Pages

Monday, 9 April 2012

Objectives of general purpose financial reporting

Objectives of general purpose financial reporting
It is clear from the above that the objectives of general purpose financial reporting are:

(a)                Maintaining the constant purchasing power of capital.

(b)                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.’

(Coenenberg and Macharzina, 1976)

‘Financial capital maintenance can be measured in either nominal monetary units or units of constant purchasing power.’  

(Framework, 2010)

‘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)

Only existing constant real non-monetary value capital can be maintained. Double–entry accounting 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 at all levels of inflation and deflation (CIPPA) automatically maintains the constant purchasing power of (existing) capital constant for an indefinite period of time in all entities that at least break even in real value at all levels of inflation and deflation – ceteris paribus. Maintaining the constant purchasing power of capital at all levels of inflation and deflation is a basic objective of financial reporting.

An entity has maintained the existing 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:

‘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.’

(Sombart, 1953)

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 fundament concept of capital logically gives rise to its respective fundamental capital maintenance concept.

Nicolaas Smith

Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.