Financial Reporting

Dr. Zeinab Elrashidy, CFA, FRM, M.Sc., PGCert, AFHEA

Chapter 2:
Financial
Reporting
Standards
The outline
 ❑ According to the IASB Conceptual
Framework for Financial Reporting 2010,
the objective of financial reporting is to

I. American and provide information about the firm to

current and potential investors and creditors
that is useful for making their decisions
international about investing in or lending to the firm.
❑ Reporting standards ensure that transactions
accounting are reported by firms similarly. However,
standards must remain flexible and allow
discretion to management to properly
standards describe the economics of the firm.
❑ Financial reporting is designed also to
provide important inputs for valuation
purposes.
• Standard-setting bodies are
professional organizations of
accountants and auditors that
establish financial reporting
standards.
• Regulatory authorities are
government agencies that
have the legal authority to
enforce compliance with
financial reporting
standards.
• The two primary standard-setting bodies are the Financial Accounting Standards Board
(FASB) and the International Accounting Standards Board (IASB). In the United States,
the FASB sets forth Generally Accepted Accounting Principles (GAAP).
• Outside the United States, the IASB establishes International Financial Reporting Standards
(IFRS).
• Other national standard-setting bodies exist as well. (Egyptian accounting standards board)
• Many of them (including the FASB) are working toward convergence with IFRS. Some of
the older IASB standards are referred to as International Accounting Standards (IAS).
US.GAAP vs IFRS

While the IASB and FASB work

together to harmonize changes to
accounting standards, some
significant differences between IFRS
and U.S. GAAP still exist. The
existence of differences between the
two sets of standards require the
analyst to exercise caution when
making comparisons between firms
operating in different jurisdictions.
Some major differences are outlined in
the following table:
The global convergence for the
accounting standards

➢The European Union requires IFRS financial reporting by

publicly listed companies. In most major countries that
have not fully adopted IFRS, accounting standard setters
are attempting to converge their standards with IFRS.
➢Many aspects of U.S. GAAP and IFRS, for example, have
converged over the past decade, and the Securities and
Exchange Commission no longer requires IFRS reporting
firms to reconcile their financial statements to U.S.
GAAP.
➢Although no further projects related to U.S. GAAP/IFRS
convergence are scheduled as of year-end 2017, IFRS
convergence efforts are ongoing in many other countries.
 Barriers to global convergence of the
accounting standards

• The different standard-setting bodies and the regulatory authorities

of different countries can and do disagree on the best treatment of a
particular item or issue.

• The political pressures that regulatory bodies face from business

groups and others who will be affected by changes in reporting
standards.
An item should be recognized in its financial statement element if a
future economic benefit from the item (flowing to or from the firm)
is probable and the item’s value or cost can be measured reliably.

• That is why (human capita) are hard to be included in the assets

of the firm as it is difficult to give them value.
• Also: Company innovation capability,
• Employees loyalty,
• Company reputation.
• Good analyst can consider this in his own analysis (subjective)
 Constraints in the financial reporting

• Cost and benefit trade off: the benefit that users gain from the
information should be higher than the cost of presenting
information.
• Non-quantifiable information: such as firm reputation, brand
loyalty, capacity of innovation ….
• That are difficult to be presented in the financial statement of the
firm.
The IASB conceptual framework for financial reporting
Qualitative characteristics of the financial reporting

• Relevance. Financial statements are relevant if the information in them

can influence users’ economic decisions or affect users’ evaluations of
past events or forecasts of future events. To be relevant, information
should have predictive value, confirmatory value (confirm prior
expectations), or both. Materiality is an aspect of relevance.
• Faithful representation. Information that is faithfully representative is
complete, neutral (absence of bias), and free from error.
There are four characteristics that enhance relevance and faithful representation:
comparability, verifiability, timeliness, and understandability.
• 1. Comparability. Financial statement presentation should be consistent among firms
• and across time periods.
• 2. Verifiability. Independent observers, using the same methods, obtain similar
• results.
• 3. Timeliness. Information is available to decision makers before the information is
• stale.
• 4. Understandability. Users with a basic knowledge of business and accounting and who
make a reasonable effort to study the financial statements should be able to readily
understand the information the statements present. Useful information should not be
omitted just because it is complicated.
 Case (1)
A company records sales revenue, and it is required to simultaneously estimate and record
an expense for potential bad debts (uncollectible accounts). Including this estimated
expense is considered to represent the economic event faithfully and to provide relevant
information about the net profits for the accounting period. The information is timely and
understandable; but because bad debts may not be known with certainty until a later period,
inclusion of this estimated expense involves a sacrifice of verifiability. The bad debt
expense is simply an estimate. It is apparent that it is not always possible to simultaneously
fulfill all qualitative characteristics. Companies are most likely to make tradeoffs between
which of the following when preparing financial reports?
• A) Relevance and materiality.
• B) Timeliness and verifiability.
• C) Relevance and faithful representation.
Required Reporting Elements

• Assets. Resources controlled as a result of past transactions that are

expected to provide future economic benefits.
• Liabilities. Obligations as a result of past events that are expected to require
an outflow of economic resources.
• Equity. The owners’ residual interest in the assets after deducting the
liabilities.
• Income. An increase in economic benefits, either increasing assets or
decreasing liabilities in a way that increases owners’ equity (but not
including contributions by owners). Income includes revenues and gains.
• Expenses. Decreases in economic benefits, either decreasing assets or
increasing liabilities in a way that decreases owners’ equity (but not
including distributions to owners). Losses are included in expenses.
The amounts at which items are reported in the financial
statement elements depend on their measurement base:

oHistorical cost (the amount originally paid for the asset),

oAmortized cost (historical cost adjusted for depreciation, amortization, depletion, and
impairment),
oCurrent cost (the amount the firm would have to pay today for the same asset),
oNet realizable value (the estimated selling price of the asset in the normal course of
business minus the selling costs),
oPresent value (the discounted value of the asset’s expected future cash flows),
oFair value (the price at which an asset could be sold, or a liability transferred.
i. The general features for preparing financial statements:

Fair presentation, defined as faithfully representing the effects of the entity’s transactions and
events according to the standards for recognizing assets, liabilities, revenues, and expenses.

Going concern basis, meaning the financial statements are based on the assumption that the
firm will continue to exist unless its management intends to (or must) liquidate it.

Accrual basis of accounting is used to prepare the financial statement other than the statement
of cash flows.

Consistency between periods in how items are presented and classified, with prior-period
amounts disclosed for comparison.
Materiality, meaning the financial statements should be free of misstatements or omissions that
could influence the decisions of users of financial statements.

Aggregation of similar items and separation of dissimilar items.

No offsetting of assets against liabilities or income against expenses unless a specific standard
permits or requires it.

Reporting frequency must be at least annually.

Comparative information for prior periods should be included unless a specific standard states
otherwise.
ii. The key concepts of financial reporting standards under IFRS and US
generally accepted accounting principles (US GAAP) reporting systems.

IASB FASB
Definition of asset as a resource from which a a probable future
future economic benefit is economic benefit.
expected to It does not allow the
flow. upward valuation of most
assets.
Income statement It lists income and It includes revenues,
expenses as elements expenses, gains, losses,
related to and comprehensive
Performance. income.
The companies present a reconciliation statement
showing what its financial results would have been
under an alternative reporting system.

For example, firms that list their shares in

the United States but do not use U.S. GAAP
or IFRS are required to reconcile their
financial statements with U.S. GAAP.
iii. characteristics of a coherent financial reporting framework
and the barriers to creating such a framework

• A coherent financial reporting framework is one that fits together logically. Such a
framework should be :
❑Transparency—Full disclosure and fair presentation reveal the underlying economics of the
company to the financial statement user.
❑Comprehensiveness—All types of transactions that have financial implications should be
part of the framework, including new types of transactions that emerge.
❑Consistency—Similar transactions should be accounted for in similar ways across
companies, geographic areas, and time periods.
 As financial reporting standards continue to evolve,
iiii. The Implications analysts need to monitor how these developments will
for financial analysis affect the financial statements they use.
of differing financial
reporting An analyst should be aware of new products
systems and the (derivatives, leasing related accounting procedures)
and innovations in the financial markets that generate
importance of new types of transactions. These might not fall into the
existing financial reporting standards.
monitoring
developments in
financial reporting The analyst can use the financial reporting framework
as a guide for evaluating what effect new products or
standards. transactions might have on financial statements.
v. The Analysis of the company disclosures of
significant accounting policies

o Companies that prepare financial statements under IFRS or U.S. GAAP must
disclose their accounting policies and estimates in the footnotes. Significant
policies and estimates that require management judgement are also addressed in
Management’s Discussion and Analysis (management commentary).
o An analyst should use these disclosures to evaluate what policies are discussed,
whether they cover all the relevant data in the financial statements, which policies
required management to make estimates, and whether the disclosures and
estimates have changed since the prior period.
o Another disclosure that is required for public companies is the likely impact of
implementing recently issued accounting standards. Management can discuss the
impact of adopting a new standard, conclude that the standard does not apply or
will not affect the financial statements materially, or state that they are still
evaluating the effects of the new standards. Analysts should be aware of the
uncertainty this last statement implies.
Thank you