for the Preparation and Presentation of Financial Reports, in reporting elements, Elements related to the measurement of financial performance are: 
Define expenses.

Answer 41

Expenses: Decreases in economic benefits in the form of outflows or depletion
 of assets or increases in liabilities that result in reductions in equity (other than reductions due to distributions to owners). Expenses include normal expenditures that occur in day‐to‐day business activities (e.g., wages) and losses. 


Question 42

IFRS Framework for the Preparation and Presentation of Financial Reports, Underlying assumptions in financial statements, Two important assumptions that determine how financial statement elements are recognized and measured are: 


Answer 42

Accrual basis

Going Concern

Question 43

IFRS Framework for the Preparation and Presentation of Financial Reports, Underlying assumptions in financial statements, Two important assumptions that determine how financial statement elements are recognized and measured are: 
Define accrual basis.

Answer 43

Accrual basis accounting requires that transactions should be recorded on the financial statements (other than on the cash flow statement) when they actually occur, irrespective of when the related exchange of cash occurs. 


Question 44

IFRS Framework for the Preparation and Presentation of Financial Reports, Underlying assumptions in financial statements, Two important assumptions that determine how financial statement elements are recognized and measured are: 
Define going concern

Answer 44

Going concern refers to the assumption that the company will continue operating for the foreseeable future. If this is not the case, fair representation would require all assets to be written down to their liquidation values. The value of a company’s year‐end stock of inventory would be higher if it were allowed to sell it over 
a normal period of time, compared to its value if the company were forced to liquidate it immediately. 


Question 45

IFRS Framework for the Preparation and Presentation of Financial Reports, describe the recognition and measurement of financial statement elements

Answer 45

An element should be recognized on the financial statements if the future benefit from the item (flowing into or out of the firm) is probable, and if its value/cost can be estimated with reliability. The monetary value of the item recognized on the financial statements depends on the measurement base used.

Question 46

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:

Answer 46

Historical cost

Amortized cost

Current cost

Realizable (settlement) value

Present value

Fair value

Question 47

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define historical cost.

Answer 47

Historical cost: For an asset, historical cost refers to the amount that it was originally purchased for. For liabilities, it refers to the amount of proceeds that were received initially in exchange for the obligation. 


Question 48

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define amortized cost.

Answer 48

Amortized cost: Historical cost adjusted for amortization, depreciation, or depletion and/or impairment. 


Question 49

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define current cost.

Answer 49

Current cost: For an asset, current cost refers to the amount that the asset can be purchased for today. For liabilities, it refers to the total undiscounted amount of cash that would be required to settle the obligation today. 


Question 50

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define realizable (settlement) value.

Answer 50

Realizable (settlement) value: In reference to assets, realizable value refers to the amount that the asset can be sold for in an ordinary disposal today. For liabilities, it refers to the undiscounted amount of cash expected to be paid to settle the liability in the normal course of business. 


Question 51

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define present value.

Answer 51

Present value: For assets, present value refers to the discounted value of future net cash flows expected from the asset. For liabilities, it refers to the present discounted value of future net cash outflows that are expected to be required to settle the liability. 


Question 52

IFRS Framework for the Preparation and Presentation of Financial Reports, for recognition and measurement of financial statement elements,the following bases of measurement are typically used:Define fair value.

Answer 52

Fair value: This is mentioned in the Conceptual Framework, but not specifically defined. It refers to the amount that the asset can be exchanged for, or a liability can be settled for, in an arm’s length transaction. Fair value may be based on market value or present value. 


Question 53

International Accounting Standard (IAS) No. 1, Presentation of Financial Statements, specifies which financial statements are mandatory and how they must be presented. 
What are the required financial statements?

Answer 53

• Statement of financial position (balance sheet). 

• Statement of comprehensive income (in a single statement or in two separate 
statements, i.e., the income statement + statement of comprehensive income). 

• Statement of changes in equity. 

• Statement of cash flows. 

• Significant accounting policies and explanatory notes to facilitate the 
understanding of financial statements. 

• In certain cases, a statement of financial position from earliest comparative period. 


Question 54

Under IFRS, what are the required general features of financial statements?

Answer 54

Fair presentation

Going concern

Accrual basis

Materiality and aggregation

No offsetting

Frequency of reporting

Comparative information

Consistency

Question 55

Under IFRS, in the required general features of financial statements, define fair presentation.

Answer 55

Fair presentation: This requires faithful representation of transactions, in compliance with the definitions and recognition criteria for reporting elements (assets, liabilities, equity, income, and expenses) set out in the Conceptual Framework. 


Question 56

Under IFRS, in the required general features of financial statements, define going concern.

Answer 56

Going concern: Financial statements should be prepared on a going concern basis unless management has plans to liquidate the company. 


Question 57

Under IFRS, in the required general features of financial statements, define accrual basis.

Answer 57

Accrual basis: All financial statements, except the cash flow statement, should be prepared on an accrual basis. 


Question 58

Under IFRS, in the required general features of financial statements, define materiality and aggregation.

Answer 58

Materiality and aggregation: Financial statements should be free from omissions and misrepresentations that could influence decisions taken by users. Similar items should be grouped and presented as a material class. Dissimilar items, unless immaterial, should be presented separately. 


Question 59

Under IFRS, in the required general features of financial statements, define no offsetting.

Answer 59

No offsetting: Assets and liabilities and income and expenses should not be used to offset each other, unless a standard requires or allows it. 


Question 60

Under IFRS, in the required general features of financial statements, define frequency of reporting.

Answer 60

Frequency of reporting: Financial statements must be prepared at least annually. 


Question 61

Under IFRS, in the required general features of financial statements, define comparative information.

Answer 61

Comparative information: Comparative amounts should be presented for prior 
periods unless a specific standard permits otherwise. 


Question 62

Under IFRS, in the required general features of financial statements, define consistency.

Answer 62

Consistency: Items should be presented and classified in the same manner in every 
period. 


Question 63

Under the IFRS, for general requirements for financial statements, what are the structure and content requirements?

Answer 63

Classified statement of financial position

Minimum information of the face of financial statements

Minimum information in the notes (or on the face of financial statements)

Comparative information

Question 64

Under the IFRS, for general requirements for financial statements, in structure and content requirements, define classified statement of financial position.

Answer 64

Classified statement of financial position: Current and noncurrent assets and current and noncurrent liabilities should be shown separately on the balance sheet. 


Question 65

Under the IFRS, for general requirements for financial statements, in structure and content requirements, define minimum information on the face of financial statements.

Answer 65

Minimum information on the face of financial statements: Certain items must be explicitly disclosed on the face of the financial statements. For example, property, plant & equipment (PP&E) must be disclosed as a separate line item on the face of the balance sheet. 


Question 66

Under the IFRS, for general requirements for financial statements, in structure and content requirements, define minimum information in the notes (or on the face of financial statements).

Answer 66

Minimum information in the notes (or on the face of financial statements): Disclosures relating to certain items must be in the notes to the financial statements (e.g., measurement bases used). (See Table 1-3.) 


Question 67

Under the IFRS, for general requirements for financial statements, in structure and content requirements, define comparative information.

Answer 67

Comparative information: Comparative amounts should be presented for prior periods unless a specific standard permits otherwise. 


Question 68

Most of the differences between IFRS and U.S. GAAP are discussed in the readings that follow. A brief summary of the differences regarding financial statement elements (definition, recognition, and measurement) are:

Answer 68

Financial performance elements

Financial position

Revenue recognition

Measurement

Question 69

Most of the differences between IFRS and U.S. GAAP are discussed in the readings that follow. A brief summary of the differences regarding financial statement elements (definition, recognition, and measurement) are: explain financial performance element differences.

Answer 69

• FASB, in addition to the financial performance elements recognized under the IASB Framework (revenues and expenses), also identifies gains, losses, and comprehensive income. 


Question 70

Most of the differences between IFRS and U.S. GAAP are discussed in the readings that follow. A brief summary of the differences regarding financial statement elements (definition, recognition, and measurement) are: explain financial position differences.

Answer 70

• Reporting elements relating to financial position are defined differently. Under FASB, assets are the “future economic benefits” rather than “resources” from which future economic benefits are expected to flow under IASB. 


Question 71

Most of the differences between IFRS and U.S. GAAP are discussed in the readings that follow. A brief summary of the differences regarding financial statement elements (definition, recognition, and measurement) are: explain revenue recognition differences.

Answer 71

• Under FASB, the word “probable” is not discussed in its revenue recognition criteria, while under IASB it is required that it is probable that a future economic benefit flow to/from the entity. FASB also has a separate recognition criterion of relevance. 


Question 72

Most of the differences between IFRS and U.S. GAAP are discussed in the readings that follow. A brief summary of the differences regarding financial statement elements (definition, recognition, and measurement) are: explain measurement.

Answer 72

• Regarding measurement of financial elements, both frameworks are broadly consistent. However, FASB does not allow upward revaluation of assets except for certain categories of financial instruments that must be reported at fair value. 


Question 73

In preparing financial statements all over the world, how has reporting of reconciliation statements and disclosures of alternate reporting standards changed recently?

Answer 73

Companies around the world follow different frameworks in preparing their financial statements. Until recently, companies were required to report reconciliation statements
 and disclosures to allow construction of financial statements as they would have been under alternative reporting standards. For example, the SEC used to (but no longer does) require reconciliation for foreign private issuers that do not prepare financial statements in accordance with U.S. GAAP. Now that reconciliation disclosures are not required, analysts must be aware of areas where accounting standards have not yet converged.

Question 74

What are the three characteristics of an effective financial reporting framework?

Answer 74

Transparency

Comprehensiveness

Consistency

Question 75

In the three characteristics of an effective financial reporting framework, define transparency.

Answer 75

Transparency: A transparent reporting framework should reflect the underlying economics of the business. Full disclosure and fair representation create transparency. 


Question 76

In the three characteristics of an effective financial reporting framework, define comprehensiveness.

Answer 76

Comprehensiveness: A comprehensive reporting framework is one that is based on universal principles that provide guidance for recording all kinds of financial transactions—those already in existence and others that emerge with time. 


Question 77

In the three characteristics of an effective financial reporting framework, define consistency.

Answer 77

Consistency: Financial transactions of a similar nature should be measured and reported in a similar manner, irrespective of industry type, geography, and time period. However, there is also a need for flexibility to allow companies discretion to be able to report results in accordance with their underlying economic activity. 


Question 78

What are the barriers to creating a single coherent financial reporting framework?

Answer 78

Valuation

Standard-setting approach

Measurement

Question 79

For the barriers to creating a single coherent financial reporting framework, describe how valuation is a barrier.

Answer 79

Valuation: When choosing a measurement base, it is important to remember the tradeoff between reliability and relevance. Historical cost is a more reliable measure of value, but fair value is more relevant over time. 


Question 80

For the barriers to creating a single coherent financial reporting framework, describe how standard-setting approach is a barrier.

Answer 80

Standard‐setting approach: Reporting standards can be based on one of the following approaches:

• A principles‐based approach provides a broad financial reporting framework with limited guidance on how to report specific transactions. It requires the use of subjective judgment in financial reporting. 

• A rules-based approach provides strict rules for classifying elements and transactions. 

• An objectives-oriented approach is a combination of a principles-based and rules-based approach. This approach includes a framework of principles and appropriate levels of implementation guidance. 


IFRS has a principles-based approach. FASB has historically followed a rules-based approach, but recently explicitly stated that it is moving toward an objectives-oriented approach. 


Question 81

For the barriers to creating a single coherent financial reporting framework, describe how measurement is a barrier.

Answer 81

Measurement: Reporting of financial statement elements can be based on the asset/ liability approach (where the elements are properly valued at a point in time) or the revenue/expense approach (where changes in the elements are properly valued over a period of time). The former gives preference to proper valuation of the balance sheet, while the latter focuses on the income statement. The use of one of these approaches will result in more reliable information on one statement and less on the other. In recent years, standard-setters have preferred the asset/liability approach. 


Question 82

It is important for analysts to be aware of developments in financial reporting standards and to assess their implications for security analysis and valuation. They need to understand how changes and developments affect financial reports from a user’s perspective. What are three areas that an analyst must be aware of?

Answer 82

New products and transactions in capital markets

Actions of standard-setting bodies

Company disclosures

Question 83

It is important for analysts to be aware of developments in financial reporting standards and to assess their implications for security analysis and valuation. They need to understand how changes and developments affect financial reports from a user’s perspective. Out of the three areas that an analyst must be aware, define how understanding NEW PRODUCTS AND TRANSACTIONS IN CAPITAL MARKETS are useful.

Answer 83

New products and transactions in capital markets: Certain economic events have led to the development of new products and new transactions. For example, online stores have led to the advent of e-commerce and related transactions that did not exist earlier. 
Analysts should evaluate companies’ financial reports to understand new transactions or products being used and implemented. Business journals, magazines, and capital markets can provide information on new transactions and financial instruments being used by various companies in an industry. Further information can always be obtained from company management regarding any products that they may have used or transactions that they might have undertaken during the year. As products or transactions become more common in the industry, it becomes imperative to understand their implications, usefulness, and impact on cash flows.

Question 84

It is important for analysts to be aware of developments in financial reporting standards and to assess their implications for security analysis and valuation. They need to understand how changes and developments affect financial reports from a user’s perspective. Out of the three areas that an analyst must be aware, define how understanding ACTIONS OF STANDARD-SETTING BODIES are useful.

Answer 84

Actions of standard-setting bodies, such as IASB and FASB, must be monitored because changes in regulations and financial reporting standards affect reported financial performance. Investment decision-making can be improved by keeping track of enacted and proposed changes. 


Question 85

It is important for analysts to be aware of developments in financial reporting standards and to assess their implications for security analysis and valuation. They need to understand how changes and developments affect financial reports from a user’s perspective. Out of the three areas that an analyst must be aware, define how understanding COMPANY DISCLOSURES are useful.

Answer 85

Company disclosures are a good source of information regarding the effects of financial reporting standards on a company’s performance. Under IFRS and U.S. GAAP, companies are required to disclose accounting policies and estimates in the footnotes to the financial statements. Public companies also discuss accounting policies and estimates that require significant material judgment in the MD&A section. 


Question 86

Why is it important to analyze thoroughly company disclosures of significant accounting policies?

Answer 86

Companies must also disclose information relating to changes in accounting policies. IFRS requires discussion about pending implementation of new standards and any known or estimable information relevant to assessing the impact of
those standards. Clear indications regarding the expected impact of changes in standards provide the most useful information and are very helpful to analysts. Vague statements like “management is still evaluating the impact of the standard” might be red flags that analysts should be wary of. Quantified disclosures (when companies are able to quantify the expected impact of standards that have changed but are not yet effective as of the reporting date) are extremely useful to analysts. 


Question 87

Give a summary of Financial Reporting Standards.

Answer 87

An awareness of the reporting framework underlying financial reports can assist in security valuation and other financial analysis. The framework describes the objectives of financial reporting, desirable characteristics for financial reports, the elements of financial reports, and the underlying assumptions and constraints of financial reporting. An understanding of the framework, which is broader than knowledge of a particular set of rules, offers an analyst a basis from which to infer the proper financial reporting, and thus security valuation implications, of any financial statement element or transaction. The reading discusses the conceptual objectives of financial reporting standards, the parties involved in standard-setting processes, and how financial reporting standards are converging into one global set of standards.

Question 88

What is the Objective of Financial Reporting?

Answer 88

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.³⁸

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.

Question 89

Summarize financial reporting standard-setting bodies and regulatory authorities.

Answer 89

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.

Question 90

Give a summary of the convergence of global financial reporting standards.

Answer 90

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.

Question 91

Summarize the IFRS Framework along with the Conceptual Framework (2010)

Answer 91

• 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.

Question 92

Summarize the requirement for IFRS Financial Statements.

Answer 92

• 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.

Question 93

What are the characteristics of a coherent financial reporting framework?

Answer 93

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.

Question 94

What is the comparison of IFRS with alternative reporting systems?

Answer 94

• 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.

Question 95

Summarize how analysts can monitor developments in financial reporting.

Answer 95

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.

Question 96

What are the constraints on financial reports?

Answer 96

Although it would be ideal for financial statements to exhibit all of these qualitative characteristics and thus achieve maximum usefulness, it may be necessary to make tradeoffs across the enhancing characteristics. The application of the enhancing characteristics follows no set order of priority. Depending on the circumstances, each enhancing characteristic may take priority over the others.²⁰ The aim is an appropriate balance among the enhancing characteristics.

A pervasive constraint on useful financial reporting is the cost of providing and using this information.²¹ Optimally, benefits derived from information should exceed the costs of providing and using it. Again, the aim is a balance between costs and benefits.

A limitation of financial reporting not specifically mentioned in the Conceptual Framework (2010) involves information not included. Financial statements, by necessity, omit information that is non-quantifiable. For example, the creativity, innovation, and competence of a company’s work force are not directly captured in the financial statements. Similarly, customer loyalty, a positive corporate culture, environmental responsibility, and many other aspects about a company may not be directly reflected in the financial statements. Of course, to the extent that these items result in superior financial performance, a company’s financial reports will reflect the results.