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An essential quality of the information is that it is readily understandable by users. Users are assumed to have a reasonable knowledge of business and accounting, and a willingness to study the information with reasonable diligence. Information about complex matters should not be excluded, merely on the grounds that it may be too difficult for certain users to understand.
You are in the property development. Publishing architects' and surveyors' reports should be done, if this confirms specific aspects of your work. Not all of your users will understand these reports, but they will be able to take expert advice, if they so wish.
The same would apply to pension actuaries' reports on pension schemes.
Information has the quality of relevance when it helps users evaluate past, present or future events, or confirms (or corrects), their past evaluations.
The same information plays a confirmatory role in respect of past predictions about the way in which the undertaking would be structured, or the outcome of planned operations.
Reporting on segments of business activities may help users if the your firm has diverse activities. .
The relevance of information is affected by its nature and materiality. In some cases, the nature of information alone is sufficient to determine its relevance.
3 Important - Material
Information is material if its omission, or misstatement, could influence the decisions of users. Materiality depends on the size of the item (or error) judged in the circumstances of its omission (or misstatement).
Your business has previously been limited to your country. You have expanded into another country, in another continent, with a view to further foreign expansion. Though this may not be material to your business today, reporting of your results and commitments in this new market will help users understand your business.
other cases, both the nature and materiality are important, for example, the amounts of inventories held in each of the main categories of the business. EXAMPLE-materiality
A competitor has filed a lawsuit against you for a large amount of money. Your lawyers are concerned, but you believe the lawsuit to be frivolous. You should disclose this information as a contingent liability, with expression of your views, and those of the lawyers.
Materiality provides a threshold (or cut-off point) rather than being a primary qualitative characteristic, which information must have, if it is to be useful.
Information has reliability when it is free from material error, and bias, and can be depended upon to represent that which it either purports to represent, or could reasonably be expected to represent.
EXAMPLE - reliabilty
If the validity, and amount of a claim, for damages under a legal action are disputed, it may be inappropriate to record the full amount of the claim in the balance sheet (although it may be appropriate to disclose the amount in the notes, and circumstances of the claim).
If information is to represent faithfully the transactions, it is necessary that they are presented in accordance with their substance, and economic reality, and not merely their legal form.
EXAMPLE-substance over form
An undertaking may dispose of an asset to another party so that the documentation purports to pass legal ownership to that party. Nevertheless, agreements may exist that ensure that the undertaking continues to enjoy the benefits from the asset. This may be done to raise finance, using the asset as collateral.
In such circumstances, the reporting of a sale would not represent faithfully the transaction.
The information contained in financial statements must be free from bias. Financial statements are not neutral if, by the presentation of information, they influence the making of a decision to achieve a predetermined result, or outcome.
Accounts should not reflect an over-optimistic nor an over-pessimistic view. Provisions should reflect the current view of events and not be increased just because "surplus" profits are available. Accounts should not be distorted to achieve management targets, if these targets had not actually been met.
To be reliable, the information in financial statements must be complete taking account of materiality, and cost. An omission can cause information to be false, or misleading, and thus unreliable and deficient in terms of its relevance.
Major commitments and contingent liabilities can easily omitted from financial statements. Their omission may mislead users.
Users must be able to compare the financial statements of an undertaking through time, to identify trends in its financial position, and performance.
Users must also be able to compare the financial statements of different undertakings in order to evaluate their relative financial position, performance and changes in financial position.
The measurement, and display, of the financial impact of similar transactions must be carried out in a consistent way by an undertaking, and over time, and in a consistent way for different undertakings.
An important implication of comparability is that users be informed of the policies employed in the financial statements, any changes in those policies, and the impacts of such changes.
Using different measurement systems of inventory (FIFO and weighted-average cost are permitted by IFRS) generates different results. Consistent use of one method is essential to allow users to compare one period with another. There should be no change of method, unless a Standard decrees it, or it would help users.
If other undertakings, in the same industry, use particular accounting policies, users will benefit if yours are consistent with theirs, to enable comparison.
Users need to be able to identify differences between the policies for like transactions, used by the same undertaking from period to period, and by different undertakings. Compliance with Standards, including the disclosure of policies, helps to achieve comparability.
As users wish to compare the financial position, performance and changes in financial position over time, it is important that the financial statements show corresponding information for the preceding periods.
Constraints on Provision of Information
Certain limits have to be places on the quality of information. The include
Management may need to balance the relative merits of timely reporting, and the provision of reliable information. To provide information on a timely basis, it may often be necessary to report before all aspects of a transaction are known, thus impairing reliability.
Conversely, if reporting is delayed until all aspects are known, the information may be reliable, but of little use to those who have had to make decisions in the interim. In achieving a balance between relevance and reliability, the overriding consideration is how best to satisfy the needs of users.
Balance Between Benefit and Cost
The benefits derived from information should not exceed the cost of providing it. The evaluation of benefits and costs is a judgmental process. The costs do not necessarily fall on those users who enjoy the benefits.
True and Fair View/Fair Presentation
Financial statements are frequently described as showing a 'true and fair view' of the financial position, performance, and changes in financial position of an undertaking.
The application of the principal qualitative characteristics, and of appropriate standards, normally results in financial statements that convey a 'true and fair view' of such information.
b.Critically asses the difficulty in preparing a set of useful financial statements,which exhibit all of the primary qualitative characteristics identified in (a) above.How well do you feel that your chosen company has achieved it.
Major difficulty: The Going Concern Principle:
when and how to assess the value of a company and/or its assets
The going concern concept is one of the cornerstones of the financial accounting world. In essence, the going concern says that a Balance Sheet of a company must reflect the value of that company as if it were to remain in existence for and beyond the foreseeable future. The opposite of the going concern concept, so to speak, is to say that the company will fold within one year from the Balance Sheet date.
We will see in this article that the going concern concept is vital for us to be able to take as much of a rational view of a company as is possible. In this article, we will discuss the following key questions: who makes the going concern assessment and why?; and how do we arrive at the liquidation value of a company and/or its assets?.
Who makes the going concern assessment and why?
There are two major parties in the assessment of a company as a going concern: the company's management and its auditors. In addition, given that the following factors may lead to a going concern reassessment, the list of who makes a going concern assessment could possibly include a major creditor; a financier/banker. Those factors are:
- substantial operation losses incurred in the current year
- continuous availability of trade credit
- potential litigation
- possible loss of a major customer
- potential patent sale and current ratio near the loan agreement limit
When to question the going concern prospects of a company
Some of the key issues that IFAC sets out as events that the auditor ought to consider in this context are financial, adverse key financial ratios, operating and other. As perhaps we should expect, the events listed by IFAC are comprehensive, even though they say their list is not exhaustive. Let's look at each of these four categories in turn.
IFAC discuss the position in which fixed term borrowings are approaching maturity but the company may have no realistic prospects of renewal or repayment. Alternatively, there could be evidence of over trading and an excessive reliance on short term borrowings to finance long-term assets.
The auditor must also look for indications of withdrawal of financial support and negative cash flows as shown either by the historical accounting records and/or by cash budgets or projections.
Adverse key financial ratios
Clearly, anything prescribed under this heading could be dangerous, misleading, or simply not comprehensive enough. That is, depending on the state of the Economy in which the company is operating, the nature of the sector in which the company is operating and so on, the number and variability of ratios could differ from case to case.
Nevertheless, the IFAC view here is a sensible one; and they discuss, inter alia , Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.
Arrears or discontinuance of dividends no longer being declared; and the possibility that the latest declared dividends have yet to be paid, well after their due date. A persistent rescheduling of creditors' payments and maybe the shift from buying on account to buying for cash would ordinarily be cause for concern. The need to reschedule formal loans would also be a cause for raised eyebrows in the context of the going concern principle.
Companies that find that they are unable to secure financing for essential new product development or other essential investments must clearly have pause for thought at least as to the view of others of their long term viability.
The development of such cost and management accounting approaches as Activity Based Costing and the Balanced Scorecard to the work of organisations should lead us to applaud the inclusion in this discussion of this section: Operating aspects. In that financial and financial management are learning more each day about the impact and importance of the non financial aspects of businesses. IFAC discuss the operating aspects of a business in the following terms:
- Loss of key management without replacement
- Loss of a major market, franchise, license, or principal supplier
- Labor difficulties or shortages of important supplies
Under the heading of Other, IFAC adds a few other aspects that are pointers to the kind of issues that the auditor needs to look out for in the context of the going concern debate. These remaining issues are:
- Non compliance with capital or other statutory requirements
- Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that could not be satisfied
- Changes in legislation or government policy expected to adversely affect the entity
Of course, whilst each of these issues, either singly or collectively, could be considered serious for any company, taken in isolation, we could take a mistaken view of the situation. For example, even though a company might be having to reschedule its creditor and debt repayments; management could be taking steps to reorganise its affairs in such a way that it resolves its financing situation within the forthcoming financial year.
Going Concern Assumption Appropriate but a Material Uncertainty Exists
Finally in this section, we should make the observation that a company may receive a going concern clean bill of health; and yet a material uncertainty exists. That is, we need to consider whether the financial statements of a company adequately describe the principal conditions that give rise to a significant doubt about the entity's ability to continue in operation for the foreseeable future and management's plans to deal with these events or conditions; and state clearly that there is a material uncertainty related to events or conditions which may cast significant doubt about the entity's ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business.
How do we arrive at the liquidation value of a company and/or its assets?
(This section is based on the work of Braun: see reference section at the end for details)
"A valuation is always determined as of a particular point in time, and generally should not be relied upon for other dates."
There are a variety of valuation approaches a business appraiser will consider in the valuation of a ... company. Among the most common are the
- asset approach,
- market approach, and
- discounted cash flow approach
- formula approaches
In actual practice, a combination of approaches is commonly used with differing weights given to each selected approach as appropriate.
The asset approach relies on a company's adjusted book value by substituting the fair market value of assets and liabilities for the stated value of assets and liabilities. This approach is most useful for valuing a company which has significantly undervalued assets. It may also be useful for valuing a company with substantial non-operating assets such as land or natural resources. This approach is generally not used, however, to value a company as a going concern .
The market approach is simple for the quoted company: just take the stock market value of the company at the relevant date and multiply it by the number of shares in issue. However, what about the private company that is not quoted on any stock exchange, and whose shares are thus very difficult to value. The solution here requires trying to find one or more public companies that are as similar as possible to the private company being valued. To use this approach, we must compare the private company to the public companies in terms of size, growth, gearing and so on to determine relative risk.
The discounted cash flow approach relies on multiple year projections based on management's reasonable estimates of the company's prospects. The reasonableness of projections should be considered by comparison to the company's historical results and the outlook for the company and the industry.
Projected cash flow is determined by depreciation to earnings to depreciation and subtracting capital expenditures plus or minus changes in working capital. A terminal value at the end of the projection period is then calculated. The appropriate discount rate may be the company's own hurdle rate or it based on the company's weighted average cost of capital. A risk premium may be added to the discount rate as appropriate under the circumstances to determine a risk-adjusted discount rate: despite the very sophisticated methods of deriving discount rates, it is still common for management to add a fudge factor to cover for risk.
The formula approach, or rules of thumb, may be considered if appropriate. A formula may take many forms, such as a multiple of book value or a multiple of revenues. The advantage of using a formula approach is that it is simple and inexpensive to use. However, the disadvantage is that it may not reflect fair market value. Furthermore, a formula may not be dynamic enough to reflect changing market conditions in which a company is operating.
Any of these approaches will need to be further adjusted to account for qualitative factors and special circumstances such as non-recurring gains and losses,
reasonable management compensation, key person risk, "excess" cash, and non-operating assets.
The going concern principle is among the most important accounting, and therefore business, principles. Nevertheless, despite the definition of the principle being relatively straightforward, the application of it can be fraught with difficulties. At one extreme, we have many examples of companies that were given a clean going concern bill of health at the end of one financial year only to find itself in liquidation within 12 months of the end of that financial year. At the other extreme, we have the significant difficulties in trying to arrive at a fair value for a company that seems properly assessed as a failing company.
We have explored several of the issues facing someone who is trying to place a value on a business: for either going concern or non going concern purposes.
ASB, (1999).Statements of Principles for Financial Reporting
The International Federation Of Accountants
International Standard on Auditing
Exposure Draft: Going Concern (1997)
International Accounting Standard 1 (revised 1997) Presentation of Financial Statements
International Accounting Standards Committee
Edwards, Donald E. Going-concern evaluation: factors affecting decisions From: http://www.fortunecity.com/banners/interstitial.html?http://www.nysscpa.org/cpajournal/old/14522928.htm
Richard S. Braun (1998) Valuing A Private Company: An Introduction to Business Valuation Willamette Capital Willamette Management Associates From: http://www.fortunecity.com/banners/interstitial.html?http://www.fed.org/leading_companies/jan98/tips.html 'Annual report Link of the company DAIRY CREST' http://online.hemscottir.com/ir/dcg/ar_2009/tn_notes.html