1. Book overview  Part 1 – Environment of financial reporting  Part 2 – Basic accounting techniques and the preparation of annual financial statements  Part 3 – Interpretation and analysis of financial statements  Part 4 – Consolidated financial statements and issues related to multinational groups  Part 5 – Advanced financial statement analysis and accounting values.

2. CHAPTER 1 Financial reporting and regulation

3. Contents  Annual financial statements  Uses of financial statements  Accounting choices  Accounting regulation  International Financial Reporting Standards

4. Financial versus management accounting  Financial accounting (FA) -> external financial reporting  Management Accounting (MA) -> financial information useful in internal decision and management processes  Starting from the same source data + FA is frame of reference for MA

5. Annual financial statements  Income statement  Balance sheet  Notes to the accounts  Cash flow statement  Statement of changes in equity  Audit report

6. Uses of financial statements  Objective of financial statements  User groups  Accounting traditions  Anglo-Saxon accounting  Continental Europe  Link with taxation

7. Objective of financial statements “ The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.” IIASB, Framework for the Preparation and Presentation of Financial Statements, par.12

8. Users of financial statements  Investors  Employees  Lenders  Suppliers  Customers  Governments  Public

9. Users of financial statements Management Shareholders Government Loan providers Potential Investors Potential Investors Public Customers Trade creditors Employees

10. Users – Focus on investors Management Government Loan providers Potential Investors Potential Investors Public Customers Trade creditors Employees Shareholders / Investors

11. Accounting traditions  Anglo-Saxon tradition  Continental European tradition

12. Anglo-Saxon accounting  US, UK, Australia, Canada, New Zealand, etc.  Financial statements as a function of a company’s financing  Market solution to accounting rules  Powerful accounting profession

13. Continental European accounting  Financial statement as a product of government regulating of the economy  All businesses are subject to accounting rules, with extra rules for:  Limited liability companies  Listed companies

14. Link with Taxation  Link between measuring performance for shareholders and measuring profit for tax purposes  Looser in Anglo-Saxon tradition  Greater impact on individual accounts (less on consolidated group accounts)  Impact of taxation on company accounting also depends on ownership of the company, which is in turn an issue frequently linked to size

15. Accounting choices  Accounting is not a set of precise measurement rules which permit the exact measurement of company profit and company value  Measurement of profit can never be anything but an estimate  Accounting measurement is full of choices  Choices made should be stated clearly in the annual financial statements

16. Accounting choices – Relevance versus reliability  To be useful, accounting information should be both relevant and reliable  Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their past evaluations  Relevant information is timely  Relevant information has predictive or feedback value

17. Accounting choices – Relevance versus reliability (cont.)  Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully what it purports (or is expected to) represent  Accounting choices may imply trade-offs between relevance and relaibility of information

18. Accounting regulation  Accounting regulation will discipline accounting choices  Types of regulatory body:  Government  Stock exchange  Private sector body  Professional accountants  Specialist industry organizations  Usually separate rules for banks and insurance companies.

19. Government as accounting regulator  Regulation of accounting designed to ensure that the markets can operate free from fraud and misrepresentation  Accounting laws  Commercial codes  Government regulatory agencies  Regulation of accounting for tax collection purposes

20. Stock exchange as accounting regulator  Stock exchange regulates the financial information to be provided by listed companies  In some countries this is done by a government regulator  US: Securities and Exchange Commission (SEC) as accounting regulator

21. Private sector as accounting regulator  Delegation of responsibility of writing detailed accounting rules to private sector bodies, financed by contributions from companies, audit industry, etc..  US: Financial Accounting Standards Board (FASB)  Global: International Accounting Standards Board (IASB)  Flexible and rapid rule-making, as opposed to governmental rule-making  Technical committees from professional accounting bodies may function as catalyst

22. International bodies  International Accounting Standards Board (IASB)  Accepted as an international source of best practice  Issues the International Financial Reporting Standards (IFRS)  International Organization of Securities Commissions (IOSCO)  Represents the world’s stock exchange regulators  Strives for a single, uniform set of accounting standards worldwide  Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR)  Under the auspices of the UN Conference on Trade and Development (UNCTAD)  Commissions research reports into current accounting problems  International Federation of Accountants (IFAC)  International representative of the accounting profession

23. International Financial Reporting Standards  Single set of global accounting and reporting standards, issued by the IASB  Increasingly used by many large and mutinational companies  Accepted by most security market authorities  Used as a basis for national accounting requirements (partially or in full) or as a benchmark for the development of national accounting rules

24. International Accounting Standards Board  A private sector body  Operates under the International Accounting Standards Committee Foundation (IASCF)  Has no responsibility to any governmental organization  Has no enforcement authority  Develops and issues both main standards (IAS / IFRS) and interpretations (SIC / IFRIC)

25. Fig. 1.1 The structure of the IASB IASC Foundation 22 Trustees Appoint, Oversee, Raise Funds Standards Advisory Council 30 or more members Board 12 full time and 2 part time Set technical agenda. Approve standards, exposure drafts and Interpretations Working groups for major agenda projects International financial reporting interpretations committee 12 members Key: Appoints Reports to Advises

26. IFRS – Standard-setting due process  The IASB’s standard-setting procedures have to ensure that resulting IFRS are of high quality and are issued only after giving IASB’s constituencies opportunities to make their views known at several points in the standard-setting due process  An overview of the due process is presented in figure 1.2

27. Fig. 1.2 Standard-setting due process of the IASB Discussion paper Comment analysis Exposure draft Exposure draft Standard Effective Date Comment analysis Research National Standard Setters Others 9-15 months 6-18 months

28. IFRS in the world  Recent decisions of various governments result in the requirement or permission of the use of IFRS by more than one hundred countries  Europe: IAS Regulation of 2002  Requirement of use of IFRS for consolidated financial statements of EU qouted companies as from 1 January 2005  Member state option to extend the application of IFRS to not-listed companies and to individual financial statements  Adoption of IFRS (-equivalent) as national accounting rules in a number of countries (Australia, Singapore, Hong Kong, …)  US: convergence process of US accounting rules and IFRS started in 2002 (“Norwalk Agreement”)

29. Table 1.2 Financial reporting in the European Union – Main developments 19784 th Company Law Directive (Individual financial statements) 19837 th Company Law Directive (Consolidated financial statements) 1995Decision on new accounting strategy (adhering to IAS instead of further development of specific European accounting rules) 2000Announcement of plan to require IAS for consolidated financial statements of listed companies by 2005 2001Fair Value Directive (requiring/allowing for fair value measurement of specific balance sheet items (mainly financial instruments)) 2002IAS Regulation (Application of IFRS by 2005 - see Table 1.3) 2003Modernization Directive (reflecting IFRS developments in the 4 th and 7 th Directive) 2005/2007IFRS mandatory for listed companies in European Union

30. Table 1.3 Effects of the IAS Regulation (EU) Individual financial statements Group/ Consolidated financial statements Listed companiesMember state optionIFRS mandatory from 2005/2007 Not-listed companiesMember state option

31. Table 1.1 List of IASB rules as of September 2005

32. Table 1.1 List of IASB rules as of September 2005 (cont.)

33. Table 1.1 List of IASB rules as of September 2005 - Interpretations