Chapter 3: Financial statements and the reporting entity
Chapter 3 of the Framework deals with two questions:
– what are financial statements; and
– what is the ‘reporting entity’ which prepares financial statements?
Financial statements provide information about economic resources of the reporting entity, claims against the entity, and changes in those resources and claims, that meet the definitions of the elements of financial statements.
Objective and scope of financial statements
The objective of financial statements is to provide financial information about the reporting entity’s assets, liabilities, equity, income and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the reporting entity and in assessing management’s stewardship of the entity’s economic resources.
That information is provided:
– in the statement of financial position, by recognising assets, liabilities and equity;
– in the statement(s) of financial performance, by recognising income and expenses; and
– in other statements and notes, by presenting and disclosing information about:
– recognised assets, liabilities, equity, income and expenses, including information about their nature and about the risks arising from those recognised assets and liabilities;
– assets and liabilities that have not been recognised, including information about their nature and about the risks arising from them;
– cash flows;
– contributions from holders of equity claims and distributions to them; and
– the methods, assumptions and judgements used in estimating the amounts presented or disclosed, and changes in those methods, assumptions and judgements.
Reporting period and comparative information
Financial statements are prepared for a specified period of time (reporting period) and provide information about:
– assets and liabilities (including unrecognised assets and liabilities) and equity that existed at the end of the reporting period, or during the reporting period; and
– income and expenses for the reporting period
To help users of financial statements to identify and assess changes and trends, financial statements also provide comparative information for at least one preceding reporting period.
Information about possible future transactions and other possible future events (forward-looking information) is included in financial statements if it:
– relates to the entity’s assets or liabilities (including unrecognised assets or liabilities) or equity that existed at the end of the reporting period, or during the reporting period, or to income or expenses for the reporting period; and
– is useful to users of financial statements.
For example, if an asset or liability is measured by estimating future cash flows, information about those estimated future cash flows may help users of financial statements to understand the reported measures.
Financial statements do not typically provide other types of forward-looking information, for example, explanatory material about management’s expectations and strategies for the reporting entity.
Financial statements include information about transactions and other events that have occurred after the end of the reporting period if providing that information is necessary to meet the objective of financial statements
Perspective adopted in financial statements
Financial statements provide information about transactions and other events viewed from the perspective of the reporting entity as a whole, not from the perspective of any particular group of the entity’s existing or potential investors, lenders or other creditors.
Going concern assumption
Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading. If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements describe the basis used.
The reporting entity
A reporting entity is an entity that is required, or chooses, to prepare financial statements. A reporting entity can be a single entity or a portion of an entity or can comprise more than one entity. A reporting entity is not necessarily a legal entity.
Sometimes one entity (parent) has control over another entity (subsidiary). If a reporting entity comprises both the parent and its subsidiaries, the reporting entity’s financial statements are referred to as ‘consolidated financial statements’. If a reporting entity is the parent alone, the reporting entity’s financial statements are referred to as ‘unconsolidated financial statements’.
If a reporting entity comprises two or more entities that are not all linked by a parent-subsidiary relationship, the reporting entity’s financial statements are referred to as ‘combined financial statements’.
Determining the appropriate boundary of a reporting entity can be difficult if the reporting entity:
– is not a legal entity; and
– does not comprise only legal entities linked by a parent-subsidiary relationship.
In such cases, determining the boundary of the reporting entity is driven by the information needs of the primary users of the reporting entity’s financial statements. Those users need relevant information that faithfully represents what it purports to represent. Faithful representation requires that:
– the boundary of the reporting entity does not contain an arbitrary or incomplete set of economic activities;
– including that set of economic activities within the boundary of the reporting entity results in neutral information; and
– a description is provided of how the boundary of the reporting entity was determined and of what constitutes the reporting entity.
Without being explicit, this discussion in the Framework seems to confirm that combined financial statements can be said to comply with accounting standards.
Consolidated and unconsolidated financial statements
Consolidated financial statements provide information about the assets, liabilities, equity, income and expenses of both the parent and its subsidiaries as a single reporting entity. That information is useful for existing and potential investors, lenders and other creditors of the parent in their assessment of the prospects for future net cash inflows to the parent. This is because net cash inflows to the parent include distributions to the parent from its subsidiaries, and those distributions depend on net cash inflows to the subsidiaries.
Consolidated financial statements are not designed to provide separate information about the assets, liabilities, equity, income and expenses of any particular subsidiary. A subsidiary’s own financial statements are designed to provide that information.
Unconsolidated financial statements are designed to provide information about the parent’s assets, liabilities, equity, income and expenses, and not about those of its subsidiaries. That information can be useful to existing and potential investors, lenders and other creditors of the parent because:
– a claim against the parent typically does not give the holder of that claim a claim against subsidiaries; and
– in some jurisdictions, the amounts that can be legally distributed to holders of equity claims against the parent depend on the distributable reserves of the parent.
Another way to provide information about some or all assets, liabilities, equity, income and expenses of the parent alone is in consolidated financial statements, in the notes.
Information provided in unconsolidated financial statements is typically not sufficient to meet the information needs of existing and potential investors, lenders and other creditors of the parent. Accordingly, when consolidated financial statements are required, unconsolidated financial statements cannot serve as a substitute for consolidated financial statements. Nevertheless, a parent may be required, or choose, to prepare unconsolidated financial statements in addition to consolidated financial statements.