Accounting #2 - Financial Reporting Framework

[samvara]

A bit foggy yesterday, my body was doing that thing it does before I get my period where it tries to achieve the closest thing to a coma possible. I did my readings very quietly with lots of breaks to stare at the wall and cuddle the woofer. Work, I love you and your willingness to give me study leave SO MUCH.

The pre-content discussion had me vowing to look up accounting scandals like the Satyam scandal and Opes Prime (which is reminiscent enough of Optimus Prime to be interesting if only to wonder where the name came from). Even better, it turns out Wikipedia has a Corporate Scandals category - see Salad Oil scandal (because it's there).

We recapped who does what to who in Australia (FRC, AASB, UIG (now disbanded), ASIC, ASX, ICAA, CPA and NIA) and Internationally (IASB, IFRIC, PSC (IFAC) and FASB). The sheer number of acronyms should make you cry - I'm tempted to - am keeping a key at the bottom of each post to aid my understanding and recall.

Australia adopted IASB in 2005 which was fun for everyone who suddenly had to change their ways (like Qantas) and no doubt cost a lot of money. What it means is financial reports explicitly state (and are required to state) that they comply with IASB. Other influences on Australian financial reporting include the Corporations Act which is notable in my mind right now for producing the amusingly named CLERP 9 (Corporate Law Economic Reform Program) and ASX which has requirements for listed companies.

We distinguish between how for profit entities are treated and not for profit entities. The former comply with both AASB and IASB, the latter have special requirements. AASB defines not for profits as entities 'whose principal objective is not the generation of a profit.'

Trivia: Sanitarium Health Foods is owned by the Seventh-day Adventist Church and is a not for profit organisation.

The Australian conceptual framework existed prior to 2005, is partially retained post-2005 and is being worked on right now. It had four Statement of Accounting Concepts (SACs) of which 3 & 4 were dropped and 1 & 2 were retained in 2005 as it was felt IASB did not cover this in enough detail.

SAC 1 defines a reporting entity as: an entity (either a single entity or a group comprising a parent and all its subsidiaries) that has users who are dependent on General Purpose Financial Reports (GPFR) for information that will be useful to them for making and evaluating decisions about the allocation of scarce resources. Why do we care? Because if you don't quality as a reporting entity your life is a lot easier (or well, you don't have to pay a CPA + auditor to write reports and audit them) and if you do, you better comply with the requirements.

• Examples of reporting entities: companies whose securities are publicly listed, listed trusts and other trusts which raise fund from the public, large proprietary companies, government controlled businesses, federal, state and territorial governments and local governments.
• Examples of non-reporting entities: small proprietary companies, family trusts, partnerships, sole traders, wholly owned subsidiaries of Australian reporting entities.

Group Exercise: We broke up into groups to workshop a short list of entities and decide if they were reporting entities or not - we have groups now! I have an engineer, an IT manager and a sales manager, all men, all potentially people I can work with. We traded emails and phone numbers and exchanged a brief, friendly set of emails this morning confirming we didn't misspell them and that I'd signed our group up to provide snacks in week 4 (there was gesticulating across the room, it wasn't entirely a unilateral decision on my part :p).

Large versus small proprietary companies; you're considered large if you meet at least two of the below:

• consolidated gross operating revenue of greater than 25 million
• consolidated gross assets greater than 12.5 million
• consolidated employees greater than 50 people

Small proprietary companies have to provide a financial report if:

• shareholders holding at least 5% of voting shares request one
• ASIC requests one (oh ASIC, I used to use your website all the time, and only now do I learn what you do, I am ashamed)
• said small company is controlled by a foreign company

SAC 2 defines the objective of general purpose financial reporting as: 'to disclose information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.' The key bit being making decisions. To achieve this, the entity must:

• use accrual accounting and not cash based accounting (i.e. you recognise an expense when you commit to it, not when you pay it)
• be a going concern (i.e. unless there is evidence to the contrary, we assume the entity will continue to exist)

Trivia: fascinating digression into how financial reporting intersects with frequent flyer points. You have to report frequent flyer points that have not yet been used as a liability somehow, because one day they will be redeemed (hopefully not all on the same day :p). Qantas has a fabulous bit (in that is seems understandable) on page six that lays out what they do

Qualitative characteristics of the financial framework:these are the attributes that make the info in a financial report useful

• Relevance, Reliability, understandability and Comparability
• Substance over form (i.e. don't report 'selling' something as a sale if you actually 'loaned' it to build up quick cash)
• Timeliness and cost vs. benefits (entity wears the cost of preparing financial reports so that users benefit by ability to make decisions, although entity benefits in the form of increased credibility)

Assets: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

• item gives rise to future economic benefits
• said future benefits are controlled
• asset arises as a result of past transaction or other past event

Other qualities that are indicative but not essential:

• acquisition at a cost (counter examples: inheritance and gifts)
• tangibility
• exchangeability
• legal enforceability

Group Exercise: What do we think of Woolworth's treatment of Research and Development in their 2008 Annual Report? It looks like they expense the Research (not an asset) but capitalise the Development (regarded as an asset) by including materials, labour and some overheads. The idea being that Research has too low an expectation of future economic benefits to count, but by the time you're committed the Development team you've increased the likelihood enough.

Liabilities: A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

• represent present obligations
• future sacrifice of economic benefits
• result of past transactions of other past events.

An asset or liability should be recognised in  the financial statements if:

• it is probably that any future economic benefit associated with the item will flow to or from the entity
• the item has a cost or other value that can be measured reliably

Equity: is the residual interest in the assets of the entity after deduction of its liabilities. Maths

Expenses: are decreases in economic benefits during the accounting period in the form of outflows or reductions of assets or increases in liabilities, that result in decreases in equity other than those relating to distributions to equity participants.

Income: is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities, that result in increases in equity other than those relating to contributions from equity participants.

...and then we ran out of time.

Guide to Acronyms
AASB: Australian Accounting Standards Board
ASIC: Australian Securities and Investments Commission
ASX: Australian Securities Exchange
CPA: Certified Public Accountant
FASB: Financial Accounting Standards Board (U.S.)
FRC: Financial Reporting Council (Australian)
IASB: International Accounting Standards Board
ICAA: Institute of Chartered Accountants Australia
IFAC: International Federation of Accountants (I kind of visualise these like well dressed Jedi)
IFRIC: International Financial Reporting Interpretations Committee
NIA: National Institute of Accountants (Australian)
UIG: Urgent Issues Group (now disbanded, Australian)
US GAAP: Generally Accepted Accounting Principles (U.S.)