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Tuesday, 16 August 2011

Objectives of general purpose financial reporting

Objectives of general purpose financial reporting
The objectives of general purpose financial reporting are:

1.    Maintaining the constant purchasing power of capital.

2.    Provision of continuously updated decision–useful financial information about the reporting entity to capital providers and other users.

It is the overall objective of reporting for price changes to ensure the maintenance of the business as an entity.

Accounting for Price Changes: An Analysis of Current Developments in Germany, Adolf G Coenenberg and Klaus Macharzina, Journal of Business Finance & Accounting, 3.1 (1976), p 53.

Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.  Framework (1989), Par 104 (a)

It is essential to the credibility of financial reporting to recognize that the recovery of the real cost of investment is not earnings — that there can be no earnings unless and until the purchasing power of capital is maintained.

FAS 33 (1979), p 24

Only existing constant real value capital can be maintained. Financial reporting does not and cannot create real value out of nothing as a result of simply passing update entries when no real value actually exists.

Financial capital maintenance in units of constant purchasing power during inflation and deflation (CIPPA) as authorized in IFRS automatically maintains the constant purchasing power of capital constant for an indefinite period of time in all entities that at least break even during inflation and deflation – ceteris paribus. Maintaining the constant purchasing power of capital is a basic objective of financial reporting.

An entity has maintained the constant purchasing power of its capital if it has as much equity – expressed in units of constant purchasing power – at the end of the reporting period as it had at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Consequently: a profit is earned only if the constant purchasing power of equity at the end of the period exceeds the constant purchasing power of equity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

The German economist Werner Sombart (1863–1941) wrote in Medieval and Modern Commercial Enterprise that The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double entry bookkeeping. ^ 

^ Lane, Frederic C; Riemersma, Jelle, eds (1953). Enterprise and Secular Change: Readings in Economic History. R. D. Irwin. p. 38.  (quoted in "Accounting and rationality)."

The objectives of general purpose financial reporting are supposed to answer the question: what is financial reporting supposed to do? The only accounting model an entity can use to implement a capital concept is double entry accounting. Every concept of capital logically gives rise to its respective capital maintenance concept.

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