Week 1: Financial reporting requirements & Conceptual Framework 1. Disclosing entity: 2. Proprietary company: 3. Public company: annual

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1 Week 1: Financial reporting requirements & Conceptual Framework 3 types of entities: 1. Disclosing entity: An entity whose securities are listed on securities exchange 2. Proprietary company: Can, cannot, cannot Can be small OR large Large IF it satisfies 2 or more conditions: Gross assets > $12.5 million 2. Gross revenues > $25 million 3. More than 50 EFT employees Cannot have more than 50 shareholders Cannot raise funds that require a disclosure document under Chapter 6D 3. Public company: Can be listed or unlisted Can have unlimited number of shareholders (adv) Can more raise funds from the public (adv) Corporations Act 2001 Financial reporting requirements 3 entities that MUST submit annual reports( financial, directors AND auditor s ) to ASIC : **Reports MUST comply with AASB standards 1. Disclosing entities most public accountability 2. Public companies 3. Large proprietary companies Small proprietary companies only have to prepare financial AND directors report IF: 1. Shareholders with 5% votes OR ASIC requests OR 自己人叫 2. Controlled by a foreign company 被外国人控制 Shareholders OR ASIC can decide whether or not company needs to comply with AASB standards Differential reporting Why the differential reporting? 差别待遇 Information asymmetry exists between managers and shareholders Shareholders have NO access to info Need financial reporting Small proprietary companies have less information asymmetry, because: 1. Fewer shareholders (small proprietary) 2. Shareholders are likely to be part of management 3. Cost of preparation > Benefits for users 1

2 4 Regulatory bodies in Australia 1. Financial Reporting Council(FRC): Perform oversight AND advisory roles in accounting standard setting process (counselor oversee + advise) Develop strategic direction of AASB Direct AASB to adopt IFRS (international) 2. Australian Accounting Standards Board(AASB): Report to FRC Develop conceptual framework(cf) Develop accounting standards (using CF) i. Identify technical issue 有问题, 才有 standard(solution) ii. Add issue to agenda Follow procedure to consider iii. Research & Consider issue research to 讨论 own opinion iv. Consult stakeholders 别人意见 v. Develop accounting standards 3. Australian Securities and Investments Commission(ASIC) : Administer Corporation Act Review financial statements to ensure compliance with Corporation Act AND accounting standards Aim : To ensure the quality of financial statements AND raise user s confidence 2. Australian Securities Exchange(ASX): Public company that operates Australia s shares market Require periodic reporting AND continuous disclosure Aim: To ensure fair trading AND informed market disclose 公平, 知道 Conceptual framework Conceptual framework: Include Framework for preparation and presentation of financial statements AND Definition of reporting entity FS + Who needs to do 4 purposes of conceptual framework: 1. To assist preparation of a consistent set of accounting standards prepare standard 2. To assist preparation of financial statements prepare FS 3. To assist auditors in forming opinions about regulatory compliance audit 4. To assist users in interpreting financial statements released user Framework for preparation & presentation of financial statements Objective of general purpose financial reporting: To provide financial info to existing AND potential investors, lenders AND creditors to help them in decision making about providing resources to the entity 2 Fundamental qualitative characteristics of financial info: (to be useful) 1. Relevance: a. Include ALL material info, without which will affect user s decision b. Have feedback OR predictive value Feedback Evaluate the entity s past decisions Predictive Predict future expectations 2. Faithful representation : Complete, neutral, and free from material error 2

3 4 Enhancing qualitative characteristics of financial info: 1. Comparability: Can be compared across time AND entities 2. Verifiability : Can be reached at the same conclusion by a 3rd party 3. Understandability: Can be understood by a person with reasonable business knowledge 4. Timeliness: Available in time to help users in decision making **Should include as many enhancing qualitative characteristics as possible, BUT is limited by cost Financial reporting requirements **3 steps to know financial reporting requirement: 1. Is it a small proprietary company? Need GPFR in 1st place? Yes Q2; No Q3 2. Is it a reporting entity? To make sure 3. Does it have public accountability? What standards? Reporting entity : An entity who has dependent users on its GPFR An entity is likely to have dependent users if it has: 1. **Users who cannot command preparation of reports 2. Separate management from economic interest (environment/safety committee) 3. Strong economic or political influence 4. Strong financial characteristics Large sales, customers, assets, liabilities MUST prepare GPFR General purpose financial report(gpfr): A financial report that meets the needs of a wide range of users, who cannot command the preparation of reports for their own purposes General purpose = cannot satisfy one by one Create reporting burden for companies downside 2 tiers of accounting standards: Aim: Provide relief for companies that have NO public accountability 1. Tier 1: All Australian accounting standards 2. Tier 2: Australian accounting standards, with reduced disclosure requirements An entity is Tier 1 entity if it has public accountability : 1. Issues debt or equity securities in a public market public 2. Holds assets as a fiduciary for many outsiders 责任 - 受信托者 把财富交给你 Eg. Bank, insurance companies 3

4 Definitions 5 Accounting elements 1. Asset: A resource controlled by an entity from a past event AND will bring FEB Control = Rights to receive substantial benefits from use of asset AND Right to direct the use 2. Liability: A present obligation from past event AND will lead to future resource outflow (NOT affected by probability) 3. Equity: Assets Liabilities 4. Income : An increase in economic benefits when Assets increase OR Liabilities decrease AND lead to an increase in equity Revenue : Income earned from operating activities Gains: Income that does not come from operating activities **Include Free gifts 5. Expense: A decrease in economic benefits when Assets decrease OR Liabilities increase AND lead to a decrease in equity Recognition criteria Recognition: The process of incorporating an item in financial statements **To recognise an item MUST satisfy definition AND recognition criteria Recognition criteria : a. Probable that it will bring FEB OR lead to future resource outflow AND b. Can be measured reliably Measurement Measurement: The process of determining the monetary amount of an item in financial statements 4 types of measurement: 1. Historical cost: Original acquisition cost 过去 2. Current cost: Cost that would be paid if asset is acquired NOW 现在 3. Fair value: Selling price 未来 发掘的价值 4. Present value: Discounted future cash flows Finance Tutorial: 1. Free gift = Gains 2. Answering structure for How to account for an item : a. Definition b. Recognition criteria c. Answer question Accounting treatment 3. *DO NOT state definition Apply it!! (Eg. Directly say xx is not controlled by ) 4

5 Week 2: Fair value measurement 2 disadvantages of fair value measurement: Based on estimations AND judgements + May lead to poor management decisions Fair value can be used to measure Assets AND Liabilities: Can be standalone OR a group 独立一个 / 一堆 Although s Fair value : Price that would be received when selling an asset OR paid to transfer a liability in an orderly transaction between market participants What, when, who 1. When measuring price MUST consider characteristics of Asset that market participants would consider when pricing an asset ie. Condition + Location + Restrictions on use 问状况, 在哪里交易, 注意事项 2. Orderly transaction : A transaction that has previous exposure to the market AND not a forced transaction 井井有条 = 之前就安排 marketing+ 不是强迫 MUST occur in principal market OR most advantageous market 卖 = 人最多 Principal market: Market with the highest level of activity 主场 = 最多买卖 Most advantageous market: Market that maximises the price that would be received when selling an asset OR minimises the price that would be paid to transfer a liability, after taking into account transaction cost AND transport cost 最大优势 = 赚最多, 赚最多 =must know total cost 3. Market participants: Buyers OR sellers, who are independent, knowledgeable AND willing to enter into transaction (Participant = 成人 + 正常的, market = transaction) **MUST measure FV based on assumptions of market participants = Cannot be entity specific Transaction & Transport cost 2 costs to consider when measuring FV: 1. Transaction cost: Cost that would not have incurred IF the asset is not to be sold OR liability is not to be transferred (Would not incur IF no transaction) Cannot be included in fair value measurement NOT characteristic of asset 根本就不是 Asset 的一部分 Entity specific : Depend on how entity enters into transaction BUT must be included when assessing most advantageous market 2. Transport cost : Cost to transfer an asset from its current location to market Must be included in fair value measurement A characteristic of asset NOT entity specific Must be included when assessing most advantageous market 5

6 Fair value measurement for non financial asset (physical) 4 Steps in measuring fair value: 1. Determine asset to be measured 什么 2. Determine appropriate valuation premise, based on market participant s HBU 了解用处 3. Determine principal OR most advantageous market 有没有市场 4. Determine appropriate valuation technique Measure price 1. Determine asset to be measured 测量什么 + 了解 2. Determine appropriate valuation premise, based on market participant s HBU Valuation premise must be based on market participant s highest and best use of asset NOT how the company wants to use it Highest and best use (HBU) : Use of asset that maximise its value MUST satisfy 3 conditions: 可不可以用, 用时合法, 有没有钱 1. Physically possible 2. Legally permissible 3. Financially feasible: Whether use of asset generates sufficient return Market participant s HBU helps to determine appropriate valuation premise 2 types of valuation premises: 假设客人最好的用法 跟生意分开 / 融入生意 1. Stand alone valuation premise Fair value = Price that would be received from market participant, who would use the asset on standalone basis 2. In combination valuation premise Fair value = Price that would be received from market participant, who would use the asset in combination with other assets (in their business) 6

7 3. Determine principal OR most advantageous market Which Market Principal market: Market with highest level of activity Most advantageous market: Market that maximises the price that would be received when selling an asset OR minimises the price that would be paid to transfer a liability, after taking into account transaction AND transport costs 4. Determine appropriate valuation technique Measure Price 3 valuation techniques to measure FV: (MUST talk about all) 1. Market approach: Measure FV based on market prices of identical OR similar assets 过去 已经有了的市场价钱 必须跟你的 asset 相关 MUST adjust for characteristics of asset 2. Cost approach: Measure FV based on current replacement cost Usually most difficult approach(estimate cost to replace with identical asset) MUST adjust for characteristics of asset 3. Income approach: Measure FV based on market expectations of future cash flow stream 未来会带给你多少收入 - 参考市场 When using valuation techniques, need info input: 2 categories of inputs: 看到 = 市场有, 看不到 = 自己猜 Observable inputs: Info based on Market data AND is objective Unobservable inputs : Info based on Estimations AND is subjective **MUST maximise observable inputs AND minimise unobservable inputs **3 levels of inputs: (higher level, less favorable = 比赛 ) Level 1 inputs : Quoted prices from active markets for identical assets (Most objective) Level 2 inputs: Observable inputs that are not Level 1 inputs = Quoted price from active markets for similar asset OR Quoted price from inactive markets for identical assets Level 3 inputs: Unobservable inputs 7

8 Fair value measurement of Financial liabilities AND Own equity instruments 3 steps in fair value measurement for liability: 只有一个用法 1. Determine liability to be measured 2. Determine principal OR most advantageous market 3. Determine appropriate valuation technique 3 requirements of fair value measurement: Measure 前至少存在 Measure Liability 时, 借钱 = 钱 + 风险 When measuring both cannot simply 1. Liability AND own equity instruments MUST be outstanding 2. Fair value of liability must include non performance risk (default) Non performance risk: Risk that entity may fail to repay maturing obligation Measured by credit rating AND interest rate *Fair value of liability = Present value of liability FV of lump sum loan = PV of principal FV of debenture = PV of principal + PV of interest payment 3. When measuring Fair value of liability AND own equity instruments, MUST use: 1. Quoted price from active market for identical instrument (Level 1 input) 2. IF cannot find A company s liability is usually another company s asset = Corresponding asset 你找不到, 问那个借给你钱的人 a. IF other parties who hold the liability OR equity instruments as assets AND i. IF they have the quoted price from active market for identical asset Use this price ii. IF they do not have the quoted price from active market for identical asset Use present value technique b. IF NO other parties who hold the liability OR equity instruments as assets 如果没有人可以问, 只能用 technique i. Use present value technique 2 Disclosure requirements for fair value measurement: 1. Valuation techniques AND inputs users don t care progress, care result 2. IF use significant unobservable inputs Effect of fair value measurement on Profit Tutorial: 1. For FV of asset: 2nd step Discuss 2 possible uses of asset + Calc FV based on Price would be received on Standalone OR In combination valuation premise 4th step Choose valuation technique based on most observable inputs 2. When calc FV given markets: IF per unit MUST multiply (price transport cost per unit) by Total units 8