In the previous post, we explained the objective of financial reporting and the fundamental qualitative characteristics of financial information. In this episode, we will start with the enhancing characteristics before delving into the elements of the financial statement and its definitions.
The enhancing characteristics of financial information are those qualities that help fine-tune its essence. They are;
- Understandability,
- Comparability,
- Verifiability, and
- Timeliness.
Understandability means that the financial information being presented must be concise, clear and easy to read. Consistency of presentation helps to achieve comparability of financial information, which helps users with an immediate and superficial assessment of the financial information contained therein. Most entities present their financial statements for the current and previous year, while the previous Nigerian standards require a five-year financial summary.
The IASB Framework explains that verifiability means “that different, knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular presentation of an item or items is a faithful representation”. It basically provides an assurance and builds confidence in the adoption of the information in the financial statements. Timeliness refers to making information available within the stipulated period, as unnecessary delays could render the value of information useless.
However, we must note that preparing financial statements takes time and money. While we ensure that the requirements listed above are met, every preparer of financial statements must ensure the benefits outweigh the costs of providing and asserting this information.
The Reporting Entity
The Framework refers to a reporting entity as one that prepares financial statements which could, as required by law or for stewardship or accountability purposes to its stakeholders. Financial statements can be produced for consolidated purposes, where two or more entities are under a group of companies with controlling stakes of different distribution or can be produced for two or more entities that are not parent/subsidiaries. These types of financial statements are called ‘combined financial statements’. It can be difficult in these circumstances to determine the boundary of the reporting entity. Note that the Conceptual Framework does not stipulate how or when to prepare combined financial statements, although the Board may develop a standard on this issue in the future.
Financial statements for a reporting entity comprising a parent company and its subsidiaries are called ‘consolidated financial statements’. These financial statements show the parent and its subsidiaries as a single economic entity. This information is essential for investors in the parent because their economic returns depend on distributions from the subsidiary to the parent. Unconsolidated financial statements also provide helpful information to investors in a parent company (for example, about the level of distributable reserves) but are not a substitute for information provided in consolidated financial statements.
The Elements of Financial Statements.
There are five elements of the financial statements, namely;
- Assets,
- Liabilities,
- Equity,
- Income, and
- Expenses.
Assets are defined by the Framework “as an economic resource controlled by an entity as a result of a past event”. This definition emphasizes the need for control before an entity can recognize an asset in its financial record. Assets can also not be referred to as futuristic because control must pass on to the entity before it can be recognized. It must also be mentioned that an economic resource is a right that has the potential for future economic benefits accruable to the entity.
On the other hand, Liabilities are “a present obligation of the entity to transfer an economic resource as a result of a past event’. A present obligation could be legal or constructive, where the former is due to the past agreement reached, and the latter is based on past behaviour patterns.
Equity is the residual after deducting all liabilities from assets. As discussed in an earlier series could be further broken down into contributed capital, income additions and expense deductions.
Income is defined as increases in assets or decreases in liabilities that result in an increase in equity. At the same time, expenses are decreases in assets or increases in liabilities that result in an increase in equity. The definition of income and expenses excludes contributions from and distributions to equity holders.
In our next episode, we will review recognition and de-recognition concepts and measurement bases as described in the Conceptual framework.
