Financial Accounting and Reporting
Lecture one: Introduction to FAR and general information (chapter one)
Financial statements
1. Balance sheet/statement of financial position (IASB)
2. Income statement & Statement of comprehensive income
- Income statement (USA)/Profit and loss account (UK)
3. Statement of cash flows
- Direct statement of cash flows
- Indirect statement of cash flows
4. Statement of changes in (shareholders’/stockholders’) equity
- Consolidated financial statements
- Company financial statements
Accounting: the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information
- Economic information: essential for economic decision making and financial decisions
- Essential characteristics of accounting:
- The process of accounting consists of identification, measurement and communication
- Accounting is about economic entities
- This process is used to show economic entities to interested parties
Financial accounting: the process that culminates in the preparation of financial reports on the enterprise for
use by both internal and external parties
- Managerial accounting: the process of identifying measuring, analyzing and communicating
financial information needed by management to plan, control and evaluate operations
- The process of identifying, measuring and communicating financial information about the reporting
entity that is useful to capital providers in making decisions about providing resources to the entity
- Communication with capital providers and other stakeholders via financial reports
Developments in financial reporting
- Sole proprietorship: 100% Owner = 100% Financier = ‘Manager’
- Loan: makes a difference between the owner and the loaner (financer), no 100% ownership
- Separation between ownership (finance) and control (management), brings agency problem
- Finance: investors, capital providers
- Management: managers who manage the company
- More complex ownership structures
- Legal entities:
- Private (limited liability) and public (listed) companies
Agency theory
1
, - Understand assumptions and behavioral risks, 7 is important
- Theory is about information asymmetry and opportunistic behaviour
- Bounded rationality: a person is bounded by their thinking, has a capacity
- Goals of agents are not always the same as those of the principals
Financial accounting versus management accounting
- Gives information asymmetry and agency problems
- Reducing information asymmetry: high quality financial reports which provide relevant & reliable
financial information
- Financial reports with relevant and reliable information
- Two parts that make sure information is of quality: accounting standards and external auditor (RA)
Accounting standards
- Rules-based standards: is like following a recipe
- Principle-based standards: according to general standards, you have to use useful information
IFRS (International Financial Reporting Standards) and IAS:
- IFRS: provides oversight to the IASB, IFRS advisory council and IFRS interpretations committee
- IASB: International Accounting Standards Board (from 2002)
- IASB: independent body based in London, part of the IFRS foundation
- IAS: International Accounting Standards
- IASC: International Accounting Standards Committee (1973-2001)
- IASs issued by IASC that have not been amended or superseded by IASB also fall
under the umbrella of IFRS
Accounting standards in the EU: IFRS endorsed
- When a new standard is issued by the IASB, the EU needs to endorse it before it comes into force,
following a specific endorsement process under the responsibility of the European Commission
- EU-listed companies and financial institutions have to prepare their consolidated financial statements
under IFRS adopted for application within the EU
- The Dutch Civil Code also permits non-listed Dutch companies to apply IFRS
Objective of financial reporting: provide financial information about a reporting entity useful to existing and
potential investors, lenders and other creditors in making decisions about providing resources to the entity
- Communication of information useful in economic decision making: resource allocation decisions
Communicate information that is useful to users in making economic decisions: (objectives)
1. Resource allocation decisions
- Buying, selling (or holding) shares and other equity instruments
- Providing or settling loans and other forms of credit
2
, 2. Accountability and assessment of management stewardship: companies use the financial report
how they use money from capital providers to create performance and how they invest the money
- Managers must be accountable for their choices and actions
- Monitor managers’ decisions and activities
- Evaluate managers’ performance
- Assessment of net income
→ Proposal for profit allocation and dividend distribution
- Discharge management from responsibility
3. Protection of capital providers
External auditor
- Role external auditor: checks whether or not the financial reports of a corporation have been filled
in truthfully and give a fair view
Independent auditor’s report:
- Mandatory audit
- Public companies (= Stock exchange listed companies)
- Financial institutions
- General criterion: see ‘Size criteria’ large and medium-sized companies
- IFRS: public companies and financial institutions have to prepare their consolidated financial
statements under IFRS
Legal entities: size criteria
3
, Lecture two: conceptual framework and accounting information systems
(chapter two and three)
Chapter two: Conceptual framework for financial reporting
The conceptual framework
Conceptual framework: establishes the concepts that underlie financial reporting
- It is a coherent system of concepts that flow from an objective
- The objective: identifies the purpose of financial reporting
- The other concepts provide guidance on:
- Identifying the boundaries of financial reporting
- Selecting the transactions, other events and circumstances to be presented
- How they should be recognized and measured, summarized and reported
- The need for a conceptual framework: rule-making should build on and relate to an established
body of concepts, to be useful
- Also: the profession should be able to more quickly solve new and emerging practical
problems by referring to an existing framework of basic theory
Overview of the conceptual framework for financial reporting:
- First level: identifies the objective of financial
reporting, the purpose of financial reporting
- Second level: provides the qualitative characteristics
that make accounting information useful and the
elements of financial statements
- Third level: identifies recognition, measurement and
disclosure concepts used in establishing and applying
accounting standards and specific concepts to
implement the objective
Level two: forms a bridge between the why and how of
accounting
Objective of financial reporting: is the foundation of the
conceptual framework
Other aspects: qualitative characteristics, elements of
financial statements, recognition, measurement and disclosure
- These aspects help to ensure that financial reporting
achieves its objective
General objective financial reporting: provide financial information about the reporting entity that is useful
to present and potential equity investors and lenders in making decisions about providing resources to the
entity
- Provided by issuing general-purpose financial statements.
- Assumption is that users need reasonable knowledge of business and financial accounting matters to
understand the information
4
Lecture one: Introduction to FAR and general information (chapter one)
Financial statements
1. Balance sheet/statement of financial position (IASB)
2. Income statement & Statement of comprehensive income
- Income statement (USA)/Profit and loss account (UK)
3. Statement of cash flows
- Direct statement of cash flows
- Indirect statement of cash flows
4. Statement of changes in (shareholders’/stockholders’) equity
- Consolidated financial statements
- Company financial statements
Accounting: the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information
- Economic information: essential for economic decision making and financial decisions
- Essential characteristics of accounting:
- The process of accounting consists of identification, measurement and communication
- Accounting is about economic entities
- This process is used to show economic entities to interested parties
Financial accounting: the process that culminates in the preparation of financial reports on the enterprise for
use by both internal and external parties
- Managerial accounting: the process of identifying measuring, analyzing and communicating
financial information needed by management to plan, control and evaluate operations
- The process of identifying, measuring and communicating financial information about the reporting
entity that is useful to capital providers in making decisions about providing resources to the entity
- Communication with capital providers and other stakeholders via financial reports
Developments in financial reporting
- Sole proprietorship: 100% Owner = 100% Financier = ‘Manager’
- Loan: makes a difference between the owner and the loaner (financer), no 100% ownership
- Separation between ownership (finance) and control (management), brings agency problem
- Finance: investors, capital providers
- Management: managers who manage the company
- More complex ownership structures
- Legal entities:
- Private (limited liability) and public (listed) companies
Agency theory
1
, - Understand assumptions and behavioral risks, 7 is important
- Theory is about information asymmetry and opportunistic behaviour
- Bounded rationality: a person is bounded by their thinking, has a capacity
- Goals of agents are not always the same as those of the principals
Financial accounting versus management accounting
- Gives information asymmetry and agency problems
- Reducing information asymmetry: high quality financial reports which provide relevant & reliable
financial information
- Financial reports with relevant and reliable information
- Two parts that make sure information is of quality: accounting standards and external auditor (RA)
Accounting standards
- Rules-based standards: is like following a recipe
- Principle-based standards: according to general standards, you have to use useful information
IFRS (International Financial Reporting Standards) and IAS:
- IFRS: provides oversight to the IASB, IFRS advisory council and IFRS interpretations committee
- IASB: International Accounting Standards Board (from 2002)
- IASB: independent body based in London, part of the IFRS foundation
- IAS: International Accounting Standards
- IASC: International Accounting Standards Committee (1973-2001)
- IASs issued by IASC that have not been amended or superseded by IASB also fall
under the umbrella of IFRS
Accounting standards in the EU: IFRS endorsed
- When a new standard is issued by the IASB, the EU needs to endorse it before it comes into force,
following a specific endorsement process under the responsibility of the European Commission
- EU-listed companies and financial institutions have to prepare their consolidated financial statements
under IFRS adopted for application within the EU
- The Dutch Civil Code also permits non-listed Dutch companies to apply IFRS
Objective of financial reporting: provide financial information about a reporting entity useful to existing and
potential investors, lenders and other creditors in making decisions about providing resources to the entity
- Communication of information useful in economic decision making: resource allocation decisions
Communicate information that is useful to users in making economic decisions: (objectives)
1. Resource allocation decisions
- Buying, selling (or holding) shares and other equity instruments
- Providing or settling loans and other forms of credit
2
, 2. Accountability and assessment of management stewardship: companies use the financial report
how they use money from capital providers to create performance and how they invest the money
- Managers must be accountable for their choices and actions
- Monitor managers’ decisions and activities
- Evaluate managers’ performance
- Assessment of net income
→ Proposal for profit allocation and dividend distribution
- Discharge management from responsibility
3. Protection of capital providers
External auditor
- Role external auditor: checks whether or not the financial reports of a corporation have been filled
in truthfully and give a fair view
Independent auditor’s report:
- Mandatory audit
- Public companies (= Stock exchange listed companies)
- Financial institutions
- General criterion: see ‘Size criteria’ large and medium-sized companies
- IFRS: public companies and financial institutions have to prepare their consolidated financial
statements under IFRS
Legal entities: size criteria
3
, Lecture two: conceptual framework and accounting information systems
(chapter two and three)
Chapter two: Conceptual framework for financial reporting
The conceptual framework
Conceptual framework: establishes the concepts that underlie financial reporting
- It is a coherent system of concepts that flow from an objective
- The objective: identifies the purpose of financial reporting
- The other concepts provide guidance on:
- Identifying the boundaries of financial reporting
- Selecting the transactions, other events and circumstances to be presented
- How they should be recognized and measured, summarized and reported
- The need for a conceptual framework: rule-making should build on and relate to an established
body of concepts, to be useful
- Also: the profession should be able to more quickly solve new and emerging practical
problems by referring to an existing framework of basic theory
Overview of the conceptual framework for financial reporting:
- First level: identifies the objective of financial
reporting, the purpose of financial reporting
- Second level: provides the qualitative characteristics
that make accounting information useful and the
elements of financial statements
- Third level: identifies recognition, measurement and
disclosure concepts used in establishing and applying
accounting standards and specific concepts to
implement the objective
Level two: forms a bridge between the why and how of
accounting
Objective of financial reporting: is the foundation of the
conceptual framework
Other aspects: qualitative characteristics, elements of
financial statements, recognition, measurement and disclosure
- These aspects help to ensure that financial reporting
achieves its objective
General objective financial reporting: provide financial information about the reporting entity that is useful
to present and potential equity investors and lenders in making decisions about providing resources to the
entity
- Provided by issuing general-purpose financial statements.
- Assumption is that users need reasonable knowledge of business and financial accounting matters to
understand the information
4
