CHAPTER 2

Business structures and financial

reporting
 LEARNING OBJECTIVES
By the end of this section of the course, you should be able
to:
• identify three forms of business structures, the main characteristics of
each structure and the major differences between their financial
statements
• identify the main characteristics of the financial statements of a public
company and the role and meaning of consolidated financial
statements
• explain the current framework for standard setting in Australia and
the influence of accounting standards, the Corporations Act 2001 and
the Australian Securities Exchange Listing Rules on financial
reporting requirements
• explain what is meant by, and the role of, a conceptual framework
and explain the major concepts
• appreciate the role of the external audit function.
 INTRODUCTION
Factors that influence the preparation of
financial reports:
• the type of business arrangement for the
reporting organisation
• regulatory requirements that apply to
specific business arrangements
• other requirements of professional bodies
and securities exchanges.
 INTRODUCTION (CONT.)
Basic financial reports
• Single statement of profit or loss and other
comprehensive income or statement of profit or
loss and statement of comprehensive income
• Statement of financial position (balance sheet)
• Statement of changes in equity
• Statement of cash flows.
TYPES OF BUSINESS STRUCTURES
(LO 1)
Profit-making enterprises Not-for-profit entities

• Sole trader • Charities

• Partnership • Government
• Company. • Cooperatives
• Friendly societies.
 THE SOLE TRADER
• Simplest form of organisation
• Unlimited liability
• Financial statements are very simple to prepare
• Not seen as separate legal entities
• No formal guidelines unless it is a reporting entity

Disadvantages
• Unlimited liability
• Relies on the owner for finance.
 PARTNERSHIPS

Advantages Disadvantages

• Ease of formation • Limited life

• Limited rules and • Unlimited liability
regulations • Mutual agency.
• Provision of capital and
expertise
• Income tax.
 COMPANIES
Advantages Disadvantages
• Limited liability • Tax
• More capital • Increased regulation
• No mutual agency • Separation of
• Professional ownership and control
management • Limited liability – small
• Continuous existence company.
• Separate legal entity.

Companies can be:

»» private (proprietary)
»» public.
 BUSINESS STRUCTURES
Sole Partner- Company
trader ship Private Entity
Public
Entity
not taxed taxed

Not a separate A separate legal entity

legal entity
Pty. Ltd Ltd
Limited
Unlimited liability
liability

Limited rules and

regulations Increased regulation
 FINANCIAL STATEMENTS OF A SOLE
TRADER: PROFIT OR LOSS STATEMENT
FINANCIAL STATEMENTS OF A SOLE
TRADER: BALANCE SHEET
 FINANCIAL STATEMENTS OF A
PARTNERSHIP: PROFIT OR LOSS
STATEMENT
 FINANCIAL STATEMENTS OF A
PARTNERSHIP: BALANCE SHEET
 FINANCIAL STATEMENTS OF A PRIVATE
COMPANY: STATEMENT OF PROFIT OR LOSS
AND OTHER COMPREHENSIVE INCOME
FINANCIAL STATEMENTS OF A PRIVATE
COMPANY: BALANCE SHEET
 FINANCIAL STATEMENTS
OF A PUBLIC COMPANY (LO 2)
Consolidated financial statements:
• report the financial performance, financial
position and cash flows of the combination of
the parent entity and any other entities it
controls
• are prepared by combining similar accounts
from the separate statements of the parent
entity and its controlled entities after the
elimination of all transactions among members
of the economic entity.
 THE FRAMEWORK FOR SETTING
ACCOUNTING STANDARDS (LO 3)
Corporations Act 2001
Australia
• FRC:
AASB IASB/IFRS

Reporting entities GPFS

Due process

Group of 100, accounting ASIC ASX

bodies, international standards APES
setters
 THE POLITICAL NATURE OF
ACCOUNTING STANDARD SETTING
• Competing interests mean a delicate
balancing act is needed when setting
standards
• Involved parties include government, the
Group of 100, accounting professional
organisations and international standard
setters.
 INTERNATIONAL ACCOUNTING
STANDARDS
• Set by the International Accounting
Standards Board (IASB)
• Standards are known as International
Financial Reporting Standards (IFRS)
• Since 2005, Australia has adopted IASB
standards after due process
• The AASB is the rule-making or
standard-setting body in Australia.
 THE CORPORATIONS ACT 2001

• Section 298 – AASB standards are

mandatory for reporting entities.

• Must include:
– directors’ report
– directors’ statement
– auditor’s report.
 INFLUENCE OF SECURITIES
EXCHANGE ON FINANCIAL REPORTING
Requirements for listed public companies:
• a disclosing entity
• half-yearly reports
• preliminary final statement
• additional details to the annual report
• additional details for mining exploration
companies
• non-compliance leads to delisting.
THE CONCEPTUAL FRAMEWORK (LO 4)
• A conceptual framework sets out the concepts that
underlie the preparation and presentation of financial
statements for external users.

• The IASB developed its Conceptual Framework for

Financial Reporting, the purposes of which are to:
– assist the IASB in the development of future IFRS
– act as a guide to resolving accounting issues that are not
addressed directly in a standard.
– assist all parties to understand and interpret the Standards.
 GENERAL-PURPOSE FINANCIAL
STATEMENTS
These include:
• the statement of profit or loss and other comprehensive
income for the period
• the statement of financial position or balance sheet at
the end of a period
• the statement of changes in equity for the period
• the statement of cash flows for the period
• notes to these statements
• comparative information in respect of the preceding
period.
 OBJECTIVES OF
A CONCEPTUAL FRAMEWORK

• Fewer accounting standards

• More consistent accounting standards –
new and existing
• Improved communication
• Defence against politicisation.
THE REVISED CONCEPTUAL FRAMEWORK
• Definition of the reporting entity:
– from 1 Jan. 2020, SAC 1: Definition of the reporting entity will not
apply to for-profit private-sector entities:

• Revised Conceptual Framework for Financial Reporting

(RCF):

– under the IASB RCF, an entity choosing to prepare general-

purpose financial statements (GPFS) would make it a reporting
entity.
 THE OBJECTIVE OF GENERAL-
PURPOSE FINANCIAL REPORTING
• General-purpose financial reporting provides
financial information about the entity that is useful
to external users (existing and potential investors,
lenders and other creditors) in making decisions
about providing resources to the entity.
• Such decisions include those about buying, selling
or holding equity instruments and providing or
settling loans and other forms of credit.
 THE OBJECTIVE OF GENERAL-
PURPOSE FINANCIAL REPORTING (CONT.)
• GPFS must be prepared on an accrual basis:

• Accrual accounting provides a better measure

of performance (but not of cash flow):
 QUALITATIVE CHARACTERISTICS OF
FINANCIAL INFORMATION
• Qualitative characteristics are the attributes that make the
information provided in financial statements useful to users.
• Financial information in general-purpose financial reports
should possess these qualities.
• Fundamental characteristics include relevance and faithful
representation.
• Usefulness is enhanced by four characteristics:
comparability, verifiability, timeliness and understandability.
• Timeliness and cost vs. benefits must also be considered.
DEFINITION AND RECOGNITION OF THE
ELEMENTS OF FINANCIAL STATEMENTS
Definitions and recognition criteria for assets, liabilities,
income, expenses and equity are found in Chapter 4 of
the RCF.

Assets
• Present economic resources
• Controlled by the entity
• Result of past events
• Rights that have the potential to produce
economic benefits.
 DEFINITION AND RECOGNITION OF THE
ELEMENTS OF FINANCIAL STATEMENTS
(CONT.)

Liabilities
• Present obligations of the entity
• Transfer of an economic resource
• Arising from past events.
Equity
• The residual interest in the assets of the
entity after deducting all its liabilities
• Equity = Assets – Liabilities = Net assets.
 DEFINITION AND RECOGNITION OF THE
ELEMENTS OF FINANCIAL STATEMENTS
(CONT.)
Expenses
• Decreases in assets, or increases in
liabilities, that result in decreases in equity,
other than those relating to distributions to
holders of equity claims.
Income
• Increases in assets, or decreases in
liabilities, that result in increases in equity,
other than those relating to contributions
from holders of equity claims.
 INCOME AND REVENUE
• Income arising in the course of an
entity’s ordinary activities.

• Revenue is, in fact, a subset of income.

RECOGNITION OF ASSETS, LIABILITIES,
EQUITY, INCOME AND EXPENSES
To recognise is to record an item with a
description and an amount. To be
recognised, an element needs to:
 meet the definition of an asset, liability,
income or expense
 provide information that is useful
(fundamental characteristics of financial
information).
 EXTERNAL AUDITS (LO 5)

External auditors of general-purpose

financial reports:
• are independent of the entity
• express an opinion that the GPFR provides
a true and fair representation of the entity’s
financial status
• do not prepare GPFR.
 EXTERNAL AUDITS (CONT.)

What do external auditors do?

• Check accounting systems
• Check compliance with the Corporations Act
2001 and accounting standards
• Check the accuracy of transactions
• Provide reasonable assurance, but not an
absolute guarantee.
 EXTERNAL AUDITS: THE AUDITOR
Requirements under the Corporations Act 2001
• Appropriate tertiary qualifications, completion of a
prescribed course in auditing or experience that ASIC
considers equivalent to both requirements
• Meet one of the following practical requirements:
– Satisfy all the components of an ASIC-approved competency
standard.
– Have the level of practical experience prescribed in the
Corporations Regulations or experience that ASIC considers
equivalent to this.
• Satisfy ASIC that he/she is capable of performing the
duties of an auditor and is otherwise a fit and proper
person to be registered as an auditor.
 EXTERNAL AUDITS:
THE EXPECTATION GAP

• The gap between what auditors do and

what users of general-purpose financial
reports expect that the auditors do or
have done.
EXTERNAL AUDITS: INDEPENDENCE
• The auditor must be independent of the client
for whom the audit is being conducted so that
their opinions about the financial statements
will be truly objective.
• Independence is both real and perceived:
– the failure of Enron raised questions about the
independence of auditors
– the profession’s reaction
– the legislator’s reaction.
 SUMMARY
• Basic financial statements: The statement of comprehensive
income, statement of financial position (balance sheet), statement
of changes in equity and statement of cash flows
• Business structures: Sole trader, partnership, private company and
public company. Differences in financial statements are reflected in
the equity section of the balance sheet
• Australia adopted the IFRS in 2005
• Financial reporting in Australia is influenced by the IASB’s
Conceptual Framework, the Corporations Act 2001 and ASX listing
rules
• Independent auditors express an opinion on GPFR that gives a true
and fair view of an entity’s financial status.