Financial Reporting Quality: A Review

This assignment delves into the multifaceted aspects of financial reporting quality. It analyzes various studies and reports, including 'Revisiting the Evidence in Financial Reporting Quality' by Leuz and Wysocki (2016), to understand how mandatory IFRS adoption affects disclosure quality and accuracy of analysts' earnings forecasts. Additionally, it explores the economic consequences of disclosure regulation and the impact of accounting conservatism on the cost of capital. The assignment also covers the conceptual framework for financial reporting and its application in various contexts.

FINANCIAL REPORTING

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Conceptual and regulatory framework of financial reporting.....................................................1
Stakeholder and the importance of financial information to stakeholders..................................3
Importance of financial reports to the organisation....................................................................5
Income Statement........................................................................................................................7
Statement of changes in shareholders equity..............................................................................8
Balance sheet...............................................................................................................................8
Interpretation of financial performance......................................................................................9
Difference between IAS and IFRS............................................................................................11
Advantages of IFRS..................................................................................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................15

INTRODUCTION
Financial reporting is an essential part of any organisation whether it is from service
industry or manufacturing industry. Financial reporting is the process of preparing statements
that are used to disclose the financial status of any organisation to its internal as well as external
users. The basic reports of financial reporting are statement of financial position, statement of
profit and loss(also known as income statement), shareholders equity statement and statement of
cash flow. All the listed companies are subjected to preparation of these financial statements for
all their financial years. For the preparation of financial reports, various boards have issued the
standards like International Accounting standards, International Financial Reporting system and
Generally Accepted Accounting Standards. These reports provide the useful information to its
users which are then able to make economic decisions.
The present report will throw some light on conceptual and regulatory framework,
qualitative characteristics and objectives of financial reporting. This report will also show the
importance of financial information to the stake holders of any organisation. The report clearly
identifies internal and external stakeholders of any organisation. In the present report, financial
statements including balance sheet, income statement and statement of changes in equity has
been prepared for Rita plc. And the interpretation of its financial statements has also been
provided. The present report also provides the interpretation of the financial performance of
Sainsbury that is UK based supermarket chain, has been provided. This also includes the
difference between International Financial Reporting System and International Accounting
Standards and the benefits of IFRS.
Conceptual and regulatory framework of financial reporting
Conceptual and regulatory framework of financial reporting has been provided to define
the purpose and nature of accounting. It must consider the conceptual issues and theoretical
issues surrounded the financial reporting. In accordance to the financial reporting, conceptual
framework can be referred as a Statement of Generally Accepted Accounting Principles
(GAAP).
1

Conceptual framework provides the theoretical basis as how the financial information is to be
presented and communicated to the users (Conceptual Framework for Financial Reporting,
2017).
To provide useful information related to economic decisions to its users is the main
motive of financial reporting. The regulatory framework of IFRS addresses the following:
The objectives of financial reporting:
 The primary users of the information of financial reporting are investors, lenders and
creditors. The information is used to take some decisions regarding selling, buying or
holding equity or debt instruments.
 The information is also used by the primary users to not only assess the future net cash
inflow of the entity but to also identify the responsibility of the management towards the
effective and efficient utilisation of entity's existing resources.
Reporting Entity:
 The reporting entity is an entity where the users exist who depend on the information of
financial statement to make economic decisions.
 An entity to be a reporting entity need not to be a legal entity. It could be a part of an
entity. A parent entity having subsidiary entities should present its financial statements in
consolidated form.
Useful Financial Information and its Qualitative features:
This includes the type of financial information that could be the most useful information
to the users for taking their decisions (Ahmed, Neel and Wang, 2013). The decisions are based
on the reporting entity and the information of its financial reports. Financial information should
contain following qualitative features: Relevance: The information presented in the financial reports must be relevant to the
reporting entity. A financial information to be relevant must contain predictive value,
2

confirmatory value or both, these values are capable to make a difference in the decisions
of users. Materiality: It is an entity specific information. For an information to be material,
auditors and accountants need to focus on that aspects of the company that can
significantly affect the decisions of users. Faithful Representation: Financial reports represents economic phenomena in numbers
and words. Therefore, the numbers and words should present a true and fair view and
should be free from misstatements. Comparability: Financial reports will be useful only if the reports can be compared
across the periods and the companies. Verifiability: Financial reports must have the characteristic of communicating underlying
economics of the company's business.
 Understandability: Characterising, classifying and presenting the financial information
concisely and clearly makes the financial information Understandable.
Other contents of IFRS framework are:
 The measurement criteria and recognition criteria of the information of financial
statements (Bonetti, Magnan and Parbonetti, 2016).
 Definition of financial statements
 Concepts of capital and capital framework.
From all the above qualitative characteristics, the financial information becomes more
reliable.
Stakeholder and the importance of financial information to stakeholders.
In general term stakeholders of any organisation is a member of a group without whose
support, the organisation would cease to exist. Stakeholders can be termed as any organisation,
group or person who has an interest in the affairs and the activities of the organisation.
Internal Stakeholders
3

Employees: Employees of any organisation are the one who create the companies products and
services that are consumed by the customers. If, the best employees of the organisation are
antagonized then the company's customer service will suffer.
Shareholder: These are considered the owners of the company. Shareholders invests the capital
in the company in order to bring the company in a running position, therefore their needs are
important. The board acts on the behalf of shareholders, so they have the capability to replace the
CEO and the executive team. They will act only when the things are going badly wrong.
External Stakeholders
Customers: Every company's purpose is to create more and more customers. A company cannot
survive without customers, therefore the need of the customers comes first (Brigham, 2014). The
customer is the only one that can make the business or can drop the business if shifted to the
competitor. Therefore, in order to retain customers it is essential for the company to innovate its
products on continue basis and offer the products at a rate that gives a good value of money.
Suppliers, other business partners: The company need to maintain relation with their partners to
run the business. Companies, having good long- term relationships with their suppliers can
succeed in long term. Good relationship with suppliers enables the business to develop
strategies, objectives and vision. Distributors and other business partners. In 21st century,
Suppliers have become more critical stakeholders.
Creditors: Lenders to the business are key stakeholders as they provide finance business
ventures, asset and building purchases and supply purchases. Banks provides loans for the
purpose of major purchases of assets like land and building and suppliers provide inventory on
credit. The only expectation of the creditors from business is that the business meets its payment
deadlines consistently and responsibly.
The Local Community: A business to become successful need to be a good citizen. Business
should fulfil its corporate social responsibility towards the community. An organisation should
be seen as a good employer that can provide a good work place (Ongore and Kusa, 2013). The
local community is important for any business but at a lower priority than the other stakeholders.
4

Government and Regulatory Authorities: every business need to comply with the regulations in
order to avoid disputes and prosecution. Decisions of government entities may have a significant
impact to the operational activities of the business. Therefore, company managers should focus
on maintaining good relationships with the government and local authority.
Importance of financial information to stakeholders
Financial information of the company can have significant impact on the decisions of
stakeholders (Brüggemann, Hitz and Sellhorn, 2013). All the stakeholders want to see the use of
their investments in the company and also to assess the management through the financial
statement. They require the financial information for the following purposes:
 To determine how well the company is operating.
 To find out the ratio of the company's revenues and expenditure.
 To get idea about the company's future strategies, plans and tactics.
 To know whether the company is earning profits or is suffering from loss.
 To know hoe the assets of the company stacks up against the liabilities of the company.
 To determine whether the business have enough capital for its future growth.
Importance of financial reports to the organisation
In all kinds of industries whether service or manufacturing, there are multiple
departments, which functions to achieve organisational goals and objectives. The functions of all
these departments may be dependent or independent. However, at the end of the day all these
departments are linked together with accountancy and finance department (Daske and et.al.,
2013). The various accounting aspects of all these departments are then reported to the
stakeholders, internal stakeholders as well as external stakeholders. For external stakeholders,
there is financial reporting and for internal stakeholders there is management reporting.
Financial reporting objectives:
Financial reporting is done with an objective to identify financial position and the
financial performance of the company. Its objective is also to provide information to the users of
that company so that they can make better economic decisions.
5

Illustration 1: Financial Reports
(Leuz and Wysocki, 2016)
Following is the summary of objectives and purpose of financial reporting:
 It provides information to the organisation's management which is then used for the
purpose of benchmarking, decision making, planning and analysing.
 It provides information to the external users including investors, promoters, creditors and
debt providers which enables them to make prudent and rational decisions regarding
credit, investments, etc.
 It provides the information about the various aspects of the organisation to the
shareholders and external users.
 Information about the procurement and the utilisation of resources of the company.
 With the help of financial reporting, management enhances social welfare by looking
towards the interest of employees, government and trade union.
All the objectives of financial reporting creates base for the organisation to meet their
organisational goals and objectives (Flower, 2016). Through all the above information that is
provided in financial reporting:
6

 More investors will get attracted towards the organisation if the reports show good
percentage of earnings to the customers.
 More investor's means more expansion of the business.
 With the help of the reports, management is able to make better future decisions
regarding investments, production, and about all other operational activities.
 Financial reporting provides the information that the operations of the business are going
in the way to accomplish the missions and visions of the organisation or not.
 It helps in identifying the loopholes of the organisation to the management, which can be
rectified at the right time.
 A sound financial position of the organisation will attract more customers which in turn
increase the profitability and the performance of the business.
Income Statement
Under this, financial statements of Rita plc are prepared and analysed.
Statement of profit and loss of Rita plc for the year ended 31st December 2016
Particulars Amount (£) '000
sales 285100
COGS -191700
Add: depreciation -4225
GPR 89175
Other income 1600
Operating expenses -39500
Add: depreciation -4225
Bank interest -1030
Loss on valuation of investment -3300
Provision for tax -12000
Net Profit 30720
7

Working notes:
Calculation of distribution of depreciation amount
Particulars Details (£) '000 Amount (£) '000
Depreciation on Land and Property 84000/16 5250
Depreciation on plant and equipment
(48000-22400) *0.125
3200
Total 8450
Cost of sales 8450*50% 4225
Operating expenses 8450*50% 4225
It is been assumed that the company is holding damaged goods, and no rectification
charges have been applied.
Like Income statement, cash flow is also a financial report. It is similar to income
statement but the only difference between two of them is that the profit and loss statement also
takes some non- cash items in account such as depreciation. Therefore, income statement of any
company also provides information about expenses and incomes which are of non- cash nature.
However, the cash flow statement is prepared to determine the short-term liquidity position of
the company.
Statement of changes in shareholders equity
Statement of changes in equity of Rita plc at the year ended 31st December 2016
Particulars Share Capital (£) '000 Retained Earnings (£) '000
opening balance nil 23300
net income 30720
dividends -6670
issue of share capital 40000
Total 40000 47350
8

Balance sheet
Balance Sheet of Rita plc at the year ended 31st December 2016
Particulars Details (£) '000 Amount (£) '000
Assets
Non-current assets
Plant and equipment 25600
Less: depreciation -3200 22400
Land and property 84000
Less: depreciation -5250 78750
Investments 18000
(A) 119150
Current assets
Inventories 14000
Trade receivables 18000
(B) 32000
Total Assets (A+B) 151150
Equities and liabilities
Equity
Ordinary shares 26700
Retained earnings 47350
Preference shares 13300
(C) 87350
Non-current liabilities
Deferred income tax 6900
Revaluation reserve 28000
(D) 34900
Current Liabilities
Trade Payables 15700
9

Bank Overdraft 1200
Provision for tax 12000
(E) 28900
Total Liabilities (C+D+E) 151150
Statement of financial position is the summary of company's financial information, while
statement of cash flow is the summary of company's flow of cash. Essentially cash flow
statement of any company measures the inflow and outflow of cash, while balance sheet of the
company measures the assets, liabilities and owner's equity of the company. Cash flow statement
provides the information about how changes in the statement of financial position and profit and
loss statement affects the cash position of the company.
Interpretation of financial performance
For the purpose of interpretation of financial performance, the organisation taken is
Sainsbury. Sainsbury is UK based one of the largest chain of supermarket. Below is the
interpretation of its financial performance with the help of ratio analysis. Ratio analysis intends
to determine and interpret the numerical relationship based the information of financial
statements.
Liquidity Ratios
Ratios Formula 2016 2017
CA (Current Assets) 26.18 31.98
CL (Current Liabilities) 39.62 43.44
Current Ratio CA / CL 0.66 0.74
Quick Assets 7.89 7.01
Quick Ratio quick assets/ quick liabilities 0.20 0.16
These ratios help in testing the short-term liquidity and solvency position of the business.
It enables the management to check the efficiency of working capital employed. Ideal ratio of
current ratio is 2:1. High current ratio reflects over capitalisation and under trading. Sainsbury
10

should make efforts in order to increase its sales. Ideal quick ratio is 1:1. Sainsbury has a low
quick ratio which means its liquidity position is not sound.
Profitability Ratios
Ratios Formula 2016 2017
GP (Gross profit) 1456 1634
Sales 23506 26224
NP (Net profit) 471 377
GPR GP/ sales *100 6.19% 6.23%
NPR NP / sales *100 2.00% 1.44%
Profitability ratio of any company indicates the profit earning capacity of that company.
These are calculated either in relation to investments or sales. Gross Profit ratio of Sainsbury is
low therefore, the management of Sainsbury is incapable to develop the sales volume. Higher the
net profit ratio, better is the profitability of the business.
Financial Performance Ratios
Ratios Formula 2016 2017
Capital employed 7212.86 7495.03
Return on Invested capital NP / Capital employed 6.530 5.030
Return on Assets 2.810 2.050
These ratios indicate the financial performance of the company. Return on capital
employed is of great importance to prospective and present the shareholders. This ratio indicates
how well the management is utilising resources of the organisation
Solvency Ratios
Ratios Formula 2016 2017
Shareholders’ Equity 37.5 34.82
Long term Debt 12.1 9.75
11

Debt-equity ratio
Shareholders equity / long term
debt 3.10 3.57
Through solvency ratio, the ability of the organisation to repay interest and loan amount
is determined. It indicates whether the organisation is capable to meet its long-term obligations.
Ideal ratio of debt equity ratio is 2:1. Debt of the Sainsbury is more than twice of equity that
means it has a weak financial structure.
Activity Ratios
Ratios 2016 2017
Total Asset Turnover Ratio 1.4 1.43
Fixed Assets Turnover Ratio 2.42 2.65
Inventory Turnover Ratio 22.44 17.93
Activity ratios indicates the performance of the organisation. Most of the ratios under this
category are based on turnover, therefore these are also known as turnover ratios. Inventory
turnover ratio establishes the relation between average stock holding capacity of the company
and Cost of goods Sold. Ideal ratio of inventory turnover ratio is 8 times. Sainsbury’s inventory
ratio is more than 8 times that indicates under investment in inventories.
Difference between IAS and IFRS
International Accounting Standards are issued by IASB (International Accounting
Standard Board). Those companies which are not listed on any stock exchange and those which
are listed locally are under the obligation to use their financial statements according to these
standards, of the countries who have accepted these (Fraser, Ormiston and Fraser, 2010).
The only major difference in International Accounting Standards (IAS) and International
Financial Reporting System (IFRS) is that the series of standards of International Accounting
Standards were published between 1973 and 2001, by International Accounting Standard
Committee (IASC). Whereas, the series of standards of IFRS were published from the starting of
2001 by International Accounting Standard Board (IASB).
12

At the time of establishment of IASB, it was agreed to adopt all the IAS's and name these
standards in future as IFRS (Glaum, and et.al., 2013).
One another major implication between two is that, in case of any principle within IFRS
is contradictory to IAS, principles of IFRS will supersede those of the IAS.
Summary:
BASIS IAS IFRS
Name IAS refers to international
accounting standards
IFRS refers to International
Financial Reporting
Systematic
Publication IAS was published between
1973 and 2001
IFRS was published from 2001
onwards.
Issuing Board IAS was issued by
International Accounting
Standard Committee (IASC).
IFRS was issued by
International Accounting
Standard Board (IASB).
Precedence Standards of IAS will be
dropped in case of
contradiction
Standards of IFRS will
supersede in case of
contradiction.
Advantages of IFRS
Many countries are moving towards the application of International Financial Reporting
system in order to use common accounting rules (Ioannou and Serafeim, 2016.). Common
accounting rules includes how transactions should be reported and the disclosure of these
transactions. Following are the benefits of IFRS: Greater Comparability: By using same set of accounting rules and standards to prepare
the financial statements, comparability of financial statements of the companies increases
and can be compared more accurately. This becomes more important when the financial
statements of the companies that are needed to be compared are situated in various
13

different countries (Leuz and Wysocki, 2016). Better comparability of financial
statements helps the investors to determine where they should invest. Globally Not Accepted: Many countries has not yet adopted the International Financial
Reporting Standards for example US. This makes accounting more difficult for the
foreign based companies that are situated in America, as they have to prepare their
financial statements using both American Generally Accepted Accounting Principle
(GAAP) and IFRS. More Flexibility: IFRS is based on the philosophy of principle based rather than rules
based. Under Principal based philosophy, the objective of each standard is to arrive at the
reasonable valuation. Through principal based philosophy, companies have freedom to
adopt IFRS to the particular situation they want to, which makes them easier to read and
makes the statements more useful. Manipulation: Companies can use only those methods that they wish to use, this is
because the flexibility that IFRS provides. This allows them to provide only the desired
results. This can be stated as the downside of the IFRS. More flexibility can lead to the
manipulation of profits and revenue. And can also be used to hide the financial problems
of the company (Li, 2015). This can also encourage the fraud.
 Beneficial to new and small investors: IFRS enhances the quality of reporting standards
and makes them simpler, this can help the small and new investors by putting them in the
similar position with professional investors. This reduces the risk of these investors at the
time of trading as the professional will not be able to take their advantage.
CONCLUSION
As per the above study it has been concluded that, the importance and objectives of
financial reports has been cleared. The above study provides the financial performance of Rita
plc that shows a net profit of 30720 m. This profit of the company can attract more investors to
the company. In the above study, financial performance of Sainsbury has been analysed and
interpreted. From the analysis of Sainsbury financial performance, it has been concluded that the
company is incapable of increasing its sales volume and the debt of the company is more than
14

twice its equity. This means the financial structure of the company is week. The above study also
clearly states the difference of IFRS and IAS along with the benefits of IFRS. Acceptance of
IFRS will allow the user of financial report to compare the financial reports of the companies of
different countries which will enable them to make their investments go in the way they want.
15

REFERENCES
Books and Journals
Ahmed, A. S., Neel, M. and Wang, D., 2013. Does mandatory adoption of IFRS improve
accounting quality? Preliminary evidence. Contemporary Accounting Research. 30(4).
pp.1344-1372.
Bonetti, P., Magnan, M. L. and Parbonetti, A., 2016. The Influence of Country‐and Firm‐level
Governance on Financial Reporting Quality: Revisiting the Evidence. Journal of Business
Finance & Accounting. 43(9-10). pp.1059-1094.
Brigham, E. F., 2014. Financial management theory and practice. Atlantic Publishers & Distri.
Brüggemann, U., Hitz, J. M. and Sellhorn, T., 2013. Intended and unintended consequences of
mandatory IFRS adoption: A review of extant evidence and suggestions for future
research. European Accounting Review. 22(1). pp.1-37.
Daske, H. and et.al., 2013. Adopting a label: Heterogeneity in the economic consequences
around IAS/IFRS adoptions. Journal of Accounting Research. 51(3). pp.495-547.
Flower, J., 2016. European financial reporting: adapting to a changing world. Springer.
Fraser, L. M., Ormiston, A. and Fraser, L. M., 2010. Understanding financial statements.
Pearson.
Glaum, M., and et.al., 2013. Introduction of International Accounting Standards, disclosure
quality and accuracy of analysts' earnings forecasts. European Accounting Review. 22(1).
pp.79-116.
Ioannou, I. and Serafeim, G., 2016. The consequences of mandatory corporate sustainability
reporting: evidence from four countries.
Leuz, C. and Wysocki, P. D., 2016. The economics of disclosure and financial reporting
regulation: Evidence and suggestions for future research. Journal of Accounting
Research. 54(2). pp.525-622.
Li, X., 2015. Accounting conservatism and the cost of capital: An international analysis. Journal
of Business Finance & Accounting. 42(5-6). pp.555-582.
16