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 Felix I. Lessambo
Financial Statements
Analysis and Reporting
Financial Statements
 Felix I. Lessambo

Financial Statements
Analysis and Reporting
Felix I. Lessambo
Central Connecticut State University
New Britain, CT, USA

ISBN 978-3-319-99983-8 ISBN 978-3-319-99984-5 (eBook)

https://doi.org/10.1007/978-3-319-99984-5

Library of Congress Control Number: 2018957071

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer
Nature Switzerland AG, part of Springer Nature 2018
This work is subject to copyright. All rights are solely and exclusively licensed by the
Publisher, whether the whole or part of the material is concerned, specifically the rights
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The use of general descriptive names, registered names, trademarks, service marks, etc. in this
publication does not imply, even in the absence of a specific statement, that such names are
exempt from the relevant protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and
information in this book are believed to be true and accurate at the date of publication.
Neither the publisher nor the authors or the editors give a warranty, express or implied,
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Cover design by Ran Shauli

This Palgrave Macmillan imprint is published by the registered company Springer Nature
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 Acknowledgements

Writing a book is always a challenge. But writing a book on Financial

Statements: Analysis and Reporting, geared to M.B.A. students, a more
daring intellectual exercise for twofold reasons: (i) because of the hard
choice of topics to cover, and (ii) financial analysis is part science and
part art.
I would like to express my gratitude to those who motivated me all
along the project, knowing my dedication to the subject, and thought
I am more than able to complete this project: Dr. Gordon Marsha, Dr.
Linda Sama, Fouad Sayegh, Esq., Jerry Izouele.
Several good friends provided me with needed guidance and materi-
als to complete this book, while others took from their busiest time to
review and comb the manuscript: Reverend Pastor Roland Dalo, Aline
Kabongo.

v
 Contents

Part I Overview of Financial Statements and the Statement

of Financial Position

1 Overview of Financial Statements 3

1.1 General 3
1.2 The International Accounting Standard Board: IFRS 4
1.3 European Financial Reporting Advisory Group
(EFRAG) 4
1.4 The USA: The FASB 5
1.5 The UK: Financial Reporting Council (FRC) 9
1.6 Japan: The Accounting Standard Board of Japan 11
1.7 Australia: The Australian Accounting Standard
Board 13
1.8 New Zealand: The New Zealand Accounting
Standards Board (NZASB) 15
1.9 India: The Council of the Institute of Chartered
Accountants of India (ICAI) 15
1.10 China: Accounting Standard for Business Enterprises 16
1.11 The Financial Statement Materials 16
1.11.1 The Proxy Statement 17
1.11.2 The Management Discussion & Analysis
(MD&A) 17

vii
viii    Contents

1.12 Interim Statements and Subsequent & Adjusting

Events 18
1.12.1 Interim Financial Statements 18
1.12.2 Subsequent Events 18
1.12.3 Adjusting Events 18
1.13 Users of Financial Statements 21

2 Cash and Cash Equivalents 23

2.1 General 23
2.2 Cash and Cash Equivalents 24
2.2.1 Bank Reconciliation 25
2.2.2 Bank Overdraft 27
2.2.3 Petty Cash 29
2.3 Marketable Equity Securities and Fair Value
Measurement 30
2.4 Accounting for Financial Instruments 32
2.5 Accounting for Derivatives 35
2.6 Accounting for Hedging 37

3 Short-Term Assets: Inventories 41

3.1 General 41
3.2 Inventory Methods 42
3.2.1 The Perpetual Inventory System 42
3.2.2 The Periodic Inventory System 43
3.3 Ownership Issues 46
3.4 Valuation of Inventory 46
3.5 The LIFO Reserve 47
3.6 LIFO Liquidation 48
3.7 Comprehensive Example 49
3.8 Restrictions on the Use of LIFO 51

4 Account Receivables 53
4.1 General 53
4.2 Cash Discount on Sales 54
4.2.1 The Gross Method 54
4.2.2 The Net Method 54
4.3 Bad Debts Concept 55
4.3.1 Rebates 55
 Contents    ix

4.3.2 Doubtful Accounts 56

4.3.3 Accounting for Bad Debts 56
4.4 Accounts Receivable Aging Method 57
4.5 Assignment of Accounts Receivable 58
4.6 Factoring of Accounts Receivable 60
4.6.1 Recourse vs Non-recourse Factoring 60
4.6.2 Factoring vs Loan 60
4.6.3 Factoring vs Assignment of Receivables 62
4.7 Securitization of Receivables 63
4.7.1 Sale Accounting Criteria 63
4.7.2 Secured Borrowing 66
4.8 Receivables—Troubled Debt Restructurings by
Creditors 66

5 Prepaid Expenses, Unearned Income,

and Other Current Assets 69
5.1 General 69
5.2 Prepaid Expenses 69
5.3 Unearned Income 72
5.4 Other Current Assets 73

6 Short-Term Liabilities and Working Capital 75

6.1 General 75
6.2 Accounts Payable 75
6.3 Notes Payable 76
6.4 Current Maturities of Long-Term Debt 77
6.5 Other Current Liabilities 77
6.6 Working Capital 77
6.6.1 Determinants of Working Capital 78
6.6.2 Financing of Working Capital 78
6.6.3 Computation of Working Capital: Example 79

7 Long-Term Assets: Plant, Property, and Equipment 81

7.1 General 81
7.2 Property, Plant, and Equipment 81
7.2.1 Acquisition of Property, Plant, and
Equipment 82
7.2.2 Cost of Land 83
x    Contents

7.2.3 Cost of Buildings 84

7.2.4 Cost of Equipment 84
7.3 Valuation of Property, Plant, and Equipment 84
7.4 Amortization, Depreciation, and Depletion 85
7.4.1 Straight-Line Method of Depreciation 85
7.4.2 Declining Balance Method of Depreciation 86
7.4.3 Double Declining Balance Depreciation
Method 87
7.4.4 Units of Production Method of Depreciation 88
7.4.5 Sum of the Years’ Digits Method of
Depreciation 89
7.5 Disposition of Property, Plant, and Equipment 91
7.5.1 Sale of Plant Assets 91
7.5.2 Involuntary Conversion 91
7.5.3 Miscellaneous Problems 92

8 Long-Term Assets: Intangibles 95

8.1 General 95
8.2 The Goodwill 96
8.2.1 Goodwill Impairment 97
8.3 Computer Software 101
8.3.1 Research and Development Costs of
Computer Software 101
8.3.2 Production Costs of Computer Software 101
8.3.3 Purchased Computer Software 102
8.3.4 Amortization of Capitalized Software Costs 102
8.3.5 Presentation and Disclosure
of Software Costs 103
8.3.6 Software Purchased Before Technological
Feasibility Established 103
8.3.7 Disclosure of Risks and Uncertainties
Related to Capitalized Software Costs 104

9 Long-Term Liabilities: Leases 105

9.1 General 105
9.2 Lease 105
9.2.1 Legal Definition of a Lease 105
9.2.2 Advantages and Disadvantages of Leasing 107
 Contents    xi

9.3 Types of Leases 107

9.3.1 Finance Lease 107
9.3.2 Operating Lease 109
9.4 Sale–Leaseback 110
9.4.1 Sale–Leaseback Advantages 111
9.4.2 Accounting Analysis 111
9.5 Short-Term Lease 113
9.6 Lease Disclosure 114
9.6.1 In the Balance Sheet 114
9.6.2 In the Statement of Cash Flows 114

10 Long-Term Liabilities: Pension and Postretirement

Liabilities 117
10.1 General 117
10.2 Types of Pension Plans 118
10.2.1 Defined Contribution Plan 118
10.2.2 Defined Benefit Plan 120
10.3 Net Pension Asset/Liability 120
10.4 Projected Benefit Obligations 121
10.5 Plan Assets 121
10.6 Reporting Pensions Plans on Financial Statements 122
10.6.1 In the Statement of Income 122
10.6.2 In the Balance Sheet 124
10.7 Funded Status 124
10.8 Postretirement Benefits Other Than Pensions 126

11 Shareholders’ Equity 127

11.1 General 127
11.2 Common Stock 129
11.2.1 Par Value of Common Stock 130
11.2.2 Stated Value of a Common Stock 130
11.2.3 Authorized Capital 130
11.2.4 Issued Capital 130
11.2.5 Outstanding Capital 130
11.3 Issuance of Shares of Stock 131
11.3.1 Issuance of Par Value Stock 131
11.3.2 Issuance of No Par Stock 132
xii    Contents

11.4 Issuance of Shares for Non-cash Items 133

11.5 Lump-Sum Stock Issuance 134
11.6 Treasury Stock—Cost Method 135
11.7 Treasury Stock—Par Value Method 136
11.8 Stock Dividends 138
11.8.1 Small Stock Dividend 138
11.8.2 Large Stock Dividend 138
11.9 Employee Stock Options 139
11.9.1 Legal Understanding 139
11.9.2 Statement of Financial Accounting
Standard No. 123 140
11.9.3 Illustration 141
11.10 Stock Splits 142
11.11 Retained Earnings 143

Part II The Statement of Income

12 Analysis of the Statement of Income 149

12.1 General 149
12.2 The Single-Step Income Statement 149
12.3 Multiple-Step Income Statement 150
12.3.1 Analysis of the Multiple-Step Components 151
12.3.2 Format and Example 154
12.4 Holding Equity 155
12.5 Income from Discontinued Operations 157

13 Other Comprehensive Income 159

13.1 General 159
13.2 Presentation of the OCI 160
13.3 Accumulated OCI 161
13.3.1 Foreign Currency Accounting 161
13.3.2 Discontinued Operations 162
13.4 Reclassification Out of Accumulated Other
Comprehensive Income 165
13.4.1 Presentation on the Face of the Statement—
In Net Income 166
13.4.2 Presentation as a Separate Disclosure
in the Notes 167
 Contents    xiii

13.5 Earnings Per Share 169

13.5.1 The Computation of the Simple EPS 169
13.5.2 The Computation of the Diluted EPS 171

14 The Sub-Statement of Retained Earnings 175

14.1 General 175
14.2 Steps in Preparing the Statement
of Retained Earnings 175
14.3 Retained Earnings Formula 176
14.4 Changes in Retained Earnings 177
14.4.1 Accounting Changes
and Retained Earnings 177
14.4.2 Accounting Errors and Retained Earnings 179

15 The Computation of the Taxable Income 181

15.1 General 181
15.2 Differed Taxes and Assets 181
15.2.1 Temporary Differences for Revenue
and Expenses 182
15.2.2 Permanent Differences 184
15.3 Net Operating Losses 185
15.4 Undistributed Profits of Foreign Subsidiaries 186
15.5 APB 23 and Indefinitely Reinvested Earnings 188
15.6 ASC 740: Accounting for Uncertainty in Income
Taxes (Formerly FIN 48) 189
15.7 Financial Statement Reporting 191
15.7.1 Statement Reporting 191
15.7.2 Presentation 191
15.7.3 Disclosure 191

Part III The Statements of Cash Flows and Financial Ratios

16 Analysis of the Statements of Cash Flows 195

16.1 General 195
16.2 Classification of Cash Flows 196
16.2.1 Cash Flows from Operating Activities 196
16.2.2 Cash Flows from Investing Activities 197
16.2.3 Cash Flows from Financing Activities 198
xiv    Contents

16.3 Content and Form of the Statement of Cash Flows 200

16.3.1 Reporting Cash Flows from Operating
Activities 200
16.3.2 Quick Analysis of the Operating Cash Flows 203
16.4 Examples 203
16.4.1 Example of Operating Cash Flows 203
16.4.2 Example with Investing Cash Flows 204
16.4.3 Example with Financing Cash Flow
Activities 205
16.5 Noncash Investing and Financing Activities 205

17 Financial Ratios Analysis 207

17.1 General 207
17.2 Liquidity Measurement Ratios 207
17.3 Solvency Ratios 214
17.4 Profitability Indicator Ratios 217
17.5 Efficiency Ratios 223
17.6 Debt Ratios 227
17.7 Operating Performance Ratios 229
17.8 Cash Flow Indicator Ratios 232
17.9 Investment Valuation Ratios 234
17.10 Strategic Financial Ratios 238
17.11 Bankruptcy Ratios 244
17.11.1 Working Capital/Total Assets 244
17.11.2 Retained Earnings/Total Assets 245
17.11.3 Earnings Before Interest and Taxes/Total
Assets 245
17.11.4 Market Value of Equity/Book Value
of Total Debt 246
17.11.5 Sales/Total Assets 246
17.12 Limitations 247

Part IV Pro-Forma Financial Statements

18 Forecasting Financial Statements’ Analysis 251

18.1 General 251
18.2 The Forecasted Statement of Income 251
18.2.1 Sales Forecasting 252
 Contents    xv

18.2.2 Production and COGS Forecasting 252

18.2.3 Expenses’ Forecasting 252
18.3 The Forecasted Statement of Position 252
18.3.1 Making Assumptions 253
18.4 The Forecasted Statements of Cash Flows 255
18.4.1 Forecasting Operating Cash Flows 255
18.4.2 Forecasting Financing Cash Flow 256
18.4.3 Forecasting Investing Cash Flow 258

Part V Consolidated Financial Statements

19 Foreign Currency Accounting 261

19.1 General 261
19.2 Determination of the Functional Currency of the
Foreign Entity 261
19.2.1 Factors to Be Considered 262
19.2.2 Changing the Functional Currency 264
19.3 Translation Methods 264
19.3.1 Current/Noncurrent Method 264
19.3.2 Monetary/Nonmonetary Method 265
19.3.3 Temporal Method 265
19.3.4 Current Rate Method 266
19.4 Re-measurement into the Functional Currency 266
19.4.1 The Foreign Entity Does Not Book
or Record in Functional Currency 267
19.4.2 Highly Inflationary Economies—US GAAP 267
19.5 Hedging Balance Sheet and Forecasted Exposure 268

20 Consolidated Financial Statements 269

20.1 Overview 269
20.2 Purpose of Consolidation 270
20.3 Consolidation Methods 271
20.4 Consolidation Theories 272
20.4.1 Parent Company Theory 272
20.4.2 Contemporary/Entity Theory 272
20.4.3 Traditional/Hybrid Theory 272
20.5 The Consolidation Process 273
20.6 Pushdown Accounting 274
xvi    Contents

21 Segment and Intermediary Financial Statements 277

21.1 General 277
21.2 Segment Statements 277
21.2.1 Reportable Segments 278
21.2.2 Identification of Additional Segment 280
21.2.3 Disclosure Requirements 282
21.2.4 Measurement 283
21.2.5 Entity-Wide Information 286
21.2.6 Goodwill Considerations 289
21.3 Intermediary Statements 289
21.3.1 Accounting Principles and Practices 289
21.3.2 Revenue 289
21.3.3 Costs and Expenses 290
21.3.4 Costs Associated with Revenue 290
21.3.5 All Other Costs and Expenses 291
21.3.6 Seasonal Revenue, Costs, or Expenses 292
21.3.7 Extraordinary Items, Unusual and
Infrequent Items, and Disposals of
Components 293
21.3.8 Accounting Changes in Interim Periods 293
21.3.9 Adjustments Related to Prior Interim
Periods of the Current Fiscal Year 294
21.3.10 Guidelines for Preparing Interim
Statements 294
21.3.11 SEC Materials: Regulation S-X Rule 10-01,
Interim Financial Statements 297

22 IFRS and GAAP 299

22.1 General 299
22.2 Principles-Based vs Rules-Based 300
22.3 Selected International Accounting Standards 301
22.3.1 IAS 1—Presentation of Financial Statement 301
22.3.2 IAS 2—Inventories 303
22.3.3 IAS 5—Non-Current Assets Held for Sale
and Discontinued Operations 303
22.3.4 IAS 7-Statements of Cash Flows 304
22.3.5 IAS16—Leases 307
22.3.6 IAS 24 Related Disclosures 309
22.3.7 IAS 27—Consolidated Financial Statements 311
 Contents    xvii

22.3.8 IAS 32, Financial Instrument—

Presentation 316
22.3.9 IAS 33—Earnings Per Shares 318
22.3.10 IAS 34—Interim Financial Reporting 320

Part VI Case Study

23 Apple and Microsoft Case Study 331

23.1 Industry Analysis 331
23.2 Apple 332
23.2.1 Overview 332
23.2.2 Business Strategy 333
23.2.3 Financial Statements 334
23.3 Microsoft 337
23.3.1 Overview 337
23.3.2 Business Strategy 340
23.3.3 Microsoft Financial Statements 340
23.4 Financial Analysis 342
23.4.1 Common-Size Income Statement Analysis 342
23.4.2 Common-Size Balance Sheet Analysis 345
23.4.3 Comparative Common-Size Analysis 347
23.4.4 Financial Ratio Analysis 347
23.4.5 Comparative Financial Ratio Analysis 351

Glossary 353

Bibliography 361

Index 365
 Abbreviations

ABS Asset-Backed Security

AIA American Institute of Accountants
AICPA American Institute of Certified Public Accountants
ARM Accrual Reversal Method
ASC Accounting Standard Committee
ASU Accounting Standard Update
COGS Cost of Goods Sold
EBITDA Earnings Before Interest Tax Depreciation and Amortization
EFRAG European Financial Reporting Advisory Group
EITF Emerging Issues Task Force
EPS Earnings per Share
ESOs Employee Stock Options
FASB Financial Accounting Standard Board
FIFO First-in, First-out
FRC Financial Reporting Council
GAAP Generally Accepted Accounting Principles
GASB Governmental Accounting Standards Board
IAS International Accounting Standard
ICAI Institute of Chartered Accountant of India
IFRS International Financial Reporting Standards
ISOs Incentive Stock Options
LIFO Last-in, First-out
MBS Mortgage-Backed Security
MD&A Management Discussion & Analysis
NZASB New Zealand Accounting Standards Board
OCI Other Comprehensive Income

xix
xx    Abbreviations

PBO Projected Benefit Obligation

PCAOB Public Company Accounting Oversight Board
PPE Plants, Property, Equipment
ROA Return on Assets
ROI Return on Investment
SEC Securities and Exchange Commission
SFAS Statement of Financial Accounting Standard
 List of Tables

Table 8.1 Starbucks (2014): Changes in the carrying amount

of goodwill 98
Table 13.1 Walmart (2014): Currency translation 161
Table 13.2 Walmart (2014): Basic and Diluted Income
per Common Share 174
Table 15.1 Starbucks (2014): Tax effect of temporary
differences and carryforward 192
Table 16.1 PepsiCo (2014): Consolidated statements of cash flows 199
Table 23.1 Apple—Consolidated statement of income 335
Table 23.2 Apple—Consolidated balance sheet 335
Table 23.3 Apple—Consolidated statement of shareholders’ equity 336
Table 23.4 Apple—Consolidated statement of cash flows 337
Table 23.5 Microsoft—Consolidated statement of income 341
Table 23.6 Microsoft—Consolidated balance sheet 342
Table 23.7 Microsoft—Consolidated statement of shareholders’ equity 343
Table 23.8 Microsoft—Consolidated statement of cash flows 344
Table 23.9 Apple—Common-sized income statement 345
Table 23.10 Microsoft—Common-sized income statement 345
Table 23.11 Apple—Common-sized balance sheet 346
Table 23.12 Microsoft—Common-sized balance sheet 347

xxi
 Disclaimer

While the author has made every effort to ensure that the information in
this book is correct at the time of publication, he does not assume and
hereby disclaims any liability to any party for any loss, damage, or dis-
ruption caused by errors or omissions, whether such errors or omissions
result from negligence, accident, or any other cause.
This publication is designed to provide accurate and authoritative
information in regard to the subject matter covered. It is sold on the
understanding that the publisher is not engaged in rendering profes-
sional services. If professional advice or other expert assistance is needed,
the services of a competent professional should be sought.

xxiii
 PART I

Overview of Financial Statements and the

Statement of Financial Position

In the USA, financial statements are prepared and presented in accord-

ance with the GAAP. However, correspondence between accounting
numbers and the events/transactions those numbers purport to repre-
sent is far from giving the real picture.1 Despite these inherent flaws, the
statements as delivered to its readers still deserve considerable amount of
scrutiny and analysis.
ASC 210-10 provides a general overview of the aspects of the bal-
ance sheet, which is also commonly referred to as a statement of financial
position. The balance sheets of most entities show separate classifications
of

• Current assets and current liabilities;

• Long-term assets and long-term;
• Shareholders’ equity.

ASC 210-20 describes the concept of offsetting assets and liabilities in

the balance sheet and notes the limited circumstances when it is allowed.
ASC 210-20 includes the overview of the Subtopic.
This Subtopic provides criteria for offsetting amounts related to cer-
tain contracts and provides guidance on presentation. It is a general
principle of accounting that the offsetting of assets and liabilities in the

1 Lawrence Revsine (1991): “The Selective Financial Misrepresentation Hypothesis,”

Accounting Horizons, pp. 16–27.

2 PART I: OVERVIEW OF FINANCIAL STATEMENTS …

balance sheet is improper except if a right of setoff exists. The general

principle that the offsetting of assets and liabilities is improper except
where a right of setoff exists is usually thought of in the context of
unconditional receivables from and payables to another party. That gen-
eral principle also applies to conditional amounts recognized for con-
tracts under which the amounts to be received or paid or items to be
exchanged in the future depend on future interest rates, future exchange
rates, future commodity prices, or other factors.
 CHAPTER 1

Overview of Financial Statements

1.1  General
Financial reporting is essentially a way of following standard practices to
give to the readers of the financial statements an accurate depiction of
a firm’s finances, including its revenues, expenses, profits, capital, cash
flows. Financial reporting is also a building block of a market-based
monitoring of companies, which allows shareholders and the public
at large to assess management performance.1 In the wake of the inter-
national financial crisis of the 1990s, the international community
embarked on a range of initiatives to strengthen the international finan-
cial architecture.2 Financial reporting plays a crucial role in supporting
the efficient functioning of the capital markets. Robust financial report-
ing increases investors’ confidence, which in turn leads to better capital
allocation decisions and economic growth.

1 UNCTD (2004): International Accounting Reporting Issues, Chapter 3, p. 54, par. 2.

2 UNCTD (2004): International Accounting Reporting Issues, Chapter 3, p. 59.

© The Author(s) 2018 3

F. I. Lessambo, Financial Statements,
https://doi.org/10.1007/978-3-319-99984-5_1
4 F. I. LESSAMBO

1.2  The International
Accounting Standard Board: IFRS
The concept of convergence first arose in the late 1950s in response
to post-World War II economic integration and related increases in
cross-border capital flows. Initially, the focus was put on harmoni-
zation. That is, reducing differences among the accounting princi-
ples used in major capital markets around the world. By the 1990s,
the notion of harmonization was replaced by the concept of conver-
gence. The International Accounting Standards Committee, formed in
1973, was the first international standards-setting body. It was reorgan-
ized in 2001 and became an independent international standard setter,
the International Accounting Standards Board (IASB). As of 2013, the
European Union and more than 100 other countries either require or
permit the use of international financial reporting standards (IFRSs)
issued by the IASB or a local variant of them. By 2016, approximately
120 countries and jurisdictions, including Hong Kong, Egypt, Canada,
Australia, and the countries in the European Union, require or permit
the use of IFRS or a local variant of IFRS.
The FASB and the IASB have been working together since 2002 to
improve and converge USA generally accepted accounting principles
(GAAP) and IFRS. As of 2013, Japan and China were also working
to converge their standards with IFRSs. The Securities and Exchange
Commission (SEC) consistently has supported convergence of global
accounting standards. However, the Commission has not yet decided
whether to incorporate IFRSs into the US financial reporting system.
The Commission staff issued its final report on the issue in July 2012
without making a recommendation.

1.3  European Financial
Reporting Advisory Group (EFRAG)
EFRAG is an advisory body that participates in the European endorse-
ment process of IFRS Standards. The European Union (EU) is not a
single jurisdiction but, rather, an economic and political partnership
between 28 European countries that together cover much of the con-
tinent of Europe. With respect to accounting, the European Union has
enacted some laws, known as (“Directives”) that all EU and EEA mem-
bers must comply with. Some of those Directives address accounting
 1 OVERVIEW OF FINANCIAL STATEMENTS 5

issues. The most notable is Directive 2013/34/EU of the European

Parliament and of the Council of June 26, 2013 on the annual financial
statements, consolidated financial statements, and related reports. EU
and EEA member states may enact additional accounting laws and reg-
ulations that add to the requirements of the Directives, but they cannot
override the requirements of the Directives.
EFRAG serves the European public interest by developing and pro-
moting European views in the field of financial reporting and ensuring
these views are properly considered in the IASB standard-setting pro-
cess and in related international debates. EFRAG ultimately provides
advice to the European Commission on whether newly issued or revised
IFRS meet the criteria in the IAS Regulation for endorsement for use
in the EU, including whether endorsement would be conducive to the
European public good. EFRAG seeks input from all stakeholders, and
obtains evidence about specific European circumstances, throughout the
standard-setting process and in providing our endorsement advice. The
EFRAG is recognized as the European Voice in financial reporting.

1.4  The USA: The FASB

The FASB is an independent, private-sector organization that oper-
ates under the oversight of the Financial Accounting Foundation
(FAF) and the US Securities and Exchange Commission (“SEC” or
“Commission”). For nearly 40 years, the FASB has established stand-
ards of financial accounting and reporting for non-governmental entities,
including both businesses (public and private) and not-for-profit organi-
zations. Those standards—US GAAP—are recognized as authoritative by
the SEC for public companies and by the American Institute of Certified
Public Accountants (AICPA) for other non-governmental entities.
US GAAP is essential to the efficient functioning of the US economy
because investors, creditors, donors, and other users of financial reports
rely heavily on credible, transparent, comparable, and unbiased financial
information. In today’s dynamic financial markets, the need for integrity,
transparency, and objectivity in financial reporting is increasingly critical
to ensure the strength of US capital markets and provide investors with
accurate and timely information.
In 2002, the US Congress enacted the Sarbanes–Oxley Act, which
included provisions protecting the integrity of the FASB’s accounting
standards-setting process. The legislation provided the FASB with an
6 F. I. LESSAMBO

independent, stable source of funding. The legislation established an

ongoing source of funding for the FASB from annual accounting sup-
port fees collected from issuers of securities, as those issuers are defined
in the Sarbanes–Oxley Act.
It is important to note that although the FASB has the responsibil-
ity to set accounting standards, it does not have the authority to enforce
them. Officers and directors of a company are responsible for prepar-
ing financial reports in accordance with accounting standards. Auditors
provide an opinion about whether those officers and directors appropri-
ately applied accounting standards. The Public Company Accounting
Oversight Board (“PCAOB”) is charged with ensuring that auditors
of public companies have performed an audit in accordance with the
auditing standards of the PCAOB, which includes an auditor’s analysis
of whether a public company has complied with appropriate accounting
standards. The SEC has the ultimate authority to determine whether
public companies have complied with accounting standards.

• The Mission of the FASB

The FASB’s mission is to establish and improve standards of financial

accounting and reporting that foster financial reporting by non-gov-
ernmental entities that provides useful decision-making information to
investors and other users of financial reports. That mission is accom-
plished through a comprehensive and independent process that encour-
ages broad participation, objectively considers all stakeholders’ views,
and is subject to oversight by the FAF’s Board of Trustees. To accom-
plish its mission, the FASB acts to:

1. Improve the usefulness of financial reporting by focusing on the

primary characteristics of relevance and reliability and on the quali-
ties of comparability and consistency.
2. Keep standards current to reflect changes in methods of doing
business and changes in the economic environment.
3. Consider promptly any significant areas of deficiency in financial
reporting that might be addressed through the standards-setting
process.
4. Improve the common understanding of the nature and purpose of
information contained in financial reports.
 1 OVERVIEW OF FINANCIAL STATEMENTS 7

As it works to develop accounting standards for financial reporting, the

FASB is committed to following an open, orderly process that considers
the interests of the many who rely on financial information.

• The Standards-Setting Process

An independent standards-setting process is paramount to produc-

ing high-quality accounting standards because it relies on the collective
judgment of experts who are informed by the input of all interested par-
ties through a deliberate process. The FASB sets accounting standards
through processes that are thorough and open, accord due process to
all interested parties, and allow for extensive input from all stakeholders.
Such extensive due process is required by the Rules of Procedure, set by
the Board within the parameters of the FAF’s bylaws. The FASB process
is similar to the Administrative Procedure Act process used by federal
agencies for rulemakings but provides far more opportunities for interac-
tion with all interested parties.
In short, the FASB actively seeks input from all of its stakeholders on
proposals and processes. Wide consultation provides the opportunity for
all stakeholders to be heard and considered, the identification of unin-
tended consequences, and, ultimately, broad acceptance of the standards
that are adopted. The Board’s wide consultation also helps it to assess
whether the benefits to users of improved information from proposed
changes outweigh the costs of the changes to preparers and others.
The FASB meets regularly with the staff of the SEC and the PCAOB.
Additionally, because banking regulators have a keen interest in US
GAAP financial statements as a starting point in assessing the safety and
soundness of financial institutions, the Board meets with them on a quar-
terly basis and otherwise, as appropriate. The FASB conducts outreach
on a frequent and regular basis with the FASB’s various advisory groups.
The primary role of advisory group members is to share their views and
experience with the Board on matters related to practice and implemen-
tation of new standards, projects on the Board’s agenda, possible new
agenda items, and strategic and other matters.
In addition to the FASB’s various advisory groups, the Emerging
Issues Task Force (“EITF”) assists the FASB in improving financial
reporting through the timely identification, discussion, and resolution of
financial accounting issues relating to US GAAP. The EITF was designed
8 F. I. LESSAMBO

to promulgate implementation guidance for accounting standards

to reduce diversity in accounting practice on a timely basis. The EITF
assists the FASB in addressing implementation, application, or other
emerging issues that can be analyzed within existing US GAAP. Task
Force members are drawn from a cross section of the FASB’s stakehold-
ers, including auditors, preparers, and users of financial statements. The
chief accountant or the deputy chief accountant of the SEC attends Task
Force meetings regularly as an observer with the privilege of the floor.
The membership of the EITF is designed to include persons who are in
a position to project emerging issues before they become widespread and
before divergent practices become entrenched.

• Oversight of FASB

The FASB’s accountability derives from oversight at two levels. First,

the Board is overseen by the independent Board of Trustees of the FAF.
Organized in 1972, the FAF is an independent, private-sector, not-for-
profit organization. The FAF exercises its authority by having respon-
sibility for oversight, administration, and finances of the FASB and its
sister organization the Governmental Accounting Standards Board
(“GASB”). The FAF’s responsibilities consist of:

1. Selecting the members of the FASB, the GASB, and their respec-
tive Advisory Councils.
2. Overseeing the FASB’s and the GASB’s Advisory Councils (includ-
ing their administration and finances).
3. Overseeing the effectiveness of the FASB’s and the GASB’s stand-
ards-setting processes and hold the Boards accountable for those
processes.
4. Protecting the independence and integrity of the standards-setting
process.
5. Educating stakeholders about those standards.

Second, the FASB is subject to oversight by the SEC with respect to

standards setting for public companies. The SEC has the statutory
authority to establish financial accounting and reporting standards for
public entities. At the time of FASB’s formation in 1973, the SEC for-
mally recognized the FASB’s pronouncements that establish and amend
accounting principles and standards as “authoritative” in the absence
 1 OVERVIEW OF FINANCIAL STATEMENTS 9

of any contrary determination by the Commission. In 2003, the SEC

issued a Policy Statement that affirms the FASB’s status as a designated,
private-sector standards setter.

1.5  The UK: Financial Reporting Council (FRC)

In the UK Accounting standards derive from a number of sources.
The chief standard-setter is the Accounting Standards Board (ASB),
which issues standards called Financial Reporting Standards (FRS). The
ASB is part of the FRC, an independent regulator funded by a levy on
listed companies, and it replaced the Accounting Standards Committee
(ASC), which was disbanded in 1990 following a number of criticisms
of its work. To the extent that the ASC’s pronouncements, known as
Statements of Standard Accounting Practice (SSAPs), have not been
replaced by FRS, they remain in force. In 2015, the UK’s FRC pub-
lished a set of new reporting standards collectively known as the New
UK GAAP. These new standards applied to all accounting periods start-
ing on or after January 1, 2016. The Board comprises the Chairman,
the Deputy Chairman, the Chief Executive, the Chair of the Codes
and Standards Committee, the Chair of the Conduct Committee, and
other non-executive directors (including the Chairs of the Corporate
Reporting and Actuarial Councils). The Chairman and Deputy
Chairman are appointed by the Secretary of State for Business, Energy &
Industrial Strategy (BEIS).
The UK’s FRC published five standards which together form the
basis of the new UK regime. The Financial Reporting Standard for
Smaller Entities will continue to be available for those that qualify to use
it and will remain fundamentally unaltered for the time being. In March
2013 the FRC (now responsible for issuing accounting standards in
the UK) issued FRS 102, The Financial Reporting Standard Applicable
in the UK and Republic of Ireland. This followed the issue of FRS 100
Application of Financial Reporting Requirements and FRS 101—The
Reduced Disclosure Framework in November 2012. Together these
standards make up what is commonly being referred to by accountants
as New UK GAAP, which takes mandatory effect for accounting periods
commencing on or after January 1, 2015. The introduction of the New
UK GAAP aimed to make financial reporting both easier and cheaper,
while creating a more unified, coherent and succinct set of standards.
Compared to the old standards, the New UK GAAP:
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