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Objective of Financial Reporting

Discuss about the Readability of Financial Reports and IFRS.

As stated in the conceptual framework under chapter 3 of the QC 12 of AASB, the financial statements of any organization shows the progress of the organization during the particular period in economic and financial terms. There are various users for the financial statement and the data must be presented in faithful and relevant way so that it can fulfil the purpose of the users. The accountant must take all the necessary steps to assure that the reports are free from error and prepared in a neutral way as well as complete in all aspects. The term faithful representation explains that the accountant has not prepared its report based on any influence of the users and prepared with the best knowledge of the accountant. As the financial report plays an important role in decision making aspect of all the users, the information must be accurate and free from any manipulation (Australian Accounting Standards Board (AASB) - Home, 2017).

The accountant’s main objective while preparing the financial statements are to make the statements free from any influence and representing it in a faithful manner. Other objectives of the faithful representation are:

  • Following the standard – the preparer of the financial statement must prepare the reports through taking care of preventing it from error, influence, inaccuracy and unethical means. Further, he must follow the standards and guidance provided by the AASB (Baker & Haslem, 2015).
  • Undue influence – the reports must not be prepared with the view of any person who is interested in the financial performance of the organization. For example, if any organization is planning to borrow finance, its better profitability will surely play an important role in getting the loan, therefore, the financial statement must not be manipulated to raise loan from the borrower (Burc?, Mate? & Pu?ca?, 2015).

The term neutrality to be maintained while preparing the financial statement is solely dependent on the view, characteristics, determination and will power of the accountant. It is a fact that, maintaining neutrality is not possible in all the cases like different accountant may uses the same aspect from different aspect. It will not be possible to match their aspect and outcome and the users are most likely to raise questions regarding the profits and losses which are tough to be answered by the accountants. . However, the accountant must take all the required consideration to prepare the statement that is reliable, neutral, faithful and presented with the best possible knowledge of the preparer. He must take care while making the important projections like estimation of depreciation, bad-debts, interest rate and profit. Generally, it will be a good practice to show the losses at the highest projected value and profits at the lowest projected value (Cheung, 2014).

Historical cost approach record the assets at its original or actual cost at which the assets were acquired. Through the historical approach the assessor can make the difference in the cost of the asset from the asset’s other costs like replacement cost, fair value or market value. Historical cost is used to state the asset in its purchasing cost in addition to the cost expensed for preparing the asset for the intended use.

Weaknesses of Historical Cost

Various weaknesses that are to be faced while valuing the asset on historical cost method are:

  • Ignore the changes – the primary objective for publication of financial reports is to show the current position of the company at the true value. However, the historical approach ignores the changes in the value of the asset due to impairment, depreciation and changes in the market value. Therefore, it does not reveal the true cost of the organization.
  • Unrealistic profit – reports prepared on this basis does not reveal the true position of the organization in respect to earnings and expenses. Under this, the earnings are measured on current value whereas the expenses are measured at historical value.
  • Mix up the holding and operating profit – the profit or loss arising from the inventory holding is confused with the operating profit or losses. However, the profit or loss arising from operation must be separated from the loss or profit arises from inventory holding.

Although the historical approach have some obligations, it has its own advantages too, these are:

Consistency – under this method, the cost of the asset can be asset can be measured consistently base on the original cost recorded at the purchasing time.

Easier and simple – assessment of cost under this method is easy and simple as the cost can be accesses from the purchase voucher and transaction. Moreover, the assessor does not have to keep an eye over the continuous changes in the market value of the asset.

Manipulation – as the cost can be analysed very easily from the purchase voucher, the chances of manipulating the cost is approximately zero and the value can be measured more reliably (Mazhambe, 2014).

Current cost method – under this method, the value of the asset are adjusted with the changes in the market value of the asset. Financial statements prepared on this basis takes into consideration the changes in the value of the asset and reveal the true value of the organization.

Cost basis approach – Under this, the earnings and expenses are accounted only after they are received or the payment made. This method is common for the small businesses and reporting for the income tax (Tan?Kantor, Abbott & Jubb, 2017).

As per the conceptual framework of AASB, the main objective of the general purpose financial reporting is to offer reliable information to the users for decision making. It shows the performance and changes in financial positions of any organization over the particular period and assist the investors, lenders, creditors and potential investors to make their decisions. While preparing the statements, the accountant must not take into consideration the influence of any external as well as internal users and assure that on the financial statements, they do not have any kind of association.

The financial statements are used by the following users for making decisions in various aspects.

  • Present and potential investors – the investors are the part of the organization and they have a right on the profits of the organization. They analyse the financial reports to assess the risk and return factor so that they can make decisions regarding their investment in the company
  • Lenders – lenders like financial institutions or banks or purchaser of debt securities expect return in form of interest on their lending. Thus, they use the financial statement to evaluate and project the future cash flows of the company and the risks involved with the cash flows (Barbier & Burgess, 2017).
  • Creditors – based on the financial reports the creditors decide on the credit terms that may be offered to the entity. They also assess the credit worthiness and financial viability of the entity for granting the credit period.

In addition to the above users, the financial reports are also used by the industrial competitors, governments, employees of the company and general public. They use the reports for comparing the entity’s performance with the competitors, calculation of tax, accurateness and reliability of the financial statement (Kigozi et al., 2014).

In few organizations, the activities like buying or selling are measured based on the historical value while others value their activities based o the current market value and hold the value till the sell or purchase of the asset. Thus the entity does not record the transaction immediately and records only after the transaction takes place. The main disadvantage for the historical cost arises when it is compared with the the fair value method. In few instances, it shows very clearly that the historical approach is not reliable and to reveal the value of the asset, any other method like fair value method is suitable. Generally this is required when the fair value method shows the cost in more reliable and relevant way (Ellul et al., 2014).

Though there are various arguments regarding which method is suitable among the two, it is completely depend upon the circumstances and requirement. Under GAAP the historical approach is considered whereas practically, the valuation under cost or market value whichever is lower is adopted (Greenberg et al., 2013).

Reference:

Australian Accounting Standards Board (AASB) - Home. (2017). Aasb.gov.au. Retrieved 5 April 2017, from https://www.aasb.gov.au/

Baker, H. K., & Haslem, J. A. (2015). Information needs of individual investors.

Barbier, E. B., & Burgess, J. C. (2017). Depletion of the global carbon budget: a user cost approach. Environment and Development Economics, 1-16.

Burc?, V., Mate?, D., & Pu?ca?, A. (2015). Standard-Setters versus Big4 Opinion, Concerning IASB Revision Project of the Conceptual Framework for Financial Reporting. Studia Universitatis Vasile Goldi?, Arad-Seria ?tiin?e Economice, 25(2), 81-107.

Cheung, E. W. Y. (2014). Readability of Financial Reports and IFRS Adoption in Australia.

Ellul, A., Jotikasthira, P., Lundblad, C., & Wang, Y. (2014). Is historical cost accounting a panacea. Market stress, incentive distortions and gains trading.(May 8, 2014).

Greenberg, M. D., Helland, E., Clancy, N., & Dertouzos, J. N. (2013). Fair Value Accounting, Historical Cost Accounting, and Systemic Risk. Rand Corporation.

Kigozi, J., Jowett, S., Lewis, M., Barton, P., & Coast, J. (2016). Estimating productivity costs using the friction cost approach in practice: a systematic review. The European Journal of Health Economics, 17(1), 31-44.

Mazhambe, Z. (2014). Review of International Accounting Standards Board (IASB) Proposed New Conceptual Framework: Discussion Paper (DP/2013/1). Journal of Modern Accounting and Auditing, 10(8).

Tan?Kantor, A., Abbott, M., & Jubb, C. (2017). Accounting Choice and Theory in Crisis: The Case of the Victorian Desalination Plant. Australian Accounting Review.

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