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Introduction. Interpreting financial statements (FS) requires a thorough understanding of basic principles of accounting and reporting. This paper discusses such concepts as accounting equation and basic formats of FS, role of international financial reporting standards (IFRS), US Generally Accepted Accounting Principles (US GAAP) and The U.S.Securities and Exchange Comission (SEC) in the reporting process.
Principal financial concepts. US GAAP are a set of accounting standards used by US companies for financial reporting. They are introduced by the Financial Accounting Standards Board (FASB) in compliance with SEC regulations and FASB mission of setting and improving principles of accounting and reporting which provide meaningful information for investors and other users of FS for making economic decisions (FASB, 2015). The set of US GAAP is rule – based, giving a detailed and prescriptive guidance for specific issues, industries or companies types. The fundamental principles of US GAAP are accrual-based accounting, historical cost, full disclosure and matching principles, with relevance and faithful representation deemed its fundamental, and comparability, verifiability, timeliness and understability – its enhancing qualitative characteristics (FASB,2010). US GAAP are fully compliant with SEC regulations as a set of high-quality standards acceptable for purposes of federal securities laws (SEC SP, 2011). American Institute of Certified Public Accountants (AICPA), responsible for standards setting prior to FASB creation, supports US GAAP development by issuing audit and accounting guidelines and position statements.
IFRS are issued by International Accounting Standards Board (IASB) to ensure international comparability and quality of financial information, as a common language for financial reporting across the countries, in line with IASB mission to promote transparency, accountability and efficiency in the world financial markets (IASB, 2014). The set of standards issued by International Accounting Standards Committee (IASC), the IASB predecessor, is commonly referred to as International Accounting Standards (IAS), while the standards issued by IASB since 2001, are named IFRS. Both sets of standards are used for the preparation of financial statements under IFRS. IFRS are based on the same assumptions (historical cost, accrual-based accounting, full disclosure and matching) and requirements to qualitative characteristics of financial information that US GAAP, but are considered principle-based and thus ensure better comparability and consistency of financial statements (IASB, 2014). IASB Conceptual Framework sets consistent accounting principles to be applied to particular events and transactions. In 2002, the joint IASB-FASB convergence project was initiated to eliminate a range of differences between IFRS and US GAAP (FASB, 2014), with one of its purposes being the increase in transparency of the US financial market for international investors. In spite of multiple differences in US GAAP rule-based and IASB principle-based approaches, both the IASB and the FASB are actively working towards convergence, with new standards emerging as the result of such joint work.
SEC was created in 1934 based on Securities Exchange Act as a federal government agency to ensure the public companies present meaningful financial information to their stakeholders (SEC, 2013). SEC mission comprises ensuring protection of and facilitating capital access for investors, enhancing efficiency of the financial markets (SEC, 2013). SEC functional responsibilities are performed by five divisions responsible for enforcing federal securities laws, overseeing the inspections of securities firms and private regulatory securities organization, coordinating securities regulations, amending existing laws and issuing new ones. Sarbanes-Oxley Act coming into force in 2002 was immediately followed by SEC adoption of set of rules for certification of disclosure in Companies' Quarterly and Annual Reports (SEC, 2002). Annual report is a document used by public companies to disclose corporate information to shareholders (SEC, 2014). Annual report main elements include opening letter from the Chief Executive Officer, set of financial data and operational results, market segmentation, subsidiary activities, research and development plans (SEC, 2013). The companies may prefer annual reporting on Form 10-K obligatory for filing with SEC and submit the form electronically in the SEC’s EDGAR database (SEC, 2014). Form 10-K annual report should be distinguished from the annual report sent to shareholders during annual company meetings, as Form 10-K provides a formal comprehensive review of the company's business state and financial condition and should be accompanied by the audited financial statements (SEC, 2009). To ensure presentation and disclosure of public companies financial information on the ongoing basis, SEC stipulates quarterly reporting with use of another format, Form 10-Q (SEC,2011).This form should be filed with SEC for each of the first three fiscal quarters of the company's fiscal year and accompanied by unaudited financial statements (SEC,2011). Both Form 10-Q, and Form K-8, used for current reporting can be also filed through SEC EDGAR database. Form K-8 is filed for a number of major specified events having impact on current operations, e.g. termination of a material agreement, bankruptcy or material impairment (SEC, 2012). Such events should commonly be reported by public companies within 4 business days from their occurrence. Form 8-K, with its report of material events on the current basis, enhances timeliness and going concern principles, disclosing the major events shareholders should know about.
Basic formats of financial statements. Both FASB and IASB provide guidance for basic elements of the main financial statements (FS) (FASB, 1985; FASB, 2010; IASB, 2015). IAS 1 particularly focuses on the structure of FS, the basic requirement to their content, presenation and disclosure of separate elements (IASB, 2007). Income statement (IS), balance sheet (BS), statement of cash flows (CFS) and statement for retained earnings (SRE) represent a complete set of FS required by both US GAAP and IFRS (BCGFS,2008).
BS (per IFRS - statement of financial position) presents a financial position of the enterprise (nature and amounts of its claims and economic resources) at a certain moment of time (accounting period-end) (FASB, 2010).US GAAP requirements for BS layout are given in the Rule 210.5-02 for commercial and industrial companies (CFR 201.5-02, 2007). They are very much similar to IAS 1 (IASB, 2007) and include presentation and separate disclosure on the face of BS of such assets as cash and cash items, marketable securities, accounts and notes receivable, allowances for doubtful debts, unearned income, prepaid expenses, other current assets, non-current securities and indebtedness of related parties, property, plant, equipment\intangibles and accumulated depreciation\amortization, other non-current and total assets. For liabilities, accounts and notes payable, other current liabilities, bonds, mortgages and other long-term debt, including capitalized leases, indebtedness to related parties, deferred credits, commitments, other non-current and total liabilities should be presented. In relation to equity, common, redeemable and non-redeemable preferred stock, other equity and non-controlling interests should be disclosed separately.
IS (per IFRS - statement of financial performance) reflects the entity financial performance within a certain accounting period and should present revenues, gains and losses arising from financial assets, finance and tax costs, share of the entity’s profit\loss in associates and discontinued items (FASB, 2010; IASB,2007). Requirements to IS specific layout are presented by Rule 210.5-03 (CFR 201.5-03, 2007) stipulating presentation on the face of IS of net sales, gross revenues, and applicable costs, selling, general and administrative expenses, provision for doubtful accounts and notes, other operating costs and expenses, non-operating income and expense, interest and amortization of debt discount and expense, income tax expense, extraordinary items, income or loss before income tax expense, from continuing\discontinued operations and before extraordinary items, cumulative effects of changes in accounting principles, net income attributable to the controling\noncontrolling interests, earnings per share data. Different from US GAAP, IAS 1 allows presenting IS either as 2 separate FS (statement of profit and loss (PL) and statement of comprehensive income (CI)) or as a single statement of PL and CI (IASB, 2007).
CFS reflects a reporting entity cashflows during the period (FASB, 2010). Requirements to the format of cash flow (CF) statement (statements of cash flows per IFRS) are similar in US GAAP and IFRS, with three main parts to be included: CFs from operating (main revenue-produicing), investment (acquisitions and disposal) and financing (altering the equity capital and borrowing structure) activities as well as reconciliation of cash amounts at the beginning and end of the period (FASB, 1987). Still, US GAAP (FAS 95) strongly requires reconciliation between direct and indirect method (additional schedule prepared when direct method is used) while IFRS (IAS 7) allows using either method (IASB, 2007).
SRE (per IFRS- statement of changes in equity) predominantly presents the financial performance accumulated results (retained earnings account on BS) but also includes the information emerging from reasons other than financial performance (FASB, 2010). SRE should present and disclose the information necessary to give users a complete understanding of the reporting entity’s economic resources and claims changes and future implications of such changes (FASB, 2010). SRE basic elements include total comprehensive income for the period, showing separately the amount attributable to owners and non-controlling interest, the effects of changes in accounting policies and restatements, contributions from, distribution to or changes in interests of owners, reconciliations between the carrying amounts at the beginning and end of the period for each component of the equity (IASB, 2007).
Accounting equation components. The basic components of assets category of accounting equation (Assets = Liabilities+Equity) are current (cash, inventory, receivables) and non - current (fixed and intangible) assets. The basic components of liabilities are current (accounts payable, short-term debt) and non-current (bonds, mortgages, long-term debt) liabilities. The basic components of equity are retained earnings, common and preference stock, effects of changes in accounting policies (Benedicto, 2008). Table 1 below represents an example set of accounts (with amounts) falling under each category.
Conclusion. Though IFRS are aimed to promote international transparency, accountability and efficiency of FS, the process of IFRS and US GAAP convergence requires reconciliation of basic differences which are depicted in basic formats of main FS: income statement, balance sheet, cash flow statement and retained earnings statement. The accounting equation, a backbone of accounting, presents three categories: assets, liabilities and equity broken into set of accounts which however can also be differently presented under IFRS and US GAAP. US GAAP is used by US companies as a basis for preparation of FS, with a specific set of forms for public companies obligatory filing (Annual report on Form 10-K, Forms 10-Q and 8-K). To ensure validity, accuracy and reliability of public companies FS, this process is secured by SEC as a principal US capital market regulator.
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