RELEVANCY OF INCOME STATEMENT/BALANCE SHEET IN FINANCIAL

REPORTING

1.0 Introduction

A company's net worth is reported as a statement of shareholders' equity which is

important to equity investors and a host of other interested parties because it reflects
the financial performance and position of a firm for a particular accounting period
(Healey & Palepu, 2001). Lately, there has been number of debates on the relevance of
financial reporting. Globally, industry practitioners and academicians have argued that
there is a shift in the global trend in the way the financial perspectives of the reporting is
prepared and presented (Journal of Accountancy, 2018). It is also noted that the
outside stakeholders, besides financial perspectives, are keen to know more about non-
financial information to consolidate their understanding on the firm’s financial
performance and position (Ramanan, 2018). This shift in stakeholder behaviour is a
significant contrast to traditional way of establishing a firm’s value before making further
decisions to venture into more investments.

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2.0 Reported Trends in the Accounting World

Reportedly there had been number of global politico-economic developments that have
significant impact on the business environment. Globalization and market integration,
diversities affecting accounting harmonization, recurrence of financial crises and
emerging perspectives of financial reporting are some of the evolving key trends
(Tamer, 1993).

2.1 Globalization and market integration

Beck, (2000) claims globalization had resulted in the assimilation of larger firms with
smaller competitors that lead to feasible market integration prospects offering new
opportunities (refer table1).

1. Economies of scale
2. Outsourcing manufacturing process
3. Global distribution
4. Technology pooling including managerial talent
5. Global sourcing
6. Flex, not fixed, manufacturing
7. Joint ventures to utilize excess idle capacity
8. Co-marketing

Source: Globalization and Emerging Markets, Chhabra (2013).

Table 1: Opportunities arising out of Globalization and Market Integration

However, in the early stages of the above phenomenon, Tamer (1993), commented that
its impact on economic transactions, processes, institutions, and players is dramatic
and wide ranging. It challenges established norms and behaviour and requires different
mindsets.

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Thus, there is a collision of cultures and social behavioral challenges. Firms face
different perceptions in trade legislations and business policies resulting in unfamiliar
legal requirements. Compliance to legal provisions may seem difficult and take long
time to adjust. As a result there is a need for readjustment and alignment in applying the
accounting standards and practices in integrated economies.

2.2 Diversities in Accounting

Naaim, (2018) argues that cultural behaviors, legal systems, taxation system, inflation,
providers of financing, and political and economic ties as the common attributes of
diversities. In the light of these diversities, when involved in foreign operations,
countries face challenges in preparing consolidated financial statements to see the
mixed financial performances through a single lens. Next, access to foreign capital
markets has to be resolved through fulfilling local accounting standards in the country in
which the capital is being obtained. A third challenge relates the lack of comparability of
financial statements between companies from different countries which can significantly
affect the effective analysis of financial statements (Hoyle, Schaefer & Doupnik, 2015)

Taxation rules also differ between countries in the sense that published financial
statement forms the basis for taxation in some countries whereas in other countries
financial statement is adjusted for tax purposes. Financial providers too determine the
level of financial disclosures to various segments that need this information. Lastly,
political and economic ties do influence the determination of a particular accounting
framework in a country, thus countries observing code law system obviously differ from
countries that observe common law system. All these differences make it difficult for
investors and creditors to make valid comparisons which can guide them to perform
accurate firm valuation in buy-sell-hold decision-making in global capital markets.

Redress to these woes is under the purview of governing bodies such as Federal
Accounting Standards Board (FASB) U.S. and International Accounting Standards
Board (IASB). Most of the world’s economies are embracing the international financial
reporting standards (IFRS), (Ball, 2006) issued by IASB. However the U.S. corporations
chose to observe the Generally Accepted Accounting Principles (GAAP) established by

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FASB. These differences in accounting standards have also led to controversial
differences and had affected the convergence and harmonization initiatives of the
governing bodies to a stalemate. Standardization efforts from both the divides had been
going for more than a decade but to vain. FASB has been dragging its feet.

2.3 Recurrence of Global Financial Crises

The financial crises had happened decades since the seventeenth century (The
Economist, Jan., 2009). There are number of factors that cause the occurrence of
market bubbles and financial scandals leading to financial crises. As a result of all these
crises, the accounting world had been inevitably caught up with revisiting the
effectiveness of regulations, standards, practices, and frameworks. Insofar, the causes
of crises indicate a high degree of commonality in attributes such as; ineffective
regulatory oversight, dodgy accounting practices, excessive over valuing of the market,
pack mindsets largely emotional and irrational and in many instances a sense of
infallibility. In some cases, government’s lackadaisical oversight actions and humans’
unethical behaviors cannot be ruled out too (Carmassi, Gros, & Micossi, 2009).

2.4 Emerging Perspectives of Financial Reporting

Recently, studies indicate that, besides revisiting financial domains such as historical
costing and fair market value adjustment on the balance sheets (Cristea, 2017) at the
behest of external users of financial information significant research into non-financial
domain has evolved. Stakeholders particularly investors are looking beyond the
financial information delving into non-traditional areas to ascertain firms’ value. Reports
indicate that today less than 15% of a company’s market value (Ramanan, 2018) can
be accounted for by its financial and physical assets. On the contrary, it is also
observed that other elements, especially relationships, and intellectual and human
capital, make up a greater percentage of a company’s value (Ramanan, 2018).

According to Ramanan, (2018), the measure of success is no more restricted to

financial regime but extended to non-financial regimes such as customer satisfaction,
loyalty and brand awareness, the priority and importance given to corporate governance
and corporate social responsibility (Balabanis, Phillips, & Lyall, 1998). also have

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significant impact upon external stakeholders. Inter alia, therefore the challenges for
corporations would be to place critical importance on corporate governance and
corporate social responsibility initiatives to enhance the financial reporting including
augmenting firm’s value.

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3.0 Critical Analysis

The main theme observed in the emergence of globalization and market integration of
various economies heralds both opportunities and threats. Apart from opportunities, the
threats posing challenges are more pervasive and inevitable due to the interplay of
systemic factors within the business fraternity. As a result financial reporting initiatives
face readjustment and alignment in applying the accounting standards and practices in
integrated market economies.

Next, traditionally observed diversities pose challenges such as; preparation of

consolidated financial statements through fulfilling local accounting standards and
gearing towards harmonization for compatible reporting standards and regulations in
view of facilitating decision making in integrated market were reportedly a grave
concern (Cristea, 2017). The stalemate in the harmonization process of regulations,
standards and practices between FASB and IASB is certainly a strategic concern for
the global economy. The delay in breakthrough will certainly stall innovative solutions
for future woes in the accounting world.

The trend of financial crises recognizes that market bubbles and financial scandals are
inherently a human doing arising from the lack of accountability and transparency. It is
not the weakness of conceptual framework and structure of financial reporting as
claimed, this platform has been existing since the middle of 14th century. Lastly, the
importance of non-financial domain as a greater influencing factor in firm valuation had
been given more emphasis is a food for thought. Hence there is a distinct shift in the
perspectives of traditional financial reporting beckoning for a review of the accounting
process. Thus the correct game changers need to be identified in order to develop
innovative solution. That said, industry opines that the overall relevance of income
statement/balance sheet remains good (Lan, 2008) and is not lost as highlighted by
some quarters from the industry and academics.

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4.0 Recommendations

In the light of the prevailing trends in the accounting world the following
recommendations (refer table 2) are made in the hope to address the current woes:

4.1 The standards governing bodies; FASB and IASB shall resolve the stalemate
differences in the nearest possible future and bring about harmonization in the
accounting world.

4.2 Global corporations shall expand their focus to non-traditional financial regime in
order to augment an innovative conceptual framework and consolidate the relevance
of income statement/balance sheet in financial reporting to boost valuation the of firm.

4.3 Standards governing bodies to develop an oversight mechanism for stakeholders’

daily updates using “Artificial Intelligence” technology and big data analytics
technology for continuous monitoring and reporting accounting activities in firms.

Source: Writer’s construct

Table 2: Recommendations for Enhancing Financial Reporting Standards

5.0 Conclusion

Judging from the reported global trends in the accounting world, certainly there is a
considerable shift of a recognizable scale with new dimensions to explore and innovate
the financial reporting perspective. Irrespective of all the developments affecting the
accounting world, the writer feels that the relevance of income statement/balance sheet
can never be replaced from the conceptual framework of accounting process and it has
to remain as bedrock in the financial reporting domain. According to Lan, (2012) unlike
other segments, the balance sheet is the starting place to analyze a company’s financial
strength and it represents the total impact of all of these transactions at a certain date .
May be consideration should be given to make relevant modification in its structure to
accommodate changes. Lastly, with structural augmentation in respect to shift in users’
perspectives, the income statement/balance sheet may strongly remain relevant and
portray a greater degree of reliability for years to come.

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