Financial Reporting Environment

Learning Outcomes
At the end of this lesson you should be able to:

Describe the concept and role of financial reporting; Identify the factors influencing financial reporting decisions; Evaluate the need for regulations in financial reporting; Discuss the role of the conceptual framework of financial accounting; and Assess the need for international harmonization in financial reporting.
2

Lesson Outline

Overview of Financial Reporting

Financial Reporting Decision Making Process

Regulations in Financial Reporting International Reporting Harmonization in Financial

Conceptual Framework in Financial Accounting

Overview of Financial Reporting

Relationship between Accounting and Financial Reporting

Accounting is the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information.
American Accounting Association (AAA)

Relationship between Accounting and Financial Reporting (Contd.)

This definition implies two phases:

identifying and measuring economic information. communicating economic information to users (stakeholders of an organisation) for decision making purposes.

The second aspect is achieved by financial reporting.

6

Financial Reporting
Activities which are intended to serve 'informational needs of external users who lack authority to prescribe the financial information they want from an enterprise and therefore must use the information that management communicates to them.'
(FASB Definition)

Financial Reporting Process

Company's transactions and events

Selection of Accounting Policies

Application of Accounting Policies

Estimates and Judgments involved

Disclosures about transactions, events, policies, estimates and judgments
Source: Gregory J Jonas and Jeannot Blanchet, (2001), Assessing Quality of Financial Reporting, Accounting Horizons, Vol.14, No.3, pp.353-363.
8

Objectives of Financial Reporting

Decision-Making - The basic objective of financial reporting is to provide information useful about an entity to make sound decisions. Management Accountability - Provide information on management accountability to judge managements effectiveness of utilising the resources and running an entity.
9

Focus of Attention in Financial Reporting

Why report?
To whom to report? What to report? How to report?
10

Financial Reporting Decision Making Process

Financial Reporting Decision Making Process

Regulation of Financial Reporting Financial Reporting Decision Making Economic Incentives for Financial Reporting Decisions

Impacts of Financial Reporting Decisions

Social Incentives for Financial Reporting Decisions

Regulations in Financial Reporting

13

Rules Governing Financial Reporting

Local (National) Legislation

National and Accounting Standards International

Stock Exchange Requirements (e.g. Listing Rules)

14

Corporate Financial Reporting Framework in Sri Lanka

Companies Act No. 07 of 2007 Accounting and Auditing Standards Act No.15 of 1995

Securities and Exchange Commission Act No. 36 of 1987 (with amendments)

Listing Rules of the Colombo Stock Exchange Sector Specific Acts

15

Sector Specific Acts

Banking Act No. amendments)

30

of

1988

(with

Finance Companies Act No. 78 of 1988 (with amendments) Regulation of Insurance Industry No.43 of 2000 (with amendments) Act

16

Regulations Is it necessary?

Arguments for and against regulations

Free-market Perspective Pro-regulation Perspective

Who will benefit from regulations?

Theories on Regulation

Are accounting regulations an output of a political process?

17

Free-market Perspective
Accounting information should be treated like other goods, with demand and supply forces allowed to operate to generate an optimal supply.

Even in the absence of regulation there are private economics-based incentives and market-related incentives to provide information.

18

Pro-regulation Perspective

Provide an counter argument on the basis that information produced through the financial reporting process is a public (free) good. Accounting information is a public good

once available it can be used and passed on without payment. parties using without incurring costs are known as free-riders. in the presence of free-riders true demand is understated.
19

International Harmonization in Financial Reporting

20

Accounting Practices around the World

Same Accounting Problems

Various National Regulations

Differing Solutions

21

Reasons for International Accounting Differences

Nature of Business Ownership and Financing System Colonial Inheritance Invasions Taxation Legal System Culture History Geography Language

Inflation Level of Education Age and Size of Accountancy Profession Stage of Economic Development Influence of Theory Political System and Social Climate Religion Accidents of History
22

Harmonization of Accounting Practices

A process of increasing the compatibility of accounting practices by setting bonds to their degree of variation. (Nobes and Parker, 2004). It is not the Standardization.

same

thing

as

Standardization implies the imposition of more rigid rules and narrow set of rules.

23

Reasons for Harmonisation

Growth in International Business Facilitate cross boarder capital flows Improvements in Resource Allocation Economic Self-Interest

Multinationals International Auditing Firms

24

Benefits of International Convergence

Increasing the comparability of financial reports Facilitate meaningful comparison of financial position and financial performance Removing barriers to international capital flows Reduce financial reporting costs of firms Improve quality of financial reporting
25

International Accounting Standards Board (IASB)

Objectives
Development of a high quality global accounting standards. Promotion of use and rigorous application of these standards. Working closely with national standardsetters to achieve convergence of national accounting standards and IAS.

26

Barriers to Harmonization

Reasons for international differences in financial reporting practices

Culture A main factor (Gray 1988, Perera

1989, Eddie 1996)

These obstacles are seen in relation to both development and enforcement of standards.

27

Conceptual Framework of Accounting and its Relevance to Financial Reporting

28

What is a Conceptual Framework?

A conceptual framework is a constitution. a coherent system of inter-related objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, limits of financial accounting and financial statements. (FASB Definition)

29

What is a Conceptual Framework?

(Contd.)

The conceptual framework is a body interrelated objectives and fundamentals.

of

The objectives identify the goals and purposes of financial reporting The fundamentals are the underlying concepts that help achieve those objectives.

Those concepts provide guidance in selecting the transactions, events and circumstances to be accounted for, how they should be recognized and measured and how they should be summarized and reported.

30

How does the Conceptual Framework affect Practice?

Conceptual Framework does not affect practice directly. It affects practice only by means of its influence in the development of new accounting standards.

31

Need for a Conceptual Framework

To assist in the development of new standards and review of existing standards. To assist in promoting harmonization of regulation, accounting standards (A/Ss) and procedures relating to F/R. To assist preparers of financial statements (F/Ss) in applying A/Ss. To assist auditors in forming an opinion. To solve new practical accounting problems quickly. To increase F/S users understanding and confidence in financial reporting. To enhance, comparability among companies F/Ss.

32

Structure of the Conceptual Framework

The objectives of financial statements Qualitative characteristics of financial statements The elements of financial statements The definition and recognition of the elements of financial statements Measurement of the elements of the financial statements

33

Components of IASB Framework

The objectives of financial statements Underlying assumptions Qualitative characteristics of F/Ss The elements of F/Ss The definition and recognition of the elements of F/Ss Measurement of the elements of the F/Ss Concepts of capital and capital maintenance
34

Summary

Overview of Financial Reporting

What is meant by financial reporting? Why it is necessary? What is the scope?

Financial Reporting Decision Making Process

Factors influencing financial reporting decisions

Regulations in Financing Reporting

What are the sources of regulations? Why regulations? Arguments for and against
35

Summary

(Contd.)

International Harmonization in Financial Reporting

What is meant by harmonization? Why it is necessary? What are the barriers ? What is the role of IASB?

Conceptual Framework of Financial Accounting

What is a conceptual framework? What is its relevance to financial reporting?

36