The Relevance of Financial Reporting

A Critical Evaluation of ‘The Relevance Of Financial Reporting On The Performance Of Quoted Romanian Companies In The Context Of Adopting The IFRS’

This critique analyzes a financial article titled “The Relevance Of Financial Reporting On The Performance Of Quoted Romanian Companies In The Context Of Adopting The IFRS” by Mironiuca et al. The reasons motivating the selection of this study will be outlined. This paper aims to critically analyze the article based on its main arguments, strengths, and weaknesses of the methodologies implemented.

The motivation for article selection

This article was selected because it investigates the impact of IFRS net income and comprehensive income reporting in enhancing the transparency of the firm’s market value and inherent risks through providing informative content. In traditional reporting, the company reported on profits and losses resulting from the conversion of production factors into products and services transacted to generate revenue. Reporting on the net income alone leaves out vital information required by the investor in decision-making. Investment in stock is coupled with two main risks: systematic and unsystematic (Parent et al., 2018, p. 195). The former relates to industry-wide risks affecting the overall capital market, while the latter refers to specific company risks. Unlike systematic risk, this risk can be diversified by developing an optimal portfolio. The investor’s main aim is to create a portfolio that optimizes returns at the highest level of risk. This can only be made possible when they access precise information on a company’s actual level of risk. For this reason, the IFRS developed a different reporting that incorporated changes to shareholders’ equity resulting from transactions with other parties other than shareholders. This new approach is referred to as “Performance Reporting: Reporting Comprehensive Income” and entails what is known as dirty reporting that extends the net income by producing a comprehensive income. In this approach, net income is reported as a subtotal, whist comprehensive income is the final profits by incorporating elements such as changes arising from the revaluation of both tangible and intangible assets at fair value (IAS16), gains and losses resulting from the conversion of financial statements from local to foreign currency (IAS 16), actuarial gains and losses from an adjustment in employees plans and benefits (IAS 19) and gains and losses on hedging instruments (IAS 39) (Mironiuc et al., 2015, p. 404). Such transactions significantly affect a company’s value, yet they are excluded in the income statement-making investors receive a side view of the company’s financial performance. Therefore the selection was inspired by the need to resolve a contemporary issue in financial reporting, which is enhancing the quality of informative content in enabling investors to make prudent investment decisions.

The Authors’ Main Argument

In this study, the author presented two main arguments encapsulated in the hypotheses that are to be tested. In the first hypothesis, the author contends that the IFRS net income reporting results in more informative content than the comprehensive income. Nonetheless, this information is subject to the quality of audits performed on the company’s financial statements (Mironiuc et al., 2015, p. 410). The quality of financial information would undermine the superior method, hence the need for an effective audit to ensure precise financial data. The author contends that the sample selected is more likely to execute a quality audit in producing their financial statements as they face a higher risk of litigation in the event of reported misleading financial information. From this assessment, the author developed the second hypothesis stating that the quality of informative content produced by both the net income computed under IFRS and comprehensive income is enhanced by the use of data provided through a rigorous audit. The author argues that the current net income has more predictive power than the comprehensive income for two reasons. First off, the components included in comprehensive income are more volatile and hence subjected to variation that undermines its predictive quality. Secondly, the computation of comprehensive income is more complicated in comparison to IFRS net income; therefore, it is subject to imprecision. On the same note, most of the elements included in these statements make it difficult for individuals with little accounting knowledge to interpret. Therefore, the authors argue that the IFRS net income is superior to comprehensive income in predicting an organization’s future performance while making investment decisions.

An Evaluation of the Research’s Methodology

The construction of variables entailed the selection of companies that used comprehensive income and IFRS net income. In its computation, the former includes components such as changes exhibiting a negative effect on shareholders’ equity other than those generated by owner transactions with the company, while the latter undertakes a surplus approach by incorporating shareholders’ equity and excluding those arising from direct transactions. Statistical measures in the study included correlation and linear regression analysis. The strength of the study lies in the sample selection since it involved those qualified to participate in the Romanian capital stock market. The main weakness of the methodology is that it gauges a company based on its financial performance only. Yet many other factors come into play when determining a company’s performance and value. Other essential elements such as investment in research and development, integration of technology in the automation of processes, employee relations, Corporate Social Responsibility(CSR) that determines the company’s relationships with its key stakeholders, and integration of environmental sustainability through the acquisition of green raw material, among others. A company’s success stems from different aspects related to its operations other than performance. This approach may blind investors from startups and middle-level enterprises that feature promising prospects. At their advent, such firms showcase poor financial performance as they strive to gain their grounding. Over time, this company’s equity could grow exponentially and prove profitable for investors. For instance, in eight years, Tesla’s share has increased twelvefold since its initial public offering. A $100 worth investment in the stock in 2010 would amount to $12000 in 2019 (Ferreira, 2019, p. 4). If investors assessed Tesla’s suitability based on the comprehensive income reporting, they would probably exclude the share from their portfolio. Nonetheless, this tool is sufficient in evaluating companies in their maturity stage, such as those included in the BCG, e.g., Apple Inc.

Summary

The article was selected because it solves a contemporary issue that involves enhancing the quality of investors’ decision making through providing informative content. The main argument presented by the author is that IFRS net income is more effective in producing informative content in comparison to Comprehensive income. The strength of the methodology is the sample selection and statistical methods used in data analysis. The main weakness is the focus on the financial aspect, yet many other factors determine a firm’s success.

Conclusion

In conclusion, the paper aimed to critically analyze the article based on its main arguments, strengths, and weaknesses of the methodologies implemented

References

Bataineh, A., and Rababah, A., 2016. Comprehensive Income and Net Income, which is more powerful in predicting Future Performance. International Journal of Academic Research in Accounting, Finance and Management Sciences, 6(2), pp.114-120.

Ferreira, M., 2019. Tesla And The Electric Vehicle Market In 2018 (Doctoral Dissertation).

Mironiuc, M., Carp, M. and Chersan, I.C., 2015. The Relevance Of Financial Reporting On The Performance Of Quoted Romanian Companies In The Context Of Adopting The IFRS. Procedia Economics and Finance, 20, pp.404-413.

Parent, M.C., Kalenkoski, C.M., and Cardella, E., 2018. Risky Business: Precarious Manhood And Investment Portfolio Decisions. Psychology of Men & Masculinity, 19(2), p.195.

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Question

Article Critique

Article

The Relevance Of Financial Reporting On The Performance Of Quoted Romanian Companies In The Context Of Adopting The IFRS
The Relevance of Financial Reporting

Assessment Criteria

You must submit a copy of your chosen article with this The chosen article must be written in English
Your coursework should be between 1000 and 1150 words
Your coursework must be clearly presented with an introduction, structured headings and sections and a fully referenced bibliography (10°/o)
You should clearly identify the article you have chosen to review, give the reasons for selecting the article and provide details of the subject area that is being examined (10°/o)
You should briefly discuss the methodology adopted by the author(s) of the article and highlight any strengths/limitations in their approach (10°/o)
You should critically analyse and evaluate the main arguments put forward in the article, considering the evidence provided and the article’s direct relevance to corporate governance, corporate social reporting or business ethics (50°/o)
You should provide a clear conclusion and summary of the key points you have discussed, together with any limitations in the approach you have adopted (10°/o)
You should provide a self-evaluation essay as outlined above, clearly related to your work on this module (10°/o)