Back to the question, it is necessary for financial reporting to rely on mandatory and statutory control because statute is a law that is mandate to be followed. Without regulations, financial report’s information will not be relevant and reliable which relates to the qualitative characteristics. With mandatory and statutory control, financial reporting is able to provide useful financial information to existing and potential investors, leaders and other creditors whom make decisions.
In order to satisfy the mandatory and statutory control, it must be following that the financial information is relevant and faithfully representing the financial statements to be enhanced if is comparable, verifiable, timely and understandable.
According to (Ganiyu, 2015), financial reporting satisfies faith representation if only it is relevant to the condition of the business, instead of just providing information about its legal form. It is considered to be perfect when faithful representation has the characteristics of complete, neutral and free from error. For example, if a company report has an amount of $1mil in account receivables as at the end of December in its balance sheet, then the amount must present on that date. As stated by (Bragg, 2014), financial statement should not have errors of the information with fair view for the organization. Financial reporting fraud happens when there is continuous error that causes bias to the result of the financial statement in certain way. Financial position and cash flow must be included in the financial statement to be complete for the readers of financial statement to look for the information they need in a clear form of result.
In addition, (Pearson, 2017) mentioned that, financial information must be comparable for users to identify and understand similarities and differences of at least two items. For instance, consistency is similar to comparability; however, they are not the same. Consistency helps to achieve goals; whereas, comparability is the goal. Information can be useful if they can be comparing to similar information between both entities for some other period. Users compare the current financial statement with past financial statement to derive with a meaningful conclusion.
(Ganiyu, 2015) stated that, verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. An independent accountant to consider verifiable should produce a company’s statement result as the same result. For examples, if a company has an asset of $100,000, after using all the depreciation method and cost of equipment, accountant must have a same amount for asset as given from the company. It can be direct or indirect. Direct verification is the verification of an amount or other representation through direct observation. Nonetheless, indirect verification is checking the inputs to a model, formula or other technique and recalculating the outputs using the same methodology.
All of the qualitative characteristics, which enhanced the financial information, should be maximized to the extent possible. To be more clarifying, a good financial reporting is the statutory and mandatory control that is followed accordingly.
(b) ‘An asset is to be defined in the Framework as an economic resource which an entity controls as a result of past events.’ Discuss whether property, plant and equipment automatically qualify as assets.
According to (Conceptual Framework for Financial Reporting, 2017), conceptual framework is defined as the concept established underlies financial reporting.
Property, plant, and equipment are qualified as an asset. According to IAS 16.7, property, plant and equipment recognized as an asset when possibility of the future economic benefits associated with the asset will flow to the entity, and the cost of asset is measured reliably. Then cost of for the initial measurement should be readily determinable. Otherwise, the asset would not meet the recognition criteria. Asset must be controlled by the entity in order to be recognized in financial statements. It is recognized when cost are incurred at the present time. Both incurred initially to acquire or construct an item of property, plant and equipment and incurred subsequently after recognition to add to, replace part of or service it. However, a property, plant and equipment item that qualifies for recognition, as an asset shall be measured at its cost. The cost of its item is the cash price equivalent at the recognition date. The entity shall measure an item of property, plant and equipment at initial recognition at its cost.
According to the definition, property, plant and equipment does not need to be directly involved in a process of manufacturing. As long as the item is an asset of the reporting entity, and the asset is an item of PPE, it is considered as an asset in property, plant and equipment. An asset must be a physical resource purchased by the business and used at their business discretion for their product, must result in cash flow or generate income from the customers to business. Business will not purchase property, plant and equipment unless it gives future economic benefits that will flow to the business.
Under IAS 16.14, “continued operation of an item of property, plant, and equipment (for example, an aircraft) may require regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognized in the carrying amount of the item of property, plant, and equipment as a replacement if the recognition criteria are satisfied. If necessary, the estimated cost of a future similar inspection may be used, as an indication of what the cost of the existing inspection component was when the item was acquired or constructed.”
(c) Download copies of the Financial Reporting Review Panel’s Annual Report from year 2012 to 2015 and critically discuss the major areas of criticism raised by the Panel in relation to Statement of Cash Flows and the improvements that could be expected in future years. (30 Marks)
Cash flow is the movement of money in and out from the business. It is a measurement of an organization’s liquidity that gives the user information about the cash receipts and cash payment of the business during the accounting period. Statement of cash flow gives a more complete financial view of the company and shows how much cash does the company have.
According to the Financial Reporting Review Panel’s Annual Report from year 2012 to 2015, there is an inconsistency between matters reported in the statement of cash flow in year 2012 and 2013. The panels also reported that in year 2012, 2014 and 2015, there are misclassifications of cash flows and non-cash movement as cash flows. However, there is a difference reported by the panels from the annual report. Inappropriately netted item was reported in the annual report of year 2014.
Statement of cash flow refers to the movement of cash and cash equivalent. Cash equivalent is short-term, which is 3 month or less, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value. To further illustrate, inconsistency in accounting explains the hidden cost, low sales, low payment, lack of productivity that causes businesses to fail. (Weiss & Yang, 2007) argues that the cash flow statements determine company’s performance. However, there are some weaknesses that make cash flow statement less useful. They are problems with operating activities, investing activities and financing activities. For example, when interest income and expense is not included in the “income from operations”, interest paid or received is presented as cash flows from operating activities. Somehow, it should be present in finance or investing activity. The ways behind accounting standards how transactions are recorded is one of the factors that cause inconsistency. Entities may record their revenue under income, but may not receive the cash in the current year or even years. When customers or clients do not pay to the entities, high chances it will be a bad debt. Though, there are qualified and experience adviser to solve the inconsistencies of the business cash flow.
Secondly, the panels stated that there is a misclassification in cash flow in financial reporting review panel’s annual report year 2012,2014 and 2015. Misclassification defines as a difference between an amount, misstatement or measurement error in a financial statement that is required to present fairly in accordance of the financial reporting framework. It can be arise from fraud or error. This can cause a transparency in financial reporting. According to (Hollie et al., 2011), “firms generally overstated cash flows from operations and understated cash flows for investing activities, thereby misrepresenting overall cash flows.” As mentioned by (AICPA, 2016), misclassified can cause by several reasons which are an omission of an amount or disclosure, a financial statement disclosure that is not followed in accordance of the financial reporting standards framework and an incorrect accounting estimation or misinterpretation of facts.
The panels also mentioned that there is a non-cash movement of cash flows in the annual report year 2012, 2014 and 2015. Non-cash movement is an accounting entry correlating to expenses rather than an actual movement of cash on a cash flow statement or an income statement. Before preparing a statement of cash flow, make sure that the cash is moving and was expensed. For instance, provision needs to record in a statement of cash flow, which is measured annually. It is no cash normally; therefore, changes are not in the direct outflow of cash. (IPSAS 2, 2000) stated that all investing and financing activity are non cash transaction that should be excluded in the statement of cash flow, which do not have direct impact on the current cash flow although they affect the capital and asset structure of an entity.
The only difference in the financial reporting review panel’s annual report in year 2014 is inappropriately on cash receipts and payments. (Alderman et al., 1991) argues that the net amount in a statement of cash flow may not be appropriate depending on the circumstances. For examples, if cash proceeds from an incurred liability are used to pay off another liability, this should be treated as a refunding if no cash is exchanged and omitted from the statement. The netting of inflow and outflow is appropriate only when there is a exchange between cash and cash equivalent, item that characterized by quick turnover, large amount and short maturity, and an exception involving financial institution. “CPAs should ensure the netting of cash receipts and cash payments does not misrepresent the underlying transactions and should be careful when using a worksheet to prepare the cash flow statement. Deriving cash flow transactions merely by comparing ending balances to beginning balances in various accounts could produce an inappropriate netting of cash receipt and payment transactions.”