Topic 9 - Financial Reporting Principles, Accounting Standards and Auditing, and Sustainability reporting

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This article is a topic within the subject Accounting 1A.

Contents

Required Reading

Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP pp. 285-328.

Financial Reporting Principles, Accounting Standards And Auditing

[1] Generally Accepted Accounting Principles (GAAP) are rules, standards and usual practices of accountancy in the preparation of financial statements. The Australian Accounting Standards Board (AASB) has created a AASB Framework to establish the accounting standards in Australia for general purpose financial statements.

AASB Framework

[2] The objectives of financial reporting are to show:

  • Position - economic resources, financial structure, liquidity and solvency
  • Performance - capacity to generate cash, how well invested funds are being used and capacity to grow
  • Cash Flows - confirmation of cash generation

The assumptions underlying financial reporting are:

  • Accrual - transactions are recognised when they occur, not when cash is received or paid
  • Going Concern - the company expects to continue operations in the foreseeable future

Qualitative Characteristics of Financial Reports

  1. Understandability
    • Ability of users to understand the financial reports
  2. Relevance
    • Ability to assist users to make, confirm or correct predictions about past, present or future events. It is the usefulness of the information for current decision making
      • Materiality - nature and magnitude affects the importance or un-importance of some information
  3. Reliability – Information is free from bias and material error (Completeness) and can be depended upon by users to faithfully represent economic reality
    • Faithful Representation - what really happened
    • Substance over Form - transactions resented in accordance with economic reality
    • Neutrality - freedom from bias
    • Prudence - caution, conservatism
      • Ensure assets or income are not overstated and expenses and revenue are not understated (conflicts with bias)
    • Completeness - material information not omitted
  4. Comparability - Compare financial reports over time, across firms, countries etc. Helped by IFRS harmonisation

There is a trade-off between Relevance & Reliability. Relevance is enhanced by future predictions whilst reliability comes from a historical focus. For example, accounts receivable reliably shows how much is owed, BUT how much will be received is more relevant. E.g. Revaluation of noncurrent assets or inventory cost method.

Assets

An Asset is a resource controlled by the entity as a result of past events & from which future economic benefits are expected to flow to the entity. Essential Characteristics are:

  • Future Economic Benefits - Potential to contribute directly or indirectly to the flow of cash to the entity
    • Part of operating activities, saleable, convert to cash, cash, capability to reduce cash outflow
  • Controlled by the Entity - If the entity controls the benefits expected to flow to the entity
    • Usually a result of legal rights, but not always e.g. certain leases, confidentiality (RnD)
  • Past Event - Usually obtained, purchased, produced or otherwise generated e.g. donations or gold discovery

Recognition occurs if expected future economic benefits are probable & the item has a cost/value that can be measured reliably.

Liabilities

A Liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Essential Characteristics are:

  • Present Obligation - A duty or responsibility to act or perform in a certain way.
    • Legally enforceable obligations are caused by a binding contract or statutory requirement.
    • Constructive obligations arise from normal business practice, customs, equitable manner (ethics) or desire to maintain good relations e.g. rectify a product after warranty expiry
    • Difference between present obligation (goods delivered or irrevocable agreement) & future commitments
      • Irrevocable Nature of the Agreement – consequences of failing to honour an obligation will cause an outflow of resources
  • Past Event - Result of past transaction or a past obligating event. E.g. buy G&S (payable), sales & warranty prov.
  • Outflow of Economic Benefits - The settlement of a present obligation involves the entity giving up resources embodying economic benefits E.g. the payment of cash or other assets, provision of services

Recognition occurs if expected future outflows of economic benefits associated with the item are probable & the item has a cost/value that can be measured reliably.

Equity

Equity is the residual interest in the assets of the entity after deduction of liabilities

Income

Increases in economic benefits during the accounting period

Expenses

Decreases in economic benefits during the accounting period

External Auditors Report

the external auditors report adds credibility to a company's financial report. It provides an independent and professional perspective in order to render a competent opinion on the true nature or fairness of the financial report.

  • Unqualified Opinion - the statement is true and fair
  • Qualified Opinion - the auditor is generally satisfied except for a specific thing that would be mentioned
  • Adverse Opinion - the financial statements are not true and fair
  • Inability - not able to prove an opinion

Professional Ethics

Accounts are meant to act with integrity, objectivity, professionalism, confidentiality and ethically (avoid tax evasion and accounting manipulation). The accounting bodies promoting these characteristics are the ICAA and CPA.

Sustainability Reporting

[3] Sustainability Reporting provides information upon which stakeholders (customers, employees, investors, communities) can judge economic, environmental and social value of an entity - triple bottom line reporting. It is meant to outline commitments, values, ethics and principles of the company. Sustainability reporting is a response to increasing public awareness (want to create a green image) and the recognition of externalities.

End

This is the end of this topic. Click Accounting 1A to go back to the main subject page for Accounting 1A

References

Textbook refers to Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP

  1. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  2. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  3. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
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