Analysis Of Financial Reporting Including Regulatory Framework And Governance

This project report consists of financial reporting its purpose, importance, objectives, regulatory framework, and governance. Interpretation of financial statements, calculation of ratios, International Accounting and International Financial Reporting Standards, models of financial reporting, and differences in financial reporting across different countries are covered under this report.

TASK 1

P1 Analysis of financial reporting including regulatory framework and governance of financial reporting

Financial reporting refers to the preparation of financial statements that help the management of the organization to analyze its performance and its current position in the market. Alpha Ltd is a manufacturing company, thus it is essential for the managers to plan financial reporting for achieving long-term goals and objectives (Bertoni and De Rosa, 2012). Financial reporting includes various financial statements such as balance sheets, cash flow statements,s, and income statements. These types are explained below:

Importance of financial reporting

• It helps the organization fulfill regulatory requirements of filing annual reports because the organizations are required to file financial statements with legal agencies.
• It facilitates the auditing process. The auditors are required to examine the annual reports of a company to explicit their views.
• Financial reports are essential for business planning, analysis,  and strategic decision-making. These reports are used by various stakeholders to analyze the performance of the company.
• It helps the companies to generate capital for business purposes.
• With the help of financial reporting, the public in large organisations can examine the execution activities of the company as well as the performance of its management.
• It is also used for bidding, labor contracts, government supplies, etc. because the organisation involved in such functions have to show their financial reports to the government.

Purpose of financial reporting

• The main purpose of financial reporting is to provide actual financial information about the company to the stakeholders.
• Another purpose is to provide information on the financial status of the company.
• Companies prepare financial reports to facilitate auditors while auditing the annual reports of the company.
• Financial reporting is conducted within the organisation to analyze economic resources.

Internation Financial Reporting Standards (IFRS): These financial reporting standards are issued to deliver a common worldwide language for the enterprise's transactions so that it can facilitate the understanding and compatibility of the company's accounts (Dyreng, Mayew, and Williams, 2012). A few selected IFRS are explained below:

• IFRS 9 (Financial instruments): It specifies the concept in which companies are instructed to classify and analyse financial instruments like financial assets and liabilities and a few contracts to enter or not.
• IFRS 10 (Consolidated financial statements): It guides organizations for consolidation in which companies are directed to present and prepare financial statements in consolidated form.
• IFRS 13 (Fair value measurement): It gives instructions to the companies on how to measure the fair value of the assets and liabilities of the business that are recorded in the balance sheet.
• IFRS 15 (Revenue from contracts with customers): It was published by the International Accounting Standard Board, and it renders direction while recording incomes from contracts with customers.

Role of organizations in financial reporting: IFRS and FRC are the regulatory authorities of the UK and both play important roles in governance in financial reporting. Explained below:

• Role of IFRS: IFRS plays an important role in the governance of financial reporting because it provides direction to the companies to formulate their financial statements in a proper manner to attract various investors and meet the expectations of their stakeholders.
• Role of FRC: FRC is a Financial reporting council, its role in financial reporting is to regulate corporate governance and report adaptive investments of various organisations. It works as an independent regulator in the UK (FriasAceituno,  RodríguezAriza, and GarciaSánchez, 2014).

P2 Purpose of financial reporting to meet organizational objectives, development, and growth

Alpha Ltd is a manufacturing company of hardware and it is very important for the management to formulate such strategies that help to meet the user expectation. The following are the users of the organization:

Customers: The financial reporting of the enterprise helps to attract more and more customers by providing them with actual information on execution activities. Buyers of the products analyze the performance first and then attract them to buy. Financial statements of the organization help the customers get insider information about the business and generate an urge to purchase the products. Thus financial reporting is very important for the company to meet customer's expectations.

Investors: Financial reporting is mainly focused on the accurate formation of financial statements. It is very important for the company to meet investors' expectations because they can decide to invest or not to invest in the business or they may have the idea of their money whether they have invested in the right company or not by analyzing the financial statements.

Suppliers: Suppliers also examine the financial status of the organization where they are going to supply their goods, it will help them to analyse whether they are supplying to the right company or not and whether they are exploiting their time and money at the right place (Fu, Kraft and Zhang, 2012). Financial reporting is very important for meeting suppliers' expectations by providing them with accurate business information.

The relevant legislation for financial reporting is IFRS (International Financial Reporting Standards). Which is explained below:

IFRS: These are the set of different standards that direct the companies while recording various types of transactions (IFRS (International Financial Reporting Standards), 2018). It helps Alpha Ltd to prepare financial statements in an effective way so that the transactions and amounts recorded in the statements show the accurate and actual position of the business. IFRS assists organization while scripting various events. These standards are introduced by the International Accounting Standards Board. It also helps to set a positive image of the business in the market by providing direction to the companies while forming final accounts.

Importance of financial reporting in meeting objectives and promoting development and growth: The main objectives of Alpha Ltd are to maximize profit and attract investors, which is possible when the company prepares proper financial statements. Objectives of Alpha Ltd can be achieved with financial reporting because it provides the exact information and shows the actual status of the organization. It will also contribute to organizational growth by maximizing profits and setting a positive image in investor's minds, which helps to attract them. Financial reporting is a tool to analyze the performance of the company.

organization's growth is possible when it focuses on the field where improvement is required (Hope, Thomas, and Vyas, 2013). It can be identified by financial statements which show the performance and position of the company. If a company follows the concept of financial reporting, it can provide information about the business to the stakeholders, which attracts them. When a company succeeds in pulling stakeholders it will create more business opportunities for the organization, which helps to maximize profits.

P3 Interpretation of P&L, balance sheet, and cash flow statement

As described in the financial statements of the company, in the income statement the revenues are increased up to £4850 from £3800. Gross profit £1100 for the year ending 31/12/2017 which is decreased by £100 because the cost of sales increased to £3740 from £2600, it also affected the operating profit of the company which was reduced by £100. organization pays an interest of £68 which is decreased as compared to the previous year. The company faces a loss of £240 that is because of the sale of obsolete stock and tax liability has also increased by £40 as compared to the previous year. It affects the net profits of the company, that are decreased from £570 to £192.

In the balance sheet, the noncurrent assets of the company are increased by £130. It does not have a cash balance in the year 2017. Total Inventory and trade receivable of the company are increased to £1190 from £1020. The share capital remains constant in both years which is £300. Retained profits are increased by £20 as compared to the previous year. Loans remain changeless which is £600. A bank overdraft of £130 has been incurred in the current year. Trade payables are increased up to £700 from £610. Tax liabilities are also increased up to £170 from £140.

Cash outflow in operating activities for the year 2017 is £430 and in the previous it was £420. Cash inflow in operating activities is £680 which is less the previous year. Cash outflow in investing activities is £180 which is the dividend paid by the company. The variation in noncurrent assets is because of the purchase of assets, so the cash outflow in financing activities is £130.

P4 Financial ratios for organizational performance and investment

Calculation of ratios:

• Return on capital employed: Net operating profit/ Capital employed*100

= 680/1270*100

= 54%

• Net assets turnover: Net sales or revenue/ total assets

= 4850/2270

= 2.14

• Gross profit margin: Gross profit/ sales revenues*100

= 1100/4850*100

= 23%

• Net profit margin: Net profit/ sales revenue*100

= 192/4850*100

= 3.96%

• Current ratio: Current assets/ current liabilities

= 1190/1000

= 1.19:1

• Quick ratio: Quick assets/ current liabilities

= 640/1000

= 0.64:1

• Inventory holding period: 365/ inventory turnover

= 365/6.8

= 54 days

Inventory turnover = cost of sales/ closing inventory

= 3740/550

= 6.8

• Trade receivables collection period: 365/Average accounts receivables

= 365/7.58

= 48 days

Average account receivables=  sales/ trade receivables

=4850/640

= 7.58

• Trade payables payment period: 365/ average account payables

= 365/5.34

= 68 days

Average account payables= cost of goods sold/ trade payables

= 3740/700

= 5.34

• Debt to equity: External liabilities / internal liabilities*100

= 1600/2270*100

= 70.48%

• Dividend yield: Dividend per share/ market value per share*100

= 1.20/12*100

= 10 %

• Dividend cover:365/(Net profit/ dividend paid)

= 365/(192/180)

= 3.44 times

Interpretation of ratios: The industry average ratio of return on capital employed is 21.6% but the ratio of Alpha Ltd is 54% which is higher than the industry average ratio. The net asset turnover of the company is 2.14 times which is higher as compared to the industry average. The gross profit and net profit margin of the company are 23% and 3.96% respectively which is lower than the industry average because of the higher cost of sales in the current year. The current and quick ratios of the company are 1.19:1 and 0.64:1 respectively and both are lower than the industry average because of lower liquidity in the company.

The inventory holding period is 54 days which is higher than the industry average which means the company holds inventory for more time. The trade receivable collection period of the company is 48 days, which is higher as compared to the industry average, which means the company recovers the amount of credit sales, late from debtors. The trade payables payment period of the company is 68 days which is also higher as compared to the industry average, which means the company makes late payments to creditors that may affect its market image. The debt-to-equity ratio is 70.48% which means the company has more external liabilities. Dividend yield and cover ratios are 10% and 3.44 times respectively for the company.

Financial problems with suggestions: As analyzed from the above-calculated ratios, a few financial problems have been identified or may occur in the future. These problems are a lack of liquidity, lower profits, and late payments by clients. Lack of liquidity can be resolved by selling more products in cash. Profits can be increased by reducing direct expenses and late payments by debtors also create financial issues that can be resolved by recovering outstanding amounts on time.

TASK 2

P5 Benefits of International Accounting Standards and International Financial Reporting Standards

Importance of International Financial Reporting Standards:

To forbid mistakes in annual reports: Economic decisions are based on financial statements. Hence, there is the possibility of errors and mistakes in accounts, that may affect business or its position in the market. IFRS directs companies to measure accurate events and record them in the financial statements which reduces the risk of mistakes and helps a company to maintain its positive image in the market. It will help interested international investors to identify the status of the organisation and get information about the company, in which they are willing to invest (Lee, and Parker, 2014).

To establish worldwide harmony: These standards are introduced internationally, which helps to set good ethical environments within various companies and set good relations with international companies. It facilitates international trade which helps to set a worldwide harmony, by setting good business relations within countries (Leuz and Wysocki, 2016).

Difference between International Accounting and International Financial Reporting Standards:

P6 Models of financial reporting and auditing

Models of financial reporting:

• Voluntary discloser model: It is a provision, that refers to disclosing various reports and other information to the stakeholders of the company. It is not mandatory for the management to follow this provision. This provision is made to disclose the vision, mission, and reports such as sustainability and human resource management reports. It helps the organizations to be transparent to the public and stakeholders of the company.
• Compulsory discloser model: It refers to the mandatory disclosure of annual reports of the company to the stakeholders and general public. It consists of financial statements like income statements, balance sheets, and cash flow statements. It is necessary for every organisation to disclose these statements to the stakeholders.

Models of financial auditing

• Policeman model: It refers to the duty of the auditor which is to concentrate on pure mathematics and on the prevention and identification of frauds.
• Lending credibility model: It is based on the concept of enhancing stakeholder trust. Audited financial statements are used by management to deepen the trust and faith of shareholders, customers, suppliers, creditors, and other stakeholders toward the company's position.
• Model of inspired confidence: It is concerned with the need for audited accounts is the direct issue of the involvement of outside parties such as customers, government, shareholders, creditors, etc. of the company. They demand the accuracy of the financial statements from the management, in return for their contribution to the organization. If the statements presented by the managers are transparent it can result in inspired confidence of the stakeholders.
• Agency model: It is mainly based on the resolution of problems that can affect the agency relationships. The problems may occur due to unspecific goals and risks involved in the operations. The main agency relation is between shareholders and the company, which may be affected by those problems (Nobes, 2014).

P7 Evaluation of the differences and importance of financial reporting across different countries

Financial reporting principles in relation to UK and US: There are two types of financial reporting principles internal and external principles that are adopted and followed by both countries. These principles are explained below:

Internal principles: The internal principles are mainly related to the quality of the recorded information in final accounts and their features. The UK and the US both follow the standards of IFRS and have set strict rules for the companies to prepare financial statements accurately. The statements should be understandable, reliable, comparable, and relevant for the stakeholders of the company (Zeff, van der Wel, and Camfferman, 2016).

External principles: It refers to the measurement of various assets and liabilities that are recorded in the balance sheet, cash transactions shown in the cash flow statement, and expenditures and revenues recorded in income statements should be measured accurately. Both countries follow these principles to pull more and more international investment and increase cross-border trade by identifying various business opportunities.

Both countries follow internal as well as external principles to improve foreign trade and investment and set up business globally.

Response of the UK and US to IFRS: IFRS was introduced in 2001 by the International Accounting Standard Board. It bound the countries to maintain their financial statements in a proper way. The UK and the US both are developed countries but follow different standards UK follows IFRS, and the US follows GAAP (Generally Accepted Accounting Principles). It helps them to prepare financial statements in an appropriate manner and increase the number of investors in their business. The standards of IFRS mainly focus on the formation of annual reports in consolidated form. The companies in the UK follow this concept and use these standards. The US SEC (Security and Exchange Commission) does not permit its local companies to use IFRS while preparing financial statements. The UK responded positively to the standards of IFRS and the US responded negatively.

Differences in external financial reporting and factors that influence the differences:  External financial reporting refers to showing the financial statements to the external parties of the company to enhance the investments and attract more people toward the organization by showing them the good performance of the business and market image. There is not any specific difference in financial reporting between the US and the UK, but there is a difference in adopting different standards, which are explained below:

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