What do you Mean by Financial Reporting Framework?
Financial Reporting Framework, as the word implies, provides a framework for financial reporting. This framework basically includes the rules and guidelines for preparing financial statements. Specifically, a framework governs measurement, recognition, and disclosure of the material items in the financial statements. Financial statement preparation is mandatory as well as an important requirement for all the stakeholders. For the purpose of an internal review, for borrowings, for compliance, and for sharing with the investors and shareholders.
The primary objective of a framework is to make sure that the financial statements fulfill the needs of the investors. Further, a framework can also assist in developing accounting policies for unusual transactions. To businesses, a framework helps to lower the cost of operations, as well as ensure financial reporting is in-line with set standards. IFRS and GAAP are the biggest examples of this reporting framework.
However, there is nothing like a single Financial reporting framework applicable across the globe. The preparation and reporting framework varies depending upon various factors. The factors like the type of business, location of the business, or type of company. Again it could be different for different countries. For instance, a company in the U.S. would generally use GAAP (Generally Accepted Accounting Principles), while companies in most other countries use IFRS (International Financial Reporting Standards).
Objectives of Financial Reporting Framework
Following are the objectives:
- To make available information for making investment and credit decisions.
- Offering details to assess potential cash flows. A framework must encourage businesses to make information available to stakeholders that assist them in assessing the amount, timing and uncertainty of cash flows, both inflows and outflows. All these information help stakeholders in assessing a company’s ability to generate net cash inflows.
- Offer details on the resources and claims. The information on the net cash flows helps to gather information on a company’s economic resources and claims applicable to those liabilities.
Criteria for Effective Financial Reporting Framework
There are six primary criteria for developing an effective financial reporting framework:
A framework needs to be transparent to ensure that the financial statement accurately reveals the underlying economic events. To ensure transparency, a framework must include full and timely disclosure, fair representation, etc.
A framework must include universal principles. This means it should offer guidance on recording all kinds of financial transactions, including existing transactions, as well as transactions that may arise in the future.
This criterion implies equal treatment. Or, we can say, a framework must ensure consistency in the measurement and reporting of similar types of financial transactions. The consistency should be regardless of location, industry, and period. Along with consistency, the framework must offer flexibility as well to ensure fair treatment of specific transactions.
This implies that the framework must assist in making investment decisions, as well as decisions pertaining to credit and resource allocation. Basically, a framework must help stakeholders to take decisions by evaluating the impact of the past, present, or future transactions on the potential cash flows.
It implies that the framework must encourage businesses to make available information that is based on the data that the framework wants to report for representation.
A framework must ensure that financial statements of the same business are comparable over time. Moreover, the financial statements must be comparable with other businesses.
It is very important for a business to understand the financial reporting framework that applies to them. Knowing and understanding the applicable framework helps a business with contractual delivery, revenue recognition, disputes, contractual delivery, and more. More importantly, a framework ensures all stakeholders are well served.