Question

The purposes of preparing a set of financial reports are often subject to different interpretations.  The Hong Kong Companies Ordinance requires directors of a company to present a set of accounts to show the true and fair view of the financial situation of the company, while the HKICPA states that the financial accounts should provide information that is useful to a wide spectrum of readers.  But other purposes of presenting a set of accounts are also observed in real life practices.

You are required to:

1. Discuss, from a theoretical and conceptual perspective, which purpose you consider should be regarded as the primary purpose or function of financial reporting.  

                         

2. It is argued that political purpose of financial reporting is often observed but there is little way to stop such practices as management and accountants know how to apply the political purpose in a legal and legitimate way.

To what extent do you agree with this argument?                      

      

Answer 1

Financial Reporting involves the disclosureof financial information to management and the public about how the company is performing over a specific peroid of time. Fianancial reports are usually issued on a quarterly and annual basis. This is different from management reporting, which is finanacial information that is disclosed to those inside the company to be used to make decisions within the company.Financial reports are included in a public company's annual report.

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)

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.

PURPOSE

Financial reporting serves two primarily purposes. First, it helps management to engage in effective decision-making concerning the company's objectives and overall strategies. The data disclosed in the reports caqn help management discern thew strengths and weaknesses of the company, as well as its overall financial health. Second, financial reporting provides vital infrmation about the financial health and activities of the comapny to its stakeholders including its shareholders, potential investors, consumers, and government regulators. It means ensuring that the company is beig run appropriately.

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.

POLITICAL PURPOSE

The U.S.based Financial Accounting Standards Board (FASB) emphasizes that accounting standard‐setting is not and should not be regarded as a “political process.” Employing the case of accounting for stock compensation, we ppexamine a recent debate in which FASB appears to have successfully established and maintained a boundary between a technical accounting process and politics. The case is interesting because an earlier, failed effort to expense stock compensation was described as highly politicized. However, the boundary between technical and political processes was maintained in the more recent episode. We find that a focus on due process, characterizations of existing accounting requirements as anomalous and available measurement methods as reliable, and warnings about the dangers of injecting “politics” into standard‐setting were important to this boundary work. We also find that the boundary work required considerable interpretive flexibility in selecting (or ignoring) the evidence to be used in justifying the standard‐setting project and its conclusions. We conclude by suggesting that a different understanding of what it means to be involved in a “political process” might help all parties understand more fully what is taking place during the accounting standard‐setting process. Attention could be turned to developing processes to facilitate debates over which values should guide decisions occurring throughout the standard‐setting process. To this end, an enhanced standard‐setting process might allow for increased participation in agenda setting, in framing and scoping standard‐setting projects, and in providing opportunities for nonexperts to participate.