Financial Reporting in New Zealand - Essay Example

Running head: PROVISION OF A TRUE AND FAIR VIEW GOVERNING FINANCIAL REPORTING IN NEW ZEALAND Financial Reporting in New Zealand Abstract Financial reporting provides information that presents the financial position of an entity that is useful to present and potential investors, creditors and other users in making rational investment, credit, and similar decisions. The information is written in a comprehensible manner for the sake of those who have a reasonable understanding of business and economic activities who are willing to study the information with reasonable diligence. The report helps in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. The prospects for those cash receipts are affected by an enterprise's ability to generate enough cash to meet its obligations when due and its other cash operating needs, to reinvest in operations, and to pay cash dividends and may also be affected by perceptions of investors and creditors generally about that ability, which affect market prices of the enterprise's securities. Therefore, financial reporting provides information that assist investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. Decision makers' uses information in the financial report on how to base investment, credit and other decisions underlies the objectives of financial reporting. A critical evaluation is done in relation to the usefulness of the financial reporting and the purpose it serves. This paper discusses if the provision of a true and fair view of an entity's financial position and performance is required by law. It shows the importance of conceptual framework and why we use regulations that are part of Generally Accepted Accounting Practice (GAAP) to govern financial reporting in New Zealand. Financial Reporting in New Zealand Companies, issuers and all public sector entities in New Zealand are required under legislation to act with accordance with General Accounting Acceptable Principles (GAAP) when presenting their external financial reports. According to New Zealand Institute of Chartered Accountants, they ensure that those involved in preparation of financial reports of entities to comply with General Accounting Acceptable Principles (GAAP) and any nonconformity should be reported. (New Zealand Institute of Chartered Accountants, 2006) Generally accepted accounting principles (GAAP) are accounting rules that are used to prepare financial statements for publicly traded companies and private companies as well as non profit making organisations. The generally accepted accounting principles operate under a different set of assumptions, principles, and constraints. GAAP ensures that the financial statements are useful to relevant users as they have the following essential qualities. Relevancy: A relevant information assist users of the financial statements to predict the future event in relation to the present and the past. This information must be available before the decision is made, so for this case they make a difference in decision making. Reliability: The information presented in the financial statement should be reliable i.e. if an independent auditor verifies it using the same method; he should be able to get the same result. Comparable: The financial reported should also be able to be reported in the same manner for a different organisation hence one can compare financial results of different companies. Consistent: This means that the same accounting method applied should be the same from period to period should be well explained and justified. This allows comparison of financial statements of the same company of different periods. For GAAP to achieve its objectives, it is usually guided by basic assumptions, principles and constrains. The Assumptions includes: Economic Entity Assumption: There is an assumption that the business is separate from its owners and revenues and expenses are kept separately from personal expenses. Going Concern Assumption: There is an assumption that the firm will continue to operate for unlimited period of time. For this case, it validates the methods of asset capitalization, depreciation, and amortization but this assumption is not applicable when liquidation is certain. Monetary Unit Assumption: There is an assumption that a stable currency is the unit of record. Periodic Reporting Assumption: There is an assumption the business operations are separated into different periods known as financial period which could be yearly, semi yearly or even monthly. These periods are used for comparison between the present and past performance. Principles include: Historical cost principle: This principle is relevant information though it is reliable as it requires the companies to account and report assets and liabilities basing on acquisition costs rather than fair market value. Revenue recognition principle: This principle requires companies to record their accounts when revenue is realised or earned, not when it is received. Matching principle: The principle states that expenses are matched with revenues and they should be recognised when a product is produced not when work is performed. Full disclosure principle: This principle means that the amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Constraints include: Cost-benefit relationship: In this constrain, it means that the benefit providing the financial information must be weighed against cost providing it. Materiality: In this constrain, the importance of an item must be considered when reported since it affects the decisions of a reasonable individual. Industry practices: In this constrain, the accounting procedures are supposed to follow industrial practice. Conservatism: In this constrain, it means that one should pick a solution that overstates assets and income when choosing between two solutions. 1 According to Amico New Zealand Limited (2006), companies are required to prepare financial statements in accordance with the requirements of the Financial Reporting Act 1993. This Act established the Accounting Standards Review Board in New Zealand where the main function of the Board is to review and approve all financial reporting standards. The Financial Reporting Act 1993 states that companies are reporting entities or exempted companies. The Act list reporting entities like: Overseas companies, Issuers, Subsidiary companies, Companies that have one or more subsidiaries, Companies with assets valued at more than $450,000 and Companies with a turnover in excess of $1,000,000. On the other hand the exempted companies are all other companies other than the reporting entities companies.2 A financial statement is supposed to be completed by all reporting entities within five months of their balance sheet date. The financial statements should include: A balance sheet showing all assets and liabilities profit and loss account if the entity is a profit making company and a income and expenditure account if the organisation is a non profit making one and A cash flow statement Additional information should be included in the above statements in order to provide a financial position of the entity that is true and fair. The statements must have complied with the General Accounting Acceptable Principles (GAAP) and signed by at least two directors of the company. The statements should be audited if the entity is an issuer, and if the entity has subsidiaries, then it has to prepare a group financial statement. In case the company is an overseas one, then the New Zealand business financial statements must also be included. The Financial Reporting Act 1993 also requires registration of the financial statements by delivering financial statements to the Registrar of Companies twenty days after completing the financial statements. The statements must be audited and should be accompanied by a fee of a hundred dollars. The following entities should register with Registrar of Companies: All overseas companies Issuers of securities to the company All subsidiaries of a company incorporated outside New Zealand and Any other company that has more than 25 percent of their voting power being controlled by a company incorporated outside New Zealand.3 The law requires provision of a true and fair view of an entity's financial position and performance. For a firm to give a true and fair view of its financial position, it must comply with the General Accounting Acceptable Principles (GAAP). In Accounting, understanding the conceptual framework for financial reporting and the reasons for developing it is very important. Accounting Conceptual framework is: "A coherent system of inter-related objectives and fundamentals that Should lead to consistent standards that prescribe the nature, function and limits of financial accounting and financial statements." (AT Foulks Lynch, 1998) An agreed conceptual framework has been developed due the following reasons: To provide fundamental principles that are not supposed to be repeated in accounting standards To provide basis for resolving accounting disputes and To provide a framework for setting accounting standards 4 A statement of principle is drafted define principle that triggers the preparation and presentation of financial statement that is general. This provides the basis for preparation of future accounting standards. The statement of principle contains eight chapters as follows: Objective of Financial Statements. Reporting Entity. Qualitative Characteristics of Financial Information. Elements of Financial Statements. Recognition in Financial Statements. Measurement in Financial Statements. Presentation of Financial Information. Accounting for Interests in Other Entities. 5 According to Accounting Standard Board (1999), the draft statement help the auditors, preparers and users of financial statements to understand better approach of accounting standard formulation. It also assist them understand the general nature and function of the information reported in the financial statements. Statement of principle does not recommend how the financial statements should be prepared since it is not an accounting standard. The financial statements that are anticipated to give a true and fair view of the entity's financial performance or anticipated to be consistent with financial statements that give such view are focussed by the draft statement. (ASB, 1999) Since the draft statement is only relevant to only profit making organisations, it could be relevant to non profit making organisations if some principles are re-expressed and their emphasis changed. True and fair view concept is crucial in any financial reporting hence it always lies at the centre. It is a vital test for financial statement hence it has a direct effect on accounting practice. It is should be noted that the concept of true and fair view is elementary to the whole system of financial reporting as recognised by draft statement. For example, persistence on the relevance and reliability as the main indicator of the quality of financial information. It is not obvious for the financial statement to give a true and fair view hence the information must be sufficient in quantity and quality to satisfy the reasonable expectation of the readers addressed. Accounting Standard Board search through their accounting standards and other pronouncements in order to respond to the expectation since these expectations changes over time. 6 There are a four accounting concepts that forms part of the accounting concept framework. The accounting concepts are as follow: Going concern: In this concept, its states that an organisation will continue to exist for unlimited period of time. This means that the firm should continue in its operations and its existence can not be dictated the profit or loss of the organisation. Accruals: In this principle, revenue and expenses are recognised at the time they are earned not when they are received. Consistency: This concept means that there is consistency of accounting treatment of items that ate alike within each accounting period and form one period to another. Prudence concept: In this concept, revenue and profits are recognised and included in the profit and loss account when they are realised but they are not anticipated. 7 Black (1998) stated that the relative importance of the accounting concepts varies according to the circumstance of each case. He also noted that where the accrual concept is inconsistent with the prudence concept, prudence take precedence. The conceptual framework of accounting facilitate the financial reporting of organisations because they provide information on how an enterprise obtains and spends cash, its borrowing and repayment, capital transactions including cash dividends and other distributions of enterprise resources to owners and other factors that affects the organisation's liquidity or solvency. References Accounting Standards Board, (1999), Revised Exposure Draft - Statement of Principles for Financial Reporting, ASB Publications. Amico New Zealand Limited (2006): Financial Reporting Act 1993, Wellington, Amico New Zealand Limited AT Foulks Lynch (1998), Drafting Financial Statements (Industry & Commerce), London, AT Foulks Lynch Ltd. Black, G. (1998), Students' Guide to Accounting and Financial Reporting Standards, Letts, Chapter 2. BPP, (1998): CAT Interactive Text - Drafting Financial Statements, London, BPP Publishing Ltd Lerner, J. and Cashin, J.A (2001): Business and Economics, New York, Mc Graw Hill Publishers Lynn C. (2004): Dynamics of Profit Focused Accounting, New York, Ross publishers New Zealand Institute of Chartered Accountants (2006): Financial Reporting Standards, Wellington, National Offices Thomsett M.C. (2001): Builder Guide to Accounting, London, Craftsman publishers Wood F., and Sangster A., (1999): Business Accounting I, London, Financial Times Professional Ltd. Read More