Weaknesses in the Current Financial Reporting in Australia - Report Example

Report Part 2 Name Institution Course Date Report Part 2 Introduction Companies in Australia are required to prepare financial performance, financial position and cash flows by submitting the annual reports. The statement of financial performance is used to show the proceeds and expenditures that a company incurs over a financial year and also illustrates the balance of retained profits during the start of the year and reserves transfer (CPA Australia, 2014). On the other hand, there is a statement of financial position that illustrates a company’s assets, liabilities as well as shareholder equity (Cotter, 2013). Assets are separated into current assets and non-current assets. Likewise, liabilities are also split into current liabilities and non-current liabilities. This statement also provides for equity tat includes shareholder capital, reserves as well as retained profits (Cotter, 2013). Finally, the statement of cash flows provides the cash input and cash output during a financial year under three wide groups that include; operating activities, investing activities and financial activities. These are all important in providing a company’s capacity to pay its debts and hence it is a very important aspect when considering solvency (Cotter, 2013). Additionally, there are other requirements that companies are required to meet apart from the annual reports, as discussed in report 1. This report will argue that there is a need to have more comprehensive requirements and measures to ensure that the details indicate the precise financial position of a company. This is because the current requirements do not reflect companies’ financial positions. Weaknesses in the current financial reporting Financial statements are used to show the financial effects of what are normally intricate commercial transactions as well as the judgement that might be needed in determining representation of the transactions and events (CPA Australia, 2014). Accounting standards are very critical when it comes to making sure that alike transactions are handled similarly. Nonetheless, a principles-based strategy in establishing accounting standards signifies that accounting rules might not be able to cover all situations (Burkspen, 2014). As a result, expert judgement might be required during the interpretation as well as during the application of accounting standards. For instance, the company can have financial amount as the exploration expenditure in the statement of financial position. This may be the cost that the company’s directors approximate can be recovered in upcoming financial years (FATF & APG, 2015). Therefore, when the accounting standards are applied in such an aspect, it will imply that the impact of the estimation from the directors is also seen within the statement of inclusive income as impairment expenditure. Judgement is often needed to determine the financial amounts and as a result directors mostly utilise external valuation professionals. In addition, directors are also expected to use judgement in determining how long an asset is likely to be useful for the company and the ensuing effect on depreciation on the asset (CPA Australia, 2014). At times the estimations might not always be exact and hence this is a clear indication that sometimes that, financial statements may not reflect the true picture of the company’s financial position (FATF & APG, 2015). In addition, the top management can prefer to use annual reports as the communication documents due to the fact that the management has key control over annual reports, unlike prospectuses which are normally compiled by external parties. Therefore, the annual reports might even not represent the real image of the company. Moreover, some companies may release the annual reports in order to meet the legal obligations and attract new investors. Still, sometimes the annual reports and other financial reports are compiled in a manner that is difficult to comprehend especially for the shareholders (CPA Australia, 2014). For example, shareholders may be lacking enough skills and knowledge for interpreting the documents appropriately and hence the annual reports may partly not be able to achieve its objectives. CPA Australia (2014) further argues that annual reports along with the financial do not provide the core information. For instance, the reports do not assure of the company’s governance and accountability and hence the reports cannot communicate if the management are working for their interests of to the best interests of the shareholders. The reports should therefore disclose more information as well as ensure there is further auditing by the external auditors. This is because at times the annual reports and financial reports might not contain the required information for decision making and hence it is important for the management to use the annual reports as the means for communicating credibly to the shareholders and the public at large (Rob, 2001). More importantly, the currents requirements do not provide information regarding uncertain or difficult financial conditions. Uncertain financial conditions present certain challenges and hence they might not be covered well in for instance the annual reports, particularly in the year-end financial reports which are very important (Burkspen, 2014). This means that a company’s going concern or the liquidity risk might not be covered well. For instance, the difficult economic conditions can result to increased uncertainty regarding the ability of the company to access debt financing as well as the effect of the economic conditions on the cash flow position of the company. Therefore, there is need to ensure that the current requirements on financial reporting are able to tackle issues such as uncertain economic conditions in order to present the authentic picture for the companies to the public, and particularly potential investors (AICD, 2009). As a result, the following recommendations have been made to improve financial reporting as well as ensure that the measures that govern financial reporting are effective. Recommendations The annual reports should include internal control report Internal controls and processes for financial reporting should encompass the preparation of financial statements for external purposes that reasonably conform to the widely accepted accounting principles (Burkspen, 2014). The internal control report should be included in company’s annual reports and should consist of the following aspects: A description of the role of the management in setting out and maintenance of sufficient internal controls and processes for financial reporting The stand and decisions of the management regarding the efficacy of the company’s internal controls and processes for financial reporting. The basis of the management decisions should be the assessment of the controls and processes A statement prepared by a public accounting firm or the audit report should be incorporated within the annual reports. These statements or the audit reports should show that the company’s internal control processes for financial reporting are comprehensive and have been assessed (Rob, 2001). Materiality considerations Materiality is among the most important aspect of financial reporting. Therefore, it is important to ensure that the financial disclosures by the companies present material information to the public and specifically the financial statement users and not just adding clutter. A fact in financial statements is material when a significant probability that the disclosure of the excluded fact can be viewed by a reasonable investor as substantially adjusts the availed information (Bernard, 2011). This means that a fact in the financial statement is material if investors consider such a fact vital. This is demonstrated in some instances where the some companies might fear exposing themselves to significant liability and this may lead the management into hiding important and massive, though trivial information (Bernard, 2011). Sometimes companies clutter their annual reports and other disclosure documents with non-material information that investors might use in making their investment decisions, while the material information is left out. Therefore, it is important for companies to use materiality in determining if information should be within the disclosure documents and materiality ought to also impact how outstandingly the financial information is presented (Bernard, 2011). However, materiality of the financial reports should be done through a professional judgement and should consider both qualitative and quantitative aspects. Making materiality decisions is not a simple task and hence it is important for companies to review their disclosures and identify the areas that can be significantly decreased or eliminated without substantially changing the information in the financial reports as this is likely to do away with the immaterial information that can confuse investors and the public at large (Rob, 2001). In addition, companies should develop and maintain systems of accounting controls that clearly show companies’ financial positions and reasonably guarantee that: Company’s transactions are carried out according to the managements specific approval All company’s transactions are documented as required in order to facilitate preparation of financial statement according the available accounting principles and also in order to ensure there is accountability for assets The company’s assets are only accessed as per the management’s approval and external auditor’s position The documented accountability for assets is assessed using the existing assets at rational intervals and the required actions are implemented in case there is any discrepancy (Bernard, 2011). Risk assessments Companies should be required to submit their risk assessments’ reports. It is necessary for companies to conduct risk assessments regularly and the risk assessment should encompass assessing the financial risks that the company is likely to face and disclosing this information in the annual reports and other financial reports (Bernard, 2011). In addition, risk assessment reports should also report how companies intend to mitigate and manage the potential risks. Information regarding potential risks that a company is likely to face can provide investors with information useful when making investment decisions (AICD, 2009). Certifications It is recommended that companies to be mandated to file the necessary certifications and also ensure that the certifications are accessible, for example online access. This is because certification ensures that companies comply with the appropriate certification requirements (Burkspen, 2014). Conclusion Companies are required to prepare financial reports indicating the financial position of the companies. In addition, companies are required to be audited in order to verify their financial positions. However, these requirements are not enough and hence there is need to implement improvements in order to ensure that the reporting is comprehensive. Some defects with the current reporting requirements are that sometimes the top management might report basing on their best interest. Again, the current reporting does not provide the core information and may also not provide enough information regarding uncertain or difficult financial conditions. Some of the recommended improvements include; implementing requirement to have internal control report, mandating companies’ risk assessment reports to be included in the financial reports, mandating the company’s to have the proper accreditation as well as ensuring that the financial reports have more of material information, rather than bulky reporting of immaterial information. Reference list Australian Institute of Company Directors (AICD), 2009, Going Concern issues in financial reporting: a guide for companies and directors, Sydney: Australian Institute of Company Directors (AICD). Burkspen N, 2014, Disclosure effectiveness What companies can do now, Melbourne: Partner, Ernst & Young LLP. Bernard F, 2011, Financial Reporting in Australia, Sydney: The Financial Reporting Council Limited. Cotter J, 2013, Relevance Of Parent Entity Financial Reports, Melbourne: Big Print. CPA Australia, 2014, A Guide to Understanding Annual Reports, Sydney: CPA Australia. FATF and APG (2015), “Preventive measures” in Anti-money laundering and counter-terrorist financing measures - Australia, Fourth Round Mutual Evaluation Report, FATF, Paris and APG, Sydney Rob M, 2001, The Corporate Image - The Regulation Of Annual Reports In Australia, Macquarie Law Journal, 1(93). Read More