Introduction to Financial

Reporting

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Overview
ACCOUNTING CONSISTS OF
TWO ELEMENTS

MANAGEMENT
Recording Summarising
ACCOUNTS

FINANCIAL STATEMENTS

Statement of Statement of
Statement of Statement of
Changes in Financial Notes
Cash Flows Profit or Loss
Equity Position
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Financial Accounting & Management
Accounting
Financial accounting focuses on recording, classifying, and summarizing
individual transactions.
It produces annual financial statements for external stakeholders like investors
and finance providers.
These statements assess directors' management of shareholder funds.

They're prepared using accepted accounting conventions and standards like IAS
and IFRS.
They facilitate investment evaluation and comparison across companies.

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Financial Accounting & Management
Accounting
Financial statements of limited companies are public but lack details on
product profitability.

Management accounting provides detailed, up-to-date information for entity

control and planning.

It helps in costing products, assessing profitability, and presenting information

useful to management.

Management accounting aids in formulating strategy, planning, controlling

activities, decision making, and resource optimization.

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Users of Financial Statements
Investors
Customers
Suppliers
Lenders

USERS Government
Competitors
The Public
Employees
Management
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Users of Financial Statements
• Interested in profit, returns, and security of investment, assess
Investors and future profits from past performance, institutional investors like
potential investors: pension funds and unit trusts are key stakeholders.

Employees and trade • Need information on job security, possible pay rises, salaries and
union benefits of senior management, and divisional profitability to
assess potential threats.
representatives:
• Concerned about repayment, depend on entity's solvency as
Lenders: shown in the statement of financial position, long-term loans
may have assets as security.

• Use financial statements for economic planning, tax assessment,

Government and industrial policies.
agencies:
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Users of Financial Statements
• Interested in payment reliability and financial health before agreeing to
Suppliers: supply goods.

• Need assurance of continued supply in the future, especially for specialist

Customers: supplies.

• Assess entity's impact on economy, local environment, and community,

Public: including employment, support for local suppliers, and corporate
responsibility programs.

• Use financial statements for economic decision-making, management

Management and relies more on management accounting information, competitors use
publicly available information for decision-making related to their own
competitors: business activities.

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Types of Business Entity

Sole Trader:
Partnership:
Limited Liability Companies
Owned and operated by one
individual.
(LLC):
Owned by at least two partners.
No legal distinction between owner Collectively share profits and have Separate legal entity from owners
and business. (shareholders).
unlimited liability for losses.
Owner receives all profits but has Established through incorporation.
Each partner has a capital account
unlimited liability for losses. and a current account. Shareholders invest capital in return
Capital structure includes a capital for shareholding.
Capital account is fixed, while
account. current account reflects profit share Shareholders not personally liable
Capital can be added through and personal drawings. for company debts.
owner's investment or business Managed by a board of directors
profits, reduced by withdrawals or elected by shareholders.
losses.
Capital structure formalized,
dividends paid from accumulated
profits.

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Operating as a Sole Trader, Partnership or
Company
• Accounting recognizes business separately, but legally tied to owner's affairs.
• Unlimited liability: owner personally responsible for business debts.
• Typically small scale due to reliance on owner's resources.
Sole Trader • Advantages: flexibility, autonomy, easy capital management.

• Like sole trader, legally undistinguished from partners.

• Partners' personal assets may cover business debts.
• Called a firm.
• Advantages: more resources (capital, knowledge, skills), lower administrative expenses,
Partnership shared responsibilities, easy capital management.

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Comparison of companies to sole traders
and partnerships
Property Holding: A company's property belongs to the company itself, unaffected by changes in
ownership of shares. In partnerships, property directly belongs to partners, subject to changes if partners
leave.
Transferable Shares: Shares in a company can usually be transferred without other shareholders' consent,
unlike partnerships where new partners need unanimous consent.

Suing and Being Sued: A company can sue and be sued in its own name, with judgments not affecting
members personally, contrasting with partnerships where individuals are personally liable.

Security for Loans: Companies can secure loans with floating charges, leveraging fluctuating assets.
Partnerships and individuals generally can't secure loans this way.

Taxation: Companies are taxed separately from shareholders, while sole traders and partners are
personally liable for income tax on business profits.

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Disadvantages of incorporation
Incorporation requires formal registration and filing of
constitution documents with the company registry, incurring
registration fees and legal costs.

Annual financial statements must be produced and submitted

to the company registry, often requiring costly audits.

Sole traders and partnerships typically don't have these

registration and financial statement requirements.

A registered company's accounts and certain documents are

publicly accessible, unlike sole traders and partnerships.

Limited companies face strict rules regarding capital and

profit management.
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The Framework

The Conceptual Framework for Financial Reporting 2010 (Conceptual Framework)

is crucial for preparing financial statements.

It's prepared by the International Accounting Standards Board (IASB) and lays out
fundamental ideas, concepts, and principles for International Financial Reporting
Standards (IFRS) and financial statements.

Key areas covered in the Conceptual Framework include its purpose, financial
reporting objectives, qualitative characteristics of financial information, elements
definition and measurement, accruals, going concern concept, and capital
concepts.

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The Framework
The purpose of the Framework is to guide the IASB in developing financial reporting
standards and to help financial statement preparers in forming accounting policies.

It's also a reference document for understanding and interpreting reporting

standards.

Financial reporting aims to provide useful information to stakeholders for decision-

making regarding economic resources allocation and other financial matters.

Prudence is emphasized, involving cautious judgment under uncertain conditions to

prevent overstatement of assets/income and understatement of
liabilities/expenses.
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Qualitative characteristics
 Qualitative characteristics make financial information useful.
 Split into fundamental and enhancing qualities.

Fundamental
Enhancing qualities:
qualities:
• Relevance • Comparability
• Faithful representation • Verifiability
• Timeliness
• Understandability

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Fundamental qualitative characteristics
Relevance is crucial for financial information to influence economic decisions in a timely manner.

Materiality directly affects relevance by determining the impact of information on decisions.

Relevant information has predictive or confirmatory value.

Predictive value helps users assess past, present, or future events. Confirmatory value aids in
confirming or correcting past evaluations.

When choosing between options, prioritize the one that maximizes information relevance.

Threshold quality ensures information is significant enough to consider further.

Material information influences primary users' decisions based on financial statements. Materiality is
determined by the potential impact of omitting, misstating, or obscuring information.
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Faithful representation
• Information must represent transactions and events accurately, focusing on substance and
economic reality over legal form (substance over form principle).

Faithful representation Completeness: Including all necessary descriptions and

in financial information explanations, even if estimates are needed for precision.
requires:
Neutrality: Being free from bias, avoiding influencing
decisions or judgments to achieve specific outcomes.

Free from error: Ensuring information is accurate within

materiality bounds, avoiding misleading statements due to
errors or omissions.
Clarity on estimates: Clearly stating when estimates are
used, ensuring accuracy in describing them as estimates.

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Enhancing qualitative characteristics
• Consistency and disclosure ensure comparability.
Comparability: Users compare
• Users need to know accounting policies and any changes.
financial statements over time • Compliance with standards and disclosing policies aid comparability.
and between entities. • Information for preceding periods is crucial for comparison.

Verifiability: Verification can be • Direct verification includes counting cash.

direct (observing) or indirect • Indirect verification involves checking inputs and recalculating.
(recalculation).

Timeliness: Information must • Older information becomes less useful over time.
be available in time to
influence decisions.

Understandability: Depends on • Assumes users have basic business and economic knowledge.
presentation and user • Users should be willing to study the information.
capabilities. • Information must be perceivable in significance.

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The elements of the financial statements
Asset: A present economic resource controlled by the entity due to past
events (e.g., a building owned by a business).
Liability: A present obligation of the entity to transfer an economic
resource due to past events (e.g., unpaid taxes or a bank loan).
Equity: The residual interest in assets after deducting liabilities; what's
returned to owners when the business ends.
Income: Increases in assets or decreases in liabilities leading to equity
increases, such as sales revenue or asset value growth.
Expense: Decreases in assets or increases in liabilities leading to equity
decreases, like purchasing goods or asset devaluation.

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Categorisation of assets, liabilities and
equity in the financial statements
ASSETS

NON-CURRENT ASSETS CURRENT ASSETS

• Any tangible or intangible asset acquired

Assets expected to be:
on a long- term basis to be used in
• realised, sold or consumed within the
providing a service to the business.
normaloperating cycle, or
• Not held for resale in the normal course of
• realised within twelve months after the
trading.
reporting period, or
• Not expected to be realised within twelve
• or held primarily for trading
months after the reporting period.

e.g. Land and buildings, motor vehicles, plant and

machinery. e.g. Inventory, receivables, cash.

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Categorisation of assets, liabilities and
equity in the financial statements
LIABILITIES ARE CLAIMS ON THE
BUSINESS BY OUTSIDERS

NON-CURRENT ASSETS CURRENT ASSETS

Liabilities that are:

Liabilities that:
• Expected to be settled within the normal operating
• have not been classified as current, or cycle, or
• payment can be deferred unconditionally • Held primarily for trading, or
for more than twelve months after the • Is due to be settled within twelve months after the
reporting period. reporting period, or
• There is not an unconditional right to defer settlement
for at least twelve months after the reporting period.

e.g. Loan e.g. Payables, Bank Overdraft, Loan (Short-term).

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The components of a set of financial
statements
A financial Assets, liabilities, It helps identify
statement and equity are relevant
includes the classified information and
statement of consistently for understand
financial clear financial data
position. understanding. better.

This statement Consistent

summarizes presentation
assets, liabilities, aids users in
and equity at comparison and
the reporting analysis.
period's end.

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The components of a set of financial
statements
Statement of financial position at 30 June 20X7
$ $
Non-current assets
Land and buildings 60,000
Plant and equipment 27,500

Current assets
Inventories 11,000
Trade receivables 10,700
Cash at bank and in hand 1,500
23,200
Total Assets 110,700

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The components of a set of financial statements
Equity and liabilities
Equity share capital @ $1 shares 40,000
Share premium 2,000
Revaluation surplus 5,000
Retained earnings 43,650
Total equity at 30 June 20X7 90,650
Non-current liabilities
6% bank loan (20X9) 10,000
Current liabilities
Trade payables 5,000
Bank overdraft 4,150
Income tax liability 600
Interest accrual 300 10,050
110,700
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The components of a set of financial statements
Assets are divided into 'non-current' (used over years for
business) and 'current' (expected to convert into cash within 12
months).

Liabilities are classified as 'non-current' (settled after 12

months) and 'current' (settled within 12 months).

Capital structure in limited liability companies is detailed in

'Capital Structure and Finance Costs' chapter; for sole traders,
'Equity' is replaced by a simple capital account.

Statement of Profit or Loss: Summarizes revenues earned and

expenses incurred during the reporting period, formerly known
as a 'profit and loss account.'
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The components of a set of financial statements
Statement of profit or loss and other comprehensive income for the year ended 30 June 20X7
$
Sales revenue 120,000
Cost of sales 72500
Gross profit 47,500
Distribution costs (10,700)
Administrative and selling expenses 15650
Operating profit 21,150
Finance costs 600
Profit before tax 20,550
Income tax 600
Profit for the year 19,950
Other comprehensive income:
Revaluation surplus in the year 2000
Total comprehensive income for the year 21,950

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The components of a set of financial statements
The statement of Summarizes changes in equity balances
changes in equity
Covers share capital, share premium,
revaluation surplus, and retained earnings

Relevant for limited liability companies only

Not necessary for sole traders or partnerships

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The components of a set of financial statements
Statement of changes in equity for the year ended 30 June 20X7
Equity share Share Revaluation Retained Total
Capital $ Premium $ surplus $ earnings $ $

Balance at 1 July 20X6 34,000 1,100 3,000 25,200 63,300

Profit for the year 19,950 19,950

Dividend paid in the year (1,500) (1,500)

Revaluation in the year 2,000 2,000

Issue of share capital 6,000 900 6,900

Balance at 30 June 20X7 40,000 2,000 5,000 43,650 90,650

Notes to Financial Statements:

• Includes statement of accounting policies.
• Provides disclosures for informed judgements by shareholders and users.
• More detailed for limited liability companies compared to sole traders/partnerships.
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Important Accounting Principles and Concepts
There are a number of other accounting principles and concepts that underpin the
preparation of financial statements. The most significant ones include:
1. Materiality and aggregation
• Materiality: Omission or misstatement of an item that can change user perception.
• Subjective Assessment: Made by those preparing financial statements, like
company directors.
• Reliability for Decision Making: Ensures financial statements are reliable for users,
especially shareholders.
• Example: A $1 misstatement in a large entity may not be material, but $100,000
could be significant.
• Aggregation: Similar items can be combined to present summarized information.
• Example: Total due from trade receivables disclosed instead of specific amounts
from each customer.
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Important Accounting Principles and Concepts
2. Substance over form

• Present information faithfully by considering economic reality, not

just legal form.

• Example: redeemable preference shares are legally shares but

treated as debt due to obligation to repay shareholders.

• Accounting reflects substance over form in such cases.

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Important Accounting Principles and Concepts
3. Going concern

Financial Going concern

statements assume means no need or
the entity will intention to liquidate
continue operating. or curtail operations.

Expectation: No guarantee;
business will operate business failures and
for the next 12 insolvencies can
months. occur.

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Important Accounting Principles and Concepts
4. The business entity

Financial accounting information in statements pertains only to

business activities, not owner activities.

Business is treated separately from its owners in accounting.

Clear distinction maintained between business and owner finances.

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Important Accounting Principles and Concepts
5. Accruals basis
Accruals basis accounting records transactions when
revenues are earned and expenses are incurred.

Timing of cash payments or receipts is not considered.

For example, a sale is recorded when the contractual duty to

supply goods is fulfilled, not when payment is received.
The financial statement reflects the sale even if payment is
received later.

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Important Accounting Principles and Concepts
6. Prudence
Preparers should use prudence in financial statements.

Avoid overstating assets and income.

Avoid understating liabilities and expenses.

Prevent deliberate misstatement for unbiased statements.

Prudence ensures fairness and reliability for users.

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Important Accounting Principles and Concepts
7. Consistency
Accounting consistency is essential within and between
accounting periods.

IFRS Standards ensure uniform treatment across entities

for comparable items.

Users rely on consistent financial statement presentation

for meaningful comparisons.

Retaining presentation and classification aids

comparability over time and across entities.

Changes are warranted only due to altered circumstances

or new IFRS requirements.
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Important Accounting Principles and Concepts
8. Consistency
1
• Accounting consistency is essential within and between accounting periods.

2
• IFRS Standards ensure uniform treatment across entities for comparable items.

• Users rely on consistent financial statement presentation for meaningful

3 comparisons.
• Retaining presentation and classification aids comparability over time and across
4 entities.
• Retaining presentation and classification aids comparability over time and across
5 entities.
• Changes are warranted only due to altered circumstances or new IFRS requirements.
6

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Important Accounting Principles and Concepts
9. Offsetting
• Offsetting refers to netting-off transactions and balances to show only the net
1 effect.

2 • This practice reduces the available financial information for users.

3 • Generally not allowed, except for limited exceptions.

• Financial statements should show the gross or full effect of transactions and
4 balances.

• Example: Cash in the bank and a bank loan are presented separately, not as a
5 net balance.

• Similarly, receivables and payables from credit transactions are shown

6 separately, not as a net amount.
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Important Accounting Principles and Concepts
10. Duality (dual aspect)
Duality in accounting means every transaction has two effects.

This principle forms the basis of double-entry bookkeeping.

Transactions are recorded twice: once for each effect.

Example: Buying a laptop with a business debit card.

Effects: New asset (laptop) and reduced bank balance.

Both effects are recorded in accounting records.

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Important Accounting Principles and Concepts
11. Historical cost and current value

Similarly, the
It doesn't reflect For instance, a
Historical cost is historical cost of
the current factory bought
the original equipment may
value, which can 30 years ago at
value of a be higher than
be influenced by $100,000 may
transaction at its current value
inflation and now be worth
the time it due to wear,
other economic much more due
occurred. changes in
factors. to inflation.
technology, etc.

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THANK YOU

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