CHAPTER 3

FINANCIAL REPORTING STANDARDS

Presenter’s name
Presenter’s title
dd Month yyyy
 OBJECTIVE OF FINANCIAL REPORTING

• Objective of general purpose financial reporting

- To provide financial information about the reporting entity that is
useful to existing and potential investors, lenders, and other
creditors in making decisions about providing resources to the
entity. Those decisions involve buying, selling, or holding equity and
debt instruments and providing or settling loans and other forms of
credit.
• Investors
- Buy, sell, or hold
• Lenders and other creditors
- Lend or not
- Amount and terms

Copyright © 2013 CFA Institute 2

 FINANCIAL REPORTING USE IN SECURITY
ANALYSIS AND VALUATION
• Decisions by investors to buy, sell, or hold securities depends on
expectations about returns (dividend yield and price appreciation).
• Expectations about returns depend on prospects for an entity’s future
cash flows, and assessing those prospects requires information about
an entity’s
- resources,
- claims on resources, and
- use of the resources by management and board.
• Financial reports are not designed to show the value of a reporting
entity; they provide information to help users estimate the value of the
reporting entity.
• Financial reports do not and cannot provide all the information needed
by investors and creditors. Other pertinent information must be
obtained from other sources.

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 IMPORTANCE OF FINANCIAL REPORTING STANDARDS
IN SECURITY ANALYSIS AND VALUATION

• Complexity involved in setting standards reflects the complexity of the

underlying economic reality.
• Complexity and uncertainty create the need for judgment by preparers.
• Judgment can vary among preparers, so standards are needed to
achieve consistency.
• Even though standards limit the range of acceptable approaches,
preparers still must make judgments and use estimates.
• By understanding how and when standards require judgments and
estimates that can affect reported numbers, an analyst can make
better use of the information.

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 STANDARD-SETTING BODIES AND
REGULATORY AUTHORITIES

• Generally,
- Standard-setting bodies set the standards and
- Regulatory authorities recognize and enforce the
standards.
• However, regulators often retain the legal authority to
establish financial reporting standards in their jurisdictions
and can overrule private sector standard-setting bodies.

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 EXAMPLES OF STANDARD-SETTING BODIES

• The International Accounting Standards Board (IASB) sets

IFRS (International Financial Reporting Standards).
• The U.S. Financial Accounting Standards Board (FASB)
sets U.S. GAAP (generally accepted accounting
principles).

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 EXAMPLES OF REGULATORY AUTHORITIES

Country Regulatory authority with primary responsibility for

securities regulation in the country
Australia Australian Securities and Investments Commission
Belgium Financial Services and Markets Authority
Brazil Comissão de Valores Mobiliários
China China Securities Regulatory Commission
France Autorité des marchés financiers
Germany Bundesanstalt für Finanzdienstleistungsaufsicht
India Securities and Exchange Board of India
Japan Financial Services Agency
Morocco Conseil déontologique des valeurs mobilières
Nigeria Securities and Exchange Commission Nigeria

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 EXAMPLES OF REGULATORY AUTHORITIES
(CONTINUED)

Country Regulatory authority with primary responsibility for

securities regulation in the country
Portugal Comissão do Mercado de Valores Mobiliários
Spain Comisión Nacional del Mercado de Valores
South Africa Financial Services Board
Turkey Capital Markets Board of Turkey
United Kingdom Financial Services Authority*
United States Securities and Exchange Commission (SEC)
Uruguay Banco Central del Uruguay

*FSA to be succeeded by the Financial Conduct Authority and the Prudential

Regulation Authority in 2013.

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 INTERNATIONAL ORGANIZATION OF
SECURITIES COMMISSIONS (IOSCO)
• Not a regulatory authority, but an international association of
securities regulators formed in 1983
• Objectives of IOSCO members:
- Develop international standards of market regulation to protect
investors and address systemic risks.
- Exchange information and cooperate in enforcement to enhance
investor protection and promote investor confidence.
- Exchange information to assist in development of markets,
infrastructure, and regulation.

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 IFRS USE AROUND THE WORLD
Country Status for Listed Companies as of December 2011
Argentina Required for fiscal years beginning on or after 1 January 2012
Required for all private sector reporting entities and as the
Australia
basis for public sector reporting since 2005
Required for consolidated financial statements of banks and
Brazil listed companies from 31 December 2010 and for individual
company accounts progressively since January 2008
Required from 1 January 2011 for all listed entities and
Canada permitted for private sector entities including not-for-profit
organizations
China Substantially converged national standards
All member states of the EU are required to use IFRS as
European Union
adopted by the EU for listed companies since 2005
India India is converging with IFRS at a date to be confirmed
Convergence process ongoing; a decision about a target date
Indonesia
for full compliance with IFRS is expected to be made in 2012

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 IFRS USE AROUND THE WORLD
Country Status for Listed Companies as of December 2011
Permitted from 2010 for a number of international companies;
Japan decision about mandatory adoption by 2016 expected around
2012
Mexico Required from 2012
Republic of
Required from 2011
Korea
Russia Required from 2012
Required for banking and insurance companies. Full
Saudi Arabia
convergence with IFRS currently under consideration.
South Africa Required for listed entities since 2005
Turkey Required for listed entities since 2005
Allowed for foreign issuers in the U.S. since 2007; target date
United States for substantial convergence with IFRS was 2011 and decision
about possible adoption for U.S. companies expected.

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 CONTINUING DEVELOPMENTS IN FINANCIAL
REPORTING STANDARDS
• As illustrated on the preceding slides, although many countries have
adopted IFRS, not all countries have done so.
• Financial reporting standards (both IFRS and home-country GAAP)
continue to evolve for various reasons, including
- Changes in economic activity (new types of products and
transactions),
- Improvements to existing standards, and
- Convergence between international and home-country standards.
• An analyst needs to understand whether and how differences in
financial reporting standards affect comparability in cross-sectional
analysis.

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 GLOBAL CONVERGENCE OF ACCOUNTING
STANDARDS: DIFFERENCES REMAIN
• Different reporting systems are used in different countries.
• For example, despite convergence efforts, differences remain between
U.S. GAAP and IFRS.
Inventory
• IFRS does not allow for the use of the LIFO (last in, first out) costing
methodology for inventory, which is permitted under U.S. GAAP.
• In the United States, the Internal Revenue Service (IRS) has
conformity provisions such that certain methods of accounting are
allowed for income tax purposes only if the entity also uses that
method for financial reporting purposes. LIFO is one such method
subject to conformity provisions.
• Thus, without a change in IRS rules, eliminating LIFO from U.S. GAAP
would, in effect, eliminate its use for tax purposes as well.

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 IFRS CONCEPTUAL FRAMEWORK

Reporting Elements

Qualitative Characteristics

Objective
To Provide Financial Information
Useful in Making Decisions about
Providing Resources to the Entity

 Relevance*  Comparability, Verifiability,

 Faithful Representation Timeliness,
Understandability

 Performance  Financial Position

o Income o Assets
o Expenses o Liabilities
o Capital Maintenance Adjustments o Equity
o Past Cash Flows

o Reporting
Constraint Ele
 Cost (cost/benefit considerations)

Underlying Assumption
 Accrual Basis
 Going Concern

*Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
OBJECTIVE OF FINANCIAL REPORTING
• At the core of the Conceptual Reporting Elements
Framework is the objective to
provide financial information that Qualitative Characteristics
is useful to current and potential
Objective
providers of resources in making To Provide Financial Information

decisions.
Useful in Making Decisions about
Providing Resources to the Entity

• All other aspects of the  Relevance*

 Faithful Representation
 Comparability, Verifiability,
Timeliness,
Understandability

framework flow from that central  Performance

o Income
 Financial Position
o Assets

objective. o
o
o
Expenses
Capital Maintenance Adjustments
Past Cash Flows
o
o
Liabilities
Equity

o Reporting
Constraint Ele
 Cost (cost/benefit considerations)

Underlying Assumption
 Accrual Basis
 Going Concern

*Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
FUNDAMENTAL QUALITATIVE CHARACTERISTICS

• Two fundamental qualitative Reporting Elements

characteristics that make
financial information useful: Qualitative Characteristics
- Relevance: Information that
Objective
could potentially make a To Provide Financial Information

difference in users’ decisions.

Useful in Making Decisions about
Providing Resources to the Entity

- Faithful Representation:  Relevance*  Comparability, Verifiability,

Information that faithfully

 Faithful Representation Timeliness,
Understandability

 Performance  Financial Position

represents an economic o
o
o
Income
Expenses
Capital Maintenance Adjustments
o
o
o
Assets
Liabilities
Equity

phenomenon that it purports o Past Cash Flows

to represent. It is ideally o Reporting

Constraint Ele
- complete,  Cost (cost/benefit considerations)

- neutral, and Underlying Assumption

 Accrual Basis
- free from error.  Going Concern

*Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
ENHANCING QUALITATIVE CHARACTERISTICS
• Four enhancing qualitative
Reporting Elements
characteristics that make financial
information useful:
Qualitative Characteristics
- Comparability: Companies record
Objective
and report information in a similar To Provide Financial Information
Useful in Making Decisions about

manner. Providing Resources to the Entity

- Verifiability: Independent people  Relevance*

 Faithful Representation
 Comparability, Verifiability,
Timeliness,
Understandability

using the same methods arrive at  Performance

o Income
 Financial Position
o Assets
o Expenses o Liabilities

similar conclusions. o
o
Capital Maintenance Adjustments
Past Cash Flows
o Equity

- Timeliness: Information is available o Reporting

Constraint Ele
 Cost (cost/benefit considerations)
before it loses its relevance.
Underlying Assumption
- Understandability: Reasonably  Accrual Basis
 Going Concern
informed users should be able to
comprehend the information. *Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
REPORTING ELEMENTS
• Elements directly related to the
Reporting Elements
measurement of financial position:
- Assets: Resources controlled by Qualitative Characteristics
the enterprise as a result of past
Objective
events and from which future To Provide Financial Information
economic benefits are expected to Useful in Making Decisions about
Providing Resources to the Entity

flow to the enterprise.

 Relevance*  Comparability, Verifiability,

- Liabilities: Present obligations of  Faithful Representation Timeliness,

Understandability

 Performance  Financial Position

an enterprise arising from past o
o
Income
Expenses
o
o
Assets
Liabilities

events, the settlement of which is o

o
Capital Maintenance Adjustments
Past Cash Flows
o Equity

expected to result in an outflow of

resources embodying economic o Reporting
Constraint Ele
 Cost (cost/benefit considerations)
benefits.
Underlying Assumption
- Equity: Residual interest in the  Accrual Basis
 Going Concern
assets after subtracting the
liabilities. *Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
REPORTING ELEMENTS
• Elements directly related to the
Reporting Elements
measurement of performance:
- Income: Increases in economic Qualitative Characteristics
benefits in the form of inflows or
Objective
enhancements of assets or To Provide Financial Information
decreases of liabilities that result Useful in Making Decisions about
Providing Resources to the Entity

in an increase in equity (other than

increases resulting from  Relevance*
 Faithful Representation
 Comparability, Verifiability,
Timeliness,
Understandability

contributions by owners).  Performance

o Income
 Financial Position
o Assets
o Expenses o Liabilities

- Expenses: Decreases in economic o

o
Capital Maintenance Adjustments
Past Cash Flows
o Equity

benefits in the form of outflows or

depletions of assets or increases o Reporting
Constraint Ele
 Cost (cost/benefit considerations)
in liabilities that result in decreases
in equity (other than decreases Underlying Assumption
 Accrual Basis
because of distributions to  Going Concern

owners). *Materiality is an aspect of relevance.

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 IFRS CONCEPTUAL FRAMEWORK:
CONSTRAINTS AND ASSUMPTIONS
• Constraint: The benefits of Reporting Elements
information should exceed the
costs of providing it. Qualitative Characteristics
• Underlying Assumptions: Objective

- Accrual Basis: Financial To Provide Financial Information

Useful in Making Decisions about
Providing Resources to the Entity

statements should reflect

 Relevance* 
transactions in the period when
Comparability, Verifiability,
 Faithful Representation Timeliness,
Understandability

they actually occur, not  Performance

o
o
Income
Expenses
 Financial Position
o
o
Assets
Liabilities

necessarily when cash o

o
Capital Maintenance Adjustments
Past Cash Flows
o Equity

movements occur.
o Reporting
Constraint Ele
- Going Concern: Assumption  Cost (cost/benefit considerations)

that the company will continue Underlying Assumption

 Accrual Basis
in business for the foreseeable  Going Concern
future. *Materiality is an aspect of relevance.

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 FINANCIAL STATEMENTS

A complete set of financial statements includes

• Statement of financial position
• Statement of comprehensive income
• Statement of changes in equity
• Statement of cash flows
• Notes

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 GENERAL FEATURES OF FINANCIAL
STATEMENTS

• Fair presentation
• Going concern
• Accrual basis
• Materiality and aggregation
• No offsetting
• Frequency of reporting
• Comparative information
• Consistency

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 STRUCTURE AND CONTENT REQUIREMENTS
FOR FINANCIAL STATEMENTS (IAS NO. 1)
• Classified statement of financial position: Balance sheet required to
distinguish between current and noncurrent assets and between
current and noncurrent liabilities unless a presentation based on
liquidity provides more relevant and reliable information (e.g., in the
case of a bank or similar financial institution).
• Minimum information on the face of the financial statements: Minimum
line item disclosures on the face of, or in the notes to, the financial
statements are specified.
• Minimum information in the notes (or on the face of financial
statements): Disclosures about information to be presented in the
financial statements are specified.
• Comparative information: For all amounts reported in a financial
statement, comparative information for the previous period is required.

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 COHERENT FINANCIAL REPORTING
FRAMEWORK

Characteristics of a coherent Barriers to creating such a

financial reporting framework
framework • Valuation: alternative
• Transparent measurement approaches
• Standard-Setting
• Comprehensive
Approach: balance
• Consistent between principles and
rules.
• Measurement: alternative
emphasis on balance
sheet versus income
statement.

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 DISCLOSURES OF SIGNIFICANT ACCOUNTING
POLICIES
• Companies are required to disclose their accounting
policies and estimates in the notes to the financial
statements.
• Companies also discuss in the management commentary
(MD&A) those policies that management deems most
important.
• Many of the policies are discussed in both the
management commentary and the notes to the financial
statement.
• Companies also disclose information about changes.

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 SUMMARY

• Objective of financial reporting is to provide financial information about the

reporting entity that is useful to existing and potential investors, lenders,
and other creditors in making decisions about providing resources to the
entity.
• Fundamental qualitative characteristics that make financial information
useful include
− Relevance and
− Faithful representation (complete, neutral, free from error)
• Enhancing qualitative characteristics that make financial information useful
include Comparability, Verifiability, Timeliness, and Understandability
• Constraint: benefits of info should exceed costs
• Underlying Assumptions
− Accrual accounting
− Going concern

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