CHAPTER 2: FINANCIAL STATEMENTS FOR DECISION MAKING

CHAPTER 2: FINANCIAL STATEMENTS FOR DECISION MAKING TYPES OF BUSINESS ENTITIES: CHARACTERISTICS OF A COMPANY: Companies are defined and regulated by the Corporations act 2001. Characteristic Status in law

Company Separate legal entity able to enter into contracts, to sue and be sued and hold assets

Sole trader and partnership Has no legal existence apart from the owner(s)

Maximum number of owners

 50 (proprietary)  Unlimited(public) Limited liability- only liable for unpaid capital contributions

 1 (sole trader)  20 (partnership) Unlimited liability- personally for all business debts Will not continue to exist

Liability of owners Continuity of existence

The status of a legal entity means that a company will continue to exist and will not be affected by changes in ownership such as a shareholder dying or selling their shares. A company will only cease to exist after a legal process of being shut down and deregistered has occurred.

Transferability of ownership

Shares represent ownership of a company, and ownership can be transferred easily through the buying and selling of shares  no approval By appointing managers that have experience and expertise, the company can be run well, and shareholders will benefit by an increasing share price and regular dividends. Considerable fees and other costs A proprietary company must have at least one director that resides in Australia and no more than fifty members (shareholders) that aren't employees of the company. A public company must have at least three directors with at least two residing in Australia and there is no maximum number of members.

Separation of ownership & management Cost of formation Number of members & directors

Taxation

 Limited to owners and associates(proprietary)  Unlimited(public) Profits at 30%

Distribution of profits

At directors discretion

Government regulation

Some(proprietary) up to considerable(public) government regulation

Access to capital

No separation

Negligible

Limited to owners and associates Business profits taxed in the hands of owner(s) Owner(s) may withdraw as much profit as they wish Little or no government regulation

MANAGEMENT FUNCTIONS:  The managers of a business are accountable to its owners for adequate profits as indicators of successful operation.  Entity to be successful, its management must be efficient and effective o Efficiency: maintaining a satisfactory relationship between an entity’s resource inputs and its outputs of g/s o Effectiveness: how well an entity attains goals. Management functions  Planning: what to do, how to do it  Organising: developing the organisational structure  Directing: performing according to plan  Controlling: evaluating actual vs planned performance BASIC FINANCIAL STATEMENTS:  Financial statements: Outcome of the accounting process, Primary info source for users, Useful for many decisions 3 Primary information types:  Financial performance: the ability of the entity to utilise its assets effectively and efficiently, o meet goals (profit)  Financial position: the financial resources controlled by the entity, financial structure, o measure of liquidity and solvency  Cash movements: the ability of the entity to generate cash flow, focusing on three areas 1. Operating: provision of and payment for g+s 2. Investing: acquisition and disposal of long term assets 3. Financing: raising of funds for an entity to carry out its operating and investing activities THE BALANCE SHEET: reports financial position of an entity at a specific point in time  Shows assets, liabilities and equity of the entity  Represents the accounting equation  Assets = Liabilities + Equity  Alternative formats (same information): Account format( A = L + E) , Narrative format (A-L = Eq)

WEEK 7: CHAPTER 10 REGULATION AND THE CONCEPTUAL FRAMEWORK REGULATION AND DEVELOPMENT OF ACCOUNTING STANDARDS HISTORY OF REGULATION  Generally Accepted Accounting Principles (GAAP)  Increasing complexity  Separation of ownership and control  Introduction of legislation to protect shareholders  international Accounting Standards FINANCIAL REPORTING COUNCIL (FRC): Overseer and advisory body to AASB  appoint members of the AASB and the AUASB, and approve and monitor the priorities, business plan, budget and staffing arrangements for both boards  determine the AASB’s broad strategic directions and encourage AASB to issue and adopt accounting standards which represent internationally accepted best practices. AUSTRALIAN ACCOUNTING STANDARDS BOARD: Adopts international standards for the Australian reporting system  Corporations Law  IASB  Role and responsibilities AUSTRALIAN SECURITIES INVESTMENT COMMISSION (ASIC)  Maintain, facilitate and improve the performance of the financial system and entities in it  Administer and enforce the law  Make information about companies publicly available Australian Stock Exchange (ASX): uses listing rules to monitor publicly listed companies and business rules for stockbrokers/advisers so that market is informed  Split into a stock exchange & future exchanges International Accounting Standards Board (IASB): formed in 2001/2002 and since 2005 is responsible for issuing international financial reporting standards globally The IFRS Interpretations Committee (IFRIC): interprets technical accounting issues- sub-committee of IASB Financial Accounting Standards Board (FASB): issues accounting standards in the US and has input from the securities exchange commission The Asian-Oceanic Standard-Setters Group (AOSSG): set up to promote convergence of IFRS with countries in region THE CONCEPTUAL FRAMEWORK: Must be consistent and meet needs of users and preparers – Develop logical, consistent standards – Provide guidance where no standard exists – Enhance understanding by users BACKGROUND TO CONCEPTUAL FRAMEWORK: 1. Set boundaries: Only GPFR’s Stakeholders- shareholders, investors, employees, public, gov, creditors 2. Define reporting entity criteria 3. Establish objective for financial reporting 4. Develop qualitative characteristics • In the 1990s Australia produced SACs 1 – 4 • SACs 3 & 4 replaced in 2005 by The Conceptual Framework for Financial Reporting THE REPORTING ENTITY: • Entity in which it is reasonable to expect existence of users who depend on general-purpose financial reports • Indicators of their existence 1. Separation of management from economic interest 2. Economic or political importance/influence 3. Financial characteristics

OBJECTIVES OF GENERAL-PURPOSE FINANCIAL REPORTING: • Provide information useful to users • Discharge of accountability by preparers • Adequate disclosure – Performance – Financial position QUALITIVE CHARACTERISTICS OF FINANCIAL INFORMATION • Fundamental Characteristics – Relevance: quality which makes a difference in decision of economic nature made by users • It will help users form predictions about the outcome of events • It will confirm or change their previous evaluations, • Must have predictive value and or confirmatory value • Materiality: relates to the significance of transactions, balances and errors contained in the financial statements – Faithful Representation: must be complete, neutral and free from material error- all necessary descriptions & explanations. E.g fair value or original cost • Enhancing Qualitative Characteristics – Comparability: enables users to identify and understand similarities and differences among items, with other entities & previous periods  consistency, e.g inventory costing methods – Verifiability: different and knowledgeable and independent observers could reach a consensus. documentation can be checked & audited, i.e calculating inventory – Timeliness: having information available to decision makers in time to be capable of influencing their decisions.  could influence usefulness, delays of financial reports – Understandability: information is clear and avoids unnecessary jargon ( complex relevant matters can still be kept in the accounts & explained in the notes) • Constraints on relevant, faithfully representative information – Cost *benefits produced for users must exceed costs of providing information – Costs include collection, storage, retrieval, presentation, analysis and interpretation, loss of competitive position. DEFINITIONS ELEMENTS OF FINANCIAL STATEMENTS: ASSET: 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 Three essential characteristics: 1. Resource must contain future economic benefits, must have the potential to contribute directly or indirectly, to flow of cash and cash equivalents to the entity. 2. Entity must have control over the resource in such a way that the entity has the capacity to benefit economically from the asset in the pursuit of the entity’s objectives, and can deny or regulate the access of others to those economic benefits. 3. The event or events giving rise to the entity’s control over the resource must have occurred.  o

Proposed: A present economic resource controlled by the entity as the result of past events an economic resource is a right, or other source of value, that is capable of producing economic benefits.