SOUTH EASTERN UNIVERSITY OF SRI LANKA

FACULTY OF MANAGEMENT AND COMMERCE

DEPARTMENT OF ACCOUNTANCY AND FINANCE
BACHELLOR OF BUSINESS ADMINISTRATION – 2016 / 2017
SEMESTER – II, THIRD YEAR – 2018

FIM 32053 – FINANCIAL REPORTING

The Financial Reporting Environment

Lecturer in Charge: A L Sarifudeen B.Com (Hons) Spl, in Acc & Fin. Mgt (SEUSL)
MBA (WUSL) , MAAT (SL) , ACPM (SL) , CTHE (Col), SEDA (UK)

Topic list

1. Introduction
2. The reporting entity
3. Users' and stakeholders' needs
4. The regulatory framework
5. Companies legislation
6. SEC Regulations
7. Corporate governance
8. Accounting standards
9. The accountancy profession
10. The purpose of financial reporting
11. International GAAP
12. A conceptual framework
13. The IASB's Conceptual Framework – an introduction
14. The Conceptual Framework – objective of general purpose financial reporting
15. he Conceptual Framework – qualitative characteristics of financial statements
16. The Conceptual Framework – the underlying assumption
17. The Conceptual Framework – elements of financial statements
18. The Conceptual Framework – recognition of the elements of financial statements

1) Financial reporting and the regulatory framework

1.1 What is financial reporting?

Financial reporting is a way of recording, analyzing and summarizing financial data.

Financial statements are used by a wide variety of interested parties.

Financial reporting has developed over a number of years, and continues to evolve. It is the process
by which organizations record the financial effect of transactions throughout the year before
summarizing this and presenting it in accepted formats for use by external parties, in particular
investors and lenders.

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1.2 Financial statements within annual reports.

Financial statements are found within a company's annual report; however they are by no means
the only information contained within such a report. It is becoming more and more usual to find
extensive narrative reports before the financial statements. These may include directors' reports,
management commentary, reports on corporate governance and sustainability or integrated
reports.

1.3 The reporting entity

A reporting entity is an entity whose general purpose financial statements are relied upon by other
parties, or users of the accounts.

1.4 Users of the financial statements and annual reports

The International Accounting Standards Board (IASB) states in the Conceptual Framework for
Financial Reporting:

The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an entity that is useful to a wide range of
users in making economic decisions.

The following groups may be interested in financial statements.

 Managers of the company

 Shareholders of the company
 Trade contacts
 Providers of finance to the company
 The taxation authorities
 Employees of the company
 Financial analysts and advisers
 Government and their agencies
 The public.

2) The regulatory framework

The regulatory framework of financial reporting refers to the many sources of regulation,
including accounting standards, company law and stock exchange rules.

2.1. GAAP

Generally Accepted Accounting Principles, or GAAP, is a term which has arisen in recent years
and signifies all the rules, from whatever source, that govern accounting. The rules may derive
from:

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  Local (national) company legislation.
 National and International Accounting Standards.
 Statutory requirements in other countries (particularly the US).
 Stock exchange requirements.

GAAP is usually supplemented by other non-mandatory sources of guidance including the

statutory requirements and accounting standards of other countries and long-standing practice.

2.2. International GAAP

International GAAP comprises the accounting standards and other guidance documents issued by
the various bodies of the IFRS Foundation:

 IASs and IFRSs issued by the IASB.

 The Conceptual Framework for Financial Reporting (covered in more detail in the next
chapter).
 Interpretations issued by the IFRS Interpretations Committee.

These documents are supplemented by local legislation, statutory and stock exchange requirements
to become local GAAP in the countries in which IFRS is adopted.

Note that you may sometimes see GAAP defined as Generally Accepted Accounting Practice, but
the meaning is the same.

2.3. Sri Lankan GAAP

In Sri Lanka, the mandatory sources of GAAP are the following.

(i) Companies' legislation
(ii) SEC Regulations and rulings
(iii) Accounting standards as issued by the Institute of Chartered Accountants of Sri Lanka
(CASL)

3) Companies legislation

Several sources of legislation are relevant to the preparation and presentation of financial
statements in Sri Lanka.

There are a number of sources of legislation relevant to companies in Sri Lanka, including:
 Companies Act No 07 of 2007
 Sri Lanka Accounting and Auditing Standards Act No 15 of 1995
 Finance Act No 38 of 1971
 Inland Revenue Act No 10 of 2002
 Employees' Provident Fund Act
 Securities and Exchange Commission Act

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4) SEC Regulations

SEC Rules govern the listing of securities on the Exchange and continuing listing requirements in
order to ensure the creation and maintenance of a market in which securities can be issued and
traded in an orderly and fair manner and which secures efficiency and confidence of all
stakeholders in the operation and conduct of the market.

It is the duty of the board of directors of an entity to ensure that all the listing requirements are met
on a continuing basis so long as its securities remain listed on the Exchange. It is the duty of the
board of directors of a managing company of a fund to ensure that all the listing requirements are
met on a continuing basis so long as units of such fund are listed on the Exchange.

The SEC Rules,

 Initial listing
 Listing of shares
 Listing of debentures
 prospectus/introductory documents
 Further issue of securities of a listed entity
 Articles of Association or other corresponding documents
 Trust deed
 Continuing listing requirements
 Corporate disclosure
 Related party transactions
 Enforcement
 Fees

5) Corporate governance

Corporate governance is the system by which companies and other entities are directed and
controlled.

Corporate governance is the system by which companies and other entities are directed and
controlled.

5.1. What is corporate governance?

Corporate governance is the system by which companies and other entities are directed and
controlled.

The trigger for developments in corporate governance was the collapse of major international
companies during the 1980s. These collapses were often unexpected, and dubious (or even
fraudulent) activities were sometimes attributed to their owners and managers. These events
represented a nasty shock for countries, such as the UK and the US, which felt they had well-
regulated markets and strong company legislation. It became obvious, however, that part of the
problem was the way in which regulation was spread between different national authorities for

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these global conglomerates, so that no one national authority had the whole picture of the affairs
of such companies, nor full powers over the whole of the business.

5.2. Corporate governance in Sri Lanka

CASL published a Code of Best Practice on matters related to financial aspects of Corporate
Governance in 1997. The fourth edition of the publication Code of Best Practice on Corporate
Governance was issued jointly by the institute of Chartered Accountants of Sri Lanka and the
Securities and Exchange Commission of Sri Lanka, and is currently applied in Sri Lanka.

6) Accounting standards

The IASB develops and publishes new International Financial Reporting Standards (IFRSs)
according to its six-step due process. CASL can input to this process and, subsequent to issue,
adopts IFRSs as SLFRS.

6.1. Professional bodies

Professional accountancy bodies are found at a national and global level. The Institute of Chartered
Accountants of Sri Lanka (CASL) is the body responsible for issuing accounting standards in Sri
Lanka; its global counterpart is the International Accounting Standards Board (IASB), part of the
International Financial Reporting Standards Foundation (IFRS Foundation).

6.1.1. The IFRS Foundation

The IFRS Foundation is the global body responsible for financial reporting.

6.1.2. The interaction of professional bodies

In 2009, the Institute of Chartered Accountants of Sri Lanka (CASL) made a decision to converge
fully with all pronouncements issued by the IASB (subject to some minor modifications) and
thereafter to adopt all pronouncements issued by the IASB.

CASL, along with other national standard setters, also has the opportunity to become involved in
the development of new IFRSs through the IASB's due process for working on new
pronouncements.

6.2. Accounting standards

The IASB issues International Financial Reporting Standards (IFRSs); prior to this, it issued
International Accounting Standards (IAS). These are adopted by CASL as SLFRS and LKAS.

6.2.1. Status of standards

IFRSs are not part of international law and therefore their use is not mandatory in a general sense.
Their use in particular countries depends on their adoption by local authorities.

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In Sri Lanka, the Sri Lanka Accounting and Auditing Standards Act No 15 of 1995 requires all
companies to comply with accounting standards established by CASL:

(a) All domestic companies whose debt or equity securities trade in a public market in Sri Lanka
must use SLFRSs. This applies to both consolidated and separate financial statements.

(b) All Specified Business Enterprises (SBEs) must apply SLFRSs, even where they are not
listed. Specified Business Enterprises include:

 Companies listed on a stock exchange

 Banks
 Insurance companies
 Factoring companies
 Finance companies
 Leasing companies
 Unit trusts
 Fund management companies
 Stockbrokers and stock dealers
 Stock exchanges
 Public corporations engaged in the sale of goods or provision of services
(c) Other companies may adopt either SLFRSs or the SLFRS for small and medium-sized entities
(SMEs).

6.2.2. Due process for the development of IFRSs

IFRSs are developed through an international consultation process that involves interested
individuals and organizations from around the world.

Due process comprises six stages:

(1) Setting the agenda

(2) Planning the project
(3) Developing and publishing the discussion paper
(4) Developing and publishing the exposure draft
(5) Developing and publishing the standard
(6) After the standard is issued

These stages are below.

1) Setting the agenda

2) Planning the project
3) Developing and publishing the discussion paper
4) Developing and publishing the exposure draft
5) Developing and publishing the standard
6) After the standard is issued

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6.2.3. Due process for the adoption of IFRSs as SLFRSs

CASL exposes for public comment all IASB exposure drafts and draft interpretations. CA Sri
Lanka also conducts chief financial officers' (CFOs') round table discussions to identify the impact
of the proposed standard in Sri Lanka. Afterwards, CA Sri Lanka forwards its views to the IASB.

When the IASB issues a final IFRS or Interpretation, CA Sri Lanka reviews the IFRS and related
technical materials. In a few cases, this review has resulted in modification or deferral of the
standard for use in Sri Lanka.

Thereafter, the standard is translated into Sinhala and Tamil and published in the Extra Ordinary
Gazette as required by the Accounting and Auditing Standards Act No 15 of 1995 in Sri Lanka.
Once gazetted, the standard becomes legally authoritative.

6.3. Interpretations

Interpretations, referred to as IFRICs (or previously SICs), are issued by the IFRS
Interpretations Committee as necessary to:

 Interpret the application of IFRSs

 Provide timely guidance on financial reporting issued not specifically addressed in IFRSs

They are therefore of limited scope in nature, dealing with specific issues only.

6.4. The Conceptual Framework

6.4.1. Definition
As well as issuing accounting standards, the IASB and CASL have issued the Conceptual
Framework for Financial Reporting. This contains the fundamental principles and concepts that
underlie financial reporting and accounting standards. It provides the framework within which new
standards are developed.

A conceptual framework is a statement of generally accepted theoretical principles, which form

the frame of reference for a particular field of enquiry.

A conceptual framework for the development of accounting standards has been defined as:

'a constitution, a coherent system of interrelated objectives and fundamentals which can lead to
consistent standards and which prescribe the nature, function and limits of financial accounting
and financial statements' [FASB, 1976].

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6.4.2. Purpose

The purpose of a financial reporting conceptual framework is twofold. Its theoretical principles
provide the basis for:
 The development of new reporting practices, and
 The evaluation of existing ones.

6.4.3. Advantages and disadvantages of a conceptual framework

Advantages
a) A consistent conceptual base should lead to standardized consistent accounting
practices.
b) The development of standards is less subject to political pressure.
c) A consistent balance sheet driven or income statement driven approach is used.
d) Avoids a 'fire-fighting' (or 'patchwork quilt') approach to setting standards.

Disadvantages

a) Different users have different needs. The needs of all users cannot be considered.
b) Different purposes or uses may require different conceptual bases.
c) A conceptual framework does not necessarily make preparing standards any easier, and
may hamper their development.

6.4.4. The Conceptual Framework for Financial Reporting

The Conceptual Framework for Financial Reporting includes chapters on the objective of general
purpose financial reporting, qualitative characteristics of financial information, underlying
assumption, definition, recognition and measurement of elements of the financial statements and
capital maintenance.

The introduction to the Conceptual Framework for Financial Reporting (the Conceptual
Framework) points out the fundamental reason why financial statements are produced worldwide;
that is, to satisfy the requirements of external users.

The preface emphasizes the way financial statements are used to make economic decisions, and
thus financial statements should be prepared to this end. The types of economic decisions for which
financial statements are likely to be used include the following.
 Decisions to buy, hold or sell equity investments
 Assessment of management stewardship and accountability
 Assessment of the entity's ability to pay employees
 Assessment of the security of amounts lent to the entity
 Determination of taxation policies
 Determination of distributable profits and dividends
 Inclusion in national income statistics
 Regulations of the activities of entities

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The Conceptual Framework recognizes that financial statements can be prepared using a variety
of models. Although the most common is based on historical cost and a nominal unit of currency
(eg the Sri Lankan rupee), the Conceptual Framework can be applied to financial statements
prepared under a range of models.

6.4.5. Purpose and status

The introduction gives a list of the purposes of the Conceptual Framework.

a) To assist the Council in the development of future Sri Lanka Accounting Standards and
in its review of existing Sri Lanka Accounting Standards.

b) To assist the Council in promoting harmonization of regulations, accounting standards and

procedures relating to the presentation of financial statements by providing a basis for
reducing the number of alternative accounting treatments permitted by Sri Lanka
Accounting Standards.
c) To assist the Council in developing Sri Lanka Accounting Standards.
d) To assist preparers of financial statements in applying Sri Lanka Accounting Standards and
in dealing with topics that have yet to form the subject of a Sri Lanka Accounting Standard.
e) To assist auditors in forming an opinion as to whether financial statements comply with Sri
Lanka Accounting Standards.
f) To assist users of financial statements in interpreting the information contained in financial
statements prepared in compliance with Sri Lanka Accounting Standards.
g) To provide those who are interested in the work of the Council with information about its
approach to the formulation of Sri Lanka Accounting Standards.

The Conceptual Framework is not a Sri Lanka Accounting Standard and so does not define
standards for any particular measurement or disclosure issue. Nothing in the Conceptual
Framework overrides any specific Sri Lanka Accounting Standard.

6.4.5.1. Scope

The Conceptual Framework deals with:

a) The objective of financial statements
b) The qualitative characteristics of useful financial information
c) The definition, recognition and measurement of the elements from which financial
statements are constructed.
d) Concepts of capital and capital maintenance

6.4.5.2. Users and their information needs

Users of accounting information consist of investors, employees, lenders, suppliers and other trade
creditors, customers, government and their agencies and the public.

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6.5. Guidelines issued by CASL

CASL issues guidelines from time to time relevant to the preparation of financial statements of
organizations. For example it has issued a statement of recommended practice (SORP) on the
preparation of financial statements of not for profit organizations / non-government organizations
(NGOs). These guidelines issued by CASL play a vital role in accountancy profession in Sri Lanka.

6.6. The objective of general purpose financial reporting

The Conceptual Framework states that the objective of general purpose financial reporting is to
provide information about the reporting entity that is useful to existing and potential investors,
lenders and other creditors in making decisions about providing resources to the entity.

These users need information about:

 The economic resources of the entity

 The claims against the entity
 Changes in the entity's economic resources and claims

Information about the entity's economic resources and the claims against it helps users to
assess the entity's liquidity and solvency and its likely need for additional financing.

Information about a reporting entity's financial performance (the changes in its economic resources
and claims) helps users to understand the return that the entity has produced on its economic
resources. This is an indicator of how efficiently and effectively management has used the
resources of the entity and is helpful in predicting future returns.

6.7. Underlying assumption

Going concern is the underlying assumption in preparing financial statements.
Going concern. The entity is normally viewed as a going concern; that is, as continuing in operation
for the foreseeable future. It is assumed that the entity has neither the intention nor the necessity
of liquidation or of curtailing materially the scale of its operations. (The Conceptual Framework).

The qualitative characteristics of financial information are those that make the information useful
to the users. The four principal characteristics are:

 Understandability
 Relevance (including materiality)
 Reliability
 Comparability.

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6.8. The elements of financial statements

The Conceptual Framework lays out the elements of financial statements as follows.

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The five elements of financial statements and their definitions are:

References:

1. Financial accounting and reporting

by Elliott, Barry; Elliott, Jamie. Edition: 16th ed.
United Kingdom : Pearson , 2013 (2013)

2. Business Financial Reporting

Study Text, KB1 Business Level,
Published by
BPP Learning Media Ltd, BPP House, Aldine Place
142-144 Uxbridge Road, London W12 8AA

3. Financial Accounting and Reporting

Study Manual, Foundation Level, CPA Australia
Published by BPP Learning Media Ltd
BPP Learning Media Ltd, BPP House, Aldine Place
142-144 Uxbridge Road, London W12 8AA

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