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4Financial Reports and Decision-Making
Financial Reports and Decision-Making
Stewardship and valuation are two important objectives of accounting information. Stewardship relates to the use of accounting information by investors to assess the performance of the firm over a specified period such as in the past financial year. This objective ensures that the management of a firm is accountable to investors. Valuation, on the other hand, refers to the use of financial information in such a way that enables the investors to make a judgment on the future performance of the company. The investors use the information to estimate future cash flows and make decisions such as whether to buy or sell their shares in a firm. Although these two objectives seem related, there are significant differences between them. The stewardship objective is concerned about the past performance of a firm while the valuation objective is concerned about the future performance of the firm. These tow objectives are also closely connected to the provisions of the IASB Conceptual Framework.
The Conceptual Framework for Financial Reporting requires companies to ensure that financial reporting reflects the needs of the user such as capital providers. The users of financial information of a company utilize such information in making significant decisions such as the amount of investments hence the need to ensure that financial reporting addresses their needs and that it reflects the actual position of the company (Cascino et al. 2014, 186). Stewardship and valuation are two useful concepts in financial accounting. Stewardship in accounting involves using accounting information to monitor the use of capital by the management after such capital has been invested in the company while valuation or decision usefulness refers to the use of financial information, which is future oriented, to make investment decisions (Cascino et al. 2014, 189). This paper provides a discussion of these two concepts and how they are related to the International Accounting Standards Board (IASB) Conceptual Framework.
Discussion of Stewardship and Valuation
The stewardship role of accounting is closely linked to the theory of agency. The investors or owners of a company entrust their investment to the management expecting that they will have the ability to oversee the conduct and behavior of the management. This is to ensure that such conduct is in line with the objectives of the owners and that the management is applying strategies to make the best use of the assets of the company (Accounting Standards Board 2007, 10). The IASB Framework stipulates that financial statements help the users of accounting information to assess the stewardship or the accountability of the management to help them make economic decisions.
Financial information is useful to users such as investors for various reasons one of which is the valuation of equity or the earnings of the company or the business concerned. Financial information helps the investors to not only know the current but also the future or prospective performance of the company. Valuation or decision usefulness relates to looking at the future cash flows of the company which investors will use to make decisions such as to increase or reduce their investment in the company. The valuation aspect in financial accounting also enables the owners of the company to determine their returns from the amount of their investment.
Stewardship and valuation objectives seem to be closely connected. At times, these objectives may be seen as the same. This is so, especially because when investors look at financial reports, their main concern is to know how the business has performed. The investors then proceed to make decisions such as whether to sell or buy shares or intervene in the management of the company to ensure better performance (Accounting Standards Board 2007, 10). These two uses of the accounting information seem to be part of the same process. However, there are significant differences between stewardship and valuation.
The difference between valuation and stewardship as two objectives of financial accounting is the fact that accounting information, from a stewardship perspective, should be informative in the efforts being made by the management in the running of the company. Such information should present a sense of accountability by the management. On the other hand, accounting information, from the valuation perspective, should provide information on the uncertain part of the value of the firm. This mostly relates to the prospective performance of the firm (University of Fribourg 2016, 5). Stewardship and valuation are two distinct objectives in accounting. Stewardship is where an investor looks at financial statements to assess how the firm has performed in the past financial year. Valuation, on the other hand, is where the investor looks at the information to make a judgment about the performance of the firm in the future (Accounting Standards Board 2007, 11). Valuation relates to resource allocation while stewardship relates to accountability.
Although the decisions made by investors while in pursuit of the stewardship and valuation objectives may be similar especially where they touch on the role of the management, there are still differences in the outcome of such decisions (Kothari et al. 2010, 24). While in stewardship the investors are focused on the past conduct and judgment of the management in relation to the assets or the capital of the firm, in valuation, investors look at the actions that may be taken by the management in the future and how such actions may affect the future cash flows. Compensation packages may be used incentives for managers to ensure that the decisions made in the future protect the interests of the shareholders or rather promote the achievement of the future goals of the owners (Kothari et al. 2010, 24).
The IASB Conceptual Framework provides for the concepts that guide financial reporting. The conceptual framework creates a foundation on which financial reporting standards arise to ensure uniformity in financial reporting across the globe (International Accounting Standards Board 2010, 2). The framework provides a guide to ensure that the members of IASB do not end up developing different standards. The conceptual framework provides that the objective of financial reporting is to provide financial information about the reporting firm that is useful to present and potential investors, lenders and other creditors as they make decisions as the capital providers of a firm (International Accounting Standards Board 2010, 3). A critical analysis of this objective shows that the purpose of financial reporting is to ensure that the present and future investors and capital providers of a firm are aware of its financial performance. The conceptual framework, therefore, ensures that this objective is met by providing guidelines to be followed in preparing financial reports.
Both stewardship and valuation objectives are concerned about the use of financial information by capital providers. As stated above, the objective of financial reporting is to provide information that can be used by capital providers in making economic decisions. Stewardship and valuation objectives arise from this principal objective since these two objectives specify how investors use the information. Although stewardship relates to how investors make managers accountable while valuation relates to how investors assess the future performance of the firm, these two objectives both arise from the primary objective as stipulated in the conceptual framework (International Accounting Standards Board 2010, 3). Both relate to how investors choose to use the financial information.
One of the ways to ensure that the objective discussed above has been met is to provide certain qualities which accounting information should possess to be regarded as useful to capital providers. The conceptual framework, therefore, requires each reporting entity to ensure that their financial information has the qualities outlined in the conceptual framework. These qualities are relevance and faithful presentation (International Accounting Standards Board 2010, 4). Financial information is relevant if it makes a difference in decision-making. As a result, financial information can make a difference if it has predictive value, that is, it enables the investor to make their predictions of the company. It can also have confirmatory value if such information helps the users of accounting information to confirm or correct prior expectations (International Accounting Standards Board 2010, 5). Faithful presentation, on the other hand, means that the numbers or descriptions in the financial report must be what happened. It means ensuring that the information is complete, that is, no information has been omitted and that the information must also be free from error. Further, the information must also be neutral such that the firm does not select information that is biased or favors one side than the other (Financial Reporting Council 2015, 8).
Relevance and faithful presentation as qualities of financial information outlined in the conceptual framework are important in both stewardship and valuation. Financial information is considered relevant if it can help users of such information to predict the future performance of the firm or to confirm or correct their expectations for the firm. The predictive and confirmatory values of financial information are similar to the stewardship and valuation objectives. Stewardship relates to how a firm has performed in a specified period which is similar to the confirmatory value. Valuation, on the other hand, relates to the future performance of the firm which is similar to the predictive value of relevance as a quality of financial information. Faithful presentation of financial information ensures that the stewardship and valuation objectives are met by creating an obligation on the reporting entity to ensure that the information provided is complete and free from error (International Accounting Standards Board 2010, 6).
Stewardship and valuation are objects of financial accounting which stipulate the different ways that capital providers may use financial information. Stewardship relates to the use of financial information to keep the management accountable while valuation enables investors to make predictions as to the future performance of the company. These objectives are closely related to the IASB conceptual framework. The conceptual framework provides for the principal objective of financial information which is to enable users to make decisions. Stewardship and valuation help capital providers in furthering the objective since they relate to how they use financial information. Further, valuation and stewardship find their usefulness from relevance and faithful presentation stipulated in the framework as fundamental qualities of financial reporting
Impairment of non-financial assets
The carrying amounts of the Group’s property, plant and equipment, goodwill and intangible assets (refer to Note 13) are reviewed for impairment as follows:
Property, plant and equipment and finite life intangibles
When there is an indication that the asset may be impaired (assessed at least each reporting date) or when there is an indication that a previously recognised impairment may have changed
Goodwill and indefinite life intangibles
At least annually when there is an indication that the asset may be impaired
Calculation of recoverable amount
In assessing impairment, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). The recoverable amount of an asset is the greater of its value in use (“VIU”) and its fair value less costs to dispose (“FVLCTD”). For an asset that does not generate largely independent cash inflows, recoverable amount is assessed at the cash-generating unit (“CGU”) level, which is the smallest group of assets generating cash inflows independent of other CGUs that benefit from the use of the respective asset. Goodwill is allocated to those CGUs or groups of CGUs that are expected to benefit from the business combination in which the goodwill arose, identified according to operating segments and grouped at the lowest levels for which goodwill is monitored for internal management purposes.
An impairment loss is recognised whenever the carrying amount of an asset or its CGU exceeds its recoverable amount. Impairment losses are recognised in the consolidated statement of profit or loss.Impairment losses recognised in respect of a CGU will be allocated first to reduce the carrying amount of any goodwill allocated to the CGU and then to reduce the carrying amount of other assets in the CGU on a pro-rata basis to their carrying amounts (Woolworths Limited 2015, 73).
Ernst and Young
Impairment of Financial Assets
The Scheme assesses at each reporting date whether a financial asset or group of financial assets classified as loans and receivables is impaired. An impairment exists if one or more events that has occurred since the initial recognition of the asset (an incurred ‘loss event’) has an impact on the estimated future cash flows of the financial asset or the group of financial assets that can be reliably estimated.
Evidence of impairment may include indications that the debtor or a group of debtors is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probability that they will enter bankruptcy or other financial reorganisation and where observable data indicate that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future expected credit losses that have not yet been incurred) discounted using the asset’s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account, and the amount of the loss is recognized in profit or loss as ‘impairment expense’ (Ernst and Young 2015, 19).
The concept of impairment accounting states that when an asset is intended for long-term use, the cost of investment through depreciation must be allocated to determine the historical cost convention (Kvaal 2005, 12). The process of depreciation is one that involves allocating the cost of investment over the economic life of the asset to reflect wear and tear. According to the Australian Accounting Standards Board (2008, 7), the objective of the requirement of impairment of assets accounting is to ensure that assets are carried at a value that does not exceed their recoverable amount. The recognition of impairment is supposed to help improve the usefulness of financial statements by ensuring that losses are reported promptly. The carrying value of an asset is an amount at which an asset is recognized after any accumulated depreciation and impairment losses are deducted (Amiraslani et al. 2015, 12). Where the carrying value of an asset is greater than the amount that could be received if a firm uses or sells an asset, such an asset is impaired. Impairment accounting standards, therefore, require a company to provide for the impairment loss in the financial statement. An impairment loss refers to the difference between the carrying amount and the recoverable amount of an asset. The impairment accounting standard requires a reporting entity to ensure that it assesses whether an asset is impaired at the date when the balance sheet of the firm is prepared (Amiraslani et al. 2015, 12).
The impairment of assets is closely connected to the both the stewardship and valuation objectives of financial accounting. Stewardship refers to the use of information to ascertain the performance of a firm during a specified period. To understand the performance of a firm, the information being relied upon must be relevant and current. The impairment of assets, therefore, ensures that any impairment losses of assets are recorded in the financial statement (Kvaal 2005, 19). This ensures that capital providers and other users of accounting information are informed of the actual position of the company as at the time the financial statements were made. Valuation, on the other hand, involves the use of information to predict the future performance of a firm. The impairment of assets caters for the depreciation of the asset over time hence allows a company to report the actual value of the asset on the day the financial statements are prepared. In effect, impairment of assets ensures that a reporting entity reports the recoverable amount of an asset which in turn helps investors to predict the future performance of the firm taking into account impairment losses of assets. To understand the current and future performance of a firm, the financial information must consider the losses that arise from wear and tear and depreciation of assets. The performance of the assets during an economic slow-down also leads to losses that should be included in the financial information to enable investors to make better judgments regarding the future performance of the firm.
Accounting Standards Board 2007, Stewardship/accountability as an objective of financial reporting, United Kingdom Government.
Amiraslani, H, Latridis, G, and Pope, P 2015, Accounting for asset impairment: A test for IFRS compliance across Europe, Cass Business School.
Australian Accounting Standards Board 2007, Impairment of assets, Australian Government.
Cascino, S, Clatworthy, M, Osma, B, Gassen, J, Imam, S, and Jeanjean, T 2014, Who uses financial reports and for what purpose? Evidence from capital providers, Accounting in Europe, 11(2), 185-209.
Ernst and Young 2015, Financial report 2015, Available at: http://www.ey.com/Publication/vwLUAssets/endeavour-mis-june-2015/$FILE/ey-endeavour-mis-june-2015.pdf [Accessed 18 September 2016]
Financial Reporting Council 2015, Conceptual framework for financial reporting (ED/2015/3), Available at: https://www.frc.org.uk/Our-Work/Publications/Accounting-and-Reporting-Policy/FRC-response-to-the-IASB-Exposure-Draft-Conceptua.pdf [Accessed 18 September 2016]
International Accounting Standards Board 2010, Conceptual framework for finance reporting, Available at: http://www.wiley.com/legacy/college/kieso/0470374942/ifrs/ch02.pdf [Accessed 18 September 2016]
Kothari, S, Ramanna, K, and Skinner, D 2010, Implications of GAAP from an analysis of positive research in accounting, Journal of Accounting and Economics, 50(2-3), 246-286.
Kvaal, E 2005, Topics in accounting for impairment of fixed assets, Department of Accounting, Auditing and Law, BI Norwegian School of Management.
University of Fribourg 2016, On the relationship of stewardship and valuation-Empirical evidence from German firms, Available at: http://events.unifr.ch/eufin16/Papers/Paper_16.pdf [Accessed 18 September 2016]
Woolworths Limited 2015, Annual Report 2015, Available at: http://www.woolworthslimited.com.au/icms_docs/182381_Annual_Report_2015.pdf [Accessed 18 September 2016]