This essay highlights issues that are relevant to the discussion of financial statements and financial reporting. In particular, this article will review the current state of GAAP (Generally Accepted Accounting Principals, or American accounting standards) and the trend toward adoption of IFRS (International Financial Reporting Standards). Mandatory auditing and reporting of company financials has been a major focus of public companies since adoption of Sarbanes-Oxley in 2002. Years after it became law, Sarbanes-Oxley requirements continue to challenge companies in terms of meeting internal reporting and accountability standards. Federal mandates have impacted companies in terms of costs, information technology requirements, and added responsibilities for CFOs (chief financial officers). Companies must adapt to changing auditing and reporting requirements in terms of globalization and the need to raise the capital to compete in global marketplaces.
Keywords Accounting Standards; Chief Financial Officer (CFO); Collective Bargaining; Compliance Initiatives; Financial Statements; Generally Accepted Accounting Principals (GAAP or US-GAAP); Global Accounting Standards; Independent Auditor; Internal Controls; International Financial Reporting Standards (IFRS); Investor Confidence; Public Company Accounting Oversight Board (PCAOB); Remediation; Securities & Exchange Commission (SEC)
Accounting: Financial Statements
Financial statements document the status of a company's assets, expenses, revenues, and liabilities. The overall financial health of a company can be ascertained from the quantitative analysis of financial statements—which serve as the complete record for an organization's financial records. A financial statement is an internal business tool that tracks the intake and outflow of money and illustrates changes in financial status over time. Financial statements are used for both short-term and long-term planning, for business forecasting, and for raising capital.
Types of Financial Statements
There are four main types of financial statements that document the financial aspects of a company (SEC, 2007).
- Balance sheets, which portray how much a company owns and the amount of money it owes at a certain point in time.
- Income statements, which demonstrate the amount of money a company earned and spent during a certain period of time.
- Cash flow statements, which display the amount of money flowing into a company and the money flowing out of the company during a certain period of time.
- Statements of shareholder equity, which present all the changes in the interests of the company’s shareholders that have taken place over time.
Users of Financial Statements
Depending upon the size and nature of a company there may be different users of the information on a financial statement. Internal users of financial information include
- Owners or managers, who use financials to determine future operations and planning.
- Individual employees, who may be negotiating compensation or groups of employees (unions) who are involved in collective bargaining.
- Stockholders, who review annual report figures.
External users of financial statements include
- Prospective investors, who may want to invest personal money.
- Banks or financial institutions, who may lend capital (money).
- Government bodies, which ensure compliance and accurate reporting.
The audience of an organization's financial statement will differ, often depending upon the size and complexity of an organization. In small companies, financial statements are used primarily for the benefit of the business owner in documenting the cash flow (revenue and expenses) of the company. The basic information on the financial statement allows owners or managers to see financial trends over time and to plan accordingly. For large organizations or corporations, financial statements can be complex documents and often include footnotes that provide additional information about each item on the balance sheet, income statement, and cash flow statement. Larger organizations will likely have more external users accessing their financial information and will therefore have much more complexity in their statements.
Trends in Financial Reporting
Two trends have profoundly shaped how companies are required to compile and report on their financial status.
- The rise of global organizations and markets has highlighted the need for the adoption of worldwide accounting standards—Americans use GAAP, and much of the rest of the world uses IFRS.
- Corporate scandals involving financial mismanagement and accounting fraud led to the adoption of the Sarbanes-Oxley Act of 2002.
The changing role of the CFO (chief financial officer) in organizations is also a topic that is closely related to the topic of financial reporting and disclosure. Regulatory burdens have added much to the plate of finance departments and CFOs.Changes in accounting standards and stringent compliance mandates are only two of the many tasks facing CFOs, even as they are taking on a greater strategic role within organizations.
The affects of compliance and reporting are also discussed in terms of the implications for investors who have become increasingly wary of risky capital investments. Organizations are balancing the need to loosen compliance and auditing standards with the desire for potential investors to have confidence in the organizations that they are seeking to invest in.
Accounting standards or principals have been put into place as guidelines for helping companies to prepare, present, and report financial statements. American companies use GAAP or US-GAAP standards for this purpose; GAAP standards are applied to financial reporting for all publicly traded companies in the United States and many privately held companies too. The SEC (Securities and Exchange Commission) requires that US-GAAP principals be followed for publicly traded companies. The GAAP standards are not directly set by the U.S. government but are overseen by the FASB (Financial Accounting Standards Board). The FASB is a nonprofit organization that has been designated by the SEC as the entity responsible for setting accounting principals in the public interest.
Local and state governments adhere to a set of GAAP standards that is different from those that govern private-sector organizations. The policy board for state and local GAAP standards is the Government Accounting Standards Board (GASB). Financial reporting for federal government entities is regulated by the Federal Accounting Standards Advisory Board (FASAB).
The International Financial Reporting Standards (IFRS) is a third set of common accounting standards that have been adopted by more than one hundred countries in the world, including the European Union and many emerging markets. The United States is the only major economy in the world to operate outside IFRS standards, but there is a general agreement that US-GAAP and IFRS standards should be reconciled to move toward a global standard.
Effects of Globalization on Financial Standards
The rise of globalization of markets around the world has increased the interaction among companies in many markets and across supply chains. Many American companies maintain offices outside U.S. borders and still other U.S.-based companies have been acquired by non-American owners. The rise of cross-border and multinational organizations has only highlighted the differences in practices kept by different divisions of multinationals. In the area of financial reporting and accounting, this is illustrated by the differing accounting standards of GAAP versus IFRS.
GAAP vs. IFRS
The United States continues to feel pressure to adopt international accounting standards and to reconcile those standards within GAAP. With emerging markets (such as China) having adopted IFRS, many U.S.-based CFOs are likely to continue to feel intense pressure to adopt too.
Edward E. Nusbaum, CEO of Grant Thornton, LLP, in Chicago, said "I would recommend that U.S. CFOs become acquainted with International Financial Reporting Standards and convergence related issues." He continued: "The impact will be significant, as U.S. companies will see U.S. GAAP written in a revised way. These changes could dramatically affect U.S. companies' financial statements." And "U.S. CFOs may also sense a shift in standards style toward an ever more principles-based approach. For global U.S. companies, foreign statutory reports may be due in IFRS. Overseas controllers will have a better understanding of IFRS than U.S. GAAP, and U.S. CFOs may want to know IFRS to speak the language" (Hansen, 2007).
Integration of International Standards
Japan announced in 2011, and again in 2013, that it was...
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