ac4304 financial reporting theory presentation casey lau gloria ho hayley cheng
TRANSCRIPT
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AC4304Financial Reporting
TheoryPresentation
Casey LauGloria Ho
Hayley Cheng
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Virtuesof
Income Statement
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Agenda
•Background•Definition•Usefulness to
users•Limitation•Recommendation
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Background
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Objectives
• Financial Statements
“to provide information that is useful to users of assessing the financial position …
… and the performance and cash flows of an enterprise ……”
(HKSA Stm. 2.01)
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• Income Statement
“…… while information about performance is primarily provided in a profit and loss account ……”
(HKSA Stm. 2.01)
“The financial statement of a firm that summarizes revenues and expenses over a specified time period.”
(The 'Lectric Law Library's Lexicon)
Objectives
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Functions
• Profitability• Past year’s operating results
• Underlying accounting conceptAccrual / Matching
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Main Items in I/S• Turnover• Cost of sales• Gross profit• Other revenue• Distribution /
Administrative / Other operating expenses
• P/L from operation• Finance cost
• Share of P/L of associates / joint ventures
• Tax expenses• P/L from ordinary
activities• Extraordinary items• Minority interest• Net P/L for the
period
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Usefulnessto
Investors
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Investors are ...
• Equity security holders
• providers of risk capital• concerned with the risk & return o
n investments
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Investors need ……
• to know if they should buy, hold or sell.
• to assess the enterprise’s ability topay dividendsi.e. Reward of ownership
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Profitability
• Profits as measure of performance
• Ratios analysis :- Profit margin- Return on assets- Dividend payout ratio - Earnings per share (EPS)
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Comparability
• Corresponding prior year’s information
• Development trend
• Comparison :- Year-to-year- Enterprise-to-enterprise- Industry-to-industry
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Control of Cost
• GP margin VS NP margin• Comparative figures of
expenses- e.g. Financial cost
• Future prospect like capital gains ?
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Usefulnessto
Creditors
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Creditors are ……
• Trade creditors :- Supplier of goods & service
• Non-trade creditors :- Customers & employees with claims- Lending institutions & individuals;- Debt security holders.
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Creditors need …...• information that enables them to
determine whether amounts owing to them will be paid when duei.e. Solvency
• interested in an enterprise
continuation of the enterprise as a major customer.
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• If enterprise can meet short-term & long-term obligation
- Finance costs e.g. interest expense- operating profits
Solvency
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Going-concern
• The continuousness of the company by comparative figures
• Profit / Loss ?
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Separate Items
• Impairment Items• Finance costs• Operating profits
• Balance Sheet as a supplementary tool
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Usefulnessto
Managers
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Mangers are ……
• Managers are basically those who run the firm on behalf of the shareholders. They are expected to act in the best interest of the shareholders.
• For the managers, income statements are published as a compliance of the Accounting Standards and the law.
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Profitability
• They are concerned about the profitability and the company’s performance.
Income Statement
Predict Future Growth, Profits Share Price
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• Income statements also serve as their channel of communication with the investors and to attract more investors.
Channel of Communication
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Channel of Communication• According to George Staubus,
Professor of University of California, Berkeley in the ‘Investor Theory’ – “accounting/financial statements is to provide information to the firm’s suppliers of capital…..help them ascertain the firm’s willingness to pay investors.”
Attract investors
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Ability Assessment• Income statements very often also
serve as a means to assess managerial ability and their remunerations are tied to the current year earnings. “Famous scholars Paton & Littleton says in
their definition of income: ‘…. It reflects managerial effectiveness and is of particular significance to those who furnish the capital and take the ultimate responsibility.”
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• Income statements (published accounts) can be used for internal control but normally managers mainly rely on the management accounts.
• Act as a monitoring tool with the support of budgeted I/S and comparison between actual and planned performance.
Planning and Control
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Limitationof the use of
Income Statements
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Limitations
• Information asymmetry
– Due to adverse selection, not all information are available to the investors in the income statements.
– Hence, income statements may not be able to reflect the full picture.
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• Earnings management & Income smoothing– manipulation of accounts– intentional dampening of
fluctuations about some level of earnings that it currently considered to be normal for a firm e.g. by classification, recognition, allocation of time, etc. (Ronald D Picur; JBFA)
MAY NOT BE THE TRUE PICTURE ! MAY NOT BE THE TRUE PICTURE !
Limitations
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• Agency relationship
Results in agency costs
Income statements may not be able to reflect the firm’s real stability or potential to make profit.
Stockholders/investors
Creditors(Michael C. Jensen)
Exist whenever a principal hire somebody else to act on its behalf as an agent
e.g. consume perquisites
e.g. increase level of debt or take high risk projectswhich are unanticipated by creditors
Limitations
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Recommendation
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ComprehensiveIncome Theory• all-inclusive income
According to Financial Accounting Standards Board (FASB) SFAS 130:‘Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes net income and other comprehensive income such as foreign currency translation adjustments, unrealized gains and losses, etc.
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• Advantages: (Stan Clark, University of Southern Mississippi)– Net income of the firm for the life of the
firm should be equal to the sum of the annual report net incomes
– Income smoothing may be checked by the inclusion of all income changes and credits
– A better picture of the total performance of the firm is conveyed, especially when both recurring and unusual, infrequently occurring items are displayed separately in the income statement.
ComprehensiveIncome Theory
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– Evaluate the firm in terms of its contribution to the society and the cooperative effort between the employees, suppliers of fund, & the government.
– Basis of theory: The above mentioned parties should cooperate together in order for a firm to survive and to make profit.
Value-added income statement
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Value-added income statement
• (Waino Suojanen, Accounting Review)
–Performance measure of wealth creation by the firm, reflect more information e.g. social change (Michael Morley, The Value Added Statement, London)
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Conclusion
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~ The End ~