Financial reporting is essential to provide shareholders and other stakeholders with relevant and reliable information to allow them to make sound economic decisions and assess stewardship performance. Regardless of their conflicting interests they are entitled to see a ‘true and fair’ view of the company and not be misled by stewards.
Annual reports are used to asses the directors’ stewardship with regards to the management of the company’s affairs and assets for the past period. Stewardship is absolutely vital as the owners of the company (shareholders) have no involvement over the activities and decisions made, and thus rely on the stewards to use their resources to the best of their abilities in aiming for growth, profits and survival.
Stewards are obliged to reliably provide the following four statements allowing for stewardship assessment and decisions to be made, such as purchasing/selling shares or even to dismiss the director.
- The statement of financial position provides a snap shot view of the company’s affairs, detailing their assets, liabilities and equity which are useful for assessing financial stability. For example one can be aware if the ratio of debt to shareholders funds is too high and observe its ability to pay current liabilities with its most liquid of assets.
- The statement of comprehensive income breaks down the revenue from the different categories of costs to provide a profit/loss for the period end. IAS 1 also requires that comprehensive income is shown on the face of this statement even though it’s not recognised. This provides users with more information and is useful to identify, for example, any revaluation gains in the year. One can decide whether certain costs are relatively high by observing the difference in the gross-profit percentage to the net-profit percentage. Revenue recognition and inventory standards regulate a major part of this statement, which can be easily manipulated. This statement also predominantly uses the accruals and prudence concept and may also be misleading as it’s possible to manipulate figures and shift/defer losses. Thus one must look at this statement in conjunction with the notes and other statements.
- The statement of changes in equity required by IAS1 shows a reconciliation of the carrying amount of each component of equity, providing a breakdown of dividends paid, issuance of shares, effects of changes in accountancy policies, profit for the period, other comprehensive income (such as revaluations) and other items affecting these balances.
-The statement of cash flows is divided into operating, investing and financial activities to provide a thorough view of cash flowing to and from an entity. This statement doesn’t follow the accruals concept and is very useful as it’s difficult to manipulate.
The link between the stewardship function and the information shown in the above financial statements is faint, due to the huge scope for misrepresentation. Therefore the supporting notes are crucial to shareholders so that they can understand the reasoning behind certain figures, allowing them to make their own judgements. For example in the statement of financial position the user can see one stand alone figure for “Property plant and equipment” which may be difficult to interpret. However IAS 16 requires the disclosure of ‘Movements in PPE’ featuring revaluations, additions, disposals and depreciation charges for the year. Users can observe the consistency in depreciation methods and useful lives chosen.
IAS 16 has made accounts more consistent and has tackled certain areas open for misrepresentation, such as requiring companies using the revaluation model to revalue all assets within that class, preventing their ability to revalue assets whose value is likely to increase (and ignoring the rest). Some subjective areas remain, such as the depreciation methods used and assessments of economic life which can majorly affect the profit. In an attempt for a conceptual framework this standard would need revising to prevent the scope for misrepresentation.
Evidently the disclosure notes required by each IAS provides not only additional qualitative information which is not represented within these numerical statements, but also important information to interpret the main financial statements. Supporting notes improves the ability to assess stewardship with regards to the accounting policies and methods chosen, and, perhaps also making it possible to spot any creative accounting practices. One can also view the justifications of omitting certain figures which may not meet IAS recognition criteria.
Thus it’s necessary to stress the importance of these notes and their function in enabling users to understand the statements and make enhanced decisions.
The regulatory framework regulates financial information provided to shareholders. This consists of three main components; legislation such as the Companies Act 2006, accounting standards which provide detailed rules on accounting treatments, and, the stock exchange regulations which listed companies must comply with. Progressively more companies are deciding to comply with standards created by the International Accounting Standards Board rather that UK standards (SSAP and FRS). This is due to globalisation as well as its ability to enhance comparability and work towards a conceptual framework. Standards aim to define the presentation of accounting figures and to ensure less subjective measurements are made. For example IAS 1 intends to make financial statements internationally comparable.
One of the reasons for a major shift in the regulatory framework is due to the Enron scandal which wounded many financial professions including the accounting/auditing profession. They used accounting loopholes and poor financial reporting to hide tremendously large amounts of liability, in addition to recognising huge amounts of revenue for projects which had no real certainty. It also led to the closure of the fifth largest audit firms (Financial Times, 2002). Those responsible certainly did not fulfil their stewardship function and deceived many stakeholders for their own personal gain.