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Chapter 4

Chapter 4. Ensuring the quality of financial statements. Qualitative characteristics. Understandability The significance of the information can be perceived by the user. Relevance Information that has the ability to influence decisions. Qualitative characteristics (Continued). Reliability

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Chapter 4

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  1. Chapter 4 Ensuring the quality of financial statements

  2. Qualitative characteristics Understandability • The significance of the information can be perceived by the user. Relevance • Information that has the ability to influence decisions.

  3. Qualitative characteristics (Continued) Reliability • Information that is a complete and faithful representation. Comparability • Similarities and differences can be discerned and evaluated.

  4. Relevance and reliability May be opposing forces Trade off – highly relevant or highly reliable? Relevant • Predictive value • Confirmatory value Reliable • Free from material error • Faithful representation • Neutral • Complete • Prudent

  5. Measurement principles • Going concern • Accruals • Consistency • Prudence

  6. Measurement principles (Continued) Going concern • Asset cost £100, depreciation £10, market price if sold in crisis = £60. Record £90 net book value. Accruals • Telephone paid £100, invoice due £20. Recorded expense is £120.

  7. Measurement principles (Continued) Consistency • Use similar policies from one year to next or explain reason for and effect of change. Prudence – see later.

  8. Materiality • Threshold for considering an item. Would a user’s decision change if the information were omitted or misstated? • For example: Error of £10m in expense item. Overall profit £500m. Error is not material at 2% of profit. • Error of £10m in expense item. Overall profit £20m. Error is material at 50% of profit. • Bad debt expense described as salespersons expenses. Materially misleading?

  9. Prudence Inclusion of a degree of caution in accounting judgements under conditions of uncertainty. • For example: Inventory (stock) valuation – uncertainty is that stock is not yet sold.

  10. Prudence (Continued) Avoid • Overstatement of assets • Understatement of liabilities Because both of these will lead to overstatement of profit. Assets – liabilities = Capital (incl. profit) • Create an asset. How does the equation balance? Answer: Create profit. • Omit a liability. How does the equation balance? Answer: Create profit.

  11. Regulation Financial statements • Objective: Information that is useful to a wide range of users. Annual reports • Mixture of regulated and non-regulated contents. Regulated section is audited.

  12. Regulation (Continued) IAS Regulation • Overrides national company law. • Requires all listed groups to prepare financial statements using IFRS. UK Company law • Requires true and fair view. • Accounting rules apply to companies not following IAS Regulation. • Contains other rules for management and audit of a company.

  13. Regulation (Continued) Financial Reporting Council • Authorised by UK government to make arrangements for accounting standards, auditing standards, oversight of professional bodies and firms, enforcement of standards. UK Accounting Standards Board • Independent standard-setting body. • Sets accounting standards for use in UK (by companies not applying the IAS Regulation).

  14. Regulation (Continued) Auditing Practices Board • Sets auditing standards (based on International Standards on Auditing) and a code of ethics for auditors. Professional Oversight Board • Has oversight of professional bodies and accountancy firms.

  15. Regulation (Continued) Financial Reporting Review Panel • Monitors compliance with true and fair view. • May ask companies to correct wrong accounts. Accountancy and Actuarial Discipline Board • Investigates complaints against accountants and applies penalties.

  16. Regulation (Continued) Committee on Corporate Governance • Sets Code on Corporate Governance for directors running a company. Financial Services Authority (will change in future to a new body/bodies) • Regulates market for shares. • Has accounting rules for fair market.

  17. Regulation (Continued) Auditors • Report to shareholders. • Use auditing standards. • Give opinion on true and fair view from financial statements. Tax system • Companies pay corporation tax. • Taxable profit is based on accounting profit but with additional rules, for example, depreciation rates fixed.

  18. Is regulation necessary? For regulation • Supply and demand do not meet unless a regulator intervenes. • Stakeholders may lose confidence, or may need protection. • Scandals result where there is inadequate regulation.

  19. Is regulation necessary? (Continued) Against regulation • Market forces ensure information flow. • Lenders will ensure they have good information for reassurance. • Costs may exceed benefits.

  20. Reviewing published financial statements Look at key figures in highlightedstatements. • Sales • Gross profit • Profit before tax • Profit after tax • Trends in key figures

  21. Reviewing published financial statements (Continued) • What kinds of assets are held? • What kind of liabilities are held? • What is the cash flow? Inflow or outflow?

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