CORPORATE

FINANCIAL
REPORTING
SYSTEM
CONCEPT OF CORPORATE FINANCIAL
REPORTING
• Financial reporting is the communication of financial information of an
enterprise to the external world.

• Bedford conceptualizes the financial reporting process as consisting of four

procedural steps:
• 1. Perception of the significant activity of the accounting entity or in the
environment in which the entity performs.
• Implicit in the traditional perception is the belief that financial transactions
represent the significant activities.
• 2. Symbolizing the perceived activities in such fashion that a database of the
activities is available that can then be analysed to grasp an understanding of the
interrelationship of the mass of perceived activities.
• Conventionally, this symbolization has taken the form of recordings in
accounts, journals, and ledgers using well-established bookkeeping and
measurement procedures.
• 3. Analysis of the model of activities in order to summarize the
interrelationships among activities and to provide a status picture or map of
the entity.
• Traditionally, this analysis process has been viewed as one of developing
accounting reports to provide insights into the nature or entity activities.
• 4. Communication (transmission) of the analysis to users of the accounting
products to guide decision makers in directing future activities of the entity or
in changing their relationship with the entity.
• First two steps constitute the process of accounting measurement, the
quantification of an entity’s past, and present, or future economic phenomena
on the basis of observations and rules.
• Implicit in this conception are the requirements that
• (a) there exist some attribute or feature of a business-related objects or event
(e.g.; the value of an asset) worthy of measurement and
• (b) there exist a means of making the measurements (e.g., the use of exchange
prices to value enterprise assets).
• Step 3 and 4 of the financial reporting process constitute disclosure.
• Hence, measurement and disclosure are two dimensions of reporting process
and these two aspects are interrelated. Together, they give corporate reporting
its substance.
• Corporate financial reporting is a series of activities that allows companies to
record operating data and report accurate accounting statements at the end of
each month, quarter and year.
• Bookkeepers record operating data by debiting and crediting financial accounts.
• Accountants prepare financial statements in accordance with corporate
policies, industry practices and regulatory guidelines.
• As per Section 2(40) of the Companies Act, 2013, the Financial statements of the
company include:
• 1. a balance sheet at the end of the financial year;
• 2. a profit and loss account, or in the case of a company carrying on any activity not
for profit, an income and expenditure account for the financial year;
• 3. cash flow statement for the financial year;
• 4. a statement of change in equity, if applicable; and
• 5. any explanatory note annexed to, or forming part of, any document referred to in
sub-clause(i) to sub-clause (iv).
• The financial statements, augmented by footnotes and supplementary data
(often referred to as ‘Notes to the Accounts’) are intended to provide relevant,
reliable and timely information essential for making investment, credit and
similar decision.
• Such financial statements are called general purpose financial statements.
• The term financial reporting is not restricted to information communicated
through financial statements.
• Financial reporting includes other means of communicating information that
relates, directly or indirectly to the information generated through accounting
process.
• Information provided by means of financial reporting other than financial
statements may take various forms and relate to various matters.
• Eg: Publication of unaudited financial results, news releases, management
forecasts and description of future plans are examples of reports that are
provided outside the general purpose financial statements.
USERS OF ACCOUNTING AND THEIR
INFORMATION NEED
• Accounting information used by various persons. Following are the users of accounting
information for various purposes.
• 1. Proprietor - proprietor is the main user of accounting.Through accounts he ascertains
operating result of his business and the financial position (assets and liabilities). He uses
accounting information to know amount due to others and due from others.
• 2. Management - in large business organisations, ownership and management have separate
functions. Management has to plan, control and execute. Accounting information is used for
fulfilling various managerial functions.
• 3. Suppliers of Goods and Services (Creditors) - persons who supply goods and services to
business on credit are interested to watch liquidity position of the business. They have to
ensure repayment capacity of the business. They use accounting information for this purpose.
• 4. Banks and Financial Institutions - banks and other financial institutions who provide loan to
the business are interested to know credit worthiness of the business. At the time of granting
loan, they study Profit and Loss Account and Balance Sheet of the firm of previous years to
know capacity of the firm to repay interest and principal amount.
• 5. Prospective investors - persons who are interested to make investment in some company,
may study annual reports (like profit and loss, balance sheet and other data) of the company
for making final decision of investment. They may select the company in which investment is to
be made by comparing past performance of these companies.
• 6. Government - government uses accounting information for levying various taxes (Income
Tax, GST, etc.). In the absence of accounting data, it is difficult to access proper tax.
• 7. Customers - customers who place orders and are dependent on a specific business
organisation for their supplies have to ensure the capability of the firm to execute the orders.
This can be done by studying accounting of that business organisation.
• 8. Employees - employees use accounting information for various purposes. They can assess their
salary increase and bonus by studying profitability of the business. If the business is constantly
incurring losses, they may decide to leave the organisation.
• 9. Regulatory agencies - various regulatory agencies such as company law department, tax
authorities, reserve Bank of India, require information to be filed with them under law. By examining
this accounting information, they ensure that concerned companies are following the rules and
regulations.
• 10. Courts - in case of disputes regarding indebtedness, insolvency, etc. courts use accounting
information and other related data as evidence.
• 11. Researchers - research scholars who have undertaken research on any aspect of business
activity, may use accounting information for the purpose of analysis. Accounting reports of various
companies and of various years may be compared for this purpose.
USERS OF FINANCIAL STATEMENTS

• Different classes of users use financial information for different purposes.

• Identification of the users and their classes is necessary in order to determine
the purposes for which they use information.
• Identification of users helps in defining user group characteristics which
influence both the specific type of information to be presented and the manner
of presentation.
• According to the Framework for the Preparation and Presentation of Financial
Statements (‘ICAI Conceptual Framework’) issued by the ICAI in 2000, the
users of financial statements include present and potential investors,
employees, lenders, suppliers and other trade creditors, customers,
governments and their agencies and the public.
• The common characteristic of external users is their general lack of authority
to prescribe the information they want from a company.
• It is also observed that some users have more resource and influence than
others so that they can obtain more information about an enterprise than is
generally available to others.
• These privileged users include managers, large scale equity investors, etc.
• These different user groups have different objectives and diverse information needs.
• But, general purpose financial statements are prepared to meet the common needs of
all types of users.
• However, all of the information needs of these users cannot be met by such a report.
• Multiplicity and conflicts of objectives of a wide variety of potential users for general
purpose reports make it difficult to design a single set of published statements that
can simultaneously provide all necessary information to all possible users.
• Traditionally, investors (both existing and potential) are singled out as the
dominant user-group of published financial statements.
• As providers of risk capital to the enterprise, investors need more
comprehensive information than other users.
• The ICAI Conceptual Framework states that the provision of financial
statements, which meet the investors’ needs, will also meet most of the needs
of other users.
• Also in practice, top priority is given to the information needs of the investors
while deciding what items of information should be disclosed in general
purpose financial statements.
OBJECTIVES OF CORPORATE FINANCIAL
REPORTING
• There are debates regarding objective of financial reporting.
• However, some consensus has been developed on the objectives of financial
reporting through the issuance of the conceptual framework.
• The conceptual framework provides the conceptual basis for generally
accepted accounting principles (GAAP).
• It outlines the characteristics, accounting information must possess to be
useful in investment and other economic decisions.
• Like other standard setting bodies, paragraph 22 of the Framework states that
the objective of financial statements is to provide information about financial
position, performance and cash flows of an enterprise that is useful to a wide
range of users in making economic decisions.
• The Framework specifies present and potential investors, employees, lenders,
suppliers and other trade creditors, customers, governments and their agencies
and the public as the users of financial statements.
• As per IASB following are the objectives of Financial Reporting:
• 1. Information to Management: Management can use this information for
planning, analysis, benchmarking and decision making.
• 2. Information to investors: Financial Reporting provides information to
investors, promoters, lenders, creditors which enables them to take rational
and prudent decisions regarding investment, credit, etc.
• 3. Information to Shareholders: Shareholders can use this information for
portfolio management.
• 4. Information about economic resources: It provides information about
economic resources.
• 5. Information to Stakeholders: It provides information to various stakeholders
regarding performance of the organisation. They can decide how diligently and
ethically they are discharging their responsibilities.
• 6. Information to Auditors: It provides information to statutory auditors so
that they can discharge their responsibilities.
• 7. Enhancing social welfare: It can enhance social welfare by looking into the
interest of employees, trade unions and government.
• 8. Information to management: Financial reporting provides information to
management for decision making.
QUALITATIVE CHARACTERISTICS OF
INFORMATION IN FINANCIAL REPORT
• Qualitative characteristics are the attributes that make the information
provided in the financial statement useful to the users.
• ICAI Conceptual Framework earmarks four principal qualitative characteristics
viz., understandability, relevance, reliability and comparability.
• According to the ICAI Conceptual Framework, materiality is not a principal
qualitative characteristic.
• A piece of information is considered to be material when its disclosure or
non-disclosure would affect decision or would make a difference in the
valuation of the firm.
• But, in the ICAI Conceptual Framework, materiality is considered as a
threshold limit, which needs to be judged before referring to any other
qualities of any information provided in financial statements.
• If any piece of information does not fulfil the threshold criteria, it need not be
considered further.
• Understandability
• Information in annual reports should be presented in such a way that it is
readily understandable by users.
• ICAI Conceptual Framework states that the criterion of understandability
requires that the users have a reasonable knowledge of business and economic
activities, accounting, and a willingness to study the information with
reasonable diligence.
• It has also suggested that information, which is relevant to the economic
decision-making needs of some of the users should not be excluded merely on
the ground that it may be difficult to understand by others.
• Relevance
• The concept of relevance is directly related to the decision-making needs of
users.
• Information is said to be relevant if it can influence ‘the economic decisions of
users by helping them evaluate past, present or future events or confirming or
correcting, their past evaluation.
• It is suggested that all those items of information, which may aid the users in
making predictions or decisions, should be reported.
• Information, which does not assist users in making decisions is irrelevant and
hence, should be omitted.
• Thus, relevance is the dominant criterion of taking decisions regarding
information disclosure.
• Timeliness is an important aspect of relevance. Information loses value rapidly
in the financial world.
• As time passes and the future becomes the present, past information became
increasingly irrelevant.
• Reliability
• Information is reliable if it is free from material error and bias, and faithfully
represents what it purports to represent.
• Information is reliable to the extent a user can depend upon it to represent
the economic conditions or events that it aims to represent.
• Being free from bias implies impartial measurement and reporting by
enterprise of its events and transactions.
• Comparability
• The ICAI Conceptual Framework emphasizes that users must be able to
compare financial statements, of an enterprise through time in order to
identify trends in its financial position, performance and cash flows, and of
different enterprises in order to evaluate their relative financial position,
performance and cash flows.
• For this purpose, the measurement and display of the financial effects of like
transactions and other events must be carried out in a consistent way.
• The Framework indicates that the important implication of comparability is
that users should be informed of the accounting policies employed in the
preparation of financial statements, any changes of those policies and the
effects of such changes.
• For achieving comparability, the Framework (paragraph 40) suggests
compliance with relevant accounting standards including the disclosure of
accounting policies used by the enterprise.
THEORIES OF DISCLOSURE

• Concept of Disclosure
• The concept of disclosure is of great significance to the accomplishment of the
objectives of financial reporting.
• Financial reporting is the communication of financial information of an
enterprise to the external world.
• The theory is that a fully informed consumer would more likely make better choices.
• Knowing the true cost of everything would force consumers to be better educated and more
informed.
• Available disclosure literature suggests that disclosure is not only fundamental to financial
reporting but is, at the same time, its most qualitative aspect and the nature and extent of
disclosure needed in individual reporting situations is determinable only by expert professional
judgment.
• Disclosure standards and practices are influenced by legal systems, source of finance, political
and economic environments, education level and culture.
• Motives behind Disclosure
• It is argued that competition for capital is the major motivating force to
disclose decision-oriented information to different user groups.
• Hence, market forces would ultimately shape the nature of corporate
disclosure.
• Corporations not only compete among each other in the capital markets but
also attempt to obtain capital at a lower cost.
• It is indicated by many researchers that there is relationship between a firm’s
capital cost and its level of disclosure in its annual report.
• Due to such linkage and decision usefulness of published financial statement,
corporate financial reporting is perceived as a pre-requisite for the growth of
capital markets.
• Apart from stock market considerations, there are varieties of considerations
that may motivate management of a company to disclose information
voluntarily and not wait for mandatory requirements.
• Some of these important considerations are:
• ♦ Political costs consideration
• ♦ Users’ needs consideration, and
• ♦ Ideological goal consideration.
• Political costs consideration:
• Fines, penalties, potential public hostility toward the company are the examples
of political costs. It is now recognized that political costs may play an important
role in decisions relating to additional disclosure in the form of social and
environmental information.
• Disclosure of environmental information can be considered to reassure the
public or the regulating agencies that companies were concerned about the
environment and were doing everything possible to reduce the negative impact
of their activities on the environment.
• Users’ needs consideration:
• Guthrie and Parker have argued that companies may disclose social
information to meet the stakeholders’ demand for such information.
• The argument is based on Users’ Utility Model.
• Disclosure of additional information on a voluntary basis depends on the
users’ needs, and how these needs are perceived by management of companies.
• Ideological goal consideration:
• It has been argued that companies would be motivated to disclose voluntarily
additional information to serve their own political and ideological goals.
• Such disclosure would be guided by companies’ agenda, ideologies and goals
which are likely to be different for different companies even within the same
industry.
• Consequently, disclosure of such information will vary from company to
company.
• Basic Problems of Disclosure
• In disclosing information, business enterprises, particularly corporate entities,
are confronted with certain basic problems, the solutions of which need
answers to the following questions:
• (i) Who are the users of information or for whom information should be
disclosed?
• (ii) What information should be disclosed?
• (iii) How much information should be disclosed?
• (iv) How should information be disclosed?
• (v) When should information be disclosed?
• The first question requires identification of users of information.
• The second question needs the identification of the purposes for which
information will be used.
• The third question relates to the problem of determining quantum of
information.
• The fourth and fifth questions concern the problems of deciding about the
mode and timing of disclosure respectively.
• Disclosure being the transmission of accounting measurement to the users
group, corporate entities views it as a major policy issue.
• As the disclosure of accounting information is not costless, preparers of
financial statement have to make judgments on the allocation of accounting
information among various user groups.
• From regulator’s standpoints, leaving the decision about disclosure in the hand
corporate management or market forces, has not been viewed favourably.
• It is possible for management to disclose information that is considered helpful
to facilitate its external relations programmes and still withhold certain pieces
of vital information that is useful for decision making by the users.
• Hence, greater control over corporate reporting is imposed whenever it is
perceived that there is failure to adequately respond to express information
needs of different stakeholders.
• Thus, the scope of negative sanctions of regulatory controls over corporate
disclosure increases when user groups perceive that there are deficiencies on
the part of companies in providing adequate disclosure.
ROLE OF AUDITORS

• The audit of financial statements is a legal requirement.

• The audit provides an external and objective check on the measurement and
disclosure aspects of corporate financial reporting.
• An auditor is appointed by the shareholders, but effectually his appointment is
subject to will of management or promoter group.
• Nevertheless, the auditor is supposed to be independent of management and
to serve the shareholders and other users of financial statements.
• Although, management is responsible for the preparation of financial statement
including the notes, the auditor through the auditor’s report states whether
financial statements presents fairly, in all material respects the financial position,
the results of operations and the cash flows for the accounting period.
• The auditor is responsible for seeing that the financial statements issued
conform with generally accepted accounting principles (GAAP).
• Thus, the auditor must agree that accounting policies adopted by the
management is appropriate and all estimates are reasonable.
• Any departure from generally accepted accounting principles (including non-
compliance with the measurement and disclosure requirements of the
accounting standards) would result in a qualified opinion.
• Auditor’s report is an important accompaniment of financial statements.
• Because of boilerplate nature (i.e. standard language) of these reports, there is
tendency to skip over them while analysing financial statements.
• However, such failure to give attention to the auditor’s report may cause the
user to miss significant information.
MODE OF FINANCIAL REPORTING

• A number of documents and avenues of communication are available through

which companies provide information about its state of affairs to the external
users of such information,
• For example, annual report, interim report, employee report, environmental
report, communications with analysts, letters to shareholders and debt holders,
question and answer sessions held at annual general meeting, telephone
conversations, speeches made by company officials at stock exchanges and so
on.
• Despite the existence of different sources of information, the annual report is
regarded as the most important source of information about a company’s
affairs.
• A typical corporate annual report usually contains a balance sheet, profit and
loss account, cash flow and / funds flow statement, and directors’ report.
• Besides, the details of information and additional information are provided in
the schedules and notes on accounts, which form parts of financial statements.
• Annual reports often contain useful supplementary financial and statistical data
as well as management comments.
• Many companies in India now include Management Discussion and Analysis
(MD & A) report, corporate governance report, chairman’s statement,
historical summary, operating positions, highlights of important data etc.
INDIAN FINANCIAL REPORTING SYSTEM

• India is a federal state with unitary bias. This is perhaps why, unlike in the USA,
there is no separate company law for any state in India.
• Apart from professional regulation, corporate financial reporting in India is
governed primarily by the Companies Act, 2013.
• Another body that has a major influence in reshaping Indian financial reporting
is the Securities and Exchange Board of India (SEBI).
• The Companies Act, 2013 prescribes the financial reporting requirements for
all the companies registered under it.
• The reporting requirements that are imposed by the SEBI through its
Guidelines and through the Listing Agreement are in addition to those
prescribed under the Companies Act.
• SEBI requirements are to be followed by the companies listed on the Indian
stock exchanges.
• The Companies Act and the SEBI requirements together provide the legal
framework of corporate reporting in India.
1. ROLE OF THE SEBI

• The Securities and Exchange Board of India (SEBI) is the regulatory authority
in India established under Section 3 of SEBI Act, 1992.
• SEBI Act, 1992 provides for establishment of Securities and Exchange Board of
India (SEBI) with statutory powers for
• (a) protecting the interests of investors in securities
• (b) promoting the development of the securities market and
• (c) regulating the securities market.
• Its regulatory jurisdiction extends over corporates in the issuance of capital
and transfer of securities, in addition to all intermediaries and persons
associated with securities market.
• SEBI has been obligated to perform the aforesaid functions by such measures
as it thinks fit.
• In particular, it has powers for
• Regulating the business in stock exchanges and any other securities markets
• Registering and regulating the working of stock brokers, sub-brokers etc.
• Promoting and regulating self-regulatory organizations
• Prohibiting fraudulent and unfair trade practices
• Calling for information, undertaking inspection, conducting inquiries and audits
of the stock exchanges, intermediaries, self - regulatory organizations, mutual
funds and other persons associated with the securities market.
• SEBI has used its power to order changes in listing agreement and such
changes are instrumental to bring about improvement in disclosure practices
of listed companies in their annual reports.
• Listing agreement is the standard agreement between a company seeking listing
of its securities and the stock exchange where listing is sought.
• Any stock exchange has power to alter the clauses of listing agreement
unilaterally, and companies listed with that exchange are bound to accept such
changes to enjoy the facility of listing.
• Thus, whenever the SEBI suggests any change, it is incumbent on the listed
companies to follow such a change.
• In effect, the SEBI has power to direct the listed companies to follow any
changed disclosure requirements.
• SEBI has imposed a number of disclosures and other requirements through
this route.
• Some important requirements are as follows:
• ♦ Dispatch of a copy of the complete & full annual report to the shareholders.
• ♦ Disclosure of Cash Flow Statement.
• ♦ Disclosure of material developments and price sensitive information.
• ♦ Compliance with Takeover Code.
• ♦ Disclosure of interim unaudited financial result
• ♦ Disclosure regarding listing fee payment status and the name and address of
each stock exchange where the company’s securities are listed.
• ♦ Corporate governance report.
• ♦ Compliance with Accounting Standards issued by the ICAI.
• The initiative to introduce the Cash Flow Statements (as a principal financial
statement) in India was taken by the SEBI and it has used its power under
section 11 of the SEBI Act, 1992 to all recognized stock exchange for a
requirement of appending an audited Cash Flow Statement (CFS) (prepared
only as per Indirect method as prescribed in AS 3 or Ind AS 7) as a part of
annual accounts.
• As per the SEBI mandate, the requirement of providing a CFS is mandatory for
listed companies from the financial year 1994-95 i.e., year ended 31st March
1995.
• Earlier in the Companies Act, 1956, there was no requirement for preparing
the cash flow statement.
• However, the new Companies Act, 2013 has mandated the Level I entities to
prepare the Cash flow statement as one of the main part of its Financial
Statements.
2. THE COMPANIES ACT, 2013

• The Companies Act, 2013 lays down the detailed provisions regarding the
maintenance of books of accounts and the preparation and presentation of
annual accounts.
• The Act also prescribes the mechanism for issuance of accounting standards by
National Financial Reporting Authority (NFRA)*
• * Constitution of NFRA is prescribed under Section 132 of the Companies Act, 2013. However,
this section has not been notified till 30th November, 2016.
• It specifies the roles and responsibilities of directors and also the matters to
be reported upon by them in the annual reports of the companies.
• Under the provisions of the Act, audit of annual accounts is compulsory for all
companies registered under it.
• The Act extensively deals with the qualification, appointment, removal, rights,
duties and liabilities of auditors and provides contents of auditors’ report.
• In case of delinquency/ default by the management or auditor, penal provisions
are prescribed.
• However, despite providing for detailed requirements in respect of
maintenance of books of account, preparation and presentation of financial
statements and audit of annual accounts, the main thrust under the Companies
Act is upon the presentation of a ‘true and fair view’ of the state of affairs and
operating results of the reporting companies.
• As the preparation of financial statements contained in annual reports
presupposes the existence of a recording procedure of transactions of the
reporting entities, the requirements as to the maintenance of books of
accounts are also mentioned.
• As per Section 129 of the Companies Act, 2013, at the annual general meeting
of a company, the Board of Directors of the company shall lay financial
statements before the company:
• Financial Statements as per Section 2(40) of the Companies Act, 2013, inter-alia include -
• (i) a balance sheet as at the end of the financial year;
• (ii) a profit and loss account, or in the case of a company carrying on any activity not for profit,
an income and expenditure account for the financial year;
• (iii) cash flow statement for the financial year;
• (iv) a statement of changes in equity, if applicable; and
• (v) any explanatory note annexed to, or forming part of, any document referred to in sub-
clause (i) to sub-clause (iv):
• Provided that the financial statement, with respect to One Person Company, small company
and dormant company, may not include the cash flow statement.