Corporate Financial Reporting 31

Unit 2: Corporate Financial Reporting

Notes
Structure
2.1 Introduction
2.2 Issues and Problems with Special Reference to Published Financial Statements
2.2.1 Key issues identified by the Financial Reporting Taskforce
2.2.2 Recommendations to the Financial Reporting Council
2.3 Including Group Financial Statements of Holding and Subsidiary Company
2.3.1 Ownership
2.3.2 Management
2.3.3 Financial Control
2.3.4 Legal Responsibility
2.4 Developments in External Reporting
2.4.1 External vs. Internal
2.4.2 Accounting Principles
2.4.3 Major Statements
2.4.4 Small Businesses
2.4.5 "Little GAAP"
2.4.6 External Reporting Classification
2.4.7 Reasons for External Reporting
2.5 Corporate Governance
2.5.1 The Board of Directors
2.5.2 Good and Bad Governance
2.5.3 Benefits of Corporate Governance
2.6 Summary
2.7 Check Your Progress
2.8 Questions and Exercises
2.9 Key Terms
2.10 Further Readings

Objectives
After studying this unit, you should be able to:
 Understand the Issues and problems with special reference to published
financial statements
 Explain the Developments in External Reporting,
 Discuss the Corporate Governance

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2.1 Introduction
Notes Corporate financial reporting is not only to show the financial statements of corporate
but it includes to highlight important financial data and to show the application of
financial policy. A good financial reporting will show true financial position of company.
Company can save from hidden losses, if its accountant highlights critical points in it. In
this way, it is helpful tool to investors for better decision making.

Definition of Corporate Financial Reporting

Corporate financial reporting is the system of making corporate financial reports. These
corporate financial reports are income statement, balance sheet, cash flow statement,
statement of retained earnings and financial policies explanation. Corporate financial
reporting may be shown at the end of month or at the end of each quarter or at the end
of year.

1st Corporate Financial Report: Income Statement

It is also called profit and loss account. In income statement, we come to know whether
company is earning profit or suffering loss. We can find the main expenses of company
and main sources of earning. What amount, it is giving in the form of dividend which is
showed in statement of retained earnings. Net income after all adjustments is
transferred to reserve and surplus section in the liability side of balance sheet.

2nd Corporate Financial Report: Balance Sheet

This corporate financial report shows the financial position at given point of time. It
provides the information of all assets and liabilities. This financial report is useful
for balance sheet analysis.
3rd Corporate Financial Report: Cash Flow Statement
In cash flow statement tells us the net cash flow in operating, investing and financial
activities. These indications are helpful to analyze cash flow. This report explains the
sources and applications of liquidity of company.

4th Corporate Financial Report: Explanation of Financial Policies and Notes

Big corporate also make some financial notes and explain the financial policies in detail
with above financial reports. In these policies, company shows its inventory policy,
depreciation policy, debt terms and dividend policy. It also shows list of loss of
impairment on fixed assets.

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Notes

Accounting being regarded as the language of business is as old as the business

itself (Gupta and Mehra, 2002). It is a social phenomenon, the primary object of which is
to let the management know the economic activity of the corporate enterprises
(Mehrotra and Kulshrestha, 1990). Accounting has two fold phases, first measuring and
arraying the economic data and second communicating the results of this process to the
interested parties (Gupta, 1977). American Accounting Association
(AAA, 1966) describes it as the process of identifying, measuring and
communicating economic information to permit informed judgments and decisions by
users of information. Accounting Principles Board (APB) of the American Institute of
Certified Public Accountants (AICPA) defined accounting as a service activity. Its
function is to provide quantitative information financial in nature and intended to be
useful in making economic decisions and making reasoned choices among alternative
courses of action.
Accounting includes branches i.e. financial accounting, managerial accounting and
government accounting (Singh, 2005). In 1975, the American Accounting Association

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34 Financial Reporting & Decision Making

redefined accounting in broader sense as to provide information which is potentially

useful for making economic decisions and which if provided will enhance social welfare.
Notes
The primary function of accounting is recording the economic data of a business
enterprise and to facilitate the administration of its financial activities. It has to measure
the economic activity i.e. employment of its assets for profit; and disclose it in the
financial statements and reports of the financial aspects of the activities of the
enterprise for a particular period (Saeed, 1990). Thus all the activities of a business
enterprise have to be disclosed to the shareholders and other users so that they can
develop their own attitude towards the firm and know that how efficiently the limited
resources of the organization are being utilized through sound decisions. Financial
accounting was formerly concerned with reporting from office managers to principals
conveying that all was well with the book-keeping of the business. But times now have
changed with an increasing control by the corporate sector over the economic activity;
these financial reports have assumed greater importance. They are now considered a
corner stone in the trading structure helping to bridge the gap between the producer
and the user, the owner and the manager and commerce and the government. Further,
these reports are consulted by a large sector of people, including the government, who
have a wide range of interests in them as owners, tax-receivers, workers, employees,
administrators, producers, creditors, debenture-holder and the like, besides labour-
unions and shareholder’s associations (Gupta, 1977).

Objectives of Financial Reporting

Corporate financial reporting is not an end in itself but is a means to certain objectives
(Devarajan, 2008). The fundamental objective of corporate financial reporting is to
communicate economic measurements of information about the resources and
performance of the reporting entity useful to those having reasonable rights to such
information and interest in the entity (Oza, 1990). The annual financial statements of a
company not only aid its management to regulate the prices of its goods and services
but also help its external users in different ways such as existing and potential investors
in evaluating their past decisions and making changes in their investment policies,
creditors in assessing company’s worthiness, profitability and liquidity, and government
in administering the system of taxing the companies (Bhattar, 1995).
Various agencies and professional bodies involved in promoting corporate financial
reporting have attempted to formulate objective of financial reporting as to make
accounting information relevant and useful (Singh, 2005). The Accounting Principle
Board of America in 1970, True Blood Report in 1973, Corporate Report London in
1975, Financial Accounting Standard Board (FASB) 1978 and The Stamp Report 1980,
Accounting Standard Board (ASB of U.K.) in 1991, Institute of Chartered Accountant of
India (ICAI) in 2000, FASB in 2006 and IASB and FASB jointly in 2007 have contributed
in the formulation of the objectives of financial reporting. The objectives of financial
reporting given by these bodies have been summarized below:

Accounting Principle Board (APB) 1970

The Accounting Principle Board of America issued its Statement (4), Basic Concepts
and Accounting Principles Underlying Financial Statement of Business Enterprises, in
1970. This statement states 1 particular, 5 general and 7 qualitative objectives. The
particular objective of financial statements is to present fairly and in conformity with
Generally Accepted Accounting Principles (GAAP), the financial position, the results of
operations and other changes in the financial position of an enterprise.
The general objectives of financial statements are:
1. To provide reliable information about economic resources and obligations of a
business enterprise in order to (a) evaluate its strengths and weaknesses, (b) show
its financing and investments, (c) evaluate its ability to meet its commitment and (d)
show its resource base for growth.

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2. To provide reliable information about changes in net resources resulting from a
business enterprise’s profit-directed activities in order to (a) show the investors the
expected dividend return; (b) show the organization’s ability to pay its creditors and Notes
suppliers, provide jobs for employees, pay taxes, and generate funds for expansion;
(c) provide the management with information for planning and control (d) show the
long-term profitability of the enterprise.
3. To provide financial information useful for estimating the earning potential of the
firm.
4. To provide other needed information about changes in its economic resources and
obligations.
5. To disclose other information relevant to the needs of the users.
The qualitative objectives of financial reporting are:
6. Relevance, which means selecting the information most likely to aid the users in
their economic decisions.
7. Understandability, which implies not only that the selected information must be
intelligible but also that the users can understand it.
8. Verifiability, which implies that the accounting results may be corroborated by
independent measurers using the same measurement methods.
9. Neutrality, which implies that the accounting information is directed towards the
common needs of the users rather than the particular needs of specific users.
10. Timeliness, which implies an early communication of information to avoid delays in
economic decision-making.
11. Comparability, which implies that differences should not be the result of different
financial accounting treatments.
12. Completeness, which implies that all the information that is “reasonably” needed to
fulfill the requirement of the other qualitative objectives should be reported. The
above general objectives fail to identify the information needs of the owners and the
creditors. The main objective was to provide general purpose financial reporting,
which provides information for unknown users having multiple decision objectives.
Providing information for specific user groups having known decision objectives was
not found operational.

The True Blood Report-1973

In view of the criticism of corporate financial reporting, the American Institute of Certified
Public Accountants appointed a study group in 1971 under the chairmanship of Robert
M. True-blood. The study group visited various places, interviewed executives, held
meetings with institutional and professional groups and submitted its report in 1973. The
True-blood committee recommended 12 objectives of financial reporting. The main
objective is stated as under: “The basic objective of financial statements is to provide
information useful for making economic decisions.” The other eleven objectives are
stated below:
1. To serve primarily those users who have limited authority, ability or resources to
obtain information and who rely on financial statements as their principal source of
information about an enterprise’s economic activity.
2. To provide information useful to investors and creditors for predicting, comparing,
and evaluating potential cash flow to them in terms of amount, timing, and related
uncertainty.
3. To provide users with information for predicting, comparing, and evaluating
enterprise’s earning power.
4. To supply information useful in judging management’s ability to utilize enterprise’s
resources effectively in achieving the enterprise’s primary goal.

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5. To provide factual and interpretative information about transactions and other

events, which is useful for predicting, comparing, and evaluating enterprise’s
Notes earning power. Basic underlying assumption with respect to matters subject to
interpretation, evaluation, prediction, or estimation should be disclosed.
6. To provide a statement of financial position useful for predicting, comparing, and
evaluating enterprise’s earning power. The statement should provide information
concerning enterprise’s transactions and other events that are part of incomplete
earning cycles. Current values should also be reported when they differ significantly
from historical cost. Assets and liabilities should be grouped or segregated by the
relative uncertainty of the amount and timing of prospective realization or
liquidation.
7. To provide a statement of periodic earnings useful for predicting, and evaluating
enterprise-earning power. The net result of completed earning cycles and enterprise
activities resulting in recognizable progress towards the completion of incomplete
cycles should be reported. Changes in the values reflected in successive
statements of financial position should also be reported, but separately, since they
differ in terms of their certainty of realization.
8. To provide a statement of financial activities useful for predicting, comparing, and
evaluating enterprise-earning power. This statement should report mainly on the
factual aspects of enterprise transactions having or expected to have significant
cash consequences. This statement should report data that requires minimal
judgment and interpretation by the preparer.
9. To provide information useful for the predictive process. Financial forecasts should
be provided when they will enhance the reliability or user’s predictions.
10. For government and not-for-profit organizations, an objective of financial statements
is to provide information useful for evaluating the effectiveness of the management
of resources in achieving the organization’s goals.
11. To report on those activities of the enterprise affecting society which can be
determined and described or measured and which are important to the role of the
enterprise in its social environment. The True Blood Report also presented
qualitative characteristics which financial statement information should possess in
order to satisfy needs of the users. These are:
(a) Relevance and Materiality
(b) Substance rather than Form
(c) Reliability
(d) Freedom from Bias
(e) Comparability
(f) Consistency
(g) Understandability
This study group considered the needs of the investors and the creditors but there
are other users of financial statements whose needs were not given proper weight.

The Corporate Report, London 1975

The Accounting Standards Steering Committee of the Institute of Chartered
Accountants in England and Wales published the Corporate Report as a discussion
paper to review the list of users, purposes and methods of modern financial reporting in
the United Kingdom. The basic philosophy of the report was that financial statements
should be appropriate to their expected use by the potential users. The report
emphasized seven characteristics viz. relevance, understandability, reliability,
completeness, objectivity, consistency and timeliness in addition to the other
fundamental objectives of annual reports. The Corporate Report suggested the need for
the following additional statements:

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1. A statement of Value Added to show how the wealth was produced, and how it has
been distributed among the employees, the state, the providers of capital and its
reinvestment for maintenance and expansion. Notes
2. An employee report dealing with the size and composition of the work force,
efficiency, productivity, industrial relations, and the benefits earned, personnel
policies, etc.
3. A statement of money exchanges with the government showing sales tax,
corporation tax, rates, royalties and other taxes paid to the government, i.e.,
financial relationship between the enterprise and the state.
4. A statement of transactions in foreign currency showing overseas borrowings and
repayment, dividends received and paid by the government to other countries.
5. A statement of future prospects showing forecasts of profits, employment and
investment.
6. A statement of corporate objectives showing management policy and strategies.

2.2 Issues and Problems with Special Reference to Published

Financial Statements
Accounting shows a financial picture of the firm. In general accounting means keeping
financial records, recording income and expenditure, valuing assets and liabilities, and
so on. An accounting department records and measures the activity of business. It
reports on the effects of the transactions on the firm's financial condition. Accounting
records give a very important data. It's used by management, stockholders, creditors,
independent analysts, banks and government.
There are several types of accounting. Managerial A. implies preparing budgets and
other financial reports necessary for management. Tax A. is calculating an individual's
or a company's liability for tax. Cost A. means working out the unit cost of products,
including materials, labour and all other expenses. There is also a special type of A. -
'creative A.', which means using all available accounting procedures and trick to
disguise the true financial position of a company. Creative A. is divided into 'Chinese
A.', 'window dressing' and 'cook the books'.
Probably there are two major questions that the managers or owners of the
business want to know: first, whether or not the business is operating at a profit,
second, they will want to know whether or not the business will be able to meet its
commitments as they fall due; and so not have to close down owing to lack of funds.
Both of these questions should be answered by the use of the accounting data of the
firm.
The most common accounting which records assets at their original purchase price
minus accumulated depreciation charges. In times of inflation, this underestimates the
value of appreciating assets such as land, but overstates profits as it doesn't record the
replacement cost of plant or inventory. The value of a business's assets under historical
cost A. - purchase price minus depreciation is known as net book value. Countries with
persistently high inflation often prefer to use current cost or replacement cost A., which
values assets (and related expenses like depreciation) at a price that would have to be
paid to replace them today.
Company law specifies that shareholders must be given certain financial
information. Companies generally include three financial statements in their annual
report.
The profit and loss account or income statement shows revenue and expenditure. It
usually gives figures for total sales or turnover and costs and overheads. The first figure
should obviously be higher than the second - there should be a profit. Part of the profit
goes to the government in taxation. Part is usually distributed to shareholders as a
dividend and part is retained by the company.

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38 Financial Reporting & Decision Making

The balance sheet shows the company's financial situation on a particular date,
generally the last day of the financial year. It lists the company's assets, its liabilities and
Notes shareholders' funds. Business's assets include debtors as it is assumed that these will
be paid. There are several tapes of assets. Current assets include 1.cash in the bank;
2.securities: investments in other companies; 3.stocks or raw materials, unfinished
goods and finished goods that are going to be sold; 2. Debtors, money owed to the
company by the customers. Fixed or tangible assets are equipment, machinery,
buildings, land. And intangible assets: things which you cannot see - goodwill, company
brands.
Liabilities include creditors, as these will have to be paid. These are debts to
suppliers, lenders, the tax authorities. Debts that have to be paid within a year are
current liabilities, and those payable in more than a year are long-term liabilities, for
example bank loans.
In order to examine the existing financial reporting requirements of the various
types of reporting entities in Australia, the task force agreed to map out the various
reporting schemes applicable to entities. These include requirements under
the Corporations Act 2001, cooperatives financial reporting requirements, not for profit
reporting requirements etc. The Secretary received information on the various reporting
requirements that the members were aware of and consequently a mapping study of
the various regulators, reporting regimes, and how they interrelate was undertaken.
PricewaterhouseCoopers voluntarily assisted the work of the task force by undertaking
the mapping exercise and reporting on progress during the project.
While undertaking the mapping study, it was noted that the various regulatory
regimes often imposed overlapping reporting requirements on entities, which may or
may not be tailored for the entities they apply to. It was suggested that one way to deal
with this is to establish a platform which they can consult, prior to imposing reporting
requirements on entities.
PricewaterhouseCoopers (PwC) also shared their observations relating to the
mapping work being undertaken on reporting requirements, namely that there were
divergent:
 reporting requirements across the different layers of Government;
 assurance requirements, especially in relation to the use of Registered Company
Auditors; and
 accounting standard requirements, especially in relation to General Purpose
Financial Reporting (GPFR);
… With no consistent justification, in terms of either entity risk profile or
accountability.
The Taskforce agreed that addressing the complexity of financial reporting
requirements would require long term action; however it remained important that the
Taskforce consider how to streamline reporting requirements, such as:
 Managing complexity within legislation, such as through having a centralized
reference point for guidance for legislators when they wish to include accounting
and auditing requirements, to minimize the likelihood of inappropriate or
inconsistent references;
 Streamlining existing reporting requirements; and
 Developing a framework for new regulation, defining appropriate reporting
requirements depending upon an entity’s risk profile and public accountability and
the likely users of an entity’s financial reports.
AASB’s research findings: The Taskforce considered how it should recommend
that the FRC respond to the AASB’s research findings into the use of Special Purpose
Financial Reporting (SPFR). The Committee was advised that ASIC has also done

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some research into this matter. A wide range of views were expressed about the nature,
extent and significance of the problem relating to the use of accounting standards.
Notes
2.2.1 Key issues identified by the Financial Reporting Taskforce
There is often no clear basis for the divergent reporting requirements, particularly where
legislative requirements differ between states and different types of organizations:
 There are a range of different size thresholds, across different entity types, with
inconsistent reporting and audit requirements. Differences in these thresholds and
reporting requirements do not appear to be the result of different risk
characteristics, or public interest in the accounts of entities.
Assurance requirements are similarly divergent between entity types:
 Some reporting requirements may call for an audit or review by a Registered
Company Auditor, others only an audit or review by a member of the Chartered
Accountants ANZ, CPA Australia, or IPA.
It was often a complex task to draw out the relevant reporting requirements from
legislation:
 Sometimes, reporting requirements are outlined in regulations, and it is not always
easy to get an overview of the different requirements that apply to different tiers of
entities required to report.
Legislative reporting requirements may be internally inconsistent:
 One instance was identified where legislation required GPFRs to be prepared, but
prescribed reporting under a non-IFRS GAAP (Trade Unions whose income
<$100,000). Here, the legislation refers to GPFRs, but did not require compliance
with AASBs, and set out an alternative set of accounting principles. These
principles permit accrual or cash basis accounting to be adopted.
Government reporting legislation on its own does not always require accounts to be
prepared in accordance with the accounting standards: sometimes, it is the treasurer’s
directives that enforce accounting standards.
One particularly significant aspect of the current overarching reporting framework is
that a very large range of entities is required to lodge financial reports on the public
record. Those that are reporting entities must provide general purpose financial reports,
complying with the appropriate accounting standards. Within this group, there are a
large number which can use the reduced disclosure regime (for example, entities which
are not listed or disclosing or governments), applying full recognition and measurement
requirements with reduced disclosure. Other entities which do not regard themselves as
reporting entities can lodge special purpose financial reports. There is currently
confusion as to what measurement requirements must be followed, if any, in special
purpose financial reports. There is another group of small entities specifically
associations, charities and not-for-profit entities which are usually small in size and for
which there is no clear accounting framework and for which general purpose financial
reporting may be too onerous.

2.2.2 Recommendations to the Financial Reporting Council

1. That the Financial Reporting Council authorizes the release of the mapping
document and make provision for it to be kept up to date.
2. In order to provide consistency going forward to avoid the proliferation of even more
complexity, that the Financial Reporting Council recommend that the Federal
Government makes arrangements to establish an online one-stop-shop reporting
requirements portal, including the mapping document, which outlines the possible
reporting and assurance obligations to consider when determining requirements
and which makes recommendations for different types of entities (including outlining
tiers of reporting), and potentially cross-references back to current legislative
requirements.

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3. That the Financial Reporting Council perform a further exercise benchmarking the
requirements of Australia against other jurisdictions; for example, New Zealand,
Notes Singapore, the US and Canada in determining reporting requirements for non-listed
entities, to further inform the following recommendations.
4. As a short term project, to improve clarity and consistency of requirements, the
Federal Government consider the current small/large thresholds with a view to
determining the appropriate threshold level at which such entities should be
required to lodge publicly available financial reports and would be required to
prepare GPFRs.
5. As a longer term project in order to respond to the existing complexity of the
financial reporting arrangements that the Federal and State Governments jointly
(possibly through a COAG process) be asked to undertake a project to consider the
following policy issues regarding entities which need to lodge financial reports on
the public record.
(a) Who is required to lodge formal financial reports on the public record both in
terms of the nature of the organization and the size, and what is the reason for
which these financial reports need to be publicly available, and what level of
attestation is appropriate (for example, audit or review or none).
(b) What is required to be reported on in these financial reports, with the
expectation that those entities required to lodge publicly should lodge GPFRs.
This would remove the application of the reporting entity concept at the user
level, providing greater clarity and consistency. This is also likely to mean the
criteria for public lodgement should be based on objective criteria such as size
and type of entity. If financial reports do not need to be lodged publicly then the
financial reporting should be specific to the purpose for which the information is
required. In the rare circumstances where some form of financial information is
considered necessary to be publicly available, but GPFRs are considered too
onerous, what the reporting requirements might be.
(c) Where the appropriate level of assurance is a review who may perform such
services.
6. The Financial Reporting Council thanks PricewaterhouseCoopers for its
considerable pro bono assistance in furthering the work of the Financial Review
Task Force.

Attachment A

Terms of Reference
The key objective of the Taskforce is to provide policy advice to the Financial Reporting
Council (FRC) in respect of the following:
To examine how the current financial reporting regimes for the various types of
reporting entities in Australia can best be understood and, if needed, make
recommendations regarding rationalization of the regimes (for example, through better
regulation of who needs to report and/or providing a vehicle for coordinating existing
and new legislation).
The Taskforce may consider the following matters:
1. What are the financial reporting and assurance requirements that are currently in
place in Australia as they apply to the different types of entities that are required to
have publicly available reports (for example, companies, managed schemes,
government departments and organizations, indigenous corporations, associations,
unincorporated ventures, co-operatives, superannuation funds, trusts, charitable
and not for profit organizations, trust funds etc.)?
2. How can these financial reporting and assurance requirements and the framework
in which they rest be best categorized, understood and communicated?

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3. Are there deficiencies and/or inconsistencies in the structure and content of these
financial reporting and assurance obligations?
4. Are there any overlaps or duplication in the purpose or content of these financial
Notes
reporting and assurance obligations?
5. Are there opportunities for improving and streamlining these financial reporting and
assurance obligations to improve consistency and efficiency having regard to the
objectives of financial reporting and assurance, as set out in the Australian
Accounting Standards Board’s Conceptual Framework underpinning general
purpose financial reporting and the Auditing and Assurance Standards Board’s
explanatory framework for audit and assurance engagements?
6. Are there any improvements to policy and to the institutional oversight framework
that can be recommended to ensure that changes to financial reporting and
assurance obligations in the future take place consistently and efficiently, having
regard to the Australian Accounting Standards Board’s Conceptual Framework
underpinning general purpose financial reporting and the Auditing and Assurance
Standards Board’s explanatory framework for audit and assurance engagements?

Attachment B

Background
The Financial Report Taskforce (FRTF) was established in response to one of the
recommendations made by the Managing Complexity Taskforce — that the FRC
examine how the current financial reporting regime for the various types of reporting
entities in Australia can be best explained and understood, and if needed, seek
rationalization of the regime (for example, through further deregulation of who needs to
report.
The FRC Members of the Taskforce are Ross Barker (Chair), Andrew
Fleming (retired during the term of the task force), Merran Kelsall, Ian Laughlin,
Ian Purchas, Kris Peach (joined the committee following the retirement of K.
Stevenson) and Kevin Stevenson (retired during the term of the task force). The
non FRC members of the Taskforce are Kevin Neville (Director and Head of
External Audit and Assurance Division, Moore Stephens) and Susan Pascoe
(Commissioner of the Australian Charities and Not for-profits Commission).
Margot Le Bras, partner of PricewaterhouseCoopers and Masha Marchev, a
senior accountant at PricewaterhouseCoopers, also attended meetings as
required, to report on the mapping exercise.

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Notes

Figure 2.1: Diagrammatic representation of the FRC portfolio and FRTF

Meetings
The FRTF committee met six times during February 2013 and May 2014. The meetings
were conducted at the Bourke Street, Melbourne office of the Australian Accounting
Standards Board (AASB). Members attended in the meeting in person and via
teleconference. The meetings were chaired by Ross Barker and APS officers from the
Markets Group, Commonwealth Treasury assisted with the Secretariat role.

2.3 Including Group Financial Statements of Holding and Subsidiary

Company
The terms “holding company” and “subsidiary” are used to describe the financial,
managerial, legal and governing relationships between different types of business
organizations, including corporations and financial institutions. A holding company is an
entity formed to buy and hold the majority of stock of other companies; a subsidiary is a
business whose majority of stock is owned by a holding company.

2.3.1 Ownership
A holding company buys, absorbs or otherwise obtains a majority percentage of stock in
another company, which becomes known as its subsidiary. Typically, a holding
company must control 50 percent or more of a company’s stock before it's considered a
subsidiary. Holding companies may also own other holding companies — in this case,
they're known as top holding companies. The holding company has all rights and
responsibilities of ownership for its subsidiaries. The subsidiaries, while not
independently owned, often continue to operate as individual entities, though major
corporate decisions are made by the holding company.

2.3.2 Management
A holding company directs the management and operations of the subsidiaries it owns
and maintains the authority to add or remove board members, directors and other key
management and personnel. A holding company may have strict managerial control or
may allow subsidiaries to act with some level of autonomy for day-to-day business
operations, including lower- and midlevel hiring and certain budgeting decisions.

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2.3.3 Financial Control
A subsidiary has little to no financial control over its operations. Even independently Notes
acting subsidiaries are ultimately financially controlled by their holding company. This
includes financial activities such as investment decisions, sales projections and
budgeting. If a subsidiary was itself a holding company prior to becoming a subsidiary of
another holding company, all of its subsidiaries also become subsidiaries of the top
holding company.

2.3.4 Legal Responsibility

A holding company may invest in subsidiaries in a variety of industries to diversify its
investment, lower its risk potential and, in some instances, take advantage of shared
loss and tax consolidation. Although a holding company may enjoy the profits of its
subsidiaries, it also has a fiduciary responsibility to the subsidiaries it controls. A
subsidiary that regains a majority of its shares also regains its autonomy from its
holding company.

(a) Unrealized Inter-Company Profits

An unrealized inter-company profit exists only when there is a sale of goods by one
company in the group to another at a profit, and the same goods remain unsold and
appear as an asset in the Balance Sheet.
This unrealized profit made by the selling company is to be eliminated at the time of
preparing a Consolidated Balance Sheet since such profit is true from the individual
point of view but not from the view of a group.
The Consolidated Balance Sheet shows an overall picture of the group and that is
why such unrealized profit should be eliminated.
The following principles should be followed for the purpose:
1. Ascertain the amount of profit on unsold stock supplied by the company in the
group;
2. Share of minority interest should be deducted from such unrealized profit so
calculated, and
3. The balance of unrealized profit (i.e., Molding Company’s share or after deducting
minority interest) is to be deducted from the profit of the company who is selling the
goods and from the books of the company receiving those goods as well. In short,
holding company’s share of unrealized profit should be deducted from the
Consolidated Stock in the assets side of the Consolidated Balance Sheet and the
same amount should also be deducted from the Profit and Loss Account in the
Consolidated Balance Sheet.
There are some authorities who prefer to eliminate the whole of such unrealized
profit in all cases since it represents the original cost of the asset in the group. Similarly,
unrealized profit on fixed assets (i.e., if one company transfers a fixed asset at a profit
to an another company in the group) should also be adjusted. However, As per AS 21,
Clause 16, Consolidated Financial Statements, Unrealized Profit must be deducted in
full.
However, the elimination of inter-company profits is made only so long as such
asset is held. On the disposal of the asset, the profit is treated for consolidation
purposes as a realised profit.

Illustration 1:
H. Ltd. acquired 4,000 shares of S. Ltd. on 1.1.2000.

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Their Balance Sheets as at 31.12.2000 stood as follows:

Notes

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Notes

(b) Issue of Bonus Shares:

When subsidiary company issues bonus shares, the same will increase only the
number of shares in the hands of the holding company. The treatment, of course,
depends on the sources from which such bonus shares are issued, i.e., whether the
bonus shares are issued out of the Pre-acquisition Profit/Capital Profit or out of the
Post-acquisition Profit/Revenue Profit.
1. If Bonus Shares are issued out of Capital Profit: There will be no effect in Cost
of Control or Goodwill Account and minority interest for this purpose since pre-
acquisition profit is reduced in one hand and paid-up value of share held will
increase on the other. As a result, there will be ultimately no effect for the purpose
of issuing bonus shares out of Capital Profit in Goodwill Account or Capital Reserve
or Minority Interest.
2. If Bonus Shares are issued out of Current Profit: When bonus shares are issued
out of current or revenue profit, holding company’s shares in current profit should be
calculated only after making the proper adjustment for bonus issue from the said
current profits, which will ultimately reduce the amount of holding company’s share
in current profits. Thus, Cost of Goodwill will be reduced by the amount of increased
value of paid-up shares.

(a) Out of Capital Profit:

Illustration 2:
Parent Ltd. acquired 6,000 equity shares of Rs.10 each in Subsidiary Ltd. on Dec.31,
2000.

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The summarized Balance Sheets of Parent Ltd. and Subsidiary Ltd. as on that date
were:
Notes

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Notes

(b) Out of Current Profit:

Illustration 3:
The Balance Sheets of H. Ltd. and S. Ltd. as at 19………………………..are:

S. Ltd. has a credit balance of Rs. 40,000 in the General Reserve when H. Ltd.
acquired share in S. Ltd. S. Ltd. capitalised Rs. 20,000 out of profits earned after the
acquisition of its shares by H. Ltd. by making a bonus issue of one share for every five
shares held. Prepare a consolidated Balance Sheet as at 19……………………

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Notes

(c) Revaluation of Fixed Assets

Sometimes fixed assets of the subsidiary company are revalued at the time of
acquisition of shares. If, as a result of revaluation, profit or loss on fixed assets takes
place, such profit or loss should be treated as capital profit or capital loss. Since the
capital profit cannot be utilized for the purpose of declaring dividend the same is shown
in the Liability side of the Balance Sheet of the subsidiary company under the head
‘Capital Reserve’ or may be written-off against Goodwill. Therefore, the profit made on
revaluation of fixed asset should be treated as Capital Profit and, hence, it will be
distributed between holding company and minority interest according to their ratio as
usual.
It should be remembered in this respect that depreciation should also be provided
on the increased or decreased value of fixed asset against the revenue profit as well. In

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other words, in case of profit on revaluation or under-valuation of assets, additional
provision for depreciation should be made, i.e., it will be deducted from the
current/revenue profit and, in the case of loss on revaluation or over-valuation of assets, Notes
provision for depreciation should be written-back, i.e., it will be added with the amount
of current/revenue loss.

Illustration 4:
From the following Balance Sheets of H. Ltd. and its subsidiary S. Ltd.
drawn up at 31.12.1999, prepare a Consolidated Balance Sheet as at that
date, having regard to the following:
1. Reserve and Profit and Loss Account (Cr.) of S. Ltd. stood at Rs. 25,000 and Rs.
15,000, respectively, on the date of acquisition of its 80% shares held by H. Ltd. on
1.1.1999, and’
2. Machinery (Book value Rs. 1,00,000) and Furniture (Book value Rs. 20,000) of S.
Ltd. were revalued at Rs. 1,50,000 and Rs. 15,000, respectively, for the purpose of
fixing the price of its shares, there was no purchase or sale of these assets since
the date of acquisition.

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Notes

(d) Debentures of Subsidiary Company

Sometimes Debentures of subsidiary company are held by holding company which are
shown under the head ‘Investments’ in the Balance Sheet of holding company. These
are to be eliminated while preparing Consolidated Balance Sheet. But if there is any
difference between the cost price and paid-up value of Debentures, the same will,
however, be adjusted against Cost of Control or Goodwill Account. Similarly, if there is
any outstanding Debenture Interest, the same also will be adjusted.

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Consider the following examples:

Notes

(e) Preference Shares of Subsidiary Company

1. When Preference Shares are Held by Outsiders: If preference shares are held by
outsiders, the same will be included with minority interest by the amount of paid-up
value of shares held (including the arrear dividend, if any). But a proper provision
should be made against existing reserves which is to be added with minority
interest if the profit of the subsidiary company becomes insufficient to pay
cumulative dividend on preference shares.

Illustration 5:
The following are the Balance Sheets of H. Ltd. and its subsidiary S. Ltd. as at
31.12.1999

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Notes

2. When Preference Shares are Held by the Holding Company: When preference
shares of subsidiary company are held by the holding company, the treatment will
be the same as in the case of equity shares, i.e., the paid-up value will be deducted
from the cost of shares. The difference (between the cost price and paid-up value),
if any, will represent cost of control which will be added with cost of control that is
derived from the equity shares. But if the subsidiary company issues these shares
either at a discount or at a premium, the same will not be adjusted against Cost of
Control/Goodwill but will be incorporated with the cost of preference shares.
The preference dividend accrued to the date of acquisition will be adjusted against
Goodwill/Cost of Control. But the dividend which has accrued from the date of

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acquisition to the date of preparation of accounts will, however, be considered as
revenue profit and the same will be included with the share of profit of holding
company in the Liability side of the Balance Sheet. Notes
Illustration 6:
H. Ltd. acquires 80% of both classes of shares of S. Ltd., on 1.1.2001, at a total cost of
Rs. 1,00,000.
The Balance Sheets of the two companies as on that date are:

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Notes

(f) Dividends
1. Ordinary: It is quite natural that the holding company will receive dividend from the
subsidiary company since the former has acquired the major portion of shares. It
may be stated that such dividend may be paid by the subsidiary company out of (i)
Pre-acquisition Profit, or (ii) Post-acquisition Profit.
(a) If dividends are paid out of Pre-acquisition Profit: If the dividend has been
distributed out of Capital Profit/Pre-acquisition Profit and has already been
credited by the Profit and Loss Account of holding company, in that case, Profit
and Loss Account should be debited and Investment Account should be
credited in order to make proper reconciliation for the Consolidated Balance
Sheet. In short, such dividend (only holding company’s share) will be adjusted
against Goodwill or Capital Reserve and the same also will be deducted from
the Consolidated Profit and Loss Account in the Consolidated Balance Sheet.
To Sum up:
1. Deduct the amount of dividend (holding company’s share) while
computing Goodwill or Capital Reserve; and
2. Deduct the same also from Consolidated Profit and Loss Account in the
Consolidated Balance Sheet, which appears in the Liability side.

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Note: There will be no adjustment if the same has correctly been recorded in the
books by the holding company.
Notes
Consider this illustration:

Illustration 7:
Holders Ltd. acquired 4,000 shares of Rs. 10 each, on 30.6.2,000, for Rs. 52,000 in
Subs. Ltd. Holders Ltd. received 10% dividend for 1999, but the dividends, as received,
has been credited to Profit and Loss Account of Holders Ltd.
The following are the Balance Sheets as at 31.12.2000:

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Notes

(b) If dividends are paid out of Post-acquisition Profit: If dividend has been
paid by the subsidiary company out of current profit and is received by the
holding company, the same will be treated as an income from investment and
should be credited to Profit and Loss Account of holding company.

2.4 Developments in External Reporting

Companies prepare external financial statements to report their business information to
outside observers, including potential investors and lenders. In many cases, a
company's external statements don't differ much from its internal accounting; other
times, the difference might be substantial. What matters is that the external documents
present a complete, accurate and readily understandable picture of the company's
financial condition.

2.4.1 External vs. Internal

As a business owner, you can handle your internal accounting just about any way they
works best for you. As long as it's accurate and you can understand it and follow it, go
ahead. If you own a store, for example, you might feel that you can better manage your
cash flow by using cash-basis accounting. That way, you record revenue only when you
receive a cash payment, and you record expenses whenever cash goes out the door.
External financial statements, however, have to be prepared according to a specific set
of rules, so that any observer with a basic understanding of business accounting can
follow them. That usually means using accrual-basis accounting. On these statements,

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your store would record revenue when it was earned, not received, and would record
expenses when incurred, not paid.
Notes
2.4.2 Accounting Principles
The rules governing the external financial statements of U.S. companies are known
collectively as generally accepted accounting principles, or GAAP. The U.S.
government has designated an accounting industry body, the Financial Accounting
Standards Board, to set and administer these rules. By requiring companies to report
under common standards, GAAP ensures that observers can get a true picture of a
company's finances without having to know too many details about its internal
operations. When you're soliciting a potential business partner or other investor, for
example, or when you approach a bank for a small business loan, they'll expect to see
GAAP-compliant statements.

2.4.3 Major Statements

Generally accepted accounting principles, as well as U.S. securities laws, provide for
four general purpose external financial statements: the balance sheet, income
statement, cash flow statement and equity statement. The balance sheet lists all of your
company's assets and all of its liabilities (financial obligations), and it identifies the
difference between them as the owners' equity in the company. The income statement
tracks your company's revenue and expenses from its core operations, as well as gains
and losses from other activities. The cash flow statement tracks how much cash your
company brings in and how much goes out. The equity statement summarizes how the
total "net assets" of the company — assets minus liabilities — translates into each
owner's stake.

2.4.4 Small Businesses

The external financial statements of large corporations are highly detailed, with dozens
of footnotes and pages upon pages of supporting information. Your business'
statements may be relatively simple by contrast. A small shop's balance sheet, for
example, might list only a handful of assets — say, cash, inventory, accounts receivable
and equipment — and a few liabilities. Nevertheless, the GAAP rules are the same. If
your external statements differ significantly from your internal accounting, be prepared
to explain the differences to investors, lenders or auditors. The more complicated your
business' finances become, the more cost-effective it may be to handle internal
accounting entirely or largely in accordance with GAAP.

2.4.5 "Little GAAP"

The accounting industry has long debated whether the Financial Accounting Standards
Board should create a slimmed-down set of rules for small businesses and privately
held companies. As of mid-2012, the so-called "Little GAAP" remains only a proposal.
Even under a Little GAAP system, though, the basics of external financial reporting —
accrual accounting, the general purpose statements — would remain the same. The
difference would lie in details about such things as transaction disclosures and value
measurements.
Organizations are using integrated reporting (IR) to communicate a clear, concise,
integrated story that explains how all of their resources are creating value. IR is helping
businesses to think holistically about their strategy and plans, make informed decisions
and manage key risks to build investor and stakeholder confidence, and improve future
performance. It is shaped by a diverse coalition, including business leaders and
investors, to drive a global evolution in corporate reporting.
From the International Integrated Reporting Council web site:
All entities doing business have the responsibility to comply with external reporting
requisites by the regulators and expectations from parties of interest. External reporting

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basically includes the financial position and performance and their impact on the
financial resources provided by their stakeholders.
Notes
In the last century, the usual external reports could have been five to 10 pages. The
dynamics of the economic landscape have driven the expectations of stakeholders and
the public, in general, to expand reports beyond the traditional type. More and more, the
basic financial report has been supplemented by non-financial information to better
inform the readers of the financial reports. Thus, external reports of more than 10 times
the pages of the traditional reports are no longer unusual.
Among the significant developments in the recent past that have led to the shifts in
reporting are
 the Global Reporting Initiative (GRI);
 the United Nations (UN) Global Compact;
 the World Business Council for Sustainable Development (WBCSD);
 the UN-supported Principles for Responsible Investment (PRI); and
 The UN Global Sustainable Stock Exchange Initiative (SSE) on Environmental
Social and Governance (ESG) disclosures.
In response to the foregoing trends, the International Integrated Reporting Council
(IIRC) was created.
The International Federation of Accountants’ (IFAC) Small and Medium Practices
Committee is developing implementation guideposts on integrated reporting for small-
and medium-sized entities. From the standards setters, the International Auditing &
Assurance Standards Board (IAASB) created the Integrated Reporting Working Group
(IRWG) to respond effectively to developments in external reporting for public interest.
In July 2015 the IRWG published Exploring Assurance on Integrated Reporting and
Other Emerging Developments in External Reporting to inform stakeholders about
ongoing work in this area.
The paper essentially covered the following:
 The evolving nature of emerging external reporting (EER) (that indicates an
expectation for wider information and it is reflected in the various EER frameworks
being developed);
 The developing call for action to support credibility and trust (this is not limited to
assurance services but includes enhancing credibility and trust through effective
governance and control); and
 The flexibility in “external assurance” as reporting frameworks evolve.
The discussion paper is a work in progress, awaiting the inputs from the IAASB and
IAASB CAG. Related existing standards and practices will be reckoned with. There will
be the usual exposure of the paper with comment period estimated at, say, 100 days.
As in any standard setting exercise, there are a lot of issues to be considered, and
continuing dialogues with parties of interest are imperatives. With the shifting economic
landscape and emerging expectations, the journey toward meeting expectations on
emerging external reporting will not be an easy ride. Rather, challenges abound and
collective efforts among all concerned parties are necessary. May those involved and to
be involved do not lose sight of the very reason behind all the changes in external
reporting—to better inform the readers/users of reports and for public interest.
External reporting requires an entity to provide well documented reports that can be
circulated amongst the public and stockholders. Such a report does not include
confidential information about the organization unless it is important to achieve a
specific purpose. External reporting is also about furnishing shareholders and public
with finance related information on a periodic basis in order to assist decision and
control related process.

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The finance related reports that are published are crafted primarily for meeting the
information requirements of different users as well as for discharging the entity’s
accountability needs. Companies are allowed to examine external reporting as per the Notes
conceptual structure of finance reporting. These structures are crafted to offer users,
prepares, standard setters and auditors with comprehensive concepts pertaining to
accounting for the purpose of guiding reporting. Once the organization has understood
the practicing style as well as introspection related analysis, it should gear up for
external reporting.

2.4.6 External Reporting Classification

External reporting is classified into two different categories. The first category involves
reporting done on a voluntary basis by the entity in view of its aim as well as for the
purpose of accountability, which may further assist the entity in providing external
reports. The second category revolves around reporting on a mandatory basis, which is
important for an entity so that it achieves its goals. Under both the categories reporting
is done via league report cards.

2.4.7 Reasons for External Reporting

A company opts for external reporting for a number of reasons. Firstly, an external
report is meant for the public so that they come to know more about the financial health
and operations of the company. Secondly, external reports are also used for attracting
interested and potential customers as well as investors. In addition to this, an external
report consists of data and information that can be used by industry experts and
analysts for assessing the existing condition of the entity.
Even though there is no specific way of preparing an external report, an entity
should stick to some important points, which can help them prepare an informative and
coherent report. The entities should arrange information in a logical way so that their
readers are able to follow the document easily. Companies shouldn’t include any secret
related information in the report.

2.5 Corporate Governance

Corporate governance is the system of rules, practices and processes by which a
company is directed and controlled. Corporate governance essentially involves
balancing the interests of a company's many stakeholders, such as shareholders,
management, customers, suppliers, financiers, government and the community. Since
corporate governance also provides the framework for attaining a company's objectives,
it encompasses practically every sphere of management, from action plans and internal
controls to performance measurement and corporate disclosure.
!--break--Governance refers specifically to the set of rules, controls, policies and
resolutions put in place to dictate corporate behavior. Proxy advisors and shareholders
are important stakeholders who indirectly affect governance, but these are not
examples of governance itself. The board of directors is pivotal in governance, and it
can have major ramifications for equity valuation.

2.5.1 The Board of Directors

The board of directors is the primary direct stakeholder influencing corporate
governance. Directors are elected by shareholders or appointed by other board
members, and they represent shareholders of the company. The board is tasked with
making important decisions, such as corporate officer appointments, executive
compensation and dividend policy. In some instances, board obligations stretch beyond
financial optimization, when shareholder resolutions call for certain social or
environmental concerns to be prioritized.

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Boards are often comprised of inside and independent members. Insiders are major
shareholders, founders and executives. Independent directors do not share the ties of
Notes the insiders, but they are chosen because of their experience managing or directing
other large companies. Independents are considered helpful for governance, because
they dilute the concentration of power and help align shareholder interest with those of
the insiders.

2.5.2 Good and Bad Governance

Bad corporate governance can cast doubt on a company's reliability, integrity or
obligation to shareholders. Tolerance or support of illegal activities can create scandals
like the one that rocked Volkswagen AG in 2015. Companies that do not cooperate
sufficiently with auditors or do not select auditors with the appropriate scale can publish
spurious or noncompliant financial results. Bad executive compensation packages fail to
create optimal incentive for corporate officers. Poorly structured boards make it too
difficult for shareholders to oust ineffective incumbents. Corporate governance became
a pressing issue following the 2002 introduction of the Sarbanes-Oxley Act in the United
States, which was ushered in to restore public confidence in companies and markets
after accounting fraud bankrupted high-profile companies such as Enron and
WorldCom.
Good corporate governance creates a transparent set of rules and controls in which
shareholders, directors and officers have aligned incentives. Most companies strive to
have a high level of corporate governance. For many shareholders, it is not enough for
a company to merely be profitable; it also needs to demonstrate good corporate
citizenship through environmental awareness, ethical behavior and sound corporate
governance practices.
Corporate Governance refers to the way a corporation is governed. It is the
technique by which companies are directed and managed. It means carrying the
business as per the stakeholders’ desires. It is actually conducted by the board of
Directors and the concerned committees for the company’s stakeholder’s benefit. It is
all about balancing individual and societal goals, as well as, economic and social goals.
Corporate Governance is the interaction between various participants
(shareholders, board of directors, and company’s management) in shaping
corporation’s performance and the way it is proceeding towards. The relationship
between the owners and the managers in an organization must be healthy and there
should be no conflict between the two. The owners must see that individual’s actual
performance is according to the standard performance. These dimensions of corporate
governance should not be overlooked.
Corporate Governance deals with the manner the providers of finance guarantee
themselves of getting a fair return on their investment. Corporate Governance clearly
distinguishes between the owners and the managers. The managers are the deciding
authority. In modern corporations, the functions/ tasks of owners and managers should
be clearly defined, rather, harmonizing.
Corporate Governance deals with determining ways to take effective strategic
decisions. It gives ultimate authority and complete responsibility to the Board of
Directors. In today’s market- oriented economy, the need for corporate governance
arises. Also, efficiency as well as globalization is significant factors urging corporate
governance. Corporate Governance is essential to develop added value to the
stakeholders.
Corporate Governance ensures transparency which ensures strong and balanced
economic development. This also ensures that the interests of all shareholders (majority
as well as minority shareholders) are safeguarded. It ensures that all shareholders fully
exercise their rights and that the organization fully recognizes their rights.

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Corporate Governance has a broad scope. It includes both social and institutional
aspects. Corporate Governance encourages a trustworthy, moral, as well as ethical
environment. Notes
2.5.3 Benefits of Corporate Governance
 Good corporate governance ensures corporate success and economic growth.
 Strong corporate governance maintains investors’ confidence, as a result of which,
company can raise capital efficiently and effectively.
 It lowers the capital cost.
 There is a positive impact on the share price.
 It provides proper inducement to the owners as well as managers to achieve
objectives that are in interests of the shareholders and the organization.
 Good corporate governance also minimizes wastages, corruption, risks and
mismanagement.
 It helps in brand formation and development.
 It ensures organization in managed in a manner that fits the best interests of all.

2.6 Summary
The concept of corporate financial reporting has gained much significance due to the
expansion and growth of company form of organization, increased competition and
increase in the information needs of the users (Singh, 2005) The corporate financial
reporting is a system of communication between the management and the user-groups
of the financial statements; in order to report the results of the business activities of a
corporate enterprise and also to demonstrate the credibility, accountability and reliability
of its working (Saeed,1990) Kohler’s dictionary for accountants defines it as an
explanation or exhibit attached to a financial statement, or embodied in a report
containing a fact, opinion or detail required or helpful in the interpretation of the
statement or report (Cooper and Ijiri, 1984). As per American Accounting Association
the financial reporting is the movement of information from the private domain (i.e.
inside information) into the public domain. It is a process through which an entity
communicates with the outside world (Chandra, 1974).
The subject of financial reporting has gained significance during the recent years
because of various compelling factors, such as the expansion and growth of the
company form of organization; shift in the emphasis from the concept of ‘shareholders’
to ‘stakeholders’ and increase in their informational needs; the enactments and
amendments in disclosure laws in various countries; professionalism of management;
emergence of accounting as a recognized profession; and the pronouncements on
disclosure made by various professional accounting bodies in India and abroad
(Chander,1992). A series of scandals that have rocked the financial markets and
shaken investor confidence have further increased the importance of financial reporting.
There is a general consensus among professionals that a disclosure should be full, fair
and adequate. Full disclosure requires that financial statements should be designed and
prepared to portray accurately the economic events that affected the firm for the period
and to contain information sufficient to make them useful and not misleading to the
average investor (Porwal, 1989). The need for adequate, fair and full disclosure is
irrefutable in a free enterprise economy. One can’t over-emphasize the importance of
availability of information in investment decisions. It assists the investors in selecting the
best portfolio for their investment (Lal, 1985). In the absence of adequate information
investors would not be in a position to make wise investment decisions, because it will
be difficult to distinguish between potentially successful and unsuccessful business.
(Chander, 1992)
Besides investors, disclosure is significant from the point of view of large number of
other potential users. Such potential users include, present and prospective investors,
lenders, suppliers, creditors, employees, management, customers, financial analysts

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and advisors, brokers, underwriters, stock exchange authorities, legislators, financial

press and reporting agencies, labour unions, trade associations, business researchers,
Notes academicians and above all the public at large. Disclosure has behavioral implications
for such a wide range of users. There is an obvious need for reliable information which
they can use to acquire an essential knowledge of the way in which business
enterprises are behaving in relation to the public interest. By perceiving enterprise
behavior through communicated information, interested parties can use this knowledge
to amend or adopt their own behavior vis-à-vis. the enterprise concerned(Lee, 1976).
Thus financial reporting in fact is an effective communication of accounting information.
The concept of fair disclosure implies that the accounting and other information
should be unbiased and impartial. Its objective is to provide equal treatment to all
potential financial statement readers (Chahal, 1990). The task of defining the term
‘adequate disclosure’ is more difficult because the adequacy of disclosure cannot be
tested accurately and precisely since no definite test exists in financial reporting to
measure it and moreover, it is a subjective term. In very comprehensive terms a
disclosure can be an ‘adequate disclosure’ when it entails the answers of “to whom,
why, how much, what and when the information to be disclosed” (Chahal, 1990).

2.7 Check Your Progress

Multiple Choice Questions
1. _________ is the first phase of accounting cycle
(a) Identifying an economic event or transaction
(b) Preparing journals
(c) Posting entries to ledger accounts
(d) Making decisions about business
2. Financial statements differ from management account because
(a) They are mainly prepared for external users of financial information
(b) They are more complex and hard to prepare
(c) The are the summary of accounting data
(d) The are prepared on basis of actual concept
3. ________ is a separate legal entity that Total capital can be divided in many shares
(a) Partnership
(b) Sole proprietorship
(c) Company
(d) Non-profit organization
4. An asset possesses which of the following?
(a) Future economic benefits for the business
(b) All kind of benefits for the business
(c) Expenses for the business
(d) Merits and Demerits for the business
5. Liabilities are which of the following?
(a) Resources
(b) Obligations
(c) Future benefits
(d) Expenses
6. ________ is the gross inflow of economic benefits
(a) Assets

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(b) Liabilities
(c) Income
Notes
(d) Expenses
7. The gross decrease in economic benefits for the business are what?
(a) Expenses
(b) Obligations
(c) Creditors
(d) Income or gain
8. An asset must be _______ by the business to be shown as an asset in its "balance
sheet"
(a) Possessed
(b) Owned
(c) Controlled
(d) Used
9. Liability are arisen from which of the following events?
(a) Present event
(b) Future event
(c) Past event
(d) None of them
10. Which of the following can be considered as the most important phase of
accounting cycle and it is the primarily objective of financial accounting?
(a) Identifying transactions
(b) Preparing "T Accounts"
(c) Preparing financial statements
(d) Preparing trial balances

2.8 Questions and Exercises

1. What are the issues and problems with special reference to published financial
statements?
2. Explain the financial statements of holding.
3. What are Subsidiary companies?
4. Discuss the concept of Developments in External Reporting.
5. What do mean by Corporate Governance?
6. Explain the phases of accounting cycle.
7. What is corporate financial reporting?
8. What are the importance of corporate governance?
9. Explain external reporting.

2.9 Key Terms

 Accrual basis, system, or method: an accounting system that records revenues
and expenses at the time the transaction occurs, not at the time cash changes
hands. If you buy a coat and charge it, the store records or accrues the sale when
you walk out with the coat, not when you pay your bill. Cash basis accounting is
used by individuals. Accrual basis accounting is used by most businesses.
 Accrued expenses, accruals: an expense which has been incurred but not yet
paid for. Salaries are a good example. Employees earn or accrue salaries each

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64 Financial Reporting & Decision Making

hour they work. The salaries continue to accrue until payday when the accrued
expense of the salaries is eliminated.
Notes  Amortize: to charge a regular portion of an expenditure over a fixed period of time.
For example if something cost $100 and is to be amortized over ten years, the
financial reports will show an expense of $10 per year for ten years. If the cost were
not amortized, the entire $100 would show up on the financial report as an expense
in the year the expenditure was made. (See entries on Expenditure and Expense.)
 Audit: a careful review of financial records to verify their accuracy.
 Bad debts: amounts owed to a company that are not going to be paid. An account
receivable becomes a bad debt when it is recognized that it won't be paid.
Sometimes, bad debts are written off when recognized. This is an expense.
Sometimes, a reserve is set up to provide for possible bad debts. Creating or
adding to a reserve is also an expense.

Check Your Progress: Answers

1. (a) Identifying an economic event or transaction
2. (a) They are mainly prepared for external users of financial information
3. (c) Company
4. (a) Future economic benefits for the business
5. (b) Obligations
6. (c) Income
7. (a) Expenses
8. (c) Controlled
9. (c) Past event
10. (c) Preparing financial statements

2.10 Further Readings

 Anton, H. R. 1964. Some aspects of measurement and accounting. Journal of
Accounting Research (spring): 1-9. (JSTOR link).
 Arnett, H. E. 1963. Recognition as a function of measurement in the realization
concept. The Accounting Review (October): 733-741. (JSTOR link).
 Arrington, E. 1988. Review essay: Reflections of a renaissance scholar: Carl
Devine's Essays in Accounting Theory, Volumes I-V. The Accounting Historians
Journal 15(1): 135-140. (JSTOR link).
 Arya, A., J. C. Fellingham and R. A. Young. 1996. On the role of historical cost
reporting. Issues in Accounting Education (Spring): 15-22.
 Ashton, R. H. 1974. The predictive-ability criterion and user prediction models. The
Accounting Review (October): 719-732. (JSTOR link).
 Ashton, R. H. 1977. Objectivity of accounting measures: A multi-rule—multi-
measurer approach. The Accounting Review (July): 567-575. (JSTOR link).

Amity Directorate of Distance & Online Education