Financial Reporting under IFRS

A Topic Based Approach

Wolfgang Dick, Franck Missonier-Piera

• Publisher: Wiley
• Year: 2011
• ISBN:
  9780470971628
• Edition: 1
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

The International Financial Reporting Standards are quite different from other sets of accounting standards, and are fundamentally different from US-GAAP, in that they are based on principles, and not on detailed rules. Financial Reporting under IFRS: A topic-based approach offers a global perspective on IFRS by presenting the prescribed rationale and principles and illustrating them through numerous examples from large international companies. It aims to develop the fundamental skills necessary to read and use the information contained in all types of financial statements, through examples, activities, questions and answers.

The book is broadly divided into three sections. Section one examines the structure of the Balance Sheet and the Income Statement, their links and the accounting mechanisms used to prepare them. Section two deals with the identification, evaluation and reporting of Balance Sheet items. Section three covers the use of financial statements to analyze a firm's performance and its risks. Throughout the book special topics are covered, including Derivatives and Hedge accounting (IAS 39), Business Combination (IFRS 3) and Operating Segments (IFRS 8).

Financial Reporting under IFRS is ideally suited to the needs of students of accounting and financial reporting, but all users of financial statements, from creditors and investors to suppliers, customers, employees and governments will benefit from its concise, topic-based approach.

1

FINANCIAL STATEMENTS AND ACCOUNTING MECHANISMS

Financial disclosure has become a critical function for businesses. Today, firms are under pressure from various stakeholders (financial markets, the State, clients, employees, etc.) and are therefore engaged in information policies, in order to meet changing requirements. Thus, we can see that annual reports are providing a growing supply of information. It covers not only the needs of corporate governance, through the establishment of a management report and description of the principal organs of corporate control (for example, the structure of the Board and capital, the firm’s Audit committee, the salaries, etc.), but also those related to the firm’s environmental responsibility. Other documents and summary tables - the financial statements - also provide various business partners with a wide range of information about the nature and performance of the firm’s activity. They perform various functions. On the one hand, they can serve as evidence or control tools for monitoring the performance of contracts between the firm and its partners. On the other hand, they provide investors and other users with relevant information for economic decision making. Financial statements are therefore supposed to better reflect the economic situation of the company so that investors can properly evaluate the performance (section 1.1). In order to produce useful and relevant information, the preparation of financial statements is based on a number of principles, uses its own mechanisms of information processing (section 1.2) and allows a rigorous synthesis.

1.1 FINANCIAL STATEMENTS

The objective of financial statements is to inform all stakeholders about the business situation at a given date. We can identify several groups of regular users of financial statements. The current or potential owners of the company (shareholders for limited liability companies) are the first to be concerned by the financial statements. They are interested in the performance of the company in order to measure the profitability of their investment. On a long-term basis, it is also useful to know the evolution of business investments in order to evaluate if the company will be able to generate profits in the future, and therefore to distribute dividends. For similar reasons, the management team is also concerned by the information contained in the financial statements. Indeed, shareholders have delegated the management of their capital invested to them. Financial statements therefore provide a means for controlling the financial performance of the management team, by informing the owners of the quality of their decisions. In that matter, financial analysts are an important group of users. Their objective is to assess the company as a whole and to make recommendations on whether to invest in it or not. Many banks and other current and potential investors use the recommendations of these experts for decision-making purposes. Thus, the company must necessarily “supply” them with the most complete information possible. Although analysts do not exclusively base their decision on the financial statements, the latter represent a fundamental element of their analysis.

Other users of financial statements are the bankers, suppliers and other creditors who wish to know whether the company is - and will be - able to meet its financial commitments. This is related to both the reimbursement of debts and the payment of interest on loans. Moreover, the State, local authorities and social organizations refer to the accounting records to calculate the contributions and corporate taxes payable by the company. Finally, employees and their representatives also need information on the situation of the firm. It allows them to determine the outlooks on job security and define their social demands.

All these groups of users need information, in near real time, on the financial situation, performance and the status of the company’s cash account.

The financial situation consists in identifying the assets used by the company (lands, buildings, machinery, vehicles, inventory, receivables, and cash) and the financial resources, evaluating them and analyzing the evolution of their value over time.

The financial situation consists, at first, in identifying the assets used by the company (for example, lands, buildings, machinery, vehicles, inventory, receivables and cash), evaluating them and analyzing the evolution of their value over time. Meanwhile, the evolution of the financial resources, which enabled the acquisition of those assets, must also be carefully monitored. For instance, the more the company gets into debt, the more difficult it will be to reimburse its debts. Even a slight increase in debt can have significant consequences on the business, when a bank decides that it has crossed a particular risk threshold and, accordingly, increases the interest rate for all future loans.

The performance or the net income shows whether the activity of the firm as a whole is profitable, which is normally the main objective of the management team.

The performance or the net income shows whether the activity of the firm as a whole is profitable, which is normally the main objective of the management team. Here, “profitability” means that the money invested by the owners can make profits and thus increase their wealth. Entrusted by the owners to achieve this objective at any cost, the management of the company has to follow the change in income, using the financial statements, to ensure that the decisions are in accordance with the target fixed by the owners. If this is not the case, the regular monitoring of income enables corrective measures to be taken, before the situation of the company deteriorates.

The cash account includes cash, bank deposits and a number of other monetary elements which the company could liquidate within a very short span of time, usually in less than 3 months.

The cash account includes cash, bank deposits and a number of other monetary elements which the company could liquidate within a very short span of time, usually in less than 3 months. The objective here is different from the profit, that is to say it is not to maximize it.¹ However, it is important to have enough cash at all times, to meet financial deadlines, i.e. reimburse loans, pay the invoices of suppliers, salaries and taxes, etc. Failure to meet financial deadlines and the inability of the company to meet its commitments may result in insolvency, or even the outright liquidation of the company shortly afterwords. The analysis of the status and evolution of cash flow is therefore of high importance for the survival of the company.

Under the international accounting standards...