Importance of Accounting Concepts and Principles for Financial Reports by ASX Listed Entities

This report discusses the importance of using accounting concepts and principles provided by the conceptual framework of accounting for developing financial reports by ASX listed entities. It examines the accounting concepts used by Ramsay Health Care Limited in the development of its financial report.

Advanced Financial Accounting
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Executive Summary
This report has been undertaken in the context of discussing the importance of using
accounting concepts and principles provided by the conceptual framework of accounting for
developing financial reports by ASX listed entities. As such, the examples from a selected ASX
listed company, Ramsay Health Care limited, has been used to examine the accounting concepts
used by the company in development of its financial report. The issue of measurement in
accounting and importance of fundamental qualitative principles of accounting framework has
also been analyzed in the context of the selected company.
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Contents
Introduction......................................................................................................................................3
Part 1: Descriptions of Accounting Concepts..................................................................................3
Part 2: Conceptual framework, and the Issue of Measurement.......................................................5
Part 3: Relevance and Faithful Representation of Information as per Fundamental Qualitative
Characteristics and Examining their Importance over each other in reference to the Selected
Company..........................................................................................................................................8
Conclusion.....................................................................................................................................10
References......................................................................................................................................11
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Introduction
The businesses are required to develop and disclose the financial information by adhering
to certain fundamental accounting concepts and principles for ensuring their accuracy and
relevancy and protecting the stakeholder interests. In this context, IASB (International
Accounting Standards Board) has developed and provided the conceptual framework of
accounting in order to provide guidance to the businesses for preparing and disclose the financial
information. This report is meant for conducting an analysis of the various types of concepts and
principles used by an ASX listed entity. The AASB (Australian Accounting Standards Board)
has also directed its ASX listed entities to comply with the IASB accounting concepts and with
the conceptual accounting framework principles. The selected ASX listed for conducting the
overall analysis is Ramsay Health Care Limited, a private health care company that is specialized
in proving mainly surgery, rehabilitation and psychiatric care services across the UK, Australia,
France, Indonesia and Malaysia. The company is headquartered within Australia and has the
presence of approximately 200 hospitals within the country. This report provides an analysis of
the accounting concepts used and compliance with the conceptual accounting framework
measurement principles and with its fundamental qualitative characteristics. The overall analysis
is carried with the use of information provided within the annual report of the selected company.
Part 1: Descriptions of Accounting Concepts
Ramsay Health Care Limited is a profit company operating within Australia traded on the
ASX (Australian Securities Exchange). The financial reports of the company are developed in
accordance with AASB standards and the Corporations Act 2001. The Group has developed its
consolidated financial statements to depict the financial results of its subsidiaries as per the basis
of consolidation.
Accounting concepts are the standards and guidelines that requires to the followed while
recording the accounting transactions and preparing the financial reports. There are many g
concepts of accounting that company needs to follow while performing the accounting process
and preparing their annual report. Accounting concepts used by Ramsey Health Care Limited
while preparing its annual report are as under:
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Use of accrual concept: As per this accounting concept revenue can only recognised only when
it has been earned not when compensation has been received. Similarly, expenses must be
recorded for the period when they occur not when they are actually been paid. As per this
concept, the cash received and cash payment does not impact the income statement as cash flows
for revenue and expenses can take place in any accounting year depending upon the company
policies (Needles, Powers and Crosson, 2013). The accrual concept requires company to
maintain accounts such as accrual expenses, unearned income, prepaid expenses, and outstanding
income. These accounts help to make reconciliation of cash flows and balance of revenue and
expenses shown in income statement.
Ramsay Health Care make use of accrual concept to record for the income & expenses,
and same can verified through the balance sheet as company make of above mentioned accounts
to record for period specific revenue and expenses.
(Source: http://www.ramsayhealth.com/common/emag/rhc/annualreport2018/RHC-AR2018.pdf)
The prepayment shown above in current asset section reflects expenses have been paid by
cash in the current year but they are related to next year (Ramsay Health Care Limited: Annual
Report, 2018).
Consistency Concept: As per this accounting concept entities should be consistent while
applying the accounting method for measurement and recognition unless there is requirement to
do so by the accounting standards or any other sound reason (Needles et al., 2013). Ramsay
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Health Care has make use of same accounting methods that have been applied in past period.
Any change in accounting method and recognition has been disclosed separately in annual report
and reason for the change has also been provided (Ramsay Health Care Limited: Annual Report,
2018).
Going Concern: This accounting concept provides that company is forever and will remain
active forever. Ramsay Health Care has made its financial statements on the assumption that it
will remain operational for future and due to this assumption it has deferred the recognition of
expenses to later reporting period (Ramsay Health Care Limited: Annual Report, 2018). If this
concept is not followed than company should have recognized all expenses in the current period
and will not leave expense recognition for later period (Albrecht, Stice, and Stice, 2010).
Matching Concept: This concept tends to provide that expense related to respective income
must be recognised in same period as income has been recognized. This concept clarifies that all
aspects of accounting transactions have been covered in same period. For example, when goods
are sold, sales revenue is recorded and at the same time cost of sold have been recognized to
match the inventory used and to provide for expenses to earn the particular income. It means
some sort expenses will always occurred to earn any type of income (Albrecht et al, 2010).
Ramsey Health Care has strictly followed this accounting concept through recording all expenses
corresponding to respective revenue in the same period (Ramsay Health Care Limited: Annual
Report, 2018).
Economic Entity Concept: This accounting concept is most important as this concept provide
that business entity and business owner are two separate bodies and any accounting transaction
related with the business owner should not be consider while making accounting of business
transactions. This concept helps to make assure that only those transactions have been accounted
for those are related with business not with personal transactions. Ramsey Health Care has
followed this accounting concept very strictly and it has provided accounting information of
business entity only (Ramsay Health Care Limited: Annual Report, 2018).
Part 2: Conceptual framework, and the Issue of Measurement
This framework of accounting has stated that a financial information in order to be
relevant and represent faithfulness for protecting the interests of the end-users. The objective of
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the conceptual framework is to attain a balance between these two stated characteristics and
maximize the usefulness of the financial information disclosed by an entity. However, the quality
of financial statements may be negatively impacted due to measurement error faced by business
entities during selection of a measurement base for reporting their financial items (Grüber,
2014). The measurement error in reporting of financial items is present due to involvement of
many events and circumstances that require estimates. For example, the managers are requires to
estimate the collection of accounts receivable. Depreciation method used for fixed assets and
others. The accounting discretion provided to the managers in selection of accounting estimates
can result in the occurrence of measurement error. This is because the discretion provided to the
management may negatively impact the relevance and faithfulness of the financial information
provided by an entity to its end-users (Mirza and Knorr, 2011).
The accounting discretion provided to the business managers can result in negatively
impacting the materiality of the financial information by injecting biasness in the reported
financial amounts. This has resulted in causing the occurrence of measurement error within
accounting that is emphasizing on the need for ensuring the reliability of the accounting
estimates used by the business managers. This is because the theory of agency has stated that the
business owners that are the shareholders intends to reduce the cost of agency by linking
compensation of business managers with the profitability released by the firm. As such, the
managers in order to realize higher incentives can adopt the use of biased accounting estimates
such as underestimating the amounting of receivable for reporting higher profits. This results in
understating the bad debts and overstating earnings (Wolk, Dodd and Rozycki, 2016). However,
it may have a negative impact on the interests of the end-users such as investors, creditors,
lenders and other stakeholders of an entity. This has resulted in developing of a mixed
accounting model that emphasizes on prevent managers from use of subjective bias into the
valuation of financial items. The model has advocated that financial items should be measured
with the use of various combinations such as historical data, current information and expectation
of the future outcome (Dye and Sridhar, 2010).
In this context, the selected company Ramsay Health Care Limited has provided in detail
the accounting judgments, estimates and assumptions that are being sued for gaining an estimate
of its future performance. The assets and liabilities that have been recognized through business
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combinations have been reported at their fair values. The judgments and estimates used during
measuring the financial items have been examined in detail in the notes section of the company.
For example, recognition of land and buildings in a business combination is done on fair value
that is determined by an external value on the basis of significant estimates and assumptions.
This is done to ensure relevancy in the financial information.
(Source: http://www.ramsayhealth.com/common/emag/rhc/annualreport2018/RHC-AR2018.pdf)
The second example that can be presented in this context is use of accounting predictions
by the company in estimating the useful lives of its fixed asset base. It has also been stated in
detail, in the financial report section of the annual report of the company. The useful lives of the
assets are measured with the use of historical experience to depict reliable financial information.
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(Source: http://www.ramsayhealth.com/common/emag/rhc/annualreport2018/RHC-AR2018.pdf)
Thus, it can be said that the selection of a measurement base for reporting the financial
information is based on the type of financial items and ensuring to realize a tradeoff between
relevance and reliability principles of the accounting framework (Ramsay Health Care Limited:
Annual Report, 2018).
Part 3: Relevance and Faithful Representation of Information as per Fundamental
Qualitative Characteristics and Examining their Importance over each other in reference
to the Selected Company
The qualitative characteristics of accounting framework intend to identify and report the
type of information that is useful in decision-making. The conceptual framework has provided
two fundamental characteristics of financial reporting that is relevant and faithful representation.
The relevancy refers to effectiveness of financial data in assisting the decision-making of the
end-users. This implies that the financial information provided by a reporting entity must make a
difference in the decision-making of the end-users such as investors, lenders, creditors or general
public at large. This means that it should possess a predictive and a confirmatory value to be
reliable for making investment decisions (IFRS, 2017). The predictive value denotes its ability to
predict the future performance of the company such as that provided in income statement
whereas confirmatory denotes its ability to ensure the present as well as past financial
performance such as that provided within the statement of financial position. The faithful
presentation of financial information implies that it should be materially correct and free from
the presence of any type of error. The financial transactions carried out by an entity should
present faithfully the financial position of assets, liabilities and equity of an entity at the
reporting date. In addition to this, the financial information should be free from any type of
biasness and should accurately depict the economic outcome that it intends to represent
(Conceptual Framework for Financial Reporting 2018, 2018).
The IASB (International Accounting Standards Board) conceptual framework has linked
closely the faithfulness and relevancy of financial information in shaping the economic reality of
an entity and representing it to the end-users. However, the main accounting challenge that is
present before the IASB in this context is to create compatibility between these two qualitative
characteristics of financial reporting. This is because placing large emphasis on relevancy can
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make the financial information less relevant while if high importance is made on its faithful
presentation then it can become less reliable (Wahlen, Baginski and Bradshaw, 2017). For
example, as per accrual accounting, the sales done by a company on credit is recognized as
revenue and thus increasing the relevancy of the revenue information. However, the sales have
not been actually realized and as such it does not represent the true and fair view of revenue
position of the company to the end-users. However, it has been argued by various accounting
researchers that financial information should be made more relevant as it is more important that
fair representation. This is because to be relevant financial information need to depict the past,
present and future financial position of an entity and make a difference in the decision-making of
investors (Bellandi, 2017).
As such, the use of relevancy in financial accounting of assets and liabilities would
ensure that the information provided has both predictive and confirmatory value. It also ensures
that the financial data disclosed for assets and liabilities is materially accurate and will protect
the interest of end-users by assuring that they are able to take right investment decisions
(Hopwood, 2013). On the other hand, faithful presentation means that financial data presented
should not have any error which is quite difficult due to use of accounting estimates and
assumptions during financial reporting of assets and liabilities. Also, relevant in it ensures that
financial information provides is materially accurate as faithful presentation does not indicate
that is it is accurate in all respects. It only means that the financial information should be able to
explain the nature and limitations of estimating process used to ensure that no errors have been
made in implementing that accounting estimate (Burlaud, 2013).
The importance of relevance over faithful presentation of information in financial
accounting of assets and liabilities can also be ascertained by providing examples from the
financial report of Ramsay Healthcare Limited. For example, it has recognized its financial
assets and liabilities initially at fair value for ensuring that the information provided is relevant
and is able to assist the future investment decisions. However, if the financial information is to
be provided in accordance with faithful presentation then financial assets and liabilities need to
be measured at historical cost for ensuring that it is reliable and represent the true view of the
financial position (IFRS, 2017). However, the subsequent measurement of the financial assets is
based on their type of classification. The fixed assets are recognized at historical cost and thus it
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can be said that the company has tried to achieve a tradeoff between relevance and reliability by
the use of different method of accounting as per the nature of assets and liabilities. However,
more emphasis is made on providing more relevant financial information so that it is able to aid
in accurate economic decision-making (Ramsay Health Care Limited: Annual Report, 2018).
Conclusion
It can be restated on the basis of discussion conducted that has provided the accounting
concepts, policies and principles to be used by businesses complying with IASB standard during
development and presentation of their financial statements. The accounting concepts such as
accrual basis, consistency and going concern are commonly adopted by business during financial
reporting. The businesses are also trying to achieve a tradeoff between reliance and faithful
representation of financial information to ensure that it is both relevant where it needs to be and
is fair on some other aspects. The use of differ measurement base by an entity for reporting its
financial items such as assets and liabilities is done as per the mixed model of accounting that
emphasize on attaining a balance between relevance and reliability qualitative characteristics of
financial reporting.
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References
Albrecht, W., Stice, E. and Stice, J. 2010. Financial Accounting. UK: Cengage Learning.
Bellandi, F. 2017. Materiality in Financial Reporting: An Integrative Perspective. UK: Emerald
Group Publishing.
Burlaud, A. 2013. Should Financial Statements Represent Fairly or be Relevant? [Online].
Available at: https://halshs.archives-ouvertes.fr/halshs-00873959/document [Accessed on: 20
May 2019].
Conceptual Framework for Financial Reporting 2018. 2018. [Online]. Available at:
https://www.iasplus.com/en/standards/other/framework[Accessed on: 20 May 2019].
Dye, R. A., and Sridhar, S. S. 2010. Reliability-relevance trade-offs and the efficiency of
aggregation. Journal of Accounting Research, 42(1), 51-88.
Grüber, S. 2014. Intangible Values in Financial Accounting and Reporting: An Analysis from the
Perspective of Financial Analysts. Switzerland: Springer.
Hopwood, T. 2013. Accounting From the Outside (RLE Accounting): The Collected Papers of
Anthony G. Hopwood. London: Routledge.
IFRS. 2017. Measurement uncertainty and the fundamental qualitative characteristics of useful
financial information. [Online]. Available at:
https://www.ifrs.org/-/media/feature/meetings/2017/september/iasb/cf/ap10-conceptual-
framework.pdf[Accessed on: 20 May 2019].
Mirza, A. and Knorr, L. 2011. Wiley IFRS: Practical Implementation Guide and Workbook.
USA: John Wiley & Sons.
Needles, B.E., Powers, M. and Crosson, S.V. 2013. Principles of Accounting. UK: Cengage
Learning.
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Ramsay Health Care Limited. 2018. Annual Report. [Online]. Available at:
http://www.ramsayhealth.com/common/emag/rhc/annualreport2018/RHC-AR2018.pdf[Accessed
on: 20 May 2019].
Wahlen, J., Baginski, S. and Bradshaw, M. 2017. Financial Reporting, Financial Statement
Analysis and Valuation. USA: Cengage Learning.
Wolk, H., Dodd, J.L. and Rozycki, J. 2016. Accounting Theory: Conceptual Issues in a Political
and Economic Environment. USA: SAGE Publications.
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