Income concepts for financial reporting – Part 2
Whoever wish to assess the stewardship or accountability of management do so in order that they may make economic decision; these decisions may include, for example, whether to hold or sell their investment in the entity or whether to reappoint or replace the management. (Framework for the preparation and presentation of Financial Statement, Paragraph 12-14).
The International Accounting Standard Board (IASB) recognizes that business enterprises have a responsibility to the society and not just to their owners. The ordering of financial statements may reflect the outcome of a political battle. International Accounting Standard Board’s (IASB) framework has been developed so that it is applicable to a range of accounting models and concepts of capital maintenance. IASB’ frame work applies to the financial statements of all the public and private sector business enterprises, where private investors play a much less important part in the economy than they do in the United States. The financial reporting needs of the public sector are more important and the objectives of financial reporting in those countries should reflect those needs.
“In a perfect world, investors, board members and executives would have full confidence in companies ‘financial statements.
Unfortunately, that’s not what happens in the real world, for several reasons.”- Where Financial Reporting Still Falls Short, The Harvard Business Review.It is obvious that there are many pitfalls associated with financial reporting. Some of them are technical pitfalls while others are ethical (Enron).
Due to a series of laws known as Sarbanes –Oxley, there is more standardization/ legal cooperation within the world of financial reporting. These laws are designed to prevent another situation like Enron from happening.
However, there are two main ways that financial reports are standardized:
The GAAP (Generally Accepted Accounting Principles). This is the system used by the United States and pretty much nobody else (just like the imperial measurement system!).
The IFRS (International Financial Reporting Standards). This system is used by more than 110 countries around the world, including Canada, Australia, India and China (although China and India have “customized “ the IFRS in their own ways).
Importance of Financial Reporting
Financial reporting is essentially a way of following standard practices to give the world an accurate depiction of a company’s finances, including their:
Financial reporting is important because of the following reasons:
It is required by law for tax purposes: this is arguably the most important reason to use financial reports- because you have to. The government uses these reports to make sure that you are paying your fair share of taxes. Frankly, if financial reports were not legally require, most companies would probably use management dash board instead (at least for internal decision making). As it is, the government’s requirements for these document has created a entire industry of auditing firms (like the (Big four” of KPMG, Ernst & Young, Deloitte ad PWC) that exist to independently review companies financial reports. This auditing process is also a legal requirement.
Financial reporting gives investors, creditors and other business an idea of the financial integrity and creditworthiness of your company.It gives you important information you can use to make business decisions- such as whether you should open new location or not.
The importance of financial analysis and reporting is also for stakeholders, if you own equity in a firm, or if you are an activist investor who owns a major equity position, you want to have full disclosure of all assets, liabilities, use of cash, revenue and costs that a company has. You also want to understand if the company is doing something it shouldn’t (such as in the case of Enron)
Due to a series of laws known as Sarbanes-Oxley, there is more standardization/legal cooperation within the world of financial reporting. These laws are designed to prevent another situation like Enron from happening.
However, financial reports are not the best tools for making internal business decisions but they serve as the “bedrock “for other reports (such as management reports).
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