24. Financial Reporting Standards
A. Objective of financial statements and importance of financial reporting standards in security analysis and valuation :
Reporting standards ensure that the financial information (financial performance and financial position) is useful to a wide range of users, including security analysts, by making financial statements comparable to one another and narrowing the range within which management’s estimates can be seen as reasonable.
Reporting standards limit the range of assumptions management can make.
Assessing the financial prospects is the responsibility of analysts.
b. Roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities :
Standard-setting bodies are professional organization of accountants and auditors that establish financial reporting standards. FASB (Financial Accounting Standards Board) sets forth the U.S. GAAP (Generally Accepted Accounting Principles) in the U.S. The IASB (International Accounting Standards Board) establishes the IFRS (International Financial Reporting Standards) outside of the U.S.
The IASB has 4 stated goals :
- Develop global accounting standards requiring transparency, comparability and high quality in financial statements.
- Promote the use of global accounting standards.
- Account for the needs of emerging markets and small firms when implementing global accounting standards.
- Achieve convergence between various national accounting standards and global accounting standards
Although standards-setting bodies should not be compromised by special interests, seeking input from stakeholders is considered a desirable attribute.
Regulatory authorities are government agencies that have the legal authority to enforce compliance with financial reporting standards. Regulatory authorities such as the SEC (Securities and Exchange Commission) in the U.S. and the FSA (Financial Services Authority) in the U.K., are established by national governments. Most national authorities belong to the IOSCO (International Organization of Securities Commission). The three objectives are :
- Protect investors.
- Ensure the fairness, efficiency and transparency of markets.
- Reduce systemic risk.
The SEC’s required filings :
- Form S-1: Registration statement filed prior to the sale of new securities to the public.
- Form 10-K: Required annual filing, includes information about the business and its management, audited financial statements and disclosures, and disclosures about legal matters.
- Form 10-Q: Required quarterly filing, with updated financial statements (audit not required) and certain events such as significant legal proceedings or changes in accounting policies.
- Form DEF-14A: When a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, it also files the statement with the SEC.
- Form 8-K: Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance...
- Form 144: A company can issue securities to certain qualified buyers without registering securities with the SEC but must notify the SEC that it intends to do so.
- Form 3, 4 & 5: Involve beneficial ownership of securities by a company’s officers and directors.
C. Status of global convergence of accounting standards and ongoing barriers :
Developing one universally accepted set of accounting standards is referred to as ‘convergence’. The IASB is an accounting-setting body involved in the process.
One barrier to this development is simply that different standard-setting bodies of different countries disagree on the best treatment of a particular item or issue. Other barriers result from political pressures from business groups and others who will be affected by these charges.
D. IASB’s conceptual framework, objective and qualitative characteristics of financial statements, required reporting elements, constraints and assumptions :
Qualitative characteristics that accounting information must possess according to the IASB’s Conceptual Framework are relevance and faithful representation, which are enhanced by the characteristics of timeliness, verifiability, understandability and comparability.
An item from the required reporting elements (asset, liability, equity, income, expenses) should be recognized in its financial statement element if a future economic benefit from the item is probable and the item’s value or cost can be measured reliably.
Measurement bases :
- 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 for the same asset today).
- Realizable value (the amount for which the firm could sell the asset).
- Present value (the discounted value of the assets’ expected future cash flows).
- Fair value (the amount at which two parties in an arm’s length transaction would exchange the asset).
The two underlying assumptions of financial statements according to the conceptual framework are accrual accounting and the going concern assumptions.
Constraints :
- The benefit that users gain from the information should be greater than the cost of presenting it.
- Non-quantifiable information about a company (reputation, brand loyalty...) cannot be captured directly in financial statements.
E. General requirements for financial statements under IFRS :
IAS n°1 defines which financial statements are required and how they must be presented. The required financial statements are:
- Balance sheet.
- Statement of comprehensive income.
- Cash flow statement.
- Statement of changes in owner’s equity.
- Explanatory notes, including a summary of accounting policies.
The features for preparing financial statements are :
- Fair presentation.
- Going concern basis.
- Accrual basis of 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.
F. Key concepts of financial reporting standards under IFRS and U.S. GAAP reporting systems :
The IASB and FASB frameworks are similar but are moving towards convergence. Some of the remaining differences are :
- The IASB framework lists income and expenses as elements related to performance, while the FASB framework includes revenues, expenses, gains, losses and comprehensive income.
- The FASB defines an asset as a future economic benefit, whereas the IASB defines it as a resource from which a future economic benefit is expected to flow. Also, the FASB uses the word ‘probable’ in its definition of assets and liabilities.
- The FASB does not allow the upward valuation of most assets.
Firms that list their shares in the U.S. but do not use U.S. GAAP or IFRS are required to reconcile their financial statements with U.S. GAAP. For IFRS, firms listing their shares in the U.S., reconciliation is no longer required.
G. Characteristics of coherent financial reporting framework and barriers :
A coherent financial reporting framework should exhibit transparency, comprehensiveness, and consistency.
Barriers to creating a coherent framework include issues of valuation, standard-setting, and measurement.
H. Implications for financial analysis of differing reporting systems :
An analyst should be aware of evolving financial reporting standards and new products and innovations that generate new types of transactions.
I. Company disclosures of significant accounting policies :
Under IFRS and U.S. GAAP, companies must disclose their accounting policies and estimates in the footnotes and MD&A. Public companies are also required to disclose the likely impact of recently issued accounting standards on their financial statements.
|