Financial Performance and Cash Flows of an Entity - Essay Example

?"The financial ments must present "present fairly" the financial position, financial performance and cash flows of an entity. Fair presentationrequires the faithful representation of the effects of transactions, other events, and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. (IAS 1.15) Introduction The year of 2008 was not a good year for the financial world. A harsh and sever wave of financial crisis was so powerful that it did not leave any option for financial companies but to shrink their payrolls, reduce their human capital, reduce work force, shut down their branches, franchises. Instead of doing investment, the concept of disinvestment was directly or indirectly supported and applied by many companies. The last quarter of 2008, the entire year of 2009; and to some extent the year of 2010 was only filled with the reports of shaken investor confidence, layoffs and financial defaults and so on. The world economy suffered the burns of financial crisis of the year of 2008. Basically, the centre of this problem was the United States of America where the problem of sub-prime loan was not handled properly; rather, it was mishandled by the related and relevant authorities. Some financial gurus and critics are of the view that the inception of financial crises emerged in the year of 2000-2001 with the sudden and huge debacle of energy giant Enron; subsequent to that, the investigative team brought the huge financial findings in the report of Sarbanes-Oxley, which heavily and greatly emphasised on the further stringent financial measures. Even the findings of the Sarbanes-Oxley were not successful in realising the dangerous financial nightmares are yet to unleash! Had more focus and attention were given to the findings of the Sarbanes-Oxley, we would have not seen the brutal and inhumane face of the financial crisis of the year of 2008. Undoubtedly, a significant and considerable role of creative accounting and window dressing was there in the presentation of financial statements; the shareholders, institutional and small investors were given and shown such financial statements which were not totally representing a ‘true and fair view’; the financial statements either to a minimum extent or to a considerable extent were filled with the help of window dressing and creative accounting. Unfortunately, the role of International Financial Reporting Standards, also known as International Accounting Standards Board, did not come for any help to rescue the international world economy from the threat and force of the 2008 financial crisis. The main reason for that, the standards and regulations of this international accounting body are voluntary in nature not compulsory or binding on any small or large financial entity. Now, in order to serve the objectives of this paper, it is vitally important to revisit the basic conceptual framework of the international financial reporting standards; what are its basic components that are highly essential for representing the financial information in a standard format and standard presentation? How this international accounting body serves the interests and objectives of small, medium and large shareholders, investors, and other people who have direct or indirect financial interest in the presentation of the financial statements? History of frameworks for IASB The decade of 1960’s observed many widespread outcry over the absence of uniformed financial standards. Due to this fact, many cases emerged that highly and greatly required a desperate need and requirement of single but unified accounting standards. They should be there to provide guidance and provide a framework that guide an entire process of accounting standards and accounting practices. In response to this accounting problem, many accounting bodies gathered and decided to have a consensus over certain accounting framework that would and that should guide an agreed treatments of many but different accounting related practices, theories, and treatments. Subsequently, they jointly agreed and formed the Accounting Standards Committee; as a result, this body of accountants issued a series of accounting standards. These accounting standards were called ‘Statements of Standard Accounting Practice (SSAPs)’ (Wood & Sangster, 2008).These accounting bodies jointly agreed to form the International Accounting Standards Committee (IASC) in the year of 1973 (Wood & Sangster, 2008). And in the year of 2000, with an agreed consensus, this accounting body changed its name and was renamed as the ‘International Accounting Standards Board (IASB)’. Conceptual framework A conceptual framework is an explicit declaration relating with the fundamental concepts and theories on which the set of standards is based (Pounder & Bruce, 2009). For example, a conceptual framework has a function to determine and identify the types of financial statements that a reporting entity should plan and prepare like, balance sheet and income statement and so on. Additionally, the conceptual framework is considerably helpful in clearly defining the basic and fundamental elements of the financial statements like income, expenses, assets, liabilities, etc. Need for conceptual framework Frameworks are essential for the financial accounting. It is the role and presence of frameworks that provides a clear and appropriate guidance and direction to a company to devise and plan its financial statements. And these financial statements of the company cannot be compared and contrasted with the financial statements of other companies in the same industry. These conceptual frameworks although do not require the company to follow an exact way of making and developing and presenting elements of financial statements; nor the guidance of frameworks is compulsory for companies to follow. Instead, the entire set of frameworks is voluntary; companies are at will to use the guidance of these frameworks in a way that suit them most. Additionally, the need of conceptual frameworks can be understood from the fact that without having uniformed and agreed conceptual accounting frameworks, the financial statements of two companies cannot be compared; the comparison between them would be meaningless. As a result, it is highly important to have agreed international conceptual accounting frameworks. The presence and practice of agreed international accounting frameworks will considerably facilitate the aims and objectives of the International Accounting Standards Board. The accounting concepts like, comparability, reliability, relevancy, and certain other basic and fundamental accounting concepts will easily be used for the purpose of comparing the financial statements of two companies in the same industry. True and fair view presentation The financial statements greatly rely on the concept of true and view presentation. It is this concept that considerably holds value and significance for shareholders. Any doubt, any ambiguity, and any misstatement in the financial statements would bring a serious repercussions and implications. The true and fair view presentation of financial statements is the only one single factor that possesses the entire competency of management, integrity of management, and professional commitment of management towards the preparation and finalisation of the financial statements. The foregoing sentences are clearly highlight the need and significance of the concept of true and fair view presentation of financial statements. Although, there is no precise and clear definition is given to this term by the relevant authorities; but for the purpose of understanding and for the purpose of clarity, this term can be defined as ‘not false’ or ‘free from bias’. This means the financial statements must be fairly representing the entire financial information; there must not be and there should not be anything that point out that the financial statements are either false or the financial statements are not free from bias. Additionally, the financial statements must be free from any material misstatement. Stakeholders A person, company or interested group, who has any stake in a company, is called a stakeholder. Stake is defined as interest or share in something. In a company, there could be many stakeholders, who may have direct or indirect stake in the company. Shareholders, management, employees, creditors, financial institutions, public, and certain pressure groups are the main types of stakeholders who find their interest involved in the management and affairs of the company. The shareholders are mostly related with the performance of the company, they want company to financially perform well and increase each year its level of dividends, profits and share price as well. The top management have stake to increase the performance of the company; for that purpose, the management plans and implements different organisational policies to attain and retain its corporate objectives and their policies must be in tune with the strategic objectives of the company. If the company is increasing its performance and it is performing well in the financial terms and then, there are more chances that management will be given more lucrative financial rewards and incentives and bonuses. In a nutshell, the management has direct stake in the financial growth and financial stability of the company.in the same way, other stakeholders have their interests, and these interests are only understood from their interests involved in the company. Four qualitative characteristics The financial statements consist of certain qualitative characteristics. These qualitative characteristics are required to be same if the financial statements of two companies in the same industry are compared. It is the work and function of theoretical accounting frameworks that have provided a certain qualitative characteristics that have same level and same sort of application on all the financial statements. If the financial statements of a company are unable to be consistent with these qualitative characteristics, then undoubtedly, there are chances that the financial statements of the company cannot be called as representing fairly the financial information of the company. As a result, this sort of financial statement presentation will raise the concerns of many stakeholders of the company, particularly, the shareholders of the company. Understand ability The provided financial information must be understandable by the users. For this purpose, it is assumed that the users have reasonable amount of knowledge of a company and economic activities and other accounting standards of the company. It is also important for the company to include and issue the complex and technical information into the company disclosures; this inclusion would help users to make reasonable economic decisions. Relevancy Only relevant information tends to be useful. The relevancy of financial information helps decision makers to understand the relevant matters and relevant issues that the users mostly want to know and understand. And on the basis of the relevant financial information; the users make economic decisions. Reliability The quality of information must be there. The financial information must be free from material errors and material bias. Information becomes useful when it is reliable. Additionally, the financial information must be represented faithfully. Comparability The published financial statements must be comparable with the financial statements of other companies in the same industry. This would ensure the smooth and uniform use and application of majority of international accounting standards. As a result, the objective of international accounting standards board would be met and achieved. Substance over form The commercial reality or substance of a transaction has always precedence over the legal form of the transaction. For example: Leased assets: in a financial lease, the lessor obtains the ownership or title of the asset at the end of their financial lease. However, the substance of this financial lease is that lessor has obtained only the right to use the asset from the very outset of the lease. As a result, it is normally treated as if it was purchased or bought at the beginning of the financial lease. In some cases, creative accounting may be used; creative accounting is misleadingly optimistic type of accounting; though it is not illegal (A Dictionary of Business). Creative accounting is done because there are number of accounting transactions which are away from the regulations or the position of regulation is ambiguous. Companies use this ambiguity in order to present their financial information in the best and required way. Financial position Financial statements represent the financial position of a company. The company’s financial position can be understood by comparing the financial statements of the company with some other financial statements. For instance, a comparison of a company’s financial statements within the industry or with the same companies in the industry would clearly highlight the significant change and significant difference between the companies. There are different benchmarks and standards that are applied to clearly understand and highlight the financial position of different companies in the industry. For instance, the most important and significant standard is measuring a net annual profit figure posted by the company. The net annual figure would clearly highlight the company’s financial position within the industry. Financial performance A change in profits, dividends, share price and certain other factors depict the financial performance of a company. Financial performance of a company is only measured by comparing the current year’s changes in net profit, dividends, share price and certain other factors with the similar standards of the previous year. This would clearly highlight whether a company has performed well or not; whether the current’s net annual profits exceed the range of the previous year’s net annual profits. It the comparison indicates that the company has shown a significant growth in the net annual profits then, this would clearly highlight that the company has financially performed well in this year in comparison with the previous year performance. Wide range of users Shareholders, creditors, management, public, government, regulatory authorities, and pressure groups can be the main users. These main users are mostly interested to know certain activities of a company by keeping in view their interests in the company. For instance, government and its regulatory authorities would be interested in profits of the company as they have to impose and collect taxes on the profits on the company. Environmental groups are a type of pressure group that is interested in a company if the company is involved any activity that might threat the natural environment. If a company heavily contributes in the greenhouse gases, then, the environmental groups would be more interested to know its current and future plans of reducing the greenhouse gases. Making economic decisions Profit generating decisions can be called as economic decisions. Each interested party is mostly driven by its economic advantage and economic benefits. Shareholders are always taking a great amount of interest in their company and certain other lucrative investment opportunities if there are chances of future or current economic benefits. It is the force of economic benefits that mostly drive and push economic decision makers to look for lucrative investment opportunities for the purpose of making economic decisions. Without the lucrativeness of economic benefits, no shareholder or investor would ever be interested to invest or think for economic decisions. IAS 36: Impairment of assets Ensuring that the fixed assets are carried and incorporated into the financial statements at no more than their recoverable amount is the main and fundamental objective of this international accounting standard. Measuring and recognising impairment loss If the carrying amount of an asset is more than the recoverable amount of an asset, the excess of carrying amount is called impairment loss. IAS 36 requires that the carrying amount must be reduced to the recoverable amount. And the difference between the carrying amount and the recoverable amount must be adjusted according to the relevant accounting standards. If the company is using the fair value approach and it has recognised some revaluation balance and revaluation account, in this case, the company must adjust the revaluation account with the impairment loss of the impaired asset. If there is no revaluation account, the company is required to channelize the impairment loss towards the profit and loss account or income statement. Discussion If the company records the impairment loss in accordance with the relevant accounting standard, this will have positive implications for the company. First, this standard based treatment of impairment loss would help to achieve the objective of true and fair representation of financial statements. And this would clearly help the shareholders and other related parties to make reasonable and appropriate economic decisions on the basis of available financial information and on the basis of available financial statements. The management would also be able to determine the future course of action. If the impairment loss of a fixed asset is material, the management is required to understand the severity of the situation. As a result, the management must evaluate the current and future financial and non-financial implications of the impairment loss. Additionally, by clearly declaring the occurrence of the impairment loss on a fixed asset in the disclosures and other financial statements, the company would be able to claim for tax reduction. Consequently, this would save company from paying a considerable amount of tax. Also, the impacts of impairment loss would decrease the possible net profit figure as the company would be showing it a loss in the income statement. This would clearly reduce the amount of dividends; due to the occurrence of impairment loss, the company would be paying less amount of dividend to its shareholders in comparison with the dividends that would have been given to the shareholders in the absence of the impairment loss. Implications of incorrect treatment of impairment loss All the related stakeholders and shareholders would be making incorrect decisions. Since the provided and published financial information and financial statements are incorrectly representing the financial position and financial performance of the company, and the financial statements are not fairly representing the true and fair view of the company’s financial situation, those economic decision makers who are considerably depending on these financial statements and financial information would not be making an appropriate economic decisions; rather, they would be making wrong economic decisions. The financial statements considerably depend on the accounting concepts of understand ability, reliability, relevancy and comparability. It is these concepts that ensure that the financial statements are fairly representing the financial position and financial performance of the company. With this fair presentation, the users of financial statements are greatly supported and helped. Different stakeholders and shareholders are enabled to first understand the financial information and financial statements; afterwards, they become in a position to make economic decisions based on the financial information. This is a sequence; if any attempt of window dressing or off-balance sheet financing is done; then the economic decisions makers would not be able to make appropriate and reasonable economic decisions. References 1. creative accounting 2006, ‘A Dictionary of Business’, Oxford University Press, High Beam Research, 27 Feb. 2011 . 2. Pounder, Bruce 2010’A common framework for accounting standards,(FINANCIAL REPORTING)’ Strategic Finance, Institute of Management Accountants Inc., High Beam Research, 27 Feb. 2011 . 3. Wood, F & Sangster A 2008, Business accounting, 10th edn, Person Education South Asia, Delhi, India Read More