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Financial Reporting and its Regulatory Framework
Financial Statements have been developed and published by both ASB and IASB to provide information about the performance and changes in financial position of an organization which is required for economic decisions by a wide range of people.
Decisions are made by different stakeholders of a business. Each stakeholder has its own particular need for making a decision based on the financial statement’s representation. The main objective for financial statements is to make the stakeholders understand about the financial position of the business before any decisions to be undertaken. There are two types of stakeholders related to a business:
- Internal Stakeholders
- External Stakeholders
INTERNAL Stakeholders consists on the company’s Senior Management such as Directors, CEO, Owners and Shareholders. Besides senior management, there are Management level employees such as Managers and Executive Managers and lastly the Functional level employees such as Workers. Each level of employee has its individual point of interest on the financial statements. Shareholders of a company seek for efficiency and effective operations in the organization. Their point of interests is on profits, assets and equity. They use the Financial Statements to identify the risks of their investment in the company to make investment decisions based on their analysis and also the return they are receiving from previous investments. Managers of a company assess financial statements to manage daily affaires and operations in the organization. They seek for company profits and expenses to ensure a consistent and effective operation so that the business can utilize its resources effectively. This analysis helps them to understand the effectiveness of their previous decisions and these will ultimately influence future decisions. Functional level employees of an organization have their point of interest on the financial statement for their job security and future remuneration. Before their own satisfaction, the employees seek information about the entity’s ability to pay their salaries and wages and provide incentive compensation and retirement and other benefits.
EXTERNAL Stakeholders consists of suppliers, customers, equity investors, potential investors, tax authorities, public, Government agencies, competitors, public etc. Suppliers need to assess the credit worthiness of the organization to make sure if it is safe to supply the goods on credit. They need to know the organizations ability to pay the credits by analyzing the organization’s financial statement. They are interested in the company’s liquidity. Liquidity is critical for the survival of a business. A business that is not liquid may be forced into bankruptcy by its creditors. Once bankrupt, a business may be forced by the courts to stop its operations, sell its assets and end its existence. Customers need to ensure that organization have the resources to maintain a steady supply the goods especially when they have a long-term involvement with the company in the future. They need the financial statements of the company to ensure that the company is a secure source of supply. Equity investors require the company’s financial statements to ensure that the company is capable of interest payments and repayment of borrowings as the business is their source of cash inflow. Through the company’s financial statements, they compute the possible current financial health of the company to calculate the possibility of a bad loan. They are mainly interested in the company’s ability of generating more favorable cash flows as they take particular decisions on the amounts, timing, and uncertainties of future cash flows. Potential investors seek financial statements to investigate whether or not to invest in the company. They foresee future dividends on the basis of Profits which are shown in the statements. For example if the previous statements shows high fluctuations in the profits, therefore it is notified as too risky to invest. This is how potential investors foresee the future financial health of the company and takes decisions based on those financial statements. Tax authorities and the Government seek financial statements to fix upon the accuracy of tax declared in the tax returns, tax policies and maintaining standard national income and other similar statistics. They assess the financial statements to evaluate the business and the various ways the company is responsible for effective allocation of economic resources. Competitors evaluate the financial statements to evaluate performance level between them in the market and to design new strategies to increase the competitiveness between them. Financial advisors evaluate the company’s financial statements to gather information about the company’s financial health, liabilities, assets etc. Based on that information, the advisors guides or assists the company to take decisions such as making more investments, buying new shares, loans etc.
Company legislation is the law under which the company’s formation, registration or incorporation, governance, and dissolution administered or controlled. The memorandum of association is a document that contains the basic rules for the formation and activities of a company. It is the basic document that sets out how the company is going to be and what work will be done. The purpose of the memorandum is to allow members of the company, its creditors, and the public to know what their powers are and what the scope of their activities. The memorandum contains rules relating to the capital structure, the liabilities of the members, the objectives of the company, and any other important issue related to the company. The memorandum is altered only after certain formalities are observed. It shows the range of the company. It enables shareholders, creditors and outside to show the permitted activities of the company. According to the UK Company Act 2006 (Part 2: Company Formation), a company must by formed by one or more individuals and dues their names into a memorandum of association and comply with the rules and regulations of the act to register. The act also states that a company cannot be formed for any unlawful purpose. The memorandum of association states that the company must form under this act and the individuals must agree to be members of the company so that in case of the company that is to have share capital, must take at least one shares each. The application of registration document must contain the company’s name, indication of company’s registered office is situated weather in England or Wales, whether the proposed company to be public or private and lastly whether member’s liability is to be limited by shares or guarantee. In Statement of capital and initial shareholdings must contain information about number of shares of the company to be taken on formation by the subscribers to the memorandum of association and the gross nominal value of the shares. Statement of guarantee contains such information as may be prescribed for the purpose of identifying the subscribers to the memorandum of association. The document must contain a statement where it states that the prescribed member or subscriber have to contribute to the liabilities of the company if the company winds up in his presence. Contribution of liabilities may include bad debts and liabilities, payments of the costs, expenses of winding up, etc.
The article of association is the rules and statutes framed for the purpose of internal management of its affairs. It is the rights of the member of the company together. The articles are aimed at the attainment of the objectives and purpose of the Memorandum. The articles of association of a company are subordinate to and are controlled by the memorandum of association. Public limited companies are not bound to register their article of association; but Private limited companies are bound or obliged to register their article of association along with the memorandum. If a company is limited by company, the number of members with whom the company is to be registered must be stated in the article. For any company, an article of association must contain some few matters. They are: number and value of shares, share allotment, alteration of capital, interpretation and definition, transfer of shares, directors and their power and duties, meeting notices, preceding of director, accounts, audit, dividends, common seal, reserves, recruitments for vacancies, secrecy, etc.
As per the Companies Act 1994 (Bangladesh), there are three types of company. They are: 1) Company limited by shares; 2) Company limited by guarantee; and 3) Company with unlimited liability.
These three different types of companies do not conduct their business in same manner. Each follows their own company constitution in legal issues. The constitution of the company is contained two documents- the memorandum of association and the articles of association. Any seven or more person or, where the company to be formed will be a private company, any two or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of association and otherwise complying with the requirements of this Act in respect of registration form an incorporated company, with or without limited liability, that is to say, either-
- a company limited by shares that is to say, a company having the liability of its member limited by the memorandum to the amount, unpaid on the shares respectively held by them; or
- a company limited by guarantee, that is to say , a company having the liability of its members limited by the memorandum to such amount as the members may respectively thereby undertake to contribute to the assets of the company in the event of its being wound up; or
- An unlimited company, that is to say, a company having no limit on the liability of its members.
The memorandum of a company, which is limited by shares, should include the name of the company including the word LIMITED at the end of it, address of office, liability is limited for the members, proposed share capital to be registered and dividends. Other than this, the memorandum should include that at least one share is owned by each member and each member’s number of share should be stated opposite to his/her name. Memorandum of a company which is limited by guarantee should state the name of the company including the word LIMITED at the end of it, address of office and that the liability is limited for the members. Other than these, it should also state that that the prescribed member or subscriber must have to contribute to the liabilities of the company if the company wounds up during his/her presence in the company. Contribution of liabilities may include bad debts and liabilities, payments of the costs, expenses of winding up, etc. If the company is to acquire share capital, then the memorandum should include the number of proposed share capital and the division thereof into shares of a fixed amount. Each member of the memorandum must acquire at least one share and each member’s number of share should be stated opposite to his/her name. When the company is to be registered as unlimited company, then its memorandum must also include the name of the company and the address of their registered office. If the company is to issue share capital, members of memorandum must acquire at least one share each and the number of shares should be stated opposite to his/her name in the memorandum.
Article of Association of company is a subordinate of and controlled by Memorandum of Association. It is a document that consists of rules, regulations and by-laws regarding the internal management of the company. An article should not violate any provision of the memorandum and the relationship between articles and memorandum. The Articles are the subordinate of Memorandum; the memorandum must be read in conjunction with the Articles; the terms of the Memorandum cannot be modified or controlled by the Articles. Every type of company must fill articles of association at the time of registration. The articles must be signed by the members of the memorandum of association and needs to be registered together with the memorandum. A private company’s article should contain information such as number of members is limited to 50, transfer of share is restricted and the restriction for inviting public to purchase shares and debentures. The article of a company which is limited by guarantee should include information about the number of member to be registered in the company and the article of an unlimited company should include information about number of members to be registered and amount of share capital if the company has a share capital. The article should include some basic information such as accounts, dividends, Directors, general meetings, borrowing powers, share certificate, arbitration, audits, operation of banks, etc.
The financial statements prepared by the company are read by Government people to even local public. All financial statements should be prepared following a basic standard so that everyone can easily understand. According to the UK Company Act 2006,
Most accounting standards are developed based on four assumptions. They are: Monetary assumption, Time period assumption, Economic entity and Going concern. The value of a company cannot be determined only by considering its assets. There are many companies in the world where the work force is much more valuable than its assets. It found that such companies generate huge amount of profit despite of its very less fixed assets; i.e. for example a company has total fixed assets valued at only TK 5, 00, 000, but the company is generating profits of TK 4, 00, 000 annually. These assumptions derived from the application of judgment in putting personal assumptions into practice. It can be found that many companies have been following similar personal assumptions for years but never came to a mutual conclusion. These manipulations in accounting standards were commenced in order to present the accounts in the most favorable light.
Accounting standards are authentic standards for financial reporting. They are generally adopted by GAAP (Generally Accepted Accounting Principle). They show how events are presented, measured, recognized and disclosed in a financial statement. They provide information about the financial positions of the company to various stakeholders of the company so that the stakeholders can use the information to make useful decisions. The accounting standards were developed in such a way that any company could easily adopt the requirements while preparing the financial standards. The standards were developed decades ago to create such accounting standards that can be easily adopted by any developing nation. As global businesses began to grow, large companies realized the necessity of having common standards in all areas of the financial reporting chain. In 2007 a survey revealed that many accounting leaders all over the world believes that for worldwide economic growth, a single set of international standard should be used. At this time more than 120 countries all over the world follows IFRS standards to prepare financial statements. The European Union (EU) countries such as UK, Italy, France, etc. adopted International Financial Reporting Standards as their national accounting standard for preparing financial statements. Other countries such as USA and Bangladesh use GAAP (Generally Accepted Accounting Principal) accounting standard to prepare financial statements. Though GAAP is an International Standard for Bangladesh, but it is being used in Bangladesh for over decades. Hence GAAP being an international standard for Bangladesh is ultimately considered as National Standard. All business entities require accounting standards whether they are limited or not. Through financial statements, a company is able to represent true and fair value of their performance, and to make sure that the statements represent true and fair value, accounting standards are required. Public limited companies are bound to publish their financial statements for the general public but private companies are not. The public limited companies are bound to follow the accounting standards for fair representation of the company’s performance but as private companies do not publish financial statements, they are not bound to comply with accounting standards. However private limited companies should practice to comply with accounting standards as fair representation of financial statements are important for its users.
International Accounting Standard (IAS) & International Financial Reporting Standards (IFRS) were developed and published by International Accounting Standards Committee (IASC) & International Accounting Standards Board (IASB) respectively. IASC was established in 1973 and later in 2001 it was restructured to become the International Accounting Standards Board (IASB). During the time when IASB was being established back in 2001, the board adopted all IAS standards and finally it was named IFRS.