01 Introduction to Financial Statements Acctg 102

Transcription

1 Introduction to Financial s Describe the financial reporting environment and explain the accounting assumptions, principles, and qualitative characteristics underlying financial statements. Describe the financial reporting environment and generally accepted accounting practise. Discuss the conceptual framework and the objectives of financial reporting. Discuss the conceptual framework s qualitative characteristics of financial information. Discuss the conceptual framework s definitions and recognition criteria for financial statements. Prepare a classified balance sheet. Be able to calculate some common ratios that attempt to analyse liquidity, leverage, profitability and asset efficiency. The NZ Financial Reporting Environment NZ Law: If you are a reporting entity, you must follow the Financial Reporting At (FRA) It governs New Zealand accounting. Applicability of standards per FRA is to all companies unless exempt (no GAAP - Generally accepted accounting practices) or entitled to differential reporting. Differential reporting is when regular standards are used but are modified for easier compliance. Usually because there is no separation of management and ownership or the business is not too big. The Players: International Accounting Standards Board (IASB): Operates in London. Established in Since then, dynamics have changed on how standards are created/changed in NZ. NZ Financial Reporting Standards Board (FRSB): Committee of NZ Institute of Chartered Accountants (NZICA). Comes up with new standards. NZ Accounting Standards Review Board (ASRB): Government body. Established by FRA. ASRB is in charge. It delegates forming standards to FRSB then reviews them and approves the standards or not. The current international standard setting process: IASB: Researches topics. Views exchanged with FRSB. Exposure drafts (ED) created. These are rough drafts of a standard. Due process. EDs are publically posted for commentary. Standard issued if 8 of 14 members approve. FRSB: 1. NZ ED based on IASB produced with modifications possible. 2. Due process. 3. Submits to ASRB for approval.

2 ASRB 1. Reviews and approves NZ equivalent to international financial reporting standards. The FRSB may also produce some financial reporting standards that are not part of the IASB but still part of GAAP in NZ. Generally Accepted Accounting Practise in NZ GAAP in NZ comprises of NZ equivalents to: International financial reporting standards (some labelled IFRS and some called IAS): This is the core of GAAP. International financial reporting interpretations committee (IFRIC) interpretations of IFRSs. NZ modifications are made to international standards to better suit NZ businesses (e.g. less choices, more disclosure, modifications for the non-profit sector). GAAP also includes financial reporting standards (FRS). When there is no standard, we should look first to analogies. We look at current standards to see if a similar standard exists that we can apply to the situation. We can also look to the NZ Framework for the preparation and presentation of financial statements (known as the Conceptual Framework) as a reference point. GAAP compliance is assumed to give a true and fair view. Departures from standards are allowed in extremely rare circumstances. The new presentation must be justified that it is more relevant and is a better view. Conceptual Framework Contains the objective of financial reporting, qualitative characteristics of financial information, definitions and recognition criteria for assets, liabilities, equity, income and expenses. The framework has no technical legal force but it is referred to in standards so the framework has indirect force of law. Objective of Financial Reporting General purpose financial reporting (includes but not is limited to financial statements) about the reporting entity (could be legal entity or different e.g. group accounts) that is decision useful to capital providers (if it helps assess future cash flows and/or how well management is doing - past and future). Capital providers are those who provide resources and have the immediate and critical need of financial reporting. There are generally 3 categories: Equity investors (shareholders) Lenders (e.g. bank) Other creditors (e.g. suppliers, employees, customers) Financial reporting is done from the perspective of the entity.

3 Underlying Assumptions Accrual Accounting: Gives better view of economic reality (assessing past and future performance). Going Concern: Reporting entity is assumed to operate in the foreseeable future. We do not prepare financial statements on a liquidation basis. The business entity and accounting period assumptions are implicit in the objective. We must have these two assumptions in order to achieve the objectives. Framework Fundamental qualitative characteristics of financial information. Qualitative means that it makes information useful. Relevance Information is relevant if it is capable of making a difference to a decision. Information has predictive or confirmatory value. Relevance deals with what should be reported, not how. Faithful Representation Information must be a faithful representation of the underlying economics. Complete No omission of relevant information. Neutral Free from bias. Does not try to achieve a particular result. Free from Material Error No big mistakes. By definition, both relevant and faithfully represented information is useful. Framework Fundamental qualitative characteristics of financial information. Enhancing quality means making information more useful. Comparability Verifiability Timeliness Understandability Suggests consistency. We can never fully achieve this goal. Direct (e.g. invoices) & indirect (e.g. depreciation methods). Sooner better than later. We prepare financial statements for a reasonably sophisticated user. However, this does not mean complex information should be omitted.

4 Materiality Materiality is a constraint/limitation on financial reporting. An item is material if its omission and misstatement could influence decisions. This is a constraint as it limits the information provided by financial reporting. It causes us to provide less information (e.g. grouping immaterial expenses). If something is not material, we allow under GAAP to bend the rules (e.g. immaterial assets can be expensed). Materiality pertains to all the qualitative characteristics. Prudence Prudence means caution. Historically, it is used to justify understating assets/revenue/profit and overstating liabilities and expenses. It s present status is that it is mentioned under reliability. If you are too prudent, you become biased. Prudence is not mentioned in the new framework we are working towards. It is gone. It cannot be used as a justification anymore because prudence causes bias. Instead, we now use our best estimate. Assets An asset is recognised on the balance sheet of an entity if because of past events, the entity controls a resource that provides probable future economic benefits which can be measured reliably as of the balance sheet date. Past Events: Something that happened. Usually a transaction. Control: Control is not the same as ownership although it encompasses ownership. Probable: Probable means more likely than not (over 50%). Future Economic Benefit: Direct or indirect, leading to an increase in cash. Also, if future economic benefit is likely to decrease, this should be reflected (e.g. doubtful debts for accounts receivable). Measured Reliably: Implicit is that estimation is okay but it must be reasonable. If you cannot at least make a reasonable estimation then it cannot be an asset (e.g. human resource). Liabilities A liability is recognised on the balance sheet of an entity if because of past events that the entity has a present obligation that probably will result in an outflow of resources which can e measured reliably as of the balance sheet date. Present Obligation: Duty/responsibility to act in the future where there is no reasonable alternative other than outflow of resources. Measured Reliably: Reasonable estimation is okay. Contingent liabilities can be stated in notes.

5 Entity Equity is the residual interest in assets after deducting all liabilities. The amount is dependent on the measurement of assets and liabilities. If you properly measure assets and liabilities, equity will be properly measured. Equity is not market value/fair value. Market value includes resources not in the balance sheet. It may be sub-classified in the balance sheet as: Share Capital Reserves (includes retained earnings) Income Income is recognised if, during the period, there are increases in economic benefits either from increases to total assets or decreases to total liabilities that cause an increase in equity, other than owner contributions. The amount is dependent on the measurement of assets and liabilities. Equity can increase by income or contributions. We must analyse other accounts to see if there is balancing effect. This is called residual analysis - income is the last thing you look at. There are two types of income: Income that increases profit (e.g. revenue) which increases retained earnings in equity. Income that increase revaluation reserves (ungained income). Expenses Expenses are recognised if, during he period, there are decreases in economic benefits either from decreases to assets or increases to liabilities that cause a decrease in equity, other than owner distributions. The amount is dependent on the measurement of assets and liabilities. There are two types: Type that reduces profit (decrease retained earnings), this is a realised loss from transactions. Type of unrealised loses (e.g. decrease in revaluation reserve). Measurement Bases Historical Cost: Purchase price (e.g. good will) Replacement Cost: Current cost to replace the asset. Not common. Realisable Value: Cash you would realise if you sell the asset now. Present Value: Present value of future cashflow discounted back (e.g. long term liabilities).

6 The Financial s NZ IAS 1 - A complete set of financial statements: Notes of Financial Position (Balance Sheet) of Comprehensive Income of Changes in Equity of Cash Flows of Comprehensive Income This comprises of the old income statement and more. Separately disclose (partial list): Revenue (sales, fees, commissions, etc. can be grouped as revenue and material items disclosed in notes separately) Finance Costs After tax information relating to discontinued operations Tax expense Profit or loss (now a subtotal) Each component of other comprehensive income (income and expenses not involved in profit & loss, e.g. unrealised gains & losses such as changes to revaluation reserve) Total comprehensive income Earnings per share (based on the profit/loss) Should disclose on face or in Notes: Fees to auditors (audit, tax and other) Donations (not an expense but needs to be disclosed) An analysis of expenses either classified by: Nature (disaggregated information e.g. totals for depreciation expense, salaries expense, etc.) or Function (aggregated information e.g. administrative expenses, selling expense, etc.) Depreciation & Employee Benefits must be shown regardless of which classification is used for expenses. Material items (e.g. impairments, write downs as long as they are big enough) of Financial Position (Balance Sheet) For most entities, assets and liabilities will be divided into two main categories: Assets: Current: For most entities, cash or cash equivalents, and assets that are expected to be realised or consumed within the next year. Non-Current Liabilities: Current: For most entities, obligations expected to be settled within the next year; or those where the entity does not have an unconditional right to deter settlement for at least 12 months after balance date. Non-Current: Companies have liabilities that they can rollover (with unconditional right) e.g. some bank loan. If they intend to do so, then it can be listed as non-current.

7 By having a current/non-current division we can determine liquidity. Certain items, at a minimum, must be presented on the face of the statement, including totals for: Property, Plant & Equipment Investment Property Intangibles Inventories Receivables Cash & Cash Equivalents Trade Payables Issued Capital and Reserves There is no standard format for the balance sheet. Usually it is A = L + E but sometimes it is A - L = E. We use A = L + E. of Changes in Equity Disclose the increase or decrease to net assets for the period. Partial list of what is required on the face of the statement: Comprehensive income for the period. Contributions by and distributions to owners in their capacity as owners. For each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing each change. On the face of the notes should be the amount of dividends recognised as distributions to owners and the related amount per share. of Cash Flows Classification of cash flows into operating, investing and financing. Operating Cash Flows: Disclose major classes of gross cash receipts and payments. Elsewhere: Reconcile profit (loss) with operating cash flows. Issues of Preparation As a general rule, comparative information from the previous period is required. Presentation and classification of items in the statement should be consistent from one period to the next (comparability, but sometimes changes cannot be avoided). The notes to the financial statements shall: Contain a statement of compliance with IFRSs. Summarise significant accounting policies, including measurement bases used and judgements made in applying the policies. Provide supporting information or items presented in the financial statements.