Objectives and Principles of the Financial Statement Presentation


1. Introduction

The International Accounting Standards Board (IASB) together with Financial Accounting Standards Board (FASB) jointly produced a discussion paper with the intention of overcoming problems with today's Financial Presentation. The proposed formats in the form of a discussion paper have numerous implications for managers, financial analysts and investors. Currently, there is an ongoing debate in respond to the issues presented in the discussion papers. (IASB 2008)

2. Objectives and Principles of Financial Statement Presentation

2.1 Objectives of the Financial Statement Presentation

The IASB together with FASB proposed three objectives which should be maintained including a) different items within an entity should complement each other; b) disaggregates information enabling users in assessing the timing, amount and uncertainty of future cash flows; c) enable to asses entity's liquidity position to overcome financial commitment as they become due. (IASCF, 2008).

The proposed Financial Statements suggested non-mandatory changes in the titles to reflect their functions more clearly. Presentation of all owner changes in equity excluding non-owner changes. All non owner changes are one statement of comprehensive income or in two separate statements, i.e. a separate income statement and a statement of comprehensive income. However, the preference is on presentation of one statement. (IASB, 2008)

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2.2 Separation of business activities from financing activities

As suggested with respect to the separate classification scheme there are difficulties in distinguishing financing activities from operating activities and a clear guidance to be developed for the applications of these classifications. Furthermore lack of definitions and distinctions between operating and investing categories in the business sector is unclear - (Accounting Standard Board Canada (referred as AcSB, 2008)).

Arnold et al (2009) suggested with respect to IASB's objectives with respect to the cohesive financial picture which implies that the relationship is "clear" to be substituted with "consistent" as former implies a connotation of reconciliation of each line across each financial statement. (Financial Executive International, 2009, pp.3).

2.3 Equity

Since users are often equity holders, separation of owner from non-owner's finance is important and should be presented separate from the financing since it meets the objectives of the project - AcSB (2008).

Financial Executive International, (2009) commented like other opinions agrees that equity as a source of capital reacts differently to market forces, and is utilized differently unlike liability financing.

2.4 Discontinued Operations

The AcSB (2008) agrees that it's important for the discontinued operations to be split into financing operating, financing and investing categories. This would provide users with more detailed information either on the notes or face of the statements. Also, Financial Executive International, (2009)are in agreement with AcSB stating that this will allow users to understand the entity's operations of the continuing business were in the past such that they assess the potential operation in the future.

In consistent with IFRS 5 information from discontinued operations is disclosed separately for decision-useful information in predicting future cash flows as illustrated by Porter (2008). However, if this discontinued operation were to be aggregated into other sections resulting in too lengthy sections diminishing the usefulness of this information. (Australian Accounting Standard Board, 2009).

2.5 Management Approach

Hutchinson et al (2009) believes that management approach to the classification of items would simplifier users in absorbing their business much easily. These principles will assist management to communicate meaningfully; however, the extent of the rules set out in the discussion paper limits the usefulness of this approach as the model might be too rigid. (The Institute of Chartered Accountants of Scotland).

2.6 Statement of Financial Position

With respect to Statement of Financial Position, as Arnold et al (2009) emphasis on larger issue to more of balance sheet focus on financial reporting. It was obvious that "Balance Sheet is the king", i.e. activities in the statement of operations result not from earning activities but from the balance sheet activities. This results in a big gap as to the way how companies actually run their business. (Financial Executive International, 2009).

2.7 More than one reportable segment

As to the issue by IASB to mandate assets and liabilities by reportable segment Arnold et al (2009) elaborated that it may not be realistic to achieve and will object to such an approach. If further elaborations are needed of the balance sheet, would include a concept that such segment classification should be consistent with how companies manage its business. (Financial Executive International, 2009).

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2.8 Segment disclosure requirements

Some of the concepts proposed by IASB indicate that this might not carry forward and that disclosure by segment might not be considered even if management does not use these measures to run the business. (IASB, 2008). However, Arnold et al (2009) emphasis that this would not be useful to the investors as this is not how the assets and liabilities are used to generate returns. (Financial Executive International, 2009).

2.9 Financing section, financing assets and liabilities categories

Arnold et al (2009) further illustrated that even though the proposed presentation is appropriate, in the absence of classified balance sheet items such as assets, liabilities and equity would make it difficult for analysts to calculate key ratios, such as working capital, debt or leverages.

3. Implications of the objectives for Financial Statement

3.1 Classified statement of financial position

IASB proposed that a classified statement of financial position except when a presentation of assets and liabilities in order of liquidity provides information that is more relevant. However, this classification allows most companies to present a classified statement of financial position which will closely align to the current presentation. Companies should be allowed a choice of presentation based on the relevance of presenting the financial position in order of liquidity. (Financial Executive International, 2009 pp.8).

3.2 Cash equivalents

AcSB (2008) supports the proposal that present the cash equivalent as other short term investments and not as part of cash.

3.3 Comprehensive income

According to AcSB (2008) which agrees on the proposal to present the comprehensive and its components in a single statement of comprehensive income since it would enable the users to analyse the information easily as it will be shown in one location. However, not addressing these issues, originally an important part of the scope of the project, is a lost opportunity, one which the IASB should reconsider.

AcSB (2008) response to the concern of whether to maintain the separate presentation of some items was not in favor to IASB. It was against the issue of recycling, an issue which might have a relation on the user's understanding of fair value accounting. They also argue the concern over the cost of preparing a direct cash flow statement as to the incremental benefits was not fully communicated.

However, British Bankers' Association complimented that comprehensive income and net income should continue to be disclosed separately else would lead to confusion to the users. (British Bankers' Association, 2009).

3.4 Income taxes

The AASB together with other professional bodies are in full agreement with the IASB proposal as to the requirement to present income tax information. The IASB requires applying the existing requirements such as presenting the "information on the face of the statement of comprehensive income other than in relation to continuing operations separately from discontinued operations and other comprehensive income". (Australian Accounting Standard Board, 2009, pp.13).

3.5 Foreign currency transaction gains and losses

As with the IASB proposal's with regard to foreign currency transactions, AASB admits that this should be catogorised into related sections to achieve cohesiveness. However, the question this would enhance the decision usefulness is debatable. They concluded that gains and losses on assets and liabilities should be presented as a single line item as part of other comprehensive income. (Australian Accounting Standard Board, 2009).

3.6 Direct method of presenting cash flow

Cherry et al (2008) argues that reconciling cash flows to comprehensive income would provide significant information on income currently unavailable, such as effects on accruals and measurement charges and also cash flow components - AcSB (2008). However, this opinion was not in favor of banking industry as Cull et al (2009) commented that even though it has relevance for corporate industry they do not believe the information available is little value in forecasting future cash flows giving little indication of the liquidity risks in managing its liquid resources. (British Bankers' Association, 2009).

With respect to reconciling the cash flows to comprehensive income Brad (2009) stated is not a decision useful in analyzing the performance of a company and in their opinion does not provide any meaningful information to the users. (Regions Financial Corporation, 2009).

4.0 Costs vs. benefits

Even thought, the discussion paper did not focus on the cost element part, the cost/benefit is critical for many of these projects as stated by AcSB. (AcSB, 2008).

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The British Bankers' Association believes that adopting a direct cash flow method would be costly and will not result in provision of consistent or meaningful information. (British Bankers' Association, 2009).

Brad (2009) commented that the benefits of making these proposed changes should outweigh the costs. The current recession has brought about a great impact on the company's profitability and the allocation of expenditures and human capital investments allocated are not in the best interest of the investors and should be avoided. (Regions Financial Corporation, 2009).

The London Society of Chartered Accountants in their opinion is concerned with the proposed aggregation level coupled with detailed reconciliation will lead to excessive information in the financial statements. They suggested it would be better if this matter is addressed if the need arises then such information could be obtained rather than imposing, which the costs outweighs the benefits.

The AASB comment on the cost associated with disaggregation will be specific. In the case of foreign exchange dealings there will be allocation difficulties as foreign exchange deals are made at the group level on behalf of subsidiaries. (Australian Accounting Standard Board, 2009).

5.0 Pros and Cons of the new presentational formats

The management approach to classification of financial statement amongst many was appropriate as per the comment letters such as Hutchinson (2009) stated current financial reporting has been too complex and does not provide an adequate view about the entity's overall position leading to recent financial scandals and do agree to the objectives of the proposed financial statement presentation. However, there are concerns about the way it has been applied will in fact might be more complex and amplify existing concerns about financial reporting. (The Institute of Chartered Accountants of Scotland).

Cull et al (2009) generally agrees that a certain degree of cohesiveness is desirable; it must be carefully balanced with management's needs to present this information in a manner to reflect the entity's business model most faithfully. However, there are instances which we believe the balance is wrong, i.e., too many restrictive, detailed and prescriptive proposals. (British Bankers Association, 2009).

The Australian Accounting Standard Board was in favor of greater transparency in the financial statements. Research conducted by academics from both Australia and New Zealand supported for the changes in the format based on their findings. This indicates a detailed approach to disaggregation does have more value to users. But concerns from smaller entities whether these changes in the format to be capital market bias. There are issues that need to be further discussed and reviewed for standards for non-publicly accountable entities. (The Australian Accounting Standard Board, 2009).

Chairman of Financial Executive International, Arnold et al (2009) concluded that even though they do share their views with IASB, there are deep concerns as that there is a real gap between the proposed theories and the practical aspects that the Board is trying to accomplish. Therefore, they recommended reconsidering certain provisions. "It would be best to have a more practical alignment with the businesses who would be preparing this unique data and the true economic costs versus benefits of preparing the data". (Financial Executive International, 2009 pp.2).

Under the proposed format the materiality is assessed as with disaggregation arises the possibility of material misstatement in individual line item which is not considered material. This requires the preparers to exercise caution in assessing the materiality of items. (Regions Financial Corporation, 2009).