Question

(a) Discuss the different sources of financial reporting regulations. Critically evaluate
the arguments in favour of, and, the arguments against the regulation of
financial reporting.  15 marks

(b) Critically evaluate what qualitative characteristics accounting information should
possess, in order to make it useful for decision making?   [10 marks]

(c) Mancy plc
In preparation for the audit of the mancy plc, for the year ended 31 March
2020, the Finance Director has asked you to prepare a report setting out the
accounting treatment for the following transaction undertaken during the year.
Transaction:
On 1 July 2019,Mancy plc commissioned a specialised piece of
equipment to be built for £350,000. The equipment was ready for use, on
time, on 1 April 2020. A loan was taken out on 1 July 2019 for the full
£350,000, as payment for the equipment was due on that date. The interest
rate on the loan is 7% pa and interest is paid monthly. The loan is
repayable after two years.

You are required to present an explanation of the accounting treatment to be applied
in the financial statements for the year ended 31 March 2020 and the reasons why
that is the appropriate treatment (with reference to the requirements of the relevant
IFRS, and where possible, please show relevant calculations).

Answer 1

a.Financial reporting standards provide principles for preparing financial reports and determine the types and amounts of information that must be provided to users of financial statements, including investors and creditors, so that they may make informed decisions.

Financial reporting requires keeping accounting records, producing financial statements, Board and Shareholder approvals, and audits.Financial Reporting is a very important and critical task of an organization. It is a vital part of Corporate Governance.

Financial Reporting involves the disclosure of financial information to the various stakeholders about the financial performance and financial position of the organization over a specified period of time. These stakeholders include – investors, creditors, public, debt providers, governments & government agencies. In case of listed companies the frequency of financial reporting is quarterly & annual.
Financial Reporting is usually considered an end product of Accounting. The typical components of financial reporting are:

1. The financial statements – Balance Sheet, Profit & loss account, Cash flow statement & Statement of changes in stock holder’s equity

2. The notes to financial statements

3. Quarterly & Annual reports (in case of listed companies)

4. Prospectus (In case of companies going for IPOs)

5. Management Discussion & Analysis (In case of public companies)

The Government and the Institute of Chartered Accounts of India (ICAI) have issued various accounting standards & guidance notes which are applied for the purpose of financial reporting. This ensures uniformity across various diversified industries when they prepare & present their financial statements. Now let’s discuss about the objectives & purposesof financial reporting.

Objectives of Financial Reporting

According to International Accounting Standard Board (IASB), the objective of financial reporting is “to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.”

The following points sum up the objectives & purposes of financial reporting –

1. Providing information to the management of an organization which is used for the purpose of planning, analysis, benchmarking and decision making.

2. Providing information to investors, promoters, debt provider and creditors which is used to enable them to male rational and prudent decisions regarding investment, credit etc.

3. Providing information to shareholders & public at large in case of listed companies about various aspects of an organization.

4. Providing information about the economic resources of an organization, claims to those resources (liabilities & owner’s equity) and how these resources and claims have undergone change over a period of time.

5. Providing information as to how an organization is procuring & using various resources.

6. Providing information to various stakeholders regarding performance management of an organization as to how diligently & ethically they are discharging their fiduciary duties & responsibilities.

7. Providing information to the statutory auditors which in turn facilitates audit.

8. Enhancing social welfare by looking into the interest of employees, trade union & Government.

Now let’s discuss few aspects about importance of financial reporting.

Importance of Financial Reporting

The importance of financial reporting cannot be over emphasized. It is required by each and every stakeholder for multiple reasons & purposes. The following points highlights why financial reporting framework is important –

1. In help and organization to comply with various statues and regulatory requirements. The organizations are required to file financial statements to ROC, Government Agencies. In case of listed companies, quarterly as well as annual results are required to be filed to stock exchanges and published.

2. It facilitates statutory audit. The Statutory auditors are required to audit the financial statements of an organization to express their opinion.

3. Financial Reports forms the backbone for financial planning, analysis, benchmarking and decision making. These are used for above purposes by various stakeholders.

4. Financial reporting helps organizations to raise capital both domestic as well as overseas.

5. On the basis of financials, the public in large can analyze the performance of the organization as well as of its management.

6. For the purpose of bidding, labor contract, government supplies etc., organizations are required to furnish their financial reports & statements.

So we can conclude from the above points that financial reporting is very important from various stakeholders point of view. At times for large organizations, it becomes very complex but the benefits are far more than such complexities. We can say that financial reporting contains reliable and relevant information which are used by multiple stakeholders for various purposes. A sound & robust financial reporting system across industries promotes good competition and also facilitates capital inflows. This, in turn, helps in economic development.

b.The demand for accounting information by investors, lenders, creditors, etc., creates fundamental qualitative characteristics that are desirable in accounting information. There are six qualitative characteristics of accounting information. Two of the six qualitative characteristics are fundamental (must have), while the remaining four qualitative characteristics are enhancing.

Fundamental (Primary) Qualitative Characteristics

Qualitative characteristics of accounting information that must be present for information to be useful in making decisions:

1. Relevance
2. Representational faithfulness

Enhancing (Secondary) Qualitative Characteristics

Qualitative characteristics of accounting information that impact how useful the information is:

1. Verifiability
2. Timeliness
3. Understandability
4. Comparability

   Relevance

   Relevance refers to how helpful the information is for financial decision-making processes. For accounting information to be relevant, it must possess:

5. Confirmatory value – Provides information about past events
6. Predictive value – Provides predictive power regarding possible future events

7. Therefore, accounting information is relevant if it can provide helpful information about past events and help in predicting future events or in taking action to deal with possible future events. For example, a company experiencing a strong quarter and presenting these improved results to creditors is relevant to the creditors’ decision-making process to extend or enlarge credit available to the company.

   Representational Faithfulness

   Representational faithfulness, also known as reliability, is the extent to which information accurately reflects a company’s resources, obligatory claims, transactions, etc. To help, think of a pictorial depiction of something in real life – how accurately does the picture represent what you see in real life? For accounting information to possess representational faithfulness, it must be:

8. Complete – Financial statements should not exclude any transaction.
9. Neutral – The degree to which information is free from bias. Note that there are subjectivity and estimation involved in financial statements, therefore information cannot be truly “neutral.” However, if a company polled 1,000 accountants and took the average of their answers, that would be considered neutral and free from bias.
10. Free from error – The degree to which information is free from errors.

11. Verifiability

    Verifiability is the extent to which information is reproducible given the same data and assumptions. For example, if a company owns equipment worth $1,000 and told an accountant the purchase cost, salvage value, depreciation method, and useful life, the accountant should be able to reproduce the same result. If they cannot, the information is considered not verifiable.

    Timeliness

    Timeliness is how quickly information is available to users of accounting information. The less timely (thus resulting in older information), the less useful information is for decision-making. Timeliness matters for accounting information because it competes with other information. For example, if a company issues its financial statements a year after its accounting period, users of financial statements would find it difficult to determine how well the company is doing in the present.

    Understandability

    Understandability is the degree to which information is easily understood. In today’s society, corporate annual reports are in excess of 100 pages, with significant qualitative information. Information that is understandable to the average user of financial statements is highly desirable. It is common for poorly performing companies to use a lot of jargon and difficult phrasing in its annual report in an attempt to disguise the underperformance.

    Comparability

    Comparability is the degree to which accounting standards and policies are consistently applied from one period to another. Financial statements that are comparable, with consistent accounting standards and policies applied throughout each accounting period, enable users to draw insightful conclusions about the trends and performance of the company over time. In addition, comparability also refers to the ability to easily compare a company’s financial statements with those of other companies.

    The qualitative characteristics of accounting information are important because they make it easier for both company management and investors to utilize a company’s financial statements to make well-informed decisions.