CHAPTER 1 - FINANCIAL REPORTING AND ACCOUNTING STANDARDS
This chapter discusses the international financial reporting
environment and the many factors affecting it. In the past, many
countries used their own sets of accounting standards or followed
standards set by larger countries, such as those used in Europe or
in the United States. That protocol has changed through the
adoption of a single set of rules, called International Financial
Reporting Standards (IFRS). Academic research and studies by
adopting jurisdictions provide overwhelming evidence that the use of IFRS has brought the following net benefits to capital markets:
created a common accounting language, adoption was largely positive for listed companies in Australia, adoption helped to reduce
investment risk in domestic firms.
GLOBAL MARKETS
Due to technological advances and less onerous regulatory requirements, investors are able to engage in financial transactions
across national borders and to make investment, capital allocation, and financing decisions involving many foreign companies.
Capital markets are increasingly integrated and companies have greater flexibility in deciding where to raise capital. In the absence
of market integration, there can be company-specific factors that make it cheaper to raise capital and list/trade securities in one
location versus another. With the integration of capital markets, the automatic linkage between the location of the company and the
location of the capital market is loosening. As a result, companies have expanded choices of where to raise capital, either equity or
debt. The move toward adoption of global accounting standards has and will continue to facilitate this trend.
FINANCIAL STATEMENTS AND FINANCIAL REPORTING
The essential characteristics of accounting are (1) the identification, measurement, and communication of financial information
about (2) economic entities to (3) interested parties. Financial accounting is the process that culminates in the preparation of
financial reports on the enterprise for use by both internal and external parties. In contrast, managerial accounting is the process of
identifying, measuring, analyzing, and communicating financial information needed by management to plan, control, and evaluate a
company’s operations.
Financial statements are the principal means through which a company communicates its financial information to those outside the
business. The financial statements most frequently provided are (1) the statement of financial position, (2) the income statement
(or statement of comprehensive income), (3) the statement of cash flows, and (4) the statement of changes in equity. Note
disclosures are an integral part of each financial statement. Some financial information is better provided, or can be provided only,
by means of financial reporting other than formal financial statements.
ACCOUNTING AND CAPITAL ALLOCATION
Efficient use of resources often determines whether a
business thrives. This fact places a substantial burden on the
accounting profession. Accountants must measure
performance accurately and fairly on a timely basis, so that
the right managers and companies are able to attract
investment capital. An effective process of capital allocation is critical to a healthy economy. It promotes productivity, encourages
innovation, and provides an efficient and liquid market for buying and selling securities and obtaining and granting credit.
HIGH-QUALITY STANDARDS
To facilitate efficient capital allocation, investors need relevant information and a faithful representation of that information to
enable them to make comparisons across borders. A single, widely accepted set of high-quality accounting standards is a necessity
to ensure adequate comparability. Important elements for the achievement of high-quality accounting standards:
- Single set of high-quality accounting standards - Common approach to regulatory review and
established by a single standard-setting body. enforcement.
- Consistency in application and interpretation. - Education and training of market participants.
- Common disclosures. - Common delivery systems (e.g., eXtensible
- Common high-quality auditing standards and Business Reporting Language—XBRL).
practices. - Common approach to company governance and
legal frameworks around the world
Capital formation and investor understanding are enhanced if a single set of high-quality accounting standards is developed.
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,OBJECTIVE OF FINANCIAL REPORTING
The objective of general-purpose financial reporting is to provide financial information about the reporting entity that is useful to
present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity.
Information that is decision-useful to capital providers (investors) may also be useful to other users of financial reporting who are
not investors.
➔ General-purpose financial statements provide financial reporting information to a wide variety of users. They provide, at
the least cost, the most useful information possible.
➔ Identifying investors and creditors as the primary user group provides an important focus of general-purpose financial
reporting.
➔ An entity perspective is adopted in the above objective. Companies are viewed as separate and distinct from their owners
(present shareholders) using this perspective. The perspective that financial reporting should be focused only on the
needs of shareholders—often referred to as the proprietary perspective—is not considered appropriate.
➔ Investors are interested in financial reporting because it provides information that is useful for making decisions (referred
to as the decision-usefulness approach). As indicated earlier, when making these decisions, investors are interested in
assessing (1) the company’s ability to generate net cash inflows and (2) management’s ability to protect and enhance
the capital providers’ investments. The emphasis on “assessing cash flow prospects” does not mean that the cash basis
is preferred over the accrual basis of accounting.
The objective of accrual-basis accounting: it ensures that a company records events that change its financial statements in the
periods in which the events occur, rather than only in the periods in which it receives or pays cash. Using the accrual basis to
determine net income means that a company recognizes revenues when it provides the goods or performs the services (that is,
satisfies its performance obligation) rather than when it receives cash.
STANDARD-SETTING ORGANIZATIONS
The main international standard-setting organization is based in London, England, and is called the International Accounting
Standards Board (IASB). The IASB issues International Financial Reporting Standards (IFRS), which are used on most foreign
exchanges. The two organizations that have a role in international standard-setting are the International Organization of Securities
Commissions (IOSCO) and the IASB.
INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (IOSCO)
The International Organization of Securities Commissions (IOSCO) is an association of organizations that regulate the world’s
securities and futures markets. Members are generally the main financial regulator for a given country. IOSCO does not set
accounting standards. Instead, this organization is dedicated to ensuring that the global markets can operate in an efficient and
effective basis. IOSCO supports the development and use of IFRS as the single set of high-quality international standards in cross-
border offerings and listings.
INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)
The standard-setting structure internationally is composed of the following four organizations:
- The IFRS Foundation provides oversight to the IASB, IFRS Advisory Council, and IFRS Interpretations Committee. In this
role, it appoints members, reviews effectiveness, and helps in the fundraising efforts for these organizations.
- The International Accounting Standards Board (IASB) develops, in the public interest, a single set of high-quality,
enforceable, and global international financial reporting standards for general-purpose financial statements.
- The IFRS Advisory Council (the Advisory Council) provides advice and counsel to the IASB on major policies and technical
issues.
- The IFRS Interpretations Committee assists the IASB through the timely identification, discussion, and resolution of
financial reporting issues within the framework of IFRS.
In addition, as part of the governance structure, a Monitoring Board was created. The purpose of this board is to establish a link
between accounting standard-setters and those public authorities (e.g., IOSCO) that generally oversee them.
Due process
In establishing financial accounting standards, the IASB has a thorough, open, and
transparent due process. The IASB due process has the following elements: (1) an
independent standard-setting board overseen by a geographically and professionally
diverse body of trustees; (2) a thorough and systematic process for developing
standards; (3) engagement with investors, regulators, business leaders, and the
global accountancy profession at every stage of the process; and (4) collaborative
efforts with the worldwide standard-setting community.
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,Types of pronouncements
The IASB issues three major types of pronouncements:
1. International Financial Reporting Standards. → Financial accounting standards issued by the IASB are referred to as
International Financial Reporting Standards (IFRS).
2. Conceptual Framework for Financial Reporting. → As part of a long-range effort to move away from the problem-by-
problem approach, the IASB uses an IFRS conceptual framework. This Conceptual Framework for Financial Reporting sets
forth the fundamental objective and concepts that the Board uses in developing future standards of financial reporting.
The intent of the document is to form a cohesive set of interrelated concepts—a conceptual framework— that will serve
as tools for solving existing and emerging problems in a consistent manner.
3. International Financial Reporting Standards Interpretations. → Interpretations issued by the IFRS Interpretations
Committee are also considered authoritative and must be followed. These interpretations cover (1) newly identified
financial reporting issues not specifically dealt with in IFRS and (2) issues where unsatisfactory or conflicting
interpretations have developed, or seem likely to develop, in the absence of authoritative guidance.
HIERARCY OF IFRS
Because it is a private organization, the IASB has no regulatory mandate and therefore no enforcement mechanism. As a result, the
Board relies on other regulators to enforce the use of its standards. The following hierarchy is used to determine what recognition,
valuation, and disclosure requirements should be used. Companies first look to:
1. International Financial Reporting Standards, International Accounting Standards (issued by the predecessor to the IASB),
and IFRS interpretations originated by the IFRS Interpretations Committee (and its predecessor, the IAS Interpretations
Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a similar conceptual framework (e.g., U.S. GAAP).
The overriding requirement of IFRS is that the financial statements provide a fair presentation (often referred to as a “true and fair
view”). Fair representation is assumed to occur if a company follows the guidelines established in IFRS.
FINANCIAL REPORTING CHALLENGES
Much is right about international financial reporting. One reason for this success is that financial statements and related
disclosures capture and organize financial information in a useful and reliable fashion. However, much still needs to be done.
IFRS IN A POLITICAL ENVIRONMENT
Various participants in the financial reporting environment may want particular economic events accounted for or reported in a
particular way, and they fight hard to get what they want. They know that the most effective way to influence IFRS is to participate
in the formulation of these rules or to try to influence or persuade the formulators of them. Considering the economic consequences
of many accounting rules, special interest groups are expected to vocalize their reactions to proposed rules. What the Board should
not do is issue standards that are primarily politically motivated. The Board should base IFRS on sound research and a conceptual
framework that has its foundation in economic reality.
THE EXPECTATIONS GAP
The expectations gap—what the public thinks accountants should do and what accountants think they can do— is difficult to
close. Although the profession can argue rightfully that accounting cannot be responsible for every financial catastrophe, it must
continue to strive to meet the needs of society.
SIGNIFICANT FINANCIAL REPORTING ISSUES
While our reporting model has worked well in capturing and organizing financial information in a useful and reliable fashion, much
still needs to be done. For example: non-financial measurements, forward-looking information, soft assets and timeliness.
ETHICS IN THE ENVIRONMENT OF FINANCIAL ACCOUNTING
Technical competence is not enough when encountering ethical decisions. Doing the right thing is not always easy or obvious. The
pressures “to bend the rules,” “to play the game,” or “to just ignore it” can be considerable.
INTERNATIONAL CONVERGENCE
Convergence to a single set of high-quality financial reporting standards is desirable and a number of convergence projects have
already been completed and differences eliminated.
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, CHAPTER 2 - CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING
Accounting needs a framework—a conceptual framework, so to
speak—that will help guide the development of standards.
CONCEPTUAL FRAMEWORK
A conceptual framework establishes the concepts that underlie financial reporting. The concepts provide guidance on (1) identifying
the boundaries of financial reporting; (2) selecting the transactions, other events, and circumstances to be represented; (3) how
they should be recognized and measured; and (4) how they should be summarized and reported.
NEED FOR A CONCEPTUAL FRAMEWORK
A soundly developed conceptual framework enables the IASB to issue more useful and consistent pronouncements over time, and a
coherent set of standards should result. Standard-setting that is based on personal conceptual frameworks will lead to different
conclusions about identical or similar issues than it did previously. As a result, standards will not be consistent with one another,
and past decisions may not be indicative of future ones. Furthermore, the framework should increase financial statement users’
understanding of and confidence in financial reporting. It should also enhance comparability among companies’ financial statements.
As a result of a soundly developed conceptual framework, the profession should be able to more quickly solve new and emerging
practical problems by referring to an existing framework of basic theory.
DEVELOPMENT OF A CONCEPTUAL FRAMEWORK
The Conceptual Framework comprises eight chapters, as follows. Chapter 1, The Objective of General Purpose Financial Statements.
Chapter 2, Qualitative Characteristics of Useful Financial Information. Chapter 3, Financial Statements and the Reporting Entity.
Chapter 4, The Elements of Financial Statements. Chapter 5, Recognition and Derecognition. Chapter 6, Measurement. Chapter 7,
Presentation and Disclosure. Chapter 8, Concepts of Capital and Capital Maintenance.
➔ The Conceptual Framework can provide guidance in many situations where an IFRS does not cover the issue under
consideration.
OVERVIEW OF THE CONCEPTUAL FRAMEWORK
BASIC OBJECTIVE
The objective of financial reporting is the foundation of the
Conceptual Framework. Other aspects of the Conceptual
Framework flow logically from the objective. The objective of
general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present
and potential equity investors, lenders, and other creditors in
making decisions about providing resources to the entity.
Management stewardship is how well management uses a
company’s resources to create and sustain value. Information
that is decision-useful to capital providers may also be helpful
to users of financial reporting who are not capital providers.
General-purpose financial reporting helps users who lack the
ability to demand all the financial information they need from a
company and who must therefore rely, at least partly, on the
information provided in financial reports. However, an implicit
assumption is that users need reasonable knowledge of
business and financial accounting matters to understand the
information contained in financial statements.
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