Financial Reporting, Lecture notes of Financial Accounting

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MODULE: M492 | PRODUCT: 4592 Financial Reporting Public Financial Management: Financial Reporting Module Introduction and Overview Contents 1 Introduction to the Module 2 2 The Module Author 2 3 Study Resources 2 4 Module Overview 3 5 Learning Outcomes 6 Unit 2 Accounting Concepts 1 2.1 Financial Standards: IFRS versus IPSAS 2.2 Cash- Versus Accruals-Based Accounting 2.3 Cash Versus Accruals and Accounting Standards 2.4 Case Study 2.5 Feedback on Case Study 2.6 Conclusion Unit 3 Accounting Concepts 2 3.1 Income, Capital and Value 3.2 The Accountant’s View 3.3 The Economist’s View 3.4 Accounting for Changes in Price Levels 3.5 Case Study 3.6 Feedback on Case Study 3.7 Conclusion Unit 4 Accounting for Assets 4.1 Current Assets 4.2 Non-Current Assets 4.3 Valuing Assets in Agriculture 4.4 Case Study 4.5 Feedback on Case Study 4.6 Conclusion Unit 5 Accounting for Liabilities 5.1 Current and Non-Current Liabilities 5.2 Provisions and Contingent Liabilities 5.3 Financial Instruments 5.4 Case Studies 5.5 Feedback on Case Studies 5.6 Conclusion Unit 6 Leases and Partnerships 6.1 Leases 6.2 What are Public Private Partnerships? 6.3 Use of PPP 6.4 Accounting for PPP 6.5 Case Study 6.6 Feedback on Case Study 6.7 Conclusion Unit 7 Group Accounts 7.1 Group Accounts 7.2 The Consolidation Process 7.3 Users and Uses of Consolidated Financial Statements 7.4 Case Studies 7.5 Feedback on Case Studies Specimen Examination 7.6 Conclusion Unit 8 Governance 8.1 Definitions 8.2 Governance Failures 8.3 Good Governance in the Public Sector 8.4 Good Governance in the Private Sector 8.5 International Comparisons and National Perspectives 8.6 Conclusion 8.7 The Examination This module introduces the core accounting concepts and explores the financial reporting framework and guidelines currently available for both the private and public sectors. The first three units set the scene for the module. Unit 1 distinguishes between private and public sector organisations, as well as introducing you to the need for organisations to produce financial reports. Importantly, the unit also introduces the Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities and the Conceptual Framework for Financial Reporting, which establish the concepts underpinning financial reporting in the public and private sectors, respectively. Unit 2 explores the development of IPSAS and IFRS, as well as the extent to which they are adopted globally, and goes onto consider alternative accounting bases that may be applied by entities in their financial reporting. It defines both cash and accruals bases, with specific focus on external financial reporting. Benefits, limitations and modifications to cash and accruals bases are also considered. The adoption of these accounting bases is explored, as is the way in which they relate to the accounting standards. A case study explores the experiences of one country moving from a cash to accruals base. Unit 3 develops the core concepts further, with consideration of how to account for income and capital, as well as how to actually value individual items. The latter is particularly relevant in economies where there is high inflation and values may change considerably in a relatively short period of time. Unit 4 builds specifically on the accruals concept by exploring how to account for assets. In particular, it focuses on inventories and the non- current assets of property, plant and equipment (PPE). The unit also looks at the special case of valuing assets in agriculture. Unit 5 explores accounting for liabilities. The distinctions between liabilities, provisions and contingent liabilities are clarified and the relevant accounting standards are reviewed. The unit also introduces the complex topic of financial instruments. The case studies consider the application of the theory on liabilities to a real-life company and to public sector pensions. Unit 6 builds on the discussion of accounting for assets and liabilities in Units 4 and 5 by considering how entities may gain access to the use of assets through methods other than purchasing the asset upfront. The two methods considered are leases and public–private partnerships (PPPs). The unit explores what both leases and PPPs are, as well as their respective accounting treatments. Unit 7 builds on the topics explored in the previous units by exploring how companies or certain public sector organisations may be grouped together and merge their financial statements into what are known as group accounts or consolidated financial statements. The unit explains how entities to be consolidated are identified, before looking at the consolidation process itself. Unit 8 considers what governance actually is and examines the best practice principles that entities in the private and public sectors globally are recommended to follow. In particular, the International Framework: Good Governance in the Public Sector and the G20/OECD Principles of Corporate Governance are explored. 5 Learning Outcomes When you have completed your study of this module, you will be able to: • discuss the international conceptual frameworks for financial reporting in the public and private sectors • discuss the development and global adoption of the International Public Sector Accounting Standards (IPSAS) and the International Financial Reporting Standards (IFRS) • explain and contrast the differences in external reporting on a cash and accruals basis • discuss the accounting treatment for specific assets and liabilities in accordance with IPSAS and IFRS • discuss the process of consolidating financial statements and identify relevant accounting standards • discuss the application of governance principles and compare with national governance guidance. understood. These comments are designed to help you master the subject and to improve your skills as you progress through your programme. Postgraduate assignment marking criteria The marking scheme for your programme draws upon these minimum core criteria, which are applicable to the assessment of all assignments: • understanding of the subject • utilisation of proper academic or other style (eg citation of references, or use of proper legal style for court reports) • relevance of material selected and arguments proposed • planning and organisation • logical coherence • critical evaluation • comprehensiveness of research • evidence of synthesis • innovation/creativity/originality. The language used must be of a sufficient standard to permit assessment of these aspects. The guidelines below reflect the standards of work expected at postgraduate level. All assessed work is marked by your tutor or a member of academic staff, and a sample is then moderated by another member of academic staff. Any assignment may be made available to the external examiner(s). 80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to plan, organise and execute independently a research project or coursework assignment • very significant ability to evaluate literature and theory critically and make informed judgements • very high levels of creativity, originality and independence of thought • very significant ability to critically evaluate existing methodologies and suggest new approaches to current research or professional practice • very significant ability to analyse data critically • outstanding levels of accuracy, technical competence, organisation and expression. 70–79 (Distinction). A mark in the range 70–79 will fulfil the following criteria: • significant ability to plan, organise and execute independently a research project or coursework assignment • clear evidence of wide and relevant reading, referencing and an engagement with the conceptual issues • capacity to develop a sophisticated and intelligent argument • rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly, and their assumptions and arguments challenged and/or appraised • correct referencing • significant ability to analyse data critically • original thinking and a willingness to take risks. 60–69 (Merit). A mark in the 60–69 range will fulfil the following criteria: • ability to plan, organise and execute independently a research project or coursework assignment • strong evidence of critical insight and thinking • a detailed understanding of the major factual and/or theoretical issues and direct engagement with the relevant literature on the topic • clear evidence of planning and appropriate choice of sources and methodology with correct referencing • ability to analyse data critically • capacity to develop a focused and clear argument and articulate clearly and convincingly a sustained train of logical thought. 50–59 (Pass). A mark in the range 50–59 will fulfil the following criteria: • ability to plan, organise and execute a research project or coursework assignment • a reasonable understanding of the major factual and/or theoretical issues involved • evidence of some knowledge of the literature with correct referencing • ability to analyse data • examples of a clear train of thought or argument • the text is introduced and concludes appropriately. 40–49 (Fail). A Fail will be awarded in cases in which there is: • limited ability to plan, organise and execute a research project or coursework assignment • some awareness and understanding of the literature and of factual or theoretical issues, but with little development • limited ability to analyse data • incomplete referencing • limited ability to present a clear and coherent argument. 20–39 (Fail). A Fail will be awarded in cases in which there is: • very limited ability to plan, organise and execute a research project or coursework assignment • failure to develop a coherent argument that relates to the research project or assignment • no engagement with the relevant literature or demonstrable knowledge of the key issues • incomplete referencing • clear conceptual or factual errors or misunderstandings • only fragmentary evidence of critical thought or data analysis. 0–19 (Fail). A Fail will be awarded in cases in which there is: • no demonstrable ability to plan, organise and execute a research project or coursework assignment • little or no knowledge or understanding related to the research project or assignment • little or no knowledge of the relevant literature • major errors in referencing • no evidence of critical thought or data analysis • incoherent argument. The grading scheme: examinations The written examinations are ‘unseen’ (you will only see the paper in the exam centre) and written by hand over a three-hour period. We advise that you practise writing exams in these conditions as part of your examination preparation, as it is not something you would normally do. You are not allowed to take in books or notes to the exam room. This means that you need to revise thoroughly in preparation for each exam. This is especially important if you have completed the module in the early part of the year, or in a previous year. Details of the general definitions of what is expected in order to obtain a particular grade are shown below. These guidelines take account of the fact that examination conditions are less conducive to polished work than the conditions in which you write your assignments. Note that as the criteria for each grade rise, they accumulate the elements of the grade below. Assignments awarded better marks will therefore have become comprehensive in both their depth of core skills and advanced skills. Postgraduate unseen written examinations marking criteria 80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to evaluate literature and theory critically and make informed judgements • very high levels of creativity, originality and independence of thought • outstanding levels of accuracy, technical competence, organisation and expression • outstanding ability of synthesis under exam pressure. 70–79 (Distinction). A mark in the 70–79 range will fulfil the following criteria: • clear evidence of wide and relevant reading and an engagement with the conceptual issues • development of a sophisticated and intelligent argument • rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues Specimen Examination Answer THREE questions. You must answer Question 1, plus ONE question from Section A and ONE question from Section B. (All students must answer THIS question.) 1 The new Chief Executive Officer (CEO) of a central government department is taking an interest in the preparation of its accounts, particularly with alternative accounting methods that can be chosen and how the International Public Sector Accounting Standards (IPSAS) apply. The CEO has queried the time taken for transactions to be recognised in the accounts. As an example, the CEO is concerned that the purchase of 20 new computers is accounted for in the department’s 2018/2019 financial statements rather than in the following financial year. The department’s financial year runs from 1st April to 31st March. Activity Date Departmental Manager authorises the purchase of 20 new computers 23.03.2019 Department’s Purchasing Officer orders 20 computers from external supplier 26.03.2019 Invoice dated 26.03.2019 is received by the department requesting payment by 26.04.2019 (30 days from order) 27.03.2019 Computers received by department from supplier 04.04.2019 Payment is made by the department to the supplier for the 20 new computers 20.04.2019 One of the department’s refuse collection vehicles was recently involved in a road traffic accident. The refuse collection vehicle’s driver has admitted responsibility for driving into a family car and the department is expecting its insurance company to cover the car’s repair costs, which are estimated at £4,800. One of the conditions of the department’s vehicle insurance is that all claims will be paid minus the excess of £200. The car’s owner has confirmed that the repairs will all be completed before 31 March 2019, but the insurance company has not yet formally agreed to pay. The department’s central offices are classed as a non-cash- generating asset. The following values are available for this asset: Carrying amount of central offices building as at 31 March 2018 £2.65 million Specimen Examination Depreciation for central offices building for 2018/2019 financial year £0.25 million Fair value of central offices building £2.35 million Value in use of central offices building £1.98 million Estimated costs to sell central offices building £0.20 million a) The department applies accruals accounting but the CEO is only familiar with cash accounting. Contrast the accounting treatments for the purchase of the 20 new computers under cash and accruals bases, clearly stating when the items should be recognised in the department’s accounts. (35% of marks) b) Determine the accounting treatment in the department’s accounts for the road traffic accident, referring to relevant IPSAS where appropriate. (25% of marks) c) Determine the value of the department’s central offices that should be shown in the 2018/2019 financial statements, referring to relevant IPSAS where appropriate. (40% of marks) Section A (Answer ONE question from this section) 2 What are the advantages and disadvantages of first in first out (FIFO), last in first out (LIFO) and weighted average cost inventory valuation methods? 3 Distinguish between liabilities, provisions and contingent liabilities and explain how they are treated in the accounts. Refer to relevant accounting standards to support your answer. 4 Critically discuss the use of cash- and accruals-based financial reporting. PLEASE TURN OVER Specimen Examination 5 Discuss the concepts of income, capital and value, referring to the accounting and economic alternative views. Section B (Answer ONE question from this section) 6 Discuss the potential uses of consolidated financial statements by a range of users. 7 Critically discuss the use of public–private partnerships (PPP). 8 Discuss the international governance principles that should be adopted by public sector organisations. [END OF EXAMINATION] understood. These comments are designed to help you master the subject and to improve your skills as you progress through your programme. Postgraduate assignment marking criteria The marking scheme for your programme draws upon these minimum core criteria, which are applicable to the assessment of all assignments: • understanding of the subject • utilisation of proper academic or other style (eg citation of references, or use of proper legal style for court reports) • relevance of material selected and arguments proposed • planning and organisation • logical coherence • critical evaluation • comprehensiveness of research • evidence of synthesis • innovation/creativity/originality. The language used must be of a sufficient standard to permit assessment of these aspects. The guidelines below reflect the standards of work expected at postgraduate level. All assessed work is marked by your tutor or a member of academic staff, and a sample is then moderated by another member of academic staff. Any assignment may be made available to the external examiner(s). 80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to plan, organise and execute independently a research project or coursework assignment • very significant ability to evaluate literature and theory critically and make informed judgements • very high levels of creativity, originality and independence of thought • very significant ability to critically evaluate existing methodologies and suggest new approaches to current research or professional practice • very significant ability to analyse data critically • outstanding levels of accuracy, technical competence, organisation and expression. 70–79 (Distinction). A mark in the range 70–79 will fulfil the following criteria: • significant ability to plan, organise and execute independently a research project or coursework assignment • clear evidence of wide and relevant reading, referencing and an engagement with the conceptual issues • capacity to develop a sophisticated and intelligent argument • rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly, and their assumptions and arguments challenged and/or appraised • correct referencing • significant ability to analyse data critically • original thinking and a willingness to take risks. 60–69 (Merit). A mark in the 60–69 range will fulfil the following criteria: • ability to plan, organise and execute independently a research project or coursework assignment • strong evidence of critical insight and thinking • a detailed understanding of the major factual and/or theoretical issues and direct engagement with the relevant literature on the topic • clear evidence of planning and appropriate choice of sources and methodology with correct referencing • ability to analyse data critically • capacity to develop a focused and clear argument and articulate clearly and convincingly a sustained train of logical thought. 50–59 (Pass). A mark in the range 50–59 will fulfil the following criteria: • ability to plan, organise and execute a research project or coursework assignment • a reasonable understanding of the major factual and/or theoretical issues involved • evidence of some knowledge of the literature with correct referencing • ability to analyse data • examples of a clear train of thought or argument • the text is introduced and concludes appropriately. 40–49 (Fail). A Fail will be awarded in cases in which there is: • limited ability to plan, organise and execute a research project or coursework assignment • some awareness and understanding of the literature and of factual or theoretical issues, but with little development • limited ability to analyse data • incomplete referencing • limited ability to present a clear and coherent argument. 20–39 (Fail). A Fail will be awarded in cases in which there is: • very limited ability to plan, organise and execute a research project or coursework assignment • failure to develop a coherent argument that relates to the research project or assignment • no engagement with the relevant literature or demonstrable knowledge of the key issues • incomplete referencing • clear conceptual or factual errors or misunderstandings • only fragmentary evidence of critical thought or data analysis. 0–19 (Fail). A Fail will be awarded in cases in which there is: • no demonstrable ability to plan, organise and execute a research project or coursework assignment • little or no knowledge or understanding related to the research project or assignment • little or no knowledge of the relevant literature • major errors in referencing • no evidence of critical thought or data analysis • incoherent argument. The grading scheme: examinations The written examinations are ‘unseen’ (you will only see the paper in the exam centre) and written by hand over a three-hour period. We advise that you practise writing exams in these conditions as part of your examination preparation, as it is not something you would normally do. You are not allowed to take in books or notes to the exam room. This means that you need to revise thoroughly in preparation for each exam. This is especially important if you have completed the module in the early part of the year, or in a previous year. Details of the general definitions of what is expected in order to obtain a particular grade are shown below. These guidelines take account of the fact that examination conditions are less conducive to polished work than the conditions in which you write your assignments. Note that as the criteria for each grade rise, they accumulate the elements of the grade below. Assignments awarded better marks will therefore have become comprehensive in both their depth of core skills and advanced skills. Postgraduate unseen written examinations marking criteria 80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to evaluate literature and theory critically and make informed judgements • very high levels of creativity, originality and independence of thought • outstanding levels of accuracy, technical competence, organisation and expression • outstanding ability of synthesis under exam pressure. 70–79 (Distinction). A mark in the 70–79 range will fulfil the following criteria: • clear evidence of wide and relevant reading and an engagement with the conceptual issues • development of a sophisticated and intelligent argument • rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues Answer THREE questions. You must answer Question 1, plus ONE question from Section A and ONE question from Section B. (All students must answer THIS question.) 1 The new Chief Executive Officer (CEO) of a central government department is taking an interest in the preparation of its accounts, particularly with alternative accounting methods that can be chosen and how the International Public Sector Accounting Standards (IPSAS) apply. The CEO has queried the time taken for transactions to be recognised in the accounts. As an example, the CEO is concerned that the purchase of 20 new computers is accounted for in the department’s 2018/2019 financial statements rather than in the following financial year. The department’s financial year runs from 1st April to 31st March. Activity Date Departmental Manager authorises the purchase of 20 new computers 23.03.2019 Department’s Purchasing Officer orders 20 computers from external supplier 26.03.2019 Invoice dated 26.03.2019 is received by the department requesting payment by 26.04.2019 (30 days from order) 27.03.2019 Computers received by department from supplier 04.04.2019 Payment is made by the department to the supplier for the 20 new computers 20.04.2019 One of the department’s refuse collection vehicles was recently involved in a road traffic accident. The refuse collection vehicle’s driver has admitted responsibility for driving into a family car and the department is expecting its insurance company to cover the car’s repair costs, which are estimated at £4,800. One of the conditions of the department’s vehicle insurance is that all claims will be paid minus the excess of £200. The car’s owner has confirmed that the repairs will all be completed before 31 March 2019, but the insurance company has not yet formally agreed to pay. The department’s central offices are classed as a non-cash- generating asset. The following values are available for this asset: Carrying amount of central offices building as at 31 March 2018 £2.65 million Depreciation for central offices building for 2018/2019 financial year £0.25 million Fair value of central offices building £2.35 million Value in use of central offices building £1.98 million Estimated costs to sell central offices building £0.20 million a) The department applies accruals accounting but the CEO is only familiar with cash accounting. Contrast the accounting treatments for the purchase of the 20 new computers under cash and accruals bases, clearly stating when the items should be recognised in the department’s accounts. (35% of marks) b) Determine the accounting treatment in the department’s accounts for the road traffic accident, referring to relevant IPSAS where appropriate. (25% of marks) c) Determine the value of the department’s central offices that should be shown in the 2018/2019 financial statements, referring to relevant IPSAS where appropriate. (40% of marks) Section A (Answer ONE question from this section) 2 What are the advantages and disadvantages of first in first out (FIFO), last in first out (LIFO) and weighted average cost inventory valuation methods? 3 Distinguish between liabilities, provisions and contingent liabilities and explain how they are treated in the accounts. Refer to relevant accounting standards to support your answer. 4 Critically discuss the use of cash- and accruals-based financial reporting. 5 Discuss the concepts of income, capital and value, referring to the accounting and economic alternative views. PLEASE TURN OVER Section B (Answer ONE question from this section) 6 Discuss the potential uses of consolidated financial statements by a range of users. 7 Critically discuss the use of public–private partnerships (PPP). 8 Discuss the international governance principles that should be adopted by public sector organisations. [END OF EXAMINATION] Unit 1 Context of Financial Reporting Centre for Financial and Management Studies 3 1.1 Introduction In this module, you will study financial reporting in a variety of industries, contexts and countries, including both public and private sector entities. First, though, it is essential that you understand what accountancy actually is and what financial reporting means. Whether you have studied account- ing before or this is a totally new topic for you, it is crucial that you are clear about the context for the remainder of the module. Accounting may be defined as ‘the process of identifying, measuring and communicating financial information about an entity to permit informed judgements and decisions by users of the information’ (Weetman, 2011: p. 19). The communication of financial information by accountants to users outside an organisation is financial reporting, and is the focus of this module.  Reading 1.1 Please now study sections from Chapter 1 ‘What are accounting and finance?’ of McLaney and Atrill (2012)’s account of the meaning of these terms, providing an over- view of what accountancy is and the distinction between accountancy and finance.  As you work through this reading, make brief notes to ensure you would be able to explain accounting.  Reading 1.2 Next, turn to Elliott and Elliott (2019) and study Sections 1.1 ‘Introduction’, 1.2 ‘Share- holders’ and 1.3 ‘What skills does an accountant require in respect of external reports?’ on pages 3–4.  These sections provide an overview of what accountancy is and introduces financial reporting for external users. Financial reporting for people outside an organisation will be the focus of this module, so make sure your notes on the reading are clear on this topic. The above readings provide an introductory overview of elements in ac- counting and external financial reporting. Although focusing primarily on the United Kingdom, the contents apply globally. Later in the module you will explore the application of such accounting in a range of countries. Dur- ing the rest of this module you will study many of these elements in more detail, so do not be too concerned if you do not fully understand certain items at this point. As mentioned earlier, this module will cover financial reporting in both the private and public sectors. The next section explores the differences between these two sectors. McLaney & Atrill (2012) Sections from Chapter 1 ‘What are accounting and finance?’ Account- ing: An Introduction. Elliott & Elliott (2019) Sections from Chapter 1 ‘Accounting and report- ing on a cash flow basis’ in Financial Accounting and Reporting, Public Financial Management: Financial Reporting 4 University of London 1.2 Private Versus Public Sectors Within this module, we will explore financial reporting in both the private and public sectors. We will consider the differences between these two sec- tors before looking at their respective financial reporting approaches. Firstly, it is important to recognise that the private and public sector are fun- damentally different, and that organisations within the private sector differ from those in the public sector. These differences form the basis of the argu- ment that financial reporting should be specific to the target sector. Let’s explore the different types of entity in the private sector before consid- ering the unique characteristics of the public sector.  Reading 1.3 Please read the Section 4.3 ‘Entities’ on pages 50–53 in Alexander and Nobes (2010).  As you study this reading, make notes on the different types of private sector entity. From this reading, you should have identified the four main types of entity in the private sector: sole trader, partnership, private company and public company. We will consider these later in the module, though the main focus on financial reporting will be on private or public companies. However, this reading only considers entities in the private sector and it is important for us to consider the public sector as well. Later in this unit (Sec- tions 1.4 and 1.5), we will study the conceptual frameworks which provide the basis for the development of financial reporting standards. The Interna- tional Public Sector Accounting Standards Board’s (IPSASB) Conceptual Framework for General Purpose Reporting by Public Sector Entities (2014) actually includes a section setting out the key characteristics of the public sector, which we will study in the following reading.  Reading 1.4 Please read Section 3.2 ‘Key characteristics of the public sector’ in Müller-Marqués Berger and Ernst & Young (2018).  As you study this reading, make notes on the specific characteristics of the public sector and consider how these differ to private sector entities. You should now appreciate the unique characteristics of the public sector and be aware of some examples of public sector entities, such as regional and local government. What does the public sector look like in your own country? The next exercise helps you to consider this. Alexander & Nobes (2010) Section 4.3 ‘Enti- ties’. Financial Accounting: An Interna- tional Introduction. Müller-Marqués Berger and Ernst & Young (2018) Section 3.2 ‘Key characteristics of the public sector’ in IPSAS Explained: A Summary of International Public Sec- tor Accounting Standards. Unit 1 Context of Financial Reporting Centre for Financial and Management Studies 5  Exercise 1.1 Taking your own country or another country of interest, identify the following:  services included in the public sector  examples of public sector entities Share your answer on the VLE and discuss the similarities or differences between coun- tries with your tutor and other students. It should be noted that the public sector has become increasingly complex, with some of the boundaries between the public and private sector becom- ing blurred – for example, in the case of state-owned enterprises and public– private partnerships (PPP). The latter are partnerships between public and private sector organisations, formed to deliver public sector projects, assets or services; you will study them in more detail in Unit 6. 1.3 Rationale for Financial Reporting Standards Financial reports are prepared by organisations to show external users (such as the public or shareholders) how the organisation is performing, and to summarise its financial position. This external financial reporting is im- portant for how a public entity is viewed and how its use of public money is demonstrated, or how a company is seen by outsiders. For example, has the organisation wasted public money? The media and general public will be keen to know the answers to such questions. Has the company made a profit? Current and future investors will be keen to know the answer to this question. However, accounting is not an exact science. There is not necessarily one sin- gle way of presenting financial information, and an organisation’s managers or accountants will likely be trying to show as positive a picture as possible. How, then, can shareholders or members of the public rely on the infor- mation included in the financial reports? One such way is through the use of auditors. External auditors are account- ants, independent from the organisation, who inspect the financial reports and provide an opinion on whether they give a true and fair view of the or- ganisation’s performance and financial position. However, what guides the auditors on how the financial reports should be presented? Each auditor could make a different judgement. To address this rather circular argument, there is a need for some sort of guidance on how entities should prepare their financial reports. Public Financial Management: Financial Reporting 8 University of London in Section 1.4.1; you will also come back to consider the financial statements included within GPFR later in the module. Recommended Practice Guidelines (RPG) are publications, produced by the IPSASB, that provide guidance on aspects of financial reporting that are out- side the financial statements (IFAC, 2013). Who does the IPSAS Conceptual Framework apply to? It applies to financial reporting by public sector entities that apply IPSAS. This may include na- tional, regional and local governments as well as other public sector entities, including international governmental organisations. We will come back to consider the extent of IPSAS adoption in Unit 2, with examples, and we will look at public sector reporting entities later in this unit (Section 1.4.3). Now, though, let’s look at the content of the IPSAS Conceptual Framework in more detail. 1.4.1 Objectives and users As mentioned in the earlier reading, Chapter 2 of the IPSAS Conceptual Framework covers the objectives and users of GPFRs. In this section, we will explore these in more detail. Objectives According to the IPSAS Conceptual Framework, the objectives of financial reporting by public sector entities are to ‘provide information about the en- tity that is useful to users of GPFRs for accountability purposes and for decision-making purposes’ (IPSASB, 2014: p. 13). In other words, the pur- pose of financial reporting is not simply for financial reports to be produced, but rather to provide useful information to the users of GPFRs. Conse- quently, the IPSAS Conceptual Framework concludes that the objectives of financial reporting are determined by the information needs of its users (IPSASB, 2014). Users Financial reports are produced by organisations for a range of potentially in- terested parties. As the IPSASB (2014) states, the purpose of financial reporting is to provide information for the organisation’s users. It is im- portant to recognise the various users, as well as how their needs for information may differ. Some potential users are summarised in Figure 1.1. Unit 1 Context of Financial Reporting Centre for Financial and Management Studies 9 Figure 1.1 Users of financial reporting in the public sector The following reading explores some of these users and their potential infor- mation needs in more detail.  Reading 1.8 Please turn to Müller-Marqués Berger and Ernst & Young (2018) and read Section 3.4 ‘Objectives and users of general purpose financial reporting’ on pages 31–32.  As you study this section of the IPSAS Conceptual Framework, make note of the key users and consider what information they require. Public sector entities have a range of stakeholders who may be interested in their financial reports for a variety of reasons and may, therefore, require different pieces of information. The following exercise helps you to think through potential users and their needs.  Exercise 1.2 For a public sector entity of your choice, identify its key users and briefly explain what in- formation these users may need from the financial reports. Share your answer to the above exercise on the VLE and discuss your findings with your tutor and other students. 1.4.2 Qualitative characteristics In order for the financial reports produced by public entities to meet the needs of their users, it is crucial that the information has certain characteris- tics. For example, can members of the public understand the information included, and can lenders rely on the information being accurate? The IPSASB (2014) suggests that the qualitative characteristics of GPFR for public sector entities are: • relevance Müller-Marqués Berger & Ernst & Young (2018) Section 3.4 ‘Objectives and users of general pur- pose financial reporting’ in IPSAS Explained: A Summary of International Public Sector Accounting Standards.. Public Financial Management: Financial Reporting 10 University of London • faithful representation • understandability • timeliness • comparability • verifiability. These are important concepts and the following reading helps to explain what they actually mean.  Reading 1.9 Please read paragraphs 3.1 to 3.42 in The Conceptual Framework for General Purpose Fi- nancial Reporting by Public Sector Entities, pages 28–34 of IPSASB (2014).  As you study this reading, please make notes on the meaning of each of the qualita- tive characteristics put forward by the IPSASB. We have considered the objectives and users of financial reports, as well as the qualitative characteristics such reports should possess. Now we will turn our attention to the actual public sector entity that produces the financial re- ports. 1.4.3 Reporting entity According to the IPSAS Conceptual Framework (IPSASB, 2014), a public sec- tor reporting entity is basically a government or other public sector organisation, programme or identifiable area of activity that prepares GPFR. Examples of such public sector reporting entities include the Ministry of Fi- nance at central government level, and United Nations system organisations such as UNICEF. You will consider other public sector reporting entities who have adopted IPSAS in more detail in Unit 2. For now, let’s consider the reporting entity more generically. As you will recall from earlier in this unit, Chapter 4 of the IPSAS Concep- tual Framework focuses on the reporting entity. This section of the IPSAS Conceptual Framework tries to bring some consensus about what a report- ing entity in the public sector actually is, and which entities should produce GPFR. The next reading is taken from Chapter 4 of the IPSAS Conceptual Framework. IPSASB (2014) Sections 3.1 to 3.42. The Concep- tual Framework for General Purpose Finan- cial Reporting by Public Sector Entities. Unit 1 Context of Financial Reporting Centre for Financial and Management Studies 13 considerably more detail than the simple definition you have studied so far, as you will see later in the module. If an item is going to be recognised in financial statements, though, the next step is to determine how to measure its value to be included. 1.4.5 Measurement The measurement section of the IPSAS Conceptual Framework is concerned with how much items within the financial statements or report should be valued at. For example, if you bought a brand-new car for £30,000 five years ago, how much do you think that car would be worth today? Unless it is a rare classic car, then it is likely to have reduced in value. As another example, if an organisation bought some land and buildings ten years ago for £200,000, do you think they will be worth more, less or the same today? In this case, the new valuation is likely to depend on the indi- vidual circumstances, such as whether the buildings have been refurbished or are dilapidated, but property quite often increases in value over time. These questions of how much an item should be valued at are crucial for the preparation and review of financial reports. The definitions of assets and lia- bilities were covered above (Section 1.4.4). Chapter 7 of the IPSAS Conceptual Framework focuses on the Measurement of Assets and Liabili- ties in Financial Statements.  Reading 1.16 Please read Section 3.8 ‘Measurement of assets and liabilities in financial statements’ on pages 37–44 in Müller-Marqués Berger and Ernst & Young (2018).  Make notes on the key points from this reading, ensuring that you understand alter- native methods for measuring assets and liabilities. Take your time to understand the different measurement methods. You may find the summaries in Tables 14 and 15 partic- ularly useful. Measurement is a complex subject and this reading only provides an intro- duction. It may be useful to reiterate here that the IPSAS Conceptual Framework sets out underlying principles on which individual IPSAS are developed. So, for example, the IPSAS covering assets will go into additional detail on measurement bases. For now, you are expected to have an over- view of the key bases and their meanings. Later in the module, you will come back to apply these underlying elements, recognition and measurement principles set out in the IPSAS Conceptual Framework. Müller-Marqués Berger & Ernst & Young (2018) Section 3.8 ‘Measure- ment of assets and liabilities in financial statements’ in IPSAS Ex- plained: A Summary of International Public Sec- tor Accounting Standards. Public Financial Management: Financial Reporting 14 University of London 1.5 International Conceptual Framework – Private Sector In the previous section, we studied the IPSASB’s Conceptual Framework for General Purpose Financial Reporting, which is specific to the public sector and the IPSAS. This section considers the equivalent conceptual framework for the private sector: the Conceptual Framework for Financial Reporting (IFRS Conceptual Framework). As you might expect, many of the concepts included within the IFRS Con- ceptual Framework are similar to those within the IPSAS Conceptual Framework. However, there are also some differences. The IFRS developed and published the revised IFRS Conceptual Framework for Financial Reporting in 2018, essentially to improve the former frame- work. It has the following structure: • Chapter 1 The objectives of financial reporting • Chapter 2 Qualitative characteristics of useful financial information • Chapter 3 Financial statements and the reporting entity • Chapter 4 The elements of financial statements • Chapter 5 Recognition and derecognition • Chapter 6 Measurement • Chapter 7 Presentation and disclosure  Reading 1.17 Please read Ernst & Young’s Project Summary on the IFRS Conceptual Framework for Fi- nancial Reporting (IFRS, 2018), which provides an excellent overview.  Make notes on the key points, particularly the sections on qualitative characteristics of useful financial information, elements of financial statements and measurement. You will have noted that the IFRS Conceptual Framework identifies the two fundamental characteristics of relevance and faithful representation, in addi- tion to the enhancing qualitative characteristics of comparability, verifiability, timeliness and understandability. These characteristics are the same as for the IPSAS Conceptual Framework – but if you need reminding what the characteristics mean, please turn back to your notes from Section 1.4.2. The definitions of assets, liabilities, income and expenses have all been up- dated in this revised version of the IPSAS Conceptual Framework and it is important that you are familiar with them. If you are uncertain, take your time to look again at the reading above now.  Exercise 1.3 Identify four similarities or differences between the IPSASB’s and IFRS’s conceptual frameworks. Share your thoughts on the VLE and note the ideas made by your fellow stu- dents to supplement your own thoughts. IFRS (2018) IFRS Con- ceptual Framework for Financial Reporting: Pro- ject Summary. Reproduced in the Mod- ule Reader. Unit 1 Context of Financial Reporting Centre for Financial and Management Studies 15 1.6 Conclusion This unit has set the scene before you study the specifics of financial report- ing in more detail in the rest of this module. You have seen that there are arguments both for and against having stand- ards that set out how financial reporting should be undertaken. The IPSASB has developed an IPSAS Conceptual Framework which covers financial re- porting by public sector entities, as well as providing the foundation for the development of individual IPSAS. Within the IPSAS Conceptual Frame- work, you have explored the users of public sector financial reports, qualitative characteristics and the public sector reporting entity, including ways in which the public sector differs from private sector organisations. The IPSAS Conceptual Framework also introduced you to elements of finan- cial statements and how they are recognised and measured. You have learned that an equivalent conceptual framework was developed by the IFRS for the private sector, and you considered the similarities and differ- ences between the components of these frameworks. In the following units, you will study specific IPSAS and IFRS in more de- tail. First, though, you will continue to set the context for financial reporting in Unit 2 by looking at the development of IPSAS and IFRS, along with some further accounting concepts. References Alexander D & C Nobes (2010) Financial Accounting: An International Introduction. 4th Edition. Harlow UK, Pearson Education Limited. Elliott B & J Elliott (2019) Financial Accounting and Reporting. 19th Edition. Harlow UK, Pearson. IFAC (2013) IPSASB Publishes First Recommended Practice Guideline on the Long-Term Sustainability of Public Finances. [Online]. Available from: https://www.ifac.org/news-events/2013-07/ipsasb-publishes-first- recommended-practice-guideline-long-term-sustainability-p [Accessed 27 January 2020] IFRS (2018) IFRS Conceptual Framework Project Summary. [Online]. Available from: https://www.ifrs.org/-/media/project/conceptual-framework/fact- sheet-project-summary-and-feedback-statement/conceptual-framework- project-summary.pdf [Accessed 27 January 2020] IPSASB (2014) The Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities. Available from: https://www.ifac.org/publications-resources/conceptual-framework-general- purpose-financial-reporting-public-sector-enti-8 [Accessed 27 January 2020] McLaney E & P Atrill (2012) Accounting, An Introduction. 6th Edition. Harlow UK, Pearson Education Ltd.