Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Book overview Part 1 – Environment of financial
reporting Part 2 – Basic accounting techniques and
the preparation of annual financial statements
Part 3 – Interpretation and analysis of financial statements
Part 4 – Consolidated financial statements and issues related to multinational groups
Part 5 – Advanced financial statement analysis and accounting values.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
CHAPTER 1Financial reporting and
regulation
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Contents
Annual financial statements Uses of financial statements Accounting choices Accounting regulation International Financial Reporting
Standards
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Financial versus management accounting
Financial accounting (FA) -> external financial reporting
Management Accounting (MA) -> financial information useful in internal decision and management processes
Starting from the same source data + FA is frame of reference for MA
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Annual financial statements
Income statement Balance sheet Notes to the accounts Cash flow statement Statement of changes in equity Audit report
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Uses of financial statements
Objective of financial statements User groups Accounting traditions
Anglo-Saxon accounting Continental Europe Link with taxation
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Objective of financial statements
“The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.”
IIASB, Framework for the Preparation and Presentation of Financial Statements, par.12
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Users of financial statements
Investors Employees Lenders Suppliers Customers Governments Public
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Users of financial statements
ManagementManagement
ShareholdersShareholders
GovernmentGovernment
Loan providersLoan providers
PotentialInvestors
PotentialInvestors
PublicPublic
CustomersCustomers
Trade creditorsTrade creditors
EmployeesEmployees
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Users – Focus on investors
ManagementManagementGovernmentGovernment
Loan providersLoan providers
PotentialInvestors
PotentialInvestors
PublicPublic
CustomersCustomers
Trade creditorsTrade creditors
EmployeesEmployees
Shareholders/ Investors
Shareholders/ Investors
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting traditions
Anglo-Saxon tradition Continental European tradition
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Anglo-Saxon accounting
US, UK, Australia, Canada, New Zealand, etc.
Financial statements as a function of a company’s financing Market solution to accounting rules
Powerful accounting profession
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Continental European accounting
Financial statement as a product of government regulating of the economy
All businesses are subject to accounting rules, with extra rules for: Limited liability companies Listed companies
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Link with Taxation
Link between measuring performance for shareholders and measuring profit for tax purposes Looser in Anglo-Saxon tradition Greater impact on individual accounts (less on
consolidated group accounts) Impact of taxation on company accounting
also depends on ownership of the company, which is in turn an issue frequently linked to size
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting choices Accounting is not a set of precise
measurement rules which permit the exact measurement of company profit and company value
Measurement of profit can never be anything but an estimate
Accounting measurement is full of choices Choices made should be stated clearly in the
annual financial statements
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting choices – Relevance versus reliability
To be useful, accounting information should be both relevant and reliable
Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their past evaluations Relevant information is timely Relevant information has predictive or
feedback value
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting choices – Relevance versus reliability (cont.)
Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully what it purports (or is expected to) represent
Accounting choices may imply trade-offs between relevance and relaibility of information
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Accounting regulation
Accounting regulation will discipline accounting choices
Types of regulatory body: Government Stock exchange Private sector body Professional accountants Specialist industry organizations
Usually separate rules for banks and insurance companies.
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Government as accounting regulator
Regulation of accounting designed to ensure that the markets can operate free from fraud and misrepresentation Accounting laws Commercial codes Government regulatory agencies
Regulation of accounting for tax collection purposes
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Stock exchange as accounting regulator
Stock exchange regulates the financial information to be provided by listed companies
In some countries this is done by a government regulator US: Securities and Exchange
Commission (SEC) as accounting regulator
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Private sector as accounting regulator
Delegation of responsibility of writing detailed accounting rules to private sector bodies, financed by contributions from companies, audit industry, etc.. US: Financial Accounting Standards Board (FASB) Global: International Accounting Standards Board (IASB)
Flexible and rapid rule-making, as opposed to governmental rule-making
Technical committees from professional accounting bodies may function as catalyst
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
International bodies International Accounting Standards Board (IASB)
Accepted as an international source of best practice Issues the International Financial Reporting Standards (IFRS)
International Organization of Securities Commissions (IOSCO) Represents the world’s stock exchange regulators Strives for a single, uniform set of accounting standards worldwide
Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) Under the auspices of the UN Conference on Trade and Development
(UNCTAD) Commissions research reports into current accounting problems
International Federation of Accountants (IFAC) International representative of the accounting profession
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
International Financial Reporting Standards
Single set of global accounting and reporting standards, issued by the IASB
Increasingly used by many large and mutinational companies
Accepted by most security market authorities
Used as a basis for national accounting requirements (partially or in full) or as a benchmark for the development of national accounting rules
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
International Accounting Standards Board
A private sector body Operates under the International Accounting
Standards Committee Foundation (IASCF) Has no responsibility to any governmental
organization Has no enforcement authority Develops and issues both main standards
(IAS / IFRS) and interpretations (SIC / IFRIC)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 1.1 The structure of the IASB
IASC Foundation22 Trustees
Appoint, Oversee, Raise Funds
Standards Advisory Council
30 or more members
Board12 full time and 2 part time
Set technical agenda. Approve standards, exposure drafts and Interpretations
Working groupsfor major agenda projects
International financial reporting interpretations committee
12 members
Key:
Appoints
Reports toAdvises
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IFRS – Standard-setting due process
The IASB’s standard-setting procedures have to ensure that resulting IFRS are of high quality and are issued only after giving IASB’s constituencies opportunities to make their views known at several points in the standard-setting due process
An overview of the due process is presented in figure 1.2
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Fig. 1.2 Standard-setting due process of the IASB
Discussion paper
Discussion paper
Comment analysis
Exposure
draft
Exposure
draft
Standard
Standard
Effective Date
Comment analysis
Research
National Standard
SettersOthers
9-15 months 9-15 months 6-18 months
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
IFRS in the world Recent decisions of various governments result in
the requirement or permission of the use of IFRS by more than one hundred countries
Europe: IAS Regulation of 2002 Requirement of use of IFRS for consolidated financial
statements of EU qouted companies as from 1 January 2005
Member state option to extend the application of IFRS to not-listed companies and to individual financial statements
Adoption of IFRS (-equivalent) as national accounting rules in a number of countries (Australia, Singapore, Hong Kong, …)
US: convergence process of US accounting rules and IFRS started in 2002 (“Norwalk Agreement”)
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Table 1.2 Financial reporting in the European Union – Main
developments1978 4th Company Law Directive (Individual financial statements)
1983 7th Company Law Directive (Consolidated financial statements)
1995 Decision on new accounting strategy (adhering to IAS instead of further development of specific European accounting rules)
2000 Announcement of plan to require IAS for consolidated financial statements of listed companies by 2005
2001 Fair Value Directive (requiring/allowing for fair value measurement of specific balance sheet items (mainly financial instruments))
2002 IAS Regulation (Application of IFRS by 2005 - see Table 1.3)
2003 Modernization Directive (reflecting IFRS developments in the 4th and 7th Directive)
2005/2007 IFRS mandatory for listed companies in European Union
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Table 1.3 Effects of the IAS Regulation (EU)
Individual financial statements
Group/ Consolidated
financial statements
Listed companies Member state option IFRS mandatory from 2005/2007
Not-listed companies
Member state option Member state option
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Table 1.1 List of IASB rules as of September 2005
Conceptual Framework CF Framework for the Preparation and Presentation of Financial Statements
Main standards
IAS 1 Presentation of Financial Statements IAS 2 Inventories IAS 7 Cash Flow Statements IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events after the Balance Sheet Date IAS 11 Constructions Contracts IAS 12 Income Taxes IAS 14 Segment Reporting IAS 16 Property, Plant and Equipment IAS 17 Leases IAS 18 Revenue IAS 19 Employee Benefits IAS 20 Accounting for Government Grants and Disclosure of Government Assistance IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs IAS 24 Related Party Disclosures
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Table 1.1 List of IASB rules as of September 2005 (cont.)
Main standards (continued)
IAS 26 Accounting and Reporting by Retirement Benefit Plans IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 29 Financial Reporting in Hyperinflationary Economies IAS 30 Disclosure in the Financial Statements of Banks and Similar Financial Institutions IAS 32 Financial Instruments: Disclosure and Presentation IAS 33 Earnings per Share IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property IAS 41 Agriculture IFRS 1 First-time Adoption of International Financial Reporting Standards IFRS 2 Share-based Payment IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-current Assets Held for Sale and Discontinued Operations IFRS 6 Exploration for and Evaluation of Mineral Resources IFRS 7 Financial Instruments: Disclosures
Use with Global Financial Accounting and Reporting ISBN 1-84480-265-5© 2005 Peter Walton and Walter Aerts
Table 1.1 List of IASB rules as of September 2005 - Interpretations
Interpretations
SIC 7 Introduction of the Euro (IAS 21) SIC 10 Government Assistance – No Specific Relation to Operating Activities (IAS 20) SIC 12 Consolidation – Special Purpose Entities (IAS 27) SIC 13 Jointly Controlled Entities – Non-Monetary Contributions By Venturers (IAS 31) SIC 15 Operating Leases – Incentives (IAS 17) SIC 21 Income Taxes – Recovery of Revalued Non-Depreciable Assets (IAS 12) SIC 25 Income Taxes – Changes in the Tax Status of an Enterprise or its Shareholders IAS (12) SIC 27 Evaluating the Substance of Transactions involving the Legal Form of a Lease SIC 29 Disclosure – Service Concession Arrangements SIC 31 Revenue – Barter Transactions Involving Services SIC 32 Intangible Assets – Web Site Costs IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments IFRIC 3 Emission Rights (withdrawn by the Board in June 2005) IFRIC 4 Determining Whether an Arrangement contains a Lease
IFRIC 5 Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds