Advanced Accounting Theory & Practice - Essay Example

Advanced Accounting Theory & Practice Introduction International Accounting Standard (IAS provides a framework for the Preparation and Presentation of Financial Statements. This accounting standard is comprised of information necessary for preparing and presenting the financial statements. The basic purpose of this standard is to enable different users to make effective economic decisions with the use of financial and non-financial information. By providing the basic structure for each type of financial statements, the standard has become highly essential for lenders, investors, shareholders and regulatory authorities. For that objective, the standard has classified different economic units as assets, equity, liabilities, income, expenses and cash flows. This classification is used to prepare and present different types of financial statements such as statement of financial position, statement of comprehensive income, statement of changes in equity and statement of cash flows. The IAS 1 provides different qualitative characteristics which are highly essential to be depicted by the financial statements. Fair presentation suggests that the financial statements faithfully represent the effects of the economic transactions and conditions which must be complying with the framework definition, recognition and measurement criteria for assets, equities, liabilities, income and expense as well. In the following parts of this paper, first key features of IAS 1 along with different types of financial statements have been accounted for. Subsequent to that, a description elaborating qualitative characteristics has also been included. It is followed by illustrative example representing how Royal Dutch Shell prepares and presents its consolidated statement of comprehensive income. Before the conclusion, critical evaluation of IAS 1 has been described to highlight the shortcomings of the accounting standard. Key features of International Accounting Standard 1- Presentation of Financial Statements International Accounting Standard (IAS 1) provides a framework for the Preparation and Presentation of Financial Statements. IAS 1 prescribes that the basis for presentation of ‘general-purpose financial statements’1, defined as statements develop to meet the needs of the users who require an entity to prepare reports tailored to their important information needs. This definition covers both consolidated and separate financial statements. Interestingly, IAS 1 does not specifically apply to the structure, content and form of interim financial statements, which are detailed in IAS 34 Interim Financial Reporting, but many of its basic underpinnings such as consistency and the need for fair presentation do apply to the interim financial statements. Types of financial statements There are five types of financial statements.2The Paragraph 10 of the IAS 1 prescribes the types of financial statements to be termed as financial statements and they are: (a) A statement of financial position as at the end of the period (b) A statement of comprehensive income for the period (c) A statement of changes in equity for the period (d) A statement of cash flow as at the end of the period (e) Notes comprising a summary of supplementary explanatory financial or non financial information and other significant accounting policies Purpose of financial statements IAS 1 details the objective of general-purpose financial statements. As a structured representation of the financial performance and the financial position of an entity, the financial statements provide information about the financial performance, the financial position and the cash flows information of an entity.3 This type of information is useful for a wide range of internal and external users who take into account such financial information with an aim of making economic decisions. In addition to that, financial statements also provide the results of the management’s stewardship of the resources extended by the shareholders of an entity. The following classification has been provided to meet the above mentioned objectives: a) Assets b) Equity c) Liabilities d) Income and expenses, including gains and losses e) Cash flows f) Distributions to and contributions by owners in their capacity as owners Structure and content of the financial statements IAS 1 mainly deals with the statements of financial position (balance sheet), the statement of comprehensive income (income statement), and the statement of changes in equity. The statement of cash flows requirements and disclosure requirements are not mentioned by the IAS 1 but they are prescribed by the IAS 7 Statement of Cash Flows. And the main content of the financial statements include: The financial statements The reporting entity Whether the financial statements represent an individual entity or for a consolidated group The period covered The currency used for presentation The extent of rounding used (Thousands or millions of dollars, and so on) Qualitative characteristics Fair presentation of financial statements IAS 1 requires that the financial statements fairly represent the financial performance, the financial position and cash flows of an entity. Fair representation requires that the faithful representation of the effects of economic transactions, conditions and other events in accordance with the framework definitions and recognition and measurement criteria for assets, equities, liabilities, income and expenses set out in the Framework. Going concern Going concern concept assumes that the entity will remain in operation long enough to use its existing assets. 4 IAS 1 requires management to ascertain and establish the entity’s ability to continue and work as a going concern. Furthermore, the management is to prepare financial statements on a going-concern basis unless they either intend to cease trading or to liquidity the entity. Within this framework, the entity management is required to prepare and maintain additional disclosures if some doubts exist about the entity’ ability to remain as a going-concern. Comparability The consistent application of accounting methods throughout an entity and through time is a key requirement for comparability.5 Entity is required to ensure the practice of comparability. The previous-period comparative financial information is needed to be disclosed for all amounts accounted for in the current period’s financial statements. In addition to that, the comparative amounts be reclassified to reflect the current presentation along with disclosures are provided concerning the nature, reasons for reclassification and amount maintained in the financial statements. Reliability Reliability involves extending financial or non-financial information representing transactions or events faithfully in accordance with their economic reality and with their substance rather than their legal form. To remain reliable, information needs to be unbiased, prepared with prudence and complete.6 Development and Rationale IAS 1 has been developed to provide a framework for preparing and presenting the financial information. The framework is not a standard itself; instead, it accounts for the concepts underling the preparation and presentation of financial statements for mainly external stakeholders. The framework is developed in a way to provide a common ground for international and national accounting standard setters, users, auditors and the financial statement preparers. In this way, the framework serves as a reference point for the preparers of the financial statements in cases where no relevant and specific guidance is available in the International Financial Reporting Standards (IFRS) or International Accounting Standards (IASs). Illustration Source: Royal Dutch Shell Plc Annual Report for the Year Ended December 31, 2009 The above mentioned illustration is the consolidated Statement of Comprehensive Income of Royal Dutch Shell Plc. In that report, the company has provided the financial performance of the company for the three consecutive years from 2007 to 2009. According to IAS 1, entity should provide comparable financial information. In this statement, it is easily visible to compare the company’ financial performance from 2007 to 2009. This proves the presence of comparability, which is the qualitative characteristic of the financial statements provided by IAS 1. Moreover, other requirements such as financial year, reporting entity, currency used are those factors that have been utilized in this illustration. In addition to that, the above mentioned financial information represents that the company has maintained the financial figures on the market value; this authenticates the presence of going-concern concept. The company has no plans to liquidate its assets. Critical evaluation of IAS 1 Comparability is not an easy notion to comprehend even within a country, let alone globally.7 Unfortunately, the dearth of literature elaborating a representative definition of comparability has further added difficult in its practical application of this concept. The view in the United States of America is that the objective of comparability is achieved by ensuring that like things look alike and unlike things look different8. Even within the light of this definition, finding and comparing like things would not be an easy task since the global accounting community separately work in the different business and financial culture, the auditing culture, the accounting culture and the regulatory culture. With respect to the business and financial cultural, there exist various differences across countries in way business is conducted. For example, because of incentives and disincentives in the come tax law and other laws, business transactions are often designed, developed and carried out differently in different countries. In the USA, partly due to tax benefits, it is a common commercial activity in certain industries to raise financing through long-term leases. Therefore, it is almost 100 percent certain that the plane would not be owned by the airline company. Instead, it would be owned by the financial institutions that have provided lease to the airline company. As a result, this practice of omitting tangible operating resource from the statement of financial position would not facilitate a comparable assessment even between two companies working in the same industry. Then, there are different corporate structures and business customs. For example, in Korea and Japan, the Chaebol and Keiretsu, respectively, denote networks of companies with interlocking relations, where it is unclear who the holding company is, if indeed there is a holding entity. Therefore, one may raise the question whether a standard on consolidated financial statement in its application in Korea and Japan would generate anything analogous to the concept of comparability with countries having a clear hierarchical relationship between subsidiaries and the holding or parent company. Moreover, an identical standard in such type of circumstances would do little more than focusing on the differences between the countries’ different method of structuring inter-corporate entities. The accounting culture is not the same in the countries. The impact on accounting of the cultural value of fixating on the reduction and minimization of the income tax burden played an important role in the choice of financial reporting standards and practices in various continental European countries until recent times, yet it may continue for years to come. A contemporary depiction is that asset impairment losses are tax deductible in Germany but it is not tax deductible in the UK9. Keeping this view in mind, the concept of comparability would not be easy to provide the expected entertainment of framework objectives. The auditing culture is not the same in many countries and there is different auditing culture among countries even though auditing and assurance standards are issued by a single body at the international level. In some companies, auditors and management often did not draw attention to the practical departures from the IAS when the company claimed that it was fulfilling and adhering to IAS. Conclusion The IAS 1 prescribes the basic components essential for the preparation and presentation of the financial statements. The financial statements include statement of financial position, statement of comprehensive income, statement of changes in equity and statement of cash flows. Except for the statement of cash flows, IAS 1 comprehensively covers and provides the basic underpinnings necessary for the above mentioned financial statements. The standard fully classifies different manifestations such as assets, equity, liabilities, income, expenses and so on. The qualitative characteristics have been defined so that the financial statements must be fairly and truly prepared and presented. Reliability, fair presentation, comparability and going concern be represented by the financial statements developed by the different companies .The basic rationale for developing this standard is to provide understandable and comparable information to the users of the financial statements including investors, shareholders and so on. However, there are various challenges that do not facilitate the uniform and equal preparation and presentation of the financial statements due to the presence of different business and financial cultures, the auditing culture, the regulatory culture and the accounting culture as well. In various companies, the auditing culture is unable to ensure the compliance of the company practices with the standard and the departures remain common. Bibliography Ankarath, N, Ghosh, T.P, Mehta, K., J, Alkafaji, Y. 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