4. Other contents and features of published financial statements Flashcards
What are the primary uses of financial statements?
What are the primary uses of published accounts?
Published accounts provide information about the company’s activities and
financial performance throughout the preceding year. To some extent, they
indicate the future prospects of the business.
Published accounts are a key element of communication with shareholders,
the market and other interested parties such as bank lenders or suppliers. The
published accounts are used by investors and other parties to examine:
profitability: investors and shareholders will be interested in the
profitability ratios and financial numbers such as dividends and retained
profits;
sources or nature of profit: for example, whether the profit generated is
from the sales of assets or normal trading;
balance sheet strength: by looking at liquidity, insolvency and gearing
positions; and
trends: for example, looking for revenue and profit trends to identify
strengths or any potential risks.
Test
What are the objectives of the strategic report?
The strategic report is a detailed report within the annual report and accounts,
written in non-financial language. It provides clear and coherent information
about the company’s activities (such as what it does and why), performance,
position, the strategic position of the business and probable risks attached with
the business. It ensures information is accessible by a broad range of users, not
just analysts and accountants who have sophisticated knowledge.
The purpose of the strategic report is to provide information to the members
of the company and help them assess how the directors have performedtheir duties and functions. The strategic report must contain and provide the
following information:
a fair review of the company’s business
a description of the principal risks and uncertainties the company faces
any change in the going concern assessment
references to the annual accounts
The strategic report of a quoted company must also include information on
the company’s strategy, business model and disclosures about environmental,
employee and social issues (including human rights and gender diversity).
What is the purpose of the notes to the financial statements in a published annual report?
Briefly discuss the purpose of notes to the accounts in a published
annual report.
The notes to the accounts in an annual report provide information not
presented elsewhere in the report. This includes:
more detailed analysis of figures in the statements
narrative information explaining figures in the statements
additional information, such as contingent liabilities and commitments
IAS 1 requires the notes to the accounts in the annual report to disclose the
following key information:
the basis for the preparation of the financial statements that includes
specific accounting policies chosen and applied to significant transactions/
events;
information which is required by IFRS but not presented elsewhere in the
annual report; and
any additional information that is relevant to understanding which is not
shown elsewhere in the annual report.
A plc sold a property to B plc on terms that the property will be leased back to A plc under a lease agreement and A plc continues to occupy the property. How will this transaction be recorded in the financial statements of A plc?
The substance over form concept will be applied. The company must first
determine whether the transfer qualifies as a sale based on the requirements
for satisfying a performance obligation in IFRS 15 ‘Revenue from Contracts with
Customers’. Under IFRS 15, the transfer of goods and services is based upon the
transfer of control – the ability to direct the use of and obtain substantially all of
the remaining benefits from, the asset. In view of this, the transaction will not
be recorded as a sale transaction in the books of A; instead it will be treated as
a lease and accounted for as per IAS 17.
IAS 17 provides a single lessee accounting model, requiring lessees to recognise
assets (representing its right to use the assets) and liabilities (representing its
obligation to make lease payments). The asset will remain in the books of A and
the money received from B by A will be recorded as a secured loan.
Test yourself
Outline the reasons why managers may engage in earnings management or creative accounting?
Creative accounting arises when managers use their knowledge of accounting
choices available to them to manipulate the figures reported in the accounts of
a business. They may resort to such practices due any of the following reasons:
managers may be attempting to secure performance bonuses;
to minimise tax liability;
to increase share values, especially if the directors are shareholders;
to disguise the fact that the business is close to insolvency; or
to use as a bargaining tool in negotiations with suppliers, customers and
employees.
What are the key limitations of historical cost as a basis for the measurement of assets?
Historical cost is the most widely used basis of measurement of assets. Use of
historical cost presents various problems for the users of published accounts as
it fails to account for the change in price levels of assets over a period of time.
This not only reduces the relevance of accounting information by presenting
assets at amounts that may be far less than their realisable value but also fails to
account for the opportunity cost of using those assets. The published accounts
neither represent the value for which fixed assets can be sold nor the amount
which will be required to replace these assets.
Chapter summary
Chapter summary
Companies publish their annual financial statements within a wider set
of information known as the annual report and financial statements (or
accounts). The annual report provides information about the company’s
activities, financial performance and the future prospects of the business.
The annual report includes:
– the strategic report or business review
– the directors’ report
– the directors’ remuneration report
– the corporate governance statement
– the auditor’s report
– audited financial statements
– notes to the financial statements
The strategic report is a detailed report written in non-financial language
that provides clear and coherent information about the company’s
activities, performance and position, including the strategic position and
probable risks of the business. It contains:
– a fair review of the company’s business
– a description of the principal risks and uncertainties
– the going concern assessment
– references to annual financial statements
– additional information for a quoted company including its strategy,
business model and information on environmental, employee and
social issues
The directors’ report helps shareholders make informed decisions when
casting their votes at annual or other meetings. It provides information
on the financial state of the company and its compliance with financial
reporting, accounting and corporate social responsibility standards.
IAS 1 provides guidance on the information to be disclosed in the notes to
the financial statements, including their structure and contents. The notes
to the financial statements provide information not presented elsewhere in
the financial statements. This includes:
– more detailed analysis of figures in the statements
– narrative information explaining figures in the statements
– additional information, such as contingent liabilities (IAS 37), capital
expenditure commitments, IFRS 7 (Financial Instruments) disclosures
and related party disclosures (IAS 24)
Segment reporting provides financial information regarding the financial
performance and position of the key operating units of a company.
International Financial Reporting Standard 8 defines reportable and
operating segments and provides the basis for financial disclosure of
businesses based on segment activity.
Substance of transactions refers to the economic benefits, economic
losses or any kind of economic implications related to the transaction. It
includes an accounting concept popularly termed as ‘substance over form’
which means the transactions recorded in the financial statements must
reflect their economic (or commercial) substance rather than their legal
form alone. It mandates that the financial statements and accompanying
disclosures of an entity should reflect the underlying realities of accounting
transactions.
Some examples where the substance can be different from the form of the
transaction include:
– sale and leaseback arrangements
– consignment stock
– debt factoring
This area of accounting is somewhat subjective. To help preparers, the
IASB has identified the relevant IFRS/IAS that provide detailed guidelines on
disclosure of some key transactions:
– IAS 8 (Accounting Policies, Changes in Accounting Estimates and
Errors)
– IFRS 15 (Revenue)
– IFRS 16 (Leases)
Published financial statements have a few inherent limitations which can
undermine the overall credibility and reliability of information contained in
the annual report and financial statements (or accounts). These include:
– historical cost basis
– creative accounting or earnings management
– intra-group transactions
– ignores non-financial matters
– non-forward looking
– seasonality of trading
– not always comparable
– only covering a specific time period.
