Question

PR-A3 Explain why non-reporting entities must prepare financial statements. Include in your response: i. General purpose for preparing financial statements ii. Legal obligations of businesses in relation to preparing financial statements i. General purpose for preparing financial statements ii. Legal obligations of businesses in relation to preparing financial statements. Include the specific act or legislation you referred to.

Answer 1

The accounting standards provide a framework for determining a consistent meaning of ‘financial position’ and ‘profit or loss’ in financial reporting across entities.

In the absence of any such framework, the figures disclosed in financial statements would lose their meaning and could be determined completely at the whim of the directors of individual entities. The profit or loss reported by an individual entity would vary greatly depending upon which individuals were responsible for the preparation of its financial statements.

This would not be consistent with the requirements of the Act for financial reports to give a true and fair view (s297), prohibiting the giving of false and misleading information (s1308), and only permitting dividends to be paid out of profits (s254T).

The following requirements of accounting standards that apply to all entities reporting under Chapter 2M are also relevant:

• (a) Paragraph 13 of accounting standard AASB 101 ‘Presentation of Financial Statements’ requires the financial report to present fairly the financial position, financial performance and cash flows. Fair presentation requires ‘the faithful representation of the effects of transactions, other events and conditions’ in accordance with the definitions and recognition criteria for ‘assets’, ‘liabilities’, ‘income’ and ‘expenses’ set out in the ‘Framework for the Preparation and Presentation of Financial Statements’ (Framework).
• (b) Paragraph 25 of AASB 101 requires all entities reporting under Chapter 2M to apply the accrual basis of accounting.
• (c) Paragraphs 10 and 11 of AASB 108 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ provides that, in the absence of an Australian accounting standard that specifically applies to a transaction, other event or condition, management should refer to, and consider the applicability of, the following sources in descending order: (i) the requirements and guidance in Australian accounting standards dealing with similar and related issues; and (ii) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Hence, the recognition and measurement requirements of accounting standards must also be applied in order to determine the financial position and profit or loss of any entity preparing financial reports in accordance with the Act

As noted earlier, the recognition and measurement requirements of the accounting standards include requirements relating to depreciation of non-current assets, tax effect accounting, lease accounting, measurement of inventories, and recognition and measurement of liabilities for employee entitlements.

The provisions of accounting standards dealing with the classification of items as assets, liabilities, equity, income and expenses also apply. This would include the provisions of AASB 132 ‘Financial Instruments: Disclosure and Presentation’ concerning the classification of financial instruments issued as debt or equity.

Class Order [CO 05/639] Application of accounting standards by non-reporting entities allows non-reporting entities to take advantage of concessions to the measurement requirements of accounting standards. Examples of these concessions include the provisions of AASB 1 ‘First-time Adoption of Australian Equivalents to International Financial Reporting Standards’ and transitional provisions in new accounting standards.

Directors of non-reporting entities must also consider carefully the need to make disclosures which are not directly prescribed by accounting standards, but which may be necessary in order for the financial statements to give a true and fair view. Such disclosures could include certain significant related party transactions.

ASIC will look closely at cases where non-reporting entities have not complied with the recognition and measurement requirements of accounting standards.

Non-reporting entities which hold out their financial reports to be general purpose financial reports must comply with all requirements of accounting standards.