Moving now to perhaps what is the most testable
item, the International Financial Reporting Standards
Framework. At the heart of the framework is the objective
and this is a summarized version of what we saw earlier
in the presentation. The objective of the framework
is to provide financial information, which is useful
in making decisions about providing resources
to the entity. So when a given company reports its
numbers, that information has to be useful to investors,
creditors who are thinking about either buying
the bond issued by the company or lending money to
the company or buying securities issued by the company.
Surrounding the objective are the qualitative
characteristics of the framework. From an exam
perspective you need to recognize these six qualitative
characteristics for IFRS; Relevance, Comparability,
Timeliness, Faithful Representation, Verifiability,
and Understandability. So learn these 6 items and you
also need to know a couple of lines about each of these
items. Imagine you are a potential investor, information
is relevant if that information could potentially
impact the decision that you are going to make. That
is the main point related to relevance. at time that
you will often hear is materiality, and again information
is material if the absence of that information impact
your decision, so any information that is useful
in making a decision can be thought of as material
information. According to the framework, information must
be comparable. Comparability allows users to identify
and understand similarities and differences of
items. Information presented in a consistent manner
over time and across entities enables users to make
comparisons more easily than information with
variations in how similar economic phenomena are
represented. Timeliness is obvious, information
needs to be presented in a timely manner. You will
notice that financial reports published within
a month or two of the end of a given financial period. If it
takes too long to present the financial reports,
then the information becomes meaningless in the
sense that if information comes one year after the
close of a period then that information doesn't really
help the financial analyst. Faithful Representation means
that the financial information presented reflects
the underlying economic reality. So if the financial
reports make the company look better than it actually
is then that means that the information is not being
faithfully represented. Verifiability means
that the information being presented is easily
verifiable, and Understandability means that the
information can be understood by a reasonably informed
business person. In financial reports detailed
accounting jargon such as debits and credits are
not used, that is because of the characteristic of
understandability. Surrounding the qualitative
characteristics are the reporting elements. We
have performance-related reporting elements
such as revenue and expenses and financial position
related reporting elements such as assets liabilities
and equity. You also need to recognize the Constraints
and Assumptions associated with a framework. A
classic constraint is the cost-benefit consideration.
Clearly if it costs an immense amount of money to
create a report that is very beneficial then there
is something wrong with that. So if it costs 20 million
dollars to create the financial reports and the
financial reports are extremely beneficial, but
clearly that represents a problem. So there has
to be appropriate balance between the cost of financial
reporting and the benefit associated with financial
reporting. The financial reporting framework has some
underlying assumptions, the two major ones that
you need to be aware of are accrual basis and going concern.
We have talked about accrual basis in earlier reading.
This simply means that revenue should be recognized
regardless of when the cash is received. So if
you sell goods and delivery services in a given period
and your cash is being received later, you need to
recognize revenue in this period Similarly, if you incur a
expense in that period, but the expenses incurred in terms
of your payment in the earlier period the recognition
needs to happen in the period where the expense was incurred.
So this is a core underlying principle or assumption.
We also need to make the going concern assumption
which means that we assume that the company will go on
forever. The opposite of a going concern assumption
would be the assumption that the company will liquidate.
If a company is going to liquidate then obviously
reporting would have to be based on the fair value
of assets and liabilities, but the standard here
or the framework assumes a going concern. Now we
will talk about the general requirements for financial
statements. According to the International Accounting
Standards Board here are the required financial
statements and we have seen this in earlier readings.
The balance sheet, income statement, comprehensive
income, changes in owner's equity, cash flow statement,
and then notes are also required. Often statements
from earlier comparative periods are also required.
Moving now to the structure and content. Classified
balance sheet. Accounting Standards require that
the balance sheet distinguish between current
and non-current assets and current and non-current
liabilities. Minimum specified information on
face. If you look at a balance sheet, you will notice
that there is some core information that has to be
presented. So Cash & Cash equivalents has to be presented,
Property, Plant and Equipment has to be presented,
so there are certain requirements for what must be presented
on the face of the balance sheet. Additional details
then are presented in the notes or footnotes and there
again there are certain minimum requirements from
what must be present in the footnotes. There are
also requirements on comparative information.
Typically companies are required to also present
information for the previous period. Moving now to the
general features. Faithful presentation means that
the impact of transactions is faithfully and accurately
represented. In other words, the economic impact
should come across in the financial reporting. Going
concern and accrual basis, we talked about in earlier
slide. Materiality and aggregation. Ss mentioned
before emissions or misstatements of items are
material if they could individually or collectively
influence the economic decisions that users make
on the basis of the financial statements. Furthermore,
each material class of similar items should be presented
separately. This means that assets and liabilities
and income and expenses are not allowed to offset
each other unless explicitly permitted by IFRS.
So you are not allowed to say that my accounts receivable
is 100. My accounts payable is 90. So I'm just
going to report a net accounts receivable of 10.
So that is not allowed, you have to show both the accounts
receivable and accounts payable. Frequency of
reporting. Financial statements must be prepared
at least annually. Comparative information financial
statements must include comparative information
from the previous periods. The comparative information
of prior periods is disclosed for all amounts reported
in the financial statements unless a specific requirement
permits otherwise. And finally Consistency. The
presentation and classification of items in the
financial statements are usually retained from
one period to the next, and finally Consistency of Presentation.
As discussed before this simply means that the information
needs to be presented in a consistent manner from
year to year. As financial analyst there might be
situations where we have to compare two companies;
company A and company B, and company A uses US GAAP,
while company B uses IFRS for financial reporting.
It is, therefore, important for us to understand the
differences between US GAAP and IFRS. Over here we are just showing some high-level
differences and later as we go through specific
readings we will discuss these differences in
more detail and also other differences between
US GAAP and IFRS will be identified. US GAAP has been
developed by FASB. This is a US based entity,
whereas IFRS has been developed by the International
Accounting Standards Board which is an international
entity. US GAAP is based on rules whereas IFRS is
more principles-based. With respect to inventory
valuation both US GAAP and IFRS allow FIFO and the
weighted-average method but only US GAAP
allows LIFO whereas IFRS does not allow the use LIFO.
With respect to extraordinary items under US GAAP,
extraordinary items are shown at the bottom of the
income statement whereas under IFRS, extraordinary
items are not segregated in the income statement.
Coming to Development Cost. According to US GAAP,
development cost is treated as an expense whereas
under IFRS it can be capitalized, but if certain conditions
are satisfied US GAAP does not allow the reversal
of inventory whereas IFRS does allow it only if
certain conditions are met. Analyst should be aware
of these differences when comparing financial
reports based on different frameworks as we will
see in later readings when we compare reports that
are being prepared using different standards.
We need to make adjustments so that the different
reports are more compatible. Monitoring Developments
in Financial Reporting Standards. You need to recognize
that reporting standards are evolving rapidly.
Analysts need to monitor developments in financial
reporting standards and assess the implication
for security analysis. A financial analyst can
remain aware of developments in financial reporting
standards by monitoring three sources; One is
new products and transactions. When companies, specially
financial institutions, come up with new products
or transactions they obviously need to report
those transactions so the financial reports that
are created where these transactions are reported
will contain details of how the accounting has happened.
Now, very often if they are reporting on new products
or transactions, the rules or the principles might
not clearly define how the reporting should take
place. So the entity's or companies which are doing
the reporting us their judgment. A,s a financial analyst
you need to study the footnotes and the discussion
to understand what judgment has been used, and then you
as an analyst can assess whether that judgment is
reasonable or not. You can also track the actions
of standard-setters and groups representing users
of financial statements. The major group here is
the CFA Institute, so you can look at what these entities
are saying about the financial reporting standards.
And finally you can look at company's disclosures
regarding critical accounting policies and estimates.
This is critical because this is where you will learn
exactly what policies a company is using, and when
you are comparing multiple companies you need
to read this material carefully because if different
companies are using different accounting policies then
clearly the numbers that are being reported cannot
simply be compared without your making adjustments.
So that brings us to the end of the reading, I will summarize
what I think are the most important and testable
points. First, you need to know the objective of financial
reporting very well. The objective is to provide
financial information that is useful to investors
in making decisions about providing resources
to the entity. So this is a short version of the definition.
What you need to know, you need to recognize the difference
between standard-setting authorities and regulatory
bodies. The major standard-setting authorities
are FASB in the United States and IASB which effectively
is the standard-setting body for most of the rest
of the world. Regulatory authorities are country-specific.
They have the power to regulate, as the name implies,
so they can enforce that companies in their jurisdiction
follow whatever standard is in place for that country.
IOSCO is a umbrella organization of all the major
regulatory bodies in the world. IASB publishes
the IFRS framework, and this I think is one of the most
testable items from this reading. You need to understand
objective, which I have stated up here that is at
the core of the framework, surrounding that framework
are six qualitative characteristics that we talked
about. Make sure you know the six characteristics
and a few lines about each of those characteristics.
Reporting elements. We've talked several times
so you should be on top of all the reporting elements.
You need to recognize the cost-benefit constraints,
and the two major assumptions; one is the going concern
assumption, and the other is that we use accrual based
accounting. Comparison of IFRS and US GAAP. At this
stage you simply need to recognize that there are
differences between these two frameworks, and
as we go through the readings in Financial Reporting
and Analysis, we will highlight the major differences,
which you need to be aware of. Financial Reporting
Standards are evolving very fast and you as a analyst
need to be on top of the changes that are taking place.
But keep in mind that you need to be on top of the changes
from a user perspective. Obviously not from a preparer or
accountant perspective. As I keep saying go over
the summary, the summary for this reading is particularly
good. it is a little hard to go through the entire reading
in the curriculum, but I think the summary captures
the material very well. And in fact, what I have done
in these slides is also captured the most important
points in the reading, so my contention is that what
you will read in these slides essentially covers 90%
of what you might be tested on. Review the learning
objectives. The examples are very few, but the few examples
that are showing in this reading are very good so I would
encourage you to go over the curriculum examples.
As with other readings in FRA the practice problems
are very good so do all of them very carefully and
do them multiple times, but unfortunately, the practice
problems are not enough. So try to do practice problems
from other sources. That is it.