Issues in Financial Reporting - Assignment Example

Financial Reporting Table of Contents Question 1 2 Question 2 4 Question 3 6 Question 4 7 Bibliography 11 Question 1 The main objective behind presenting proper and useful information in financial statement is that it allows the users to take the right decision. For a better understanding of a company’s activity the data should be comprehensive. Not only the users, on the basis of financial statement the directors and the managers also take decisions on behalf of the owners. A financial statement deliver information regarding the economic sources of the fund and their applications as well as the owner’s equity and reserve, current year’s earnings and expenses. That is why it enables the stakeholders to understand the financial position and performance of the company. There are few assumptions of a financial statement. Such as, a business entity is assumed to carry on its operation forever which refers to a going concern concept. Financial statements should be prepared periodically, basically after a specified interval which is termed as ‘accounting period’. All the transaction recorded in a statement should be at cost, not market price. As per the money measurement concept, the information recorded in the statement should be in monetary terms. The business entity concept says that the legal entity of a corporate business should be different from the owners. The method or the practice that has been adopted by a company initially for presenting an event should be followed life long in order to maintain the consistency. Preparation of financial statements is subject to quite a few regulations. For the purpose, Accounting Standards should be followed. Accounting Standards are issued by Accounting Standard Board (ASB). ASB is a part of Financial Reporting Council (FRC). It is a self -regulatory body in UK and is responsible for promoting quality corporate governance. ASB collaborate with the International Accounting Standard Board (IASB) to ensure the acceptance of Accounting Standard at the international level. UITF plays major role of assisting the ASB while solving a conflicting and unsatisfactory interpretation regarding the requirements of Companies Act. Financial Reporting Review Panel (FRRP) is also a part of FRC, which check the financial statement of private and public companies to ensure that statements are presented as accordance with Accounting Standards and Companies Act, 2006. Accountability and transparency are absolute necessity for maximising long term share holder’s value. The rules and procedures of gathering data must be flexible and consistent; otherwise a scope of misinterpretation of data will arise. There can be manipulation in calculation that might lead to unfair allocation of funds. The transparency in disclosure of accounts should be maintained by all departments. It is essential for long term success of the firm. It interprets the importance of accountants and auditors in a company. Corporate governance is a system by which business corporation are directed and controlled. The efficiency and accountability issues that must be addressed by corporate governance are the growth of private companies, need for restructuring of boards, litigation against directors, the importance of institutional investors, insider trading, reasonable remuneration of managers and directors, interest of shareholders and other stakeholders, reasonable risk, auditing practice among others. Corporate governance mechanism consists of few important things that bring more transparency in financial reporting system. The board ensures timely and accurate reports provided on corporate performance as well as the financial and non - financial conditions. The Audit committee acts as a bridge between the external auditors and board. It supervises the financial reporting process to make it sure that all disclosure of financial information is adequate, sufficient and credible and looks after the issues raised by the external auditors. Question 2 The objective provided in the financial statement is intended to show a clear picture of the company’s financial performance, financial position and cash flow for making economic decision by the stakeholders. It also provides the information regarding accountability of management towards the resources assigned to it. Financial reports not only provide the current information but also the comparison with past records and effect of previous events. The financial statement should essentially be understandable by the users. The most complex but necessary things should not be attached at the initial stage. The information presented in statement must be relevant to the decision making criteria of the users. As per the materiality concept, information will prove to be material information if its erroneous statement can influence the decision of its users. Along with relevance, the information must be reliable. Financial information can be reliable if it is free from all sorts of omission or misleading information and data. Another most important characteristic of financial statement is neutrality. It means no biasness should be there at the time of preparing the report. No doubtful or unpredictable information should be given in financial statement. Even there must not be any intention to overvalue the assets or undervalue the liabilities. A comparison with last performance and a comparable figure should be studied along to understand the trend and position of the company. Through a financial statement, only the financial performance of a company and the performance of the management and the utilisation of sources can be assessed but other performances cannot be measures duly. It is not useful to control the business because it does not describe the cause. It only describes the consequence. Even a business need to deal with the future financial performance also but financial statements are based on historical data. That is why the question arises that how an entity’s overall performance can be understood or be judged. An entity is a combination of different departments like operation, marketing, human resource, finance, information technology, administration, etc. Every department’s work procedures and strategies are different so the performance also varies. Not only this, companies have different stakeholders also as suppliers, customers, shareholders, employees, management, government, etc. And therefore the business organisation has certain duties toward all the stakeholders. It is also included in the assessment procedure. That is why financial condition is not the only factor. There are many other factors such as ethical issues, environmental consciousness, customer relationships, employee relationships, technological efficiencies, innovation and strategy adoption, legal framework, etc. Financial reports are a part of this and not the only decision making criteria. The risk primarily depends upon the consistency. A loss making company’s risk can also be less if they use proper technique to recover it. In order to understand the risk of an entity, benchmarking process can be adopted. Question 3 Even before two decades, it was observed that most of the wealth creating work was done manually. On those days, focus was on the physically based work but with the development of the technology and the progress of science, it shifted towards the knowledge-based work. It is known that knowledge is less tangible assets and mainly depended on the human knowledge and awareness. It is a combined process of cognitive process, personal memory and sensing. Assessing knowledge assets refer to adding enhanced value on people. It may be of individual capabilities or the collective capabilities. Some where it also depended on the artificial intelligence and the intelligence of the computer system of the institution. In today’s world, accounting practice is some where lagging behind. It needs to be updated as it is not measuring the knowledge assets aptly compared to the procedure of calculating physical assets, which is much more refined. The companies also provide little information regarding the knowledge assets. In present days, the growth of knowledge based companies is increasing rapidly even more than the growth of other industries because of the improvements of the technology. In most of the countries, the base of economy depends on the agricultural sector and the industrial sector but now there is more emphasis on the knowledge based industry. The reason behind it is this kind of industry is able to reduce the unemployment problem as it deals with the human asset. The work procedure of most of the companies in this sector is related with the foreign clients. That is why it is able to earn more foreign currencies. Till now, there is no such mechanism which can track or maintain the accounts or the accurate data related with this industry. Therefore, it might not be possible for the government or for the other stakeholders to interpret the true picture of such organisations. Question 4 Agency Theory Agency theory is based on the relationship between the agent and the principal. In case of a company, managers are agents of the shareholder or of the owners. Basically, shareholders posses short term view where managers use to take long term decisions and hence, arises the conflicts. Very often the managers have to take wrong decisions because of the share holders. It is called external agency cost. Again, the relationship between the employees and the managers is also the agent - principal relation. Here, mangers are principal and employees are agents. Sometimes the result of employees’ wrong decision has to suffer because of mangers. This is known as internal agency cost. Here, a proper understanding should develop. Restructuring is the process of minimizing agency cost. As per this theory, the principal and the agent both can demand their requirements and both the party can initiate decisions about what to do in such situations. Communication Theory Lass Well’s maxim, “who says what to whom in what channel with what effect” is the core meaning of communication. Financial communication means the strategies and tools use for allocating data and sharing recommendation with the shareholders, customers or other interested parties. The companies should increase their communication competencies for evaluating the capital market. The result will definitely get reflected on the share price and operating performance of the particular industry. Financial communication only concentrates on target audience. With relation to this concept another new theory has been observed, known as ‘Stakeholder Capitalization’. It refers that capitalism should be performed with an ethical context. The share holders’ requirements of information and interest should be taken into account. Therefore, the main objective of the financial communication will be to provide information to the shareholders as per their requirements and needs and build up a better interpersonal relationship between the management and the shareholders of the company. According to the perspective of Stakeholder Capitalism, financial communication should be a two - way symmetrical communication process. This will be followed by a better decision making procedure. Normally, in case of financial communication, integrated approach is to be proposed. It must be an interdisciplinary effort between communication and accounting principle. Financial Scandals The examples of few very recent accounting scandals are as follows: Name of the company Year Audit firm Country Lehman Brothers 2010 Ernst & Young United States Satyam computer Service 2009 Pricewaterhouse Coopers India Anglo Irish bank 2008 Ernst & young Ireland Tyco International 2002 Pricewaterhouse Coopers Bermuda All of these are financial and accounting mistakes and errors. The ultimate sufferers of such errors (or rather scandals) are the shareholders and the employees. This is because of lack of communication and ethical issues. The financial statements of these companies of repute do not show a true and fair picture of the company. That is why shareholders and the other users of the financial statements are not able to predict the financial positions and the risk engaged with company. Now, the question is whether the preparer should concentrate on past or future of financial performance while preparing. Most of the stakeholders are interested in past records e.g. the employees, the government and the shareholders. Banks need to know the future probabilities but banks are provided with budget of the company. Therefore, it can be recommended that financial statement should fuscous on past performance and only then, a trend can be followed from where the users can predict the future possibilities. It can be concluded that the Agency Theory and the Communication Theory are more effective and able to evaluate the financial reporting function as it is able to remove the deficiencies from the process and brings more transparency and flexibility in the system. Bibliography Deegan, C. M. Financial Accounting Theory. McGraw-Hill, 2003. Glautier, M. & Underdown, B. Accounting Theory and Practice. Financial Times Prentice Hall, 2001. Scott, W. R. Financial Accounting Theory. Prentice Hall, 2003. Wolk, H. I. & Et. Al. Accounting Theory: Conceptual Issues in Political and Economic Envi. SAGE-USA, 2007. Read More