Reporting entity

Reporting entity ED: Page 206-207 Discussion Paper Conceptual Framework - July 2013

a)      Describe a reporting entity as:

…a circumscribed area of economic activities whose financial information has the potential to be useful to existing and potential equity investors, lenders and other creditors who cannot directly obtain the information they need in making decision about providing resources to the entity and in assessing whether management and the government board of that entity make efficient and effective use of resources provided.

b)      Explained that most, if not all, single legal entities have the potential to be reporting entities. However, a legal entity may not qualify as a reporting entity if, for example, there is no basis for objectively distinguishing its economic activities from whose of another entity.

c)       Stated that a portion of an entity could qualify as a reporting entity:

i.         If the economic activities of that portion can be distinguished objectively form the rest of the entity, and

j.        Financial information about the portion of the entity has the potential to be useful in making decision about providing resources to that portion of the entity.

Page 5 of Conceptual framework 2010

The board believes that financial statements prepared for  this purpose meet the common needs of most users. This is because nearly all users are making economic decision, for example:

(a)    To decide when to buy, hold or sell and equity investment.

(b)   To assess the stewardship or accountability of management.

(c)    To assess the ability of the entity to pay and provide other benefits to its employees.

(d)   To assess the security for amounts lent to the entity.

(e)   To determine taxation policies.

(f)     To determine distributable profits and dividends.

(g)    To regulate the activities of entities

Exploring these key needs of users of financial statement is helpful in distinguishing a reporting entity. These needs focus no how a proprietary perspective (sole trader and partnership) is differentiated from those organizations with entity perspective (Ltd and PLC).

(a)    Shareholders/lenders as the users of financial statements use the information provided to decide whether to buy, hold or sell any portion of investment in shares and securities (i.e. the reporting entity should be listed company) or a limited company where members can hold, buy or sell their shareholding to other members.

(b)   In a proprietary entity managers are owners. This is not the case for limited liability company, where there is separation of ownership and control and manager act as agent of shareholders.

(c)    In proprietary entity owner is liable to pay his employees the promised benefit even if the company suffers loss. Whereas for a limited liability company the ability of the entity to pay and provide other benefits of its employees rest on the performance of the company and if company suffers loss owners need not pull money out of their pocket to pay for employees.

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 Conceptual Framework on Financial Reporting

Different approaches in understanding accounting

There are different approaches to understand basic principles of accounting.

Balance sheet perspective of accounting starts with stating balance equation (Assets = Liabilities + Equities/”Net Assets”). This always does not means change in balance in one side (i.e. Assets) always affect other side (i.e. Liabilities or Equity). A very simple example to justify the statement is cash purchase of machine. Here, both elements of double entry transaction are covered under assets heading where, decrease in cash results in increase in value of machinery.

The long-term financing approach used in UK and elsewhere is fixed assets + current assets - short term payables = long-term debt plus equity.

Another simplified approach to practice accounting is to apply general rule (Debit for increase in Assets and Expenses and credit for increase in Liabilities, Equity and Revenue/Income).

For simplicity, better understanding and clean presentation I like to adopt breakeven equation approach, which combines (balance sheet) financial position and income statement. We know that (Expenses + Profit = Revenue) and (Assets = Liabilities + Equity). Combining both (given Profit is Zero) at breakeven we get Expenses + Assets = Liabilities + Equity + Revenue.  Understanding the concept simplifies problems encountered in accounting process.

Having discussed different approaches we now see how double entry accounting system affects two sides of the equation and how they simplifies the presentation in different books accounts and financial statements.

The Debit Side : The recording of transaction starts from journal. The debit side/left side of journal amount represents the increase in value of Assets and Expenses or decrease in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on left for assets or expenses. The rule again follows to trial balance. Income statement records expenses in debit side under same rule whereas balance sheet debit side records assets.

The Credit Side : The credit side/right side of journal amount represents the decrease in value of Assets and Expenses or increase in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on right for liabilities, equity, or revenue. The rule again follows to trial balance. Income statement records revenue in credit side under same rule whereas balance sheet credit side records liabilities and equity.

Not for Profit Financial Accounting

Financial accounting perspective:

Ø  Statement of operation/activities (income and expenses): Since a nonprofit's primary purpose is to provide programs that meet certain societal needs, it issues a statement of activities (instead of the income statement that is issued by a for-profit business). The statement of activities reports revenue and expense amounts according to the three classifications of net assets discussed later.  

Ø  Statement of financial position:

o   Net Assets - Since a nonprofit organization does not have owners, the third section of the statement of financial position is known as net assets (instead of owner's equity or stockholders' equity).

A nonprofit's statement of financial position is represented by the following accounting equation:

Assets = Liabilities + Net Assets

The net assets section of a nonprofit's statement of financial position reports totals for each of the following classifications:

Ø   Unrestricted net assets - If a donor does not specify a restriction on his or her contribution, the amount received by the nonprofit is recorded as an asset and as unrestricted contribution revenues. Unrestricted contribution revenues (reported on the statement of activities) also cause the amount of unrestricted net assets to increase.

Ø   Temporarily restricted net assets - If a nonprofit receives a contribution that has a donor-imposed restriction (other than to be held in perpetuity), the amount is usually recorded as an asset and as temporarily restricted contribution revenues. Temporarily restricted contribution revenues (reported on the statement of activities) also cause the amount of temporarily restricted net assets to increase.

Ø  Permanently restricted net assets - If a donor stipulates that her contribution must be held by the nonprofit in perpetuity (forever, not be used up), the amount is recorded as an asset and as permanently restricted contribution revenues. Permanently restricted contribution revenues (reported on the statement of activities) also cause the amount of permanently restricted net assets to increase.

Total net assets

The grand total of the three classifications of net assets is reported as Net Assets or as Total Net Assets.

Not-for-profitAccounting Part 1, Part 2, Part 3 and Part 4

Financial Reporting and Type of business

Reporting period: Quarterly, Semi-annual, Annual and Change in reporting period

Change in financial year end date

Reporting period 

There is a presumption that financial statements will be prepared at least annually. If the annual reporting period changes and financial statements are prepared for a different period, the entity must disclose the reason for the change and state that amounts are not entirely comparable. [IAS 1.36]

Financial report includes statement of profit or loss and other comprehensive income, statement of financial position, cash flow statement and disclosure notes.

Financial reporting is the activity of stating business operating performance, business position and cash position at the end of reporting period.

Financial data used by financial report are historical in nature. These data stand for business reoccurring operational transactions and period end adjustments. Where there is uncertainty in respect to the precise value of assets, liabilities or equity managers/directors use estimate to reach value presented in financial statement.

Recording – transaction processing system – operational data

Analyzing – estimates, control accounts and reconciliation

Summarizing – final value to present in financial statement

Types of business entity  

Unlimited liability		Limited liability
Sole trader	Partnership	Private Limited (Ltd)	Public Limited (PLC)
An individual (owner) sets up business and run under own control. The owner bears all risk and reward resulting from the business	Two or more individuals (owners) set up business and run in shared control. Risk and reward is shared between partners as per partnership agreement.	Limited by share –  liability is limited to issued value of share Limited by guarantee – liability is backed up to a specific amount by members or directors	Offers share to general public and the liability of shareholders is limited contribution agreed for share
Not separate legal entity	Not separate legal entity registered partnership can sue	Separate legal entity which can sue and be sued	Separate legal entity which can sue and be sued
Ownership can change through sales of business.	Changes in partnership share can take place by mutual understanding	Transfer of rights within members	Shares are traded on Stock Exchange

Identify the advantage and disadvantage of operating as

Limited liability partnership:

Private unlimited company: 

Single member companies