Reading 24 LOS's Flashcards
LOS 24a: Describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation
the International Accounting Standards Board’s (IASB’s) objective of gneral purpose financial reporting, as stated in its Conceptual Framework for Financial Reporting 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.”
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 comparison between companies
LOS 24b: Describe role and desirable attributes of financial reporting standard setting bodies and regulatory authorities in establishing and enforcing reporting standards, and describe the role of the Iinternational Organization of Securities Commissions
The Role of Standard Setting Bodies and Regulatory Authorities
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 SEC in the US and the Financial Standards Authority (FSA) in the UK, 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
Standard Setting Bodies
International Accounting Standards Board (IASB)
The IASB is the independent standard-setting body of the IFRS Foundation, which is an independent, not-for-profit private sector organization. The principles and objectives of the IFRS are to develop and promote the use and adoption of a single set of high-quality financial standards
Financial Accounting Standards Board (FASB)
The FASB issues new and revised standards with the aim of improving standards of financial reporting so that info provided to users is useful for decision making. The FASB Accounting Standard Codification is the source of all authoritative US GAAP for nongovernmental entities.
Desireable Attritbutes of an Accounting Standards Board
- 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
- 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 not succumb to pressure from external forces
Regulatory Authorities
International Organization of Securities Commission (IOSCO) is not a regulatory authority, but its members regulate a large portion of the world’s financial capital markets. They have 3 objectives:
- Protection of investors
- Ensuring that markets are fair, efficient, and transparent
- Reducing systematic risk
Their principles are grouped into nine categories, including principles for regulators, for enforcement, for issuers, and for auditors. With increasing golbalization, the organization aims to assist its members in the development of internationally comparable financial reporting standards
The U.S Securities and Exchange Commission
Any company issuing securities in the US is subject to the SEC. The SEC requires companies to submit numerous forms periodically. The most relevant forms are:
- All companies issuing new security must file a Securities Offerings Registration Statement. the statement requires info such as disclosures about the securities, the securities relationship with other securities, recently audited financial statements, and risk factors involved
- Form 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.
- Form 10-Q and 6-K - US companies file form 10-Q quarterly while non-US firms file form 6-K semiannually. These submissions require unaudited financial statements, MD&A reports, and disclosure of any nonrecurring events
- 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 authoritization from a shareholder granting another party the right to vote on her behalf
- Form 8-K this form must be filed for significant events that include acquisitions or disposal of corporate assets, changes in management or corporate governance, changes in securities, and matters related to accountants and financial statements
- Form 144 form filed to announce a possible sale of restricted securities
LOS 24c: Describe the status of global convergence of accounting standards and ongoing barriers to developing one universally accepted set of financial reporting standards
The IASB and FASB, are working to achieve convergence of financial reporting standards:
- In 2002, they both acknowledged their commitment to develop high quality, compatible accounting standards
- in 2004 both boards agreed to align their conceptual framework and to work together in developing any significant accounting standards in the future
- in 2009 both boards affirmed their commitment to achieve convergence in seleceted major projects by june 2011
Convergence between US GAAP and IFRS is underway. Time and again, the SEC has reiterated its commitment to global accounting standards and is looking to incorporate IFRS into the financial reporting system for US users
There are 2 barriers to developing a universal standard:
- Standard-setting bodies and regulators have different opinions
- Powerful lobbyists and business groups
LOS 24d: Describe the International Accounting Standards Board’s conceptual framework, including the objective and qualitative characteristics of financial statements, required reporting elements, and constraints and assumptions in preparing financial statements
The IASB uses the Conceptual Framework for Financial Reporting 2010 to develop reporting standards.
Objective of Financial Standards
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 exisiting and potential providers
Qualitative Characteristics 2 Fundamental
- Relevance- the information presented in financial statements should be useful in making forecasts and evaluating past decisions. The criterion of materiality states that info should be timely and sufficiently detailed
- Faithful Representation - requires information presented to be complete, neutral, and free from error
4 supplementary
- Comparability - presentation of financial statements should be consistent over time and across firms
- Verifiability- different knowledgeable and independent observers should be able to verify the infor is correct
- Timeliness- Info should be available in a timely manner
- Understandability- users with basic business and accounting knowledge should be able to understand the reports
Constraints on Financial Statements
- There can be tradeoffs between certain desirable characteristics. Companies must estimate measures to present info in a timely manner, but since it is estimated it hinders its verifiability
- There is a cost of providing useful financial info
- Intangible aspects ( company reputation and name) cannot be quantified and reflected in financial statements
Reporting Elements
The elements of financial statements that are related to the measurement of financial position are Assets, Liabilities, and Owner’s Equity (balance sheet)
The elements related to the measurement of financial performance are Revenues and Expenses ( Income Statement)
Underlying Assumptions in Financial Statements
2 important assumptions :
- Accrual Basis requires that transactions should be recorded on the financial statements when the occur, regardless of when the exchange of cash occurs
- Going Concern refers to the assumption that the company will continue operating for the foreseeable future. This allows the company to value its assets higher than their immediate liquidation value. The idea is over time the company can sell the assets for the price it wants, but if it were to go out of business tomorrow, these assets would suffer deep discounts in liquidation
Recognition and Measurement of Financial Statement Elements
An element should be recognized if the future benefit of the item is probable, and if its value/cost can be estimated with reliablility. To measure value/cost we can use:
- Historical cost- amount it was originally purchased for
- Amortized cost- historical costs adjusted for amortization, depreciation, or depletion
- Current Cost- the amount that it would cost today
- Realizable value- the amount an asset could be sold for in an ordinary disposal today. For a liability, its the amount of cash expected to be paid to settle the liability
- Present Value- present value of future cash inflows/outflows
LOS 24e: Describe the general requirements for financial statements under IFRS
Required Financial Statements:
- Statement of financial position (balance sheet)
- Statement of comprehensive income (income statement)
- Statement of changes in equity
- Statement of cash flows
- Significant accounting policies and explanatory notes to facilitate the understanding of financial statements
General Features of Financial Statements
- Fair presentation
- Going Concern
- Accrual Basis
- Materiality and aggregation - statement should be free from omissions and misrepresentations that could influence decisions taken by users
- No offsetting- Assets and Liabilities and income and expenses should not be used to offset each other
- Frequency of reporting- at least annually
- Comparative information- comparative amounts should be presented for prior periods
- Consistency
Structure and Content Requirements
- Classified statement of financial position- current and noncurrent assets/liabilities should be shown seperately on balance sheet
- Minimum information on the face of financial statements - certain items must be explicitly disclosed on the face of the financial statements
- Minimum information in the notes- disclosurs relating to certain items must be in the notes to the financial statements
- Comparative information - comparative amounts should be presented for prior periods
LOS 24f: Compare key concepts of financial reporting standards under IFRS and U.S. GAAP reporting systems
- FASB, in addition to the financial performance elements recognized under the IASB, also include gains, losses, and comprehensive income
- Reporting elements relating to financial position are defined diferently. Under FASB, assets are “future economic benefits” rather than “resources”
- Under FASB, the word probable is not discussed in its revenue recognition cirteria
- Regarding measurement of financial elements, both frameworks are broadly consistent
LOS 24g: Identify characteristics of a coherent financial reporting framework and the barriers to creating such a framework
Characteristics of an Effective Financial Reporting Framework
- Transparency- full disclosure and fair representation create transparency
- Comprehensiveness- is one that is based on universal principles that provide guidance for recording all kind of financial transactions
- Consistency - financial transactions of similar nature should be measured and reported in a similar manner, irrespective of industry type, geography, and time period
Barriers to Creating a Single Coherent Framework
- valutaion- historical cost is a more reliable measure of value, but fair value is more relevant over time
- _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.
- 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
- IFRS has a principles based, while FASB has a rules-based, though both are moving to an objective-oriented
- Measurement reporting of financial statement elements can be based on the asset/liabilites approach or the revnues/expenses approach
LOS 24h: Describe implications for financial analysis of differing financial reporting systems and the importance of monitoring developments in financial reporting standards.
LOS 24i: Analyze company disclosure of significant accounting policies
New products and transactions in capital markets
Analysts should evaluate companies’ financial reports to understand new transactions or products being used and implemented ( like bit coin or e-commerce). As products or transactions become more common in the industry, it becomes imperative to understand their implications, usefulness, and impact on cash flows
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
Company Disclosures
Are a good source of information regarding the effects of financial reporting standards on a company’s performance. Under IFRS and US GAAP, companies are required to disclose accounting policies and estimate in the footnotes to the financial statements. Companies must also disclose information relating to changes in accounting policies. Quanitfied 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
