decision usefulness

decision usefulness

Supports making economic decisions by investors and lenders about buying, selling, or holding equity and debt instruments e.g. a loan.

When making decisions, what do we need? Pretend you are an investor in Diageo plc:

May partly depend on my needs, but I would want to know about financial performance (income statement). What do I get told in Diageo plc? I get told about the year past. But in making economic decisions, the more information about the future I have is better!
Qualitative characteristics of accounting information – would need the information in Diageo to be relevant to my decision making needs.
So the past is a guide to the future but is it enough? Could I get my hands on some forecasts?
No – although forecasts and budgets are used within the organisation for management planning and control, they do not feature in published financial statements. Why not? Directors/managers would see this as ‘risky’ as forecasts may not turn out to be what actually happens.

So, to what extent do we have information about the future in sets of published financial statements, like Diageo plc?
you need to look through the accounts. could look at the narrative reports – chairman’s report. chief executive officer’s report, business review section. see what you can find!
look in the financial performance, income statement and disclosure notes. you should be able to see information about ‘discontinued operations’ so that won’t happen again . there could also be information about ‘acquisitions’ in the year, so that is new and that will affect profits in the future. have a look in the income statement to see about discontinued operations effect.
chairman’s statement – talks about next decade but in very general terms; but also highlights changing the shape of the organisation – what does this mean for diageo?
chief exec statement – paul walsh. some discussion about acquisitions which gives us some information about what is new in the future.

stewardship
this is the ‘traditional’ view of the purpose of financial reporting. relates to the divorce of ownership and control between shareholders and the managers/directors.
easy! reports on what has happened – what profits have been made. what assets are held, what liabilities exist. cash flows over past year.
all in historic terms – and so the use of historic cost accounting has not been replaced despite a lot of discussion about using more current values for measurement. remember the story of laurel and hardy in your measurement seminar.
when you are looking at part (a) of the requirement you need to start with stewardship to say what supports this in the accounts of diageo. you will be spoilt for choice (remember the word limit!). you can look at the primary statements – income statement (for the past year); balance sheet (as at one date already gone); cash flows (past year). look at disclosure notes which back up the information in the primary statements – do they add any more (look for any clues here about the future)
for example, you could say unders stewardhip that the income statement gives investors the information about how well the directors/managers used the money to produce profits in the past year. but how does it support decision usefulness? you could say there is information about discontinued operations which also goes down to eps line. you could refer to the narrative reports as part of the story – in the chairman and ceo’s statements on pages 8 – 11.

measurement
important issue here – if we want information about the future for decision usefulness, could we argue that current values are more relevant than historic cost which is still the most common measurement basis? this helps with you evaluation. what is more ‘fit for purpose’ when looking at stewardship compared to decision usefulness?

part b
pick two areas of the balance sheet and/or income statement (but only two items in total!). for example, you could look at intangible assets in balance sheet. then identify the accounting standard ias 38.
then look at disclosure note 11 to see the breakdown provided.
factual – so what could be an approach to give a critical evaluation of the usefulness of the information for investors/lenders?
ias 38 will say what an intangible asset is (based on the cf definitions of assets), will talk about recognition (when can i put this in my balance sheet) and it will talk about measurement.
when i can put this in my balance sheet is an interesting area to discuss. situation with brands is that the acc standard basically says that acquired brands are fine to include (as they are purchased) but internally generated brands cannot be. they are not ‘homogeneous’, nor traded in an active market to find a value for measurement. but what impact does this have on comparability when one company has internally generated brands names (wilma’s ‘munchy bar’) and another, like diageo, which has acquired them. their roce and gearing ratios (just for starters) will be quite different, but they could be generating very similar levels of profit.
or, still with intangibles, you could think about human resource accounting! think about a consultancy company – their biggest asset is the staff! are they on the balance sheet?? no

you may want to look at your evaluation by using the qualitative characteristics of financial information: relevant and faithful representation; then the enancing ones – esp comparability and understandabilty

part c
please use a report format and not an essay format!
structure is important – headings and sub-headings. you may wish to number your paragraphs.
start with:

heading – report on usefulness of financial information in diageo plc published financial statements
to: wwt and jed
from: you
date:
part a – heading
information regarding stewardship objective
support for decision usefulness objective
information about the future

part b – heading

sub headings for each of the two items you select

 
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