The Provision of Financial Information - Essay Example

Essay: Finance and Accounting

Table of Contents

1.0 Introduction4

2.0 Part – A: Critical Evaluation of the effects of the proposed IFRS Practice Statement on the Preparers of Financial Statements4

3.0 Part – B: Critical Evaluation of the effects of the proposed IFRS Practice Statement on the Users of Financial Statements6

5.0 Reference List10

• 1.0 Introduction

This assignment reports on the usefulness of the proposed ‘IFRS Practice Statement’ to various stakeholders, investors, users and preparers of financial statements, which was published in the Exposure Draft by IASB on 28th October 2015. This was published to guide the company managements in deciding which information is material, what materiality means and make financial disclosures accordingly so as to avoid disclosure of immaterial information, which makes the financial statements clumsy and un-impressive (IFRS, 2015b).

A Financial Information is considered material if it has the capacity to influence the economic decisions of investors or inferences drawn by interested parties. Materiality is a pervasive constraint over the provision of financial information. However, there are no standards for judging materiality. It rather depends on the entity’s assessment of information as material or immaterial and disclosures are made accordingly (Artiach, et al., 2014).

• 2.0 Part – A: Critical Evaluation of the effects of the proposed IFRS Practice Statement on the Preparers of Financial Statements

The objective of General-Purpose Financial Reporting is to make the necessary financial information available to the users, both internal and external, so as to enable them to formulate proper economic or investment decisions (Norton and Porter, 2012). The motive of the Exposure Draft of IFRS Practice Statement (ED/2015/8) – ‘Application of Materiality to Financial Statements’ published by IASB is to assist the management of corporate bodies in implementing the concept of information-materiality while preparing the financial statements in accordance with the IFRS guidelines. Information is considered to be material if its omission or misstatement in the financial reports affects the investment decisions of the existing and prospective investors. The Practice Statement gives guidelines regarding the characteristics of materiality, application of the concept of materiality in preparing financial statements, presenting and disclosing financial information and assessment of the impact of omission or misstatement of a financial information (IFRS, 2015c). The Exposure Draft explains how to improve the standard of financial disclosures, objectives of financial statements and their relationship with materiality and decision-making, how to identify and omit immaterial information and how to judge the consequence of such omission (IFRS, 2015d).

This initiative of IASB has been highly supported by various organisations in the comment letters. European Securities and Markets Authority reacted favourably to this initiative, but suggested for additional guidance on the application of materiality in IFRS financial statement (ESMA, 2016). However, the Federation of Accounting Professions, Thailand has supported the practice statement and appreciated it to be useful for the preparers of financial statements but suggested for inclusion of the process of determining materiality and asserted that the application of materiality may face legal challenges in many countries. It also suggested that this statement should have been published along with the publication of the Principles of Disclosures (IFRS, 2015a). Ideally, there should be no legal barriers to the application of materiality, since this influences the economic decisions of various stakeholders and interested parties. Application of materiality means all the material items should be disclosed separately in the financial statements and immaterial items should be aggregated and presented in a group of similar items (Everingham, Kleynhans and Posthumus, 2007). Ernst & Young Global Limited welcomed the Exposure Draft of IASB and agreed that it will be helpful to the preparers of financial statements since they can rely on its guidance on application of materiality and this initiative will possibly increase awareness related to disclosure-principles and disclosure-overload (Ernst & Young Global Limited, 2016). The overall Exposure Draft on IFRS Practice Statement has been largely appreciated by the preparers of financial statements and they have suggested for further improvement in guidance regarding the application of materiality.

The proposed Practice Statement in the Exposure Draft is likely to assist the preparers of financial statements all over the world. With the acceptance of IFRS-guidelines and global convergence of Accounting Principles, reporting entities across the world are required to prepare financial reports in accordance with the IFRS-criteria of reporting so that they can be compared on a global and uniform base (Alkafaji, et al., 2010). This requires the corporate bodies to frame their financial reports in such a way so as to signify the material information only. This exposure draft gives a clear idea about materiality of accounting information, identification and inclusion of material information and strategic omission of irrelevant information from the financial reports. These concepts will be hugely helpful for the preparers of financial statements since, without proper guidance on application of materiality, firms may report on certain information which is not necessary for decision-making while excluding any important information. The preparers will get a clear guideline regarding how to apply the concept of materiality in financial reporting and frame reports on information which are only relevant in decision-making or ascertaining the financial state of affairs of the entity.

For example, while preparing the financial statements, the reporting entity may consider the petty-cash expenses to be too material and may list those items of expenses separately, which is not required. These items of expenditure may be grouped together under the head of Petty Cash Expenses and disclosed under a single head. This concept of judging materiality has been published in the exposure draft.

• 3.0 Part – B: Critical Evaluation of the effects of the proposed IFRS Practice Statement on the Users of Financial Statements

Users of financial information are classified as Internal and External. Internal users are management, employees and workers whereas External users are creditors, debtors, suppliers, dealers, clients, bankers, bondholders and shareholders. They depend on relevant financial information about the firm such as profitability and investment risks for making economic decisions (Francis, et al., 2010).

The European Financial Reporting Advisory Group opines that, the proposed guideline on application of materiality will be helpful in disclosure and decision-making by the users, since it will provide a common platform for comparing the financial state of affairs of different entities on a global base. However, it criticizes the draft for not being precise and lacking practical solutions to deal with information which are difficult to be categorized as material or immaterial (EFRAG, 2016). KPMG IFRG Limited has also appreciated this initiative by IASB to be helpful to the users of financial information in a number of ways, but asserted that the proposed practice statement should be much more operational and easy to implement and that further developments are necessary. It also criticised the exposure Draft as a mere summary of the existing IFRS Literature and that IASB should provide a much more analytical and practical guideline for the assessment of information as material or immaterial and the effective application of the Principles of disclosure and Materiality. The IASB’s Practice Statement should identify the specific principles of materiality and their proper implementation before it puts forward the definite guidelines regarding disclosure, presentation, recognition, measurement and misstatement of financial information (KPMG IFRG Limited, 2016).

The creditors, investors, suppliers, dealers, shareholders, debenture-holders depend a lot on the financial information for undertaking their financial or investment decisions. Therefore, accounting information should be clearly and specifically disclosed in the annual financial statements of the entity, since absence of any crucial financial information have the capacity to bring about distortions in managerial plans as well as investment decisions. The financial statements depict the financial health of the concern such as, its credit worthiness or capacity to repay loans, chances of being a defaulter, its interest payment schemes on bonds and debentures, dividend payout policy, future expected profits, possibility of increase in the value of stock or capital gain and other current and long-term financial obligations. These elements are fundamental requisites for formulation of decisions by internal and external users, stakeholders and various interested parties (Hansen, et al., 2012). The Exposure Draft gives guidelines regarding proper disclosure of these items in the financial reports which if implemented will certainly help the investors to analyse and undertake rational economic decisions. Financial information is also much important for the auditors to review the financial statements and make an Audit Report for an entity. For this purpose, the auditor requires all information which is material for the framing of an audit report. Therefore, immaterial or irrelevant information should be eliminated from the financial statements under the purview of an audit. Information which has the capacity to influence the Auditor’s Report or which if manipulated in the books of accounts can impact the Auditor’s Report in a negative way is said to possess Audit Materiality (Basu, 2009). This draft also provides guidelines for the preparation of financial statements in a way so that it exhibits the material information required for auditing the books. Thus, the Exposure Draft provides assistance to a number of users in several ways.

For example, the investors are interested in the financial health of the entity. Therefore, they may require information about the asset position and loans taken by the company. This will help them to judge the organisation’s capacity to pay returns on their investments. If the entity does not disclose these items properly and accurately, then it will affect the investors’ decision. The Practice Statement offers solutions to these problems by giving guidelines regarding Disclosure Principles as per IFRS.

4.0 Conclusion

This report is a summary of what is included in the Exposure Draft published by the IASB regarding the Application of Materiality in preparing financial statements and the comments made by different interested parties. The Draft Practice Statement provides specific guidelines for recognising and differentiating material and immaterial information, thereby framing the reports in such a way so that it is precise and free from irrelevant information. These guidelines provide genuine help to the preparers of financial reports in identifying and eliminating the immaterial information. The Practice Statement gives guidelines which are useful for preparing the financial statements as per the requirements of IFRS. The IFRS criteria relating to disclosures have also been stated in this draft which will eventually help the various stakeholders to compare two or more business entities on a common ground and thereby effectively formulate economic decisions. The comments from various parties reveal their appreciation towards this initiative of IASB, but there are also some criticisms made against this exposure draft and practice statement such as its descriptive format and lack of practical guidelines to actually implement the materiality concept. However, this draft practice statement is expected to provide good assistance to the preparers and users of financial information to a great extent.

• 5.0 Reference List

Alkafaji, Y.A., Ankarath, N., Ghosh, T.P. and Mehta, K.J., 2010. Understanding IFRS Fundamantals: International Financial Reporting Standards, pp. 1. Hoboken: John Wiley b& Sons, Inc.

Artiach, T., Henderson, S., Herbohn, K., Howieson, B. and Peirson, G., 2014. Issues in Financial Accounting, 15th Edition, pp. 596. Australia: Pearson Australia

Basu, S.K., 2009. Fundamentals of Auditing, pp. 3.39. New Delhi: Pearson

EFRAG, 2016. 08/03/2016 - EFRAG's Comment Letter and Feedback Statement on the IASB's Exposure Draft ED/2015/8 IFRS Practice Statement: Application of Materiality to Financial Statements. [online] Available at: <http://www.efrag.org/News/Project-169/EFRAGs-Comment-Letter-and-Feedback-Statement-on-the-IASBs-Exposure-Draft-ED20158-IFRS-Practice-Statement-Application-of-Materiality-to-Financial-Statements> [Accessed 05 July 2016]

Ernst & Young Global Limited, 2016. Invitation to comment – Exposure Draft ED/2015/8 - IFRS Practice Statement: Application of Materiality to Financial Statements. [PDF] Available at: <http://www.ey.com/Publication/vwLUAssets/ey-application-of-materiality-to-financial-statements/$FILE/ey-cl-ed-materiality-ps-feb2016.pdf > [Accessed 05 July 2016]

ESMA, 2016. Ref: Exposure Draft IFRS Practice Statement: Application of materiality to Financial Statements. [online] Available at: <https://www.esma.europa.eu/sites/default/files/library/2016-302_cl_to_ifrs_ps_on_materiality.pdf> [Accessed 05 July 2016]

Everingham, G.K., Kleynhans, J.A.E. and Posthumus, L.C., 2007. Principles of GAAP, pp. 20. Cape Town: Juta & Co.

Francis, J., Schipper, K., Stickney, C.P. and Weil, R.L., 2010. Financial Accounting: An Introduction to Concepts, Methods and Uses, 13th Edition, pp. 11 – 12. Boston: South-Western Cengage Learning

Hansen, D.R., Heitger, D.L., Jones, J.P., Mowen, M.M. and Rich, J.S., 2012. Cornerstones of Financial and Managerial Accounting, 2nd Edition, pp. 587. Boston: South-western Cengage Learning

IFRS, 2015a. Comment Letters. [online] Available at: <http://www.ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Materiality/Exposure-Draft-October-2015/Pages/Comment-letter.aspx> [Accessed 05 July 2016]

IFRS, 2015b. Exposure Draft - IFRS Practice Statement: Application of Materiality to Financial Statements, pp. 4. London: IFRS Foundation

IFRS, 2015c. IASB publishes draft guidance to help Management apply the concept of Materiality. [online] Available at: <http://www.ifrs.org/Alerts/PressRelease/Pages/IASB-publishes-draft-guidance-to-help-management-apply-the-concept-of-materiality.aspx> [Accessed 05 July 2016]

IFRS, 2015d. Snapshot: IFRS Practice Statement Application of Materiality to Financial Statements – Overview of the Draft Practice Statement. [online] Available at: <http://www.ifrs.org/Current-Projects/IASB-Projects/Disclosure-Initiative/Materiality/Exposure-Draft-October-2015/Documents/Snapshot_IFRSPracticeStatement_OCT2015_WEBSITE.pdf> [Accessed 05 July 2016]

KPMG IFRG Limited, 2016. Comment Letter on Exposure Draft ED/2015/8 IFRS Practice Statement: Application of Materiality to Financial Statements. [PDF] Available at: <https://home.kpmg.com/content/dam/kpmg/pdf/2016/02/comment-letter-ed20158-application-materiality-financial-statements.pdf> [Accessed 05 July 2016]

Norton, C.L. and Porter, G.A., 2012. Using Financial Accounting Information: The Alternative to Debits and Credits, 8th Edition, pp. 57. Boston: South-Western Cengage Learning