The main focus of this paper is on the primary qualitative characteristics of a financial statement. This was obtained from the conceptual framework laid down by the Accounting Standards Board. There have been four fundamental characteristics identified namely relevant, reliable, comparability and understandability and how has it been applied in the chosen company
There are also limitations in meeting the criteria of all the characteristics in preparing a financial statement. This paper analysis if the chosen company was able to overcome these limitations in order to produce a true and fair financial statement.
This paper discusses the qualitative characteristics of the financial statements and how it relates to the content and presentation of a financial statement. The second part of this paper sets out to assess the difficulty preparing a useful set of financial statements that exhibits the qualitative characteristics mentioned in the first part.
A financial report is a written report which quantitatively describes the financial health of a company. Financial statements are usually compiled on a quarterly and annually basis (investorwords). According to the Accounting Standards Board (1999), the objective of financial statement is to provide information on the reporting entity's financial position and performance that is useful to a wide range of users to assess the management and for decision making.
As per IAS 1 (international Accounting Standard), a complete set of financial statement comprises of:
- A statement of financial position (balance sheet)
- A statement of comprehensive income for the period (income statement)
- A statement of cash flow
- A statement of changes in equity
- Notes comprising a summary of significant accounting policies and other explanatory information.
- A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement in items in financial statement or when it reclassifies in its financial statement.
However, the primary financial statements comprises of statement of financial position, statement of comprehensive income and statement of cash flow.
In preparing a set of financial statements there is a set of principles that need to be adhered to. Qualitative characteristics are attributes which makes the financial statement useful to the users. There are four principle qualitative characteristics namely, understandability, relevance, reliability and comparability. Each of these qualitative characteristics have other characteristics that are attached to them in order to enhance the primary qcharacteristics.Understandability
Uses need to understand the information provided in the financial statement for it to be useful. The understandability depends on (Accounting Standards Board, 1999):
- The way a transaction and other events are characterised, aggregated and classified.
- The way information is presented
- The capabilities of the users. Assumption that users have a reasonable knowledge of business and economic activities and accounting is made when financial statements are prepared.
Relevant information is one that is able to influence the uses in decision making. It has predictive or confirmatory value. Predictive value is where it helps uses or capital providers to form their own expectations about the future. On the other hand, confirmatory value is when it is able to confirm of change past (or present) evaluations or assessments. When choices are to be made between relevant and reliable but mutually exclusive, the one that is most useful in decision making is chosen.Reliability
The information is reliable if (Accounting Standards Board, 1999 and Framework):
- It is able to represent faithfully what it purports to or could be reasonable expected to represent. A transaction or other event is considered represented faithfully in the financial statement if its recognition, measurement and presentation represent the effect of that transaction or event.
- Free from deliberate or systemic bias (neutral). The information is not considered neutral if it is selected and presented in a way that is able to influence the decision making process.
- Free from material errors
- Complete within the bound of materiality. Information id complete when all information necessary are included and it's omission can cause false or misleading information.
- A degree of cautions is applied when exercising judgement and making necessary estimates under uncertain conditions (prudence).
Comparability is where financial information enables users to identify similarity and differences between two sets of accounts. It helps in comparing similar information for two different periods of to compare the entity's performance with their competitors. There are two other characteristics that relate to comparability as follows:
- Disclosure of accounting policies
In order for information to be comparable, it has to be consistent from one period to another. Consistency relates to the application of the accounting policies and procedures used to prepare the financial statement. If comparability is the goal than, consistency is the mean in achieving it. (ED, 2008)
To compare information, uses need to be able to identify difference between the accounting policies adopted by an entity to record a transaction or other events, the accounting policies adopted from one period to another and policies adopted by different entities.RELATING THE PRINCIPLES TO THE CONTENT AND PRESENTATION OF FINANCIAL STATEMENT
The annual report for the year ended 31 December 2008 of ESSO Malaysia Berhad has been chosen for this assignment. This is a subsidiary of ExxonMobil in Malaysia and is listed in Bursa Malaysia main board. Some of the qualitative characteristics can be interrelated with each other.
In order the users understand the business activities of the ESSO, there is a brief explanation given on the activities carried out and performance throughout the reporting period. This is stated in the Chairman's Statement which is the first report in an annual report (pp 2-4). Besides that, there is also a statement that highlights corporate citizenship which talks about workplace and safety, environmental performance and community development (pp 14-17). ESSO also presented a statement on corporate governance. This report entails information about the board of directors, audit committee, nomination committee, directors' remuneration and internal control system.
Based on the review done on the annual report, it can be said that the information provided are relevant and would be able to help in decision making. It presents its income statement and balance sheet together with its' comparative figures. This gives users to evaluate and assess performance for the year reported. It is noted in the disclosure, that they have capital expenditure commitment and also contingent liabilities. This would help users to know and assess the future expenses of the company and the liability that they have.
On the other hand, comparative figures given also can be used for comparison purposes. Users can compare the performance of the company in 2008 as compared to 2007. For example there has been a decrease in the gross profit margin from 4.72% (2007) to 0.54% (2008). The consistency of the accounting policies used can be seen in the notes to the financial statement (pp 36-40). The breakdown of certain line item which does appears in the face of the income statement and balance sheet can be found in the disclosure. For example the property, plant and equipment for 2008 are RM 828,178,000 and the breakdown of this is available in the disclosure portion (Note 11, pp 43).
The management has assumed responsibility over information presented and disclosed in the financial statement. This can be seen in the directors' declaration and statutory declaration made by the directors and management (pp 51). This declaration gives a sense of reliability on the content of the statement. The company's auditor has given them an unqualified opinion which enhances the reliability on the financial statements. Besides that, the transactions are represented faithfully in terms of recognition, measurement and presentation based on the disclosure of the accounting policies adopted by ESSO.USERS OF FINANCIAL STAEMENTS
A financial statement is considered useful when the uses gain benefit from it or if they are able to use it practically for the intended reason. Different users have different need and use the financial statement from a different perspective. There is broad range of users identified as follows:
- The public
Investors are also known as the owners or potential owners. They are the providers of risk capital. They would be seek for information useful for decision making and would be risk inherent in and return provided by their investment.
They are the creditor of the entity and would need information to assess the creditworthiness of their debtor. At the same time the potential lenders would also use this information to decide if they want to lent to the firm.
Employees would need information to assess their employer's ability to continue to provide remuneration, employment opportunities and retirement benefits.
They would require information regarding the entity to regulate the activities, assess the taxation and provide basis for national statistics.
An entity affects the public in many ways. They may need the information to assess the entity's contribution to the local economy like providing employment or contribution to the community through social work and other.
Based on the users above it can be seen that each of them requires the statement for different purposes.CONSTRAINSTS ON THE QUALITATIVE CHARACTERISTICS
Sometimes there seem to be conflict between relevance, reliability, comparability and understandability.Relevance and Reliability
There have been times where the most relevant information may not necessarily be reliable and vice versa. This can be seen when choosing a measurement method for the asset or liability. Here the most relevant of the reliable information would be chosen. Timeliness on an information could also lead to a conflict between relevance and reliable. For example, an audited financial statement is only issued a few months after the year end by which the information could be outdated. Here the information may lose its relevance but it would be more reliable.Neutrality and prudence
Conflict can also arise between neutrality and prudence. Neutrality is where information is free from bias. On the other hand, there is potential bias using a prudence concept. This is because prudence seeks to ensure that assets, gains, liabilities and losses are not either understated or overstated in the presence of uncertainty.Understandibility
Under normal circumstances it is not easy to provide information that is relevant, reliable and comparable in a way where all users would be able to understand. However, reliable and relevant information should be included even though some users may not be able to understand and appreciate the information provided.HOW DID ESSO FAIR IN THIS?
As seen above, conflict between qualitative characteristics can happen in any financial statement. Based on the review done on ESSO's financial statement, there could be a few place where conflict could have arrived. Firstly the auditor's report was signed on 18 February 2009, which means the financial statement would only reach the public after this date. There would be is a gap of almost 2 months in between .Therefore, some information in the financial statement may be out date and not relevant to certain class of users. However, the information published is reliable.
Next the property, plant and equipment are all measured at historic cost less accumulated depreciation less accumulated impairment. For example if a property that has no impairment and the market value appreciates, it seems that the assets could be understated. This may not give a reliable value of the assets held. However, it is not feasible to revalue an asset every year if it is not held for investment purposes as revaluation by independent expert is costly. Therefore, it is more relevant to continue using the historic cost and test for impairment on a yearly basis.
Provision is an estimated amount which uses the prudence method. Provision for bad debts and provision for expenses incurred towards the end of the year are all based on management judgement. There may seem to be a certain level of biasness here. However, as the firm is sure that some of the debt may never be recovered but the amount is uncertain, the amount has to be estimated in order not to overstate the trade receivables.
There is some amount of foreign exchange gain or loss recorded in the financial disclosure (note 6, pp.41). This amount may be confusing and complicated fro users that do not have any accounting background. However, this amount still need to be included or it could distort the gain or loss of the firm.
Though some conflict could arise, the firm has manage to portray to include relevant and reliable information for the benefit of all users. They have also tried to make it understandable to all users by inserting charts and graphs where possible.CONCLUSION
Based on the findings above, there are four fundamental qualitative characteristics in preparing a financial statement. All of these characteristics have to be adhered to in preparing the statement. A review done on the financial statement of ESSO Malaysia Berhad, shows that they have to their level best complied with the principles mentioned above.
It is also noted that though these characteristics are fundamental in preparing a financial statement, conflicts between them can arise. This would make preparing a financial statement difficult. However, ESSO Malaysia Berhad seems to be able to portray the information which is more useful in order to fulfil the needs of its many stakeholders who rely on the financial statement to make decision.
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