The Objective Of Financial Reporting Accounting Essay

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Generally, this paper is an Exposure Draft issued and published by Financial Accounting Standards Board (FASB) as well as International Accounting Standards Board (IASB) for public comment. It is a product of the Boards' considerations of the issues and feedbacks received on the Discussion Paper, which is being addressed in the first phase of the project to develop a common conceptual framework for financial reporting to replace their existing frameworks.

There are quite some reasons why Boards are reconsidering their frameworks.

A common goal of the Boards to set their standards clearly based on consistent principles.

Both of the IASB's Framework and FASB's Concept Statement explained concepts that continuously being an adequate foundation for consistent standards.

The goal of Boards to converge their standard.

There are a total of two chapters discussed in the Exposure Draft. Basically, Chapter 1 describes the objectives of financial reporting, the primary user group to which financial reporting is directed, types of decision made by the group as well as financial information that are useful to that group in making those decisions. On the other hand, Chapter 2 describes the qualitative characteristics that make financial information useful. Besides, it also discuss on two pervasive constraints in providing financial reporting information which is materiality and cost.

Chapter 1: The Objective of Financial Reporting


In this chapter, it establishes the objective of general purpose financial reporting by business entities in private sector, which is also the foundation of the frameworks.

Objective of General Purpose Financial Reporting

The main purpose of general purpose financial reporting is to provide financial information for present and potential capital providers as well as non capital providers in which are useful in making decision related to reporting entity.

General Purpose Financial Reporting

The general purpose financial reporting focuses on the needs of a wide range of users rather than only to the needs of single group. It stems from the information need of users who lack in ability to prescribe all the financial information they need from the reporting entity, in which they rely partly on information provided in financial reports.

Capital Providers and the Entity Perspective

Financial reports should reflect on the perspective of the entity rather than the perspective of the entity's equity investors as it focuses on the need of all capital provider rather than the needs of particular group. However, additional information that aimed for the need of specific entity's equity investors is also allowable. Capital providers (equity investors, lenders, and other creditors) provide economic resources to entity in exchange for claims to those resources. Therefore, capital providers have the most critical and immediate need for general purpose financial information about the economic resources of an entity.

Decision Usefulness

Financial reporting is important because it provides information that is useful in making decisions especially for capital providers.

Usefulness of Financial Reporting in Assessing Cash Flow Prospects

Financial reports provide information about cash flows in an entity, the amount, timing and uncertainty from various resources. However, future predictions of cash flows depend on entity's present cash resources and its ability to generate enough cash. The ability of entity's to generate cash also affects the values of debt and equity interests.

Usefulness of Financial Reporting in Assessing Stewardship

Management's performance in discharging responsibilities, also known as stewardship responsibilities, affects greatly on entity's ability to generate net cash inflows. Therefore, it helps existing equity investors to make decision in their capacity as owners about whether to replace or reappoint managements, how to compensate management, and how to vote on shareholders proposals about management's policies and other matters. Potential investors may also use the information in deciding whether to provide economic resources to entity.

Limitations of General Purpose Financial Reporting

Financial reporting provides only one sources of information needed. Thus, users of financial reports also have to consider information from other sources such as political events in order to make good decision. Besides, the information provided are also based on estimates, judgment and models that had happened and exist rather than exact depictions of the effect. Although standards did establish concepts underlying the estimates, judgment and models of financial effect, it is unlikely that ideal financial reporting can be produced due to constraint such as cost.

Information about an Entity's Resources, Claims to Those Resources, and Changes in Resources and Claims

Financial reporting should provide information about the economic resources of the entity (its assets) and the claims to those resources (its liabilities and equity) as well as the effects of transactions or other events that changes them.

Economic Resources and Claims to Them

Information on economic resource and claims to them help capital providers to identify entity's financial strengths and weaknesses as well as assessing entity's liquidity and solvency. Besides, it also indicates the cash flow potential of some economic resources and cash needed to satisfy claims of lenders and other creditors. Furthermore, users may also assess the effectiveness of management discharging their stewardship responsibilities by comparing actual results with expectations. In conclusion, information on these resources and claim are important for users to predict how future cash flows will be distributed to claims to economic resources besides considering the needs of additional financing and how likely it'll be successful in obtaining financing.

Changes in Economic Resources and Claims to Them

Information about effects of transactions and other events as well as circumstances that changes in economic resource and claims to them help user of the entity's financial reports to assess the amount, timing, and uncertainty of its future cash flows. This information includes quantitative measures and other information about changes in economic resources and claims that are a result of the entity's financial performance, which are reflected by accrual accounting and cash flows during a period, and changes that are not a result of the entity's financial performance.

Changes in Resources and Claims Resulting from Financial Performance

An entity's financial performance provides information about the return it has produced on its economic resources. The variability of that return is important, especially in assessing the uncertainty of future cash flows. Besides, entity's past financial performance are also helpful in predicting the entity's future returns on its resources, and also in assessing management's ability to discharge its stewardship responsibilities to its capital providers.

Financial Performance Reflected by Accrual Accounting

Accrual accounting shows the financial effects of transactions and other events and circumstances that have cash or other consequences for an entity's resources and the claims to them in the periods in which those transactions, events, or circumstances occur. Without accrual accounting, important economic resources and claims to resources would be excluded from financial statements which may makes it difficult to assess entity's past performance and future prospects. Other than changes resulting from transactions, information about an entity's financial performance during a period reflected by changes in its resources and the claims to those resources are useful in assessing entity's past and future ability to generate net cash inflows. Besides, it may also indicate the extent to which events such as changes in market prices influence entity's economic resources and the claims to those resources. This in turn affects the entity's ability to generate net cash inflows

Financial Performance Reflected by Cash Flow Accounting

Information about an entity's cash flow during a period helps users to assess the entity's ability to generate future net cash inflows. Besides, it also indicated how entity obtains and spends cash which may affect the entity's liquidity and solvency.

Changes in Resources and Claims Not Resulting from Financial Performance

This information provided in financial reports helps capital providers to distinguish between changes that are the result of financial performance or not. It is useful in assessing to what extent the total change in economic resources and claims to those resources caused by management's ability to protect and enhance the entity's economic resources which may form expectations about its future financial performance.

Management's Explanation

Since management understand more about the operations and ongoing activities of the entity than external users, management's explanation and other information should be disclosed in financial reporting to help users understand the information provided. Furthermore, information provided in financial reporting depends on, or affected by, management's estimates and judgments. Therefore, disclosing management's explanation on underlying assumptions or methods used, including those significant uncertainties in the principal applied helps capital providers in better evaluation of financial information.

Appendix: Basis for Conclusions

This appendix summarizes considerations that Board members thought significant in reaching the conclusions in this chapter of the proposed conceptual framework. It includes reasons for accepting some alternatives and rejecting others.

Objective of Financial Reporting

General Purpose Financial Reporting

Objectives should focus on financial reporting as a whole and not just presenting financial statements.

Common Needs of Users

Information needed by users other than capital providers which did not overlap with common needs of capital providers are beyond the scope of general purpose financial reporting.

One Set of General Purpose Financial Reports

For now, information conveyed in general purpose financial reports still considered the best to serve the needs of users. This is because of common interest of users in evaluating entity's ability to generate net cash inflows and management's ability to enhance and safeguard the investment by capital providers.

Entity Perspective

In modern business environment, most of the companies tend to grow larger and need for capital increases and new business forms evolved whereby there is a separate legal entity between entity, management and capital providers. Therefore, reporting based on entity's perspective is more consistent.

Primary User Group

Boards concluded that primary users of financial reporting information would be present and potential capital providers as they have the most direct and immediate interest in entity's ability to generate net cash inflows and management's ability to enhance and protect the investment by capital providers.

Usefulness for Making Decisions

Evaluating Past Performance and Predicting Future Cash Flows

Information to assess how management has fulfilled its stewardship responsibility should stay as a part of overall objective to provide useful information in making resources allocation decisions. It is unnecessary to eliminate any discussion of stewardship; even with explanation as it may mistakenly understood that Boards do not think it's important. Besides, adding a separate objective for stewardship is also not necessary because it might imply that financial reporting attempt to separate the effects of management's performance from the effects of events and circumstances that are beyond management's control. Thus, a modification to objective of general purpose financial reporting had been done which includes decisions made to protect and enhance an investment.

Decision Usefulness for Different Types of Entities

The objective of general purpose financial reporting should be the same for all entities that issue such reports so. Although objective is the same for all entities, cost constraints sometimes may lead standard setters to permit or require differences in reporting for some types of entities. However, such differences are a result of variations in the perceived costs and benefits of the information when applied to different entity types, not different objectives.

Financial Reporting and Management's Information Needs

Basically, general purpose financial reporting focused on the common need of capital providers. While management's needs of information are differ from capital providers. Since managements can get access to entity's financial information easily to meet its unique needs, general purpose financial reporting is should not focus on needs of management.

The Significance of Information about Financial Performance

Information on entity's financial performance measured by accrual accounting is needed by users to assess entity's ability to generate net cash inflows or to assess management discharge of its stewardship responsibility. Therefore, entity's economic resources and changes in resources and claims as reflected by various measurement attributes within accrual accounting are essential.

Financial Position and Solvency

Since preparing a statements of financial positions towards the need of particular group of user are inconsistent with the main objectives of serving common needs of capital providers as primary user group, Boards rejected the suggestions on main purpose of preparing statement of financial position to assess entity's solvency.