The financial information used for internal purposes should be in a format that facilitates effective management of the entity. On the other hand, financial information prepared for external users is typically laid out in accordance with applicable accounting standards.
Different types of financial reporting
External financial reporting requirements
The Corporations Act 2001 (Cth) (the Act) sets out the financial reporting requirements for entities in Australia.
The form of the financial records will vary between companies. However, there is a set of basic financial records that should be kept, including financial statements (profit and loss, balance sheet, cash flow, taxation return, depreciation schedules), general ledgers, cash records, wages and superannuation records, and more.
All companies must keep financial records that correctly record and explain the transactions, financial performance and positions of the company, and enable ‘true and fair’ financial statements to be prepared.
While all companies must keep appropriate and adequate financial records, only some need to produce yearly financial reports. Financial reports – and directors’ reports – are documents which need to be prepared by entities incorporated or formed in Australia, all public companies, large proprietary companies, and registered schemes.
The information to be included in statutory financial reports must be prepared and presented in accordance with the Australian Accounting Standards, as required by the Act. These reports are for a range of external users, including present and potential shareholders, investors, employees, lenders, suppliers and other creditors, customers, competitors, government agencies and the public. The objective of these general-purpose reports is to provide information about the organisation’s ‘financial story’ of the previous year.
Accounting disclosures can also provide a more detailed analysis of components of financial statements – the nature and extent of additional information provided in accounting disclosures are mandated in the Australian Accounting Standards. These are an essential element of a financial report.
Listed companies must make additional disclosures in their financial report and comply with the ASX Listing Rules. Companies may choose to also prepare other reports for external users voluntarily, like ESG (environmental, social and governance) criteria reports. The content and presentation of these reports are not mandated by the Act. These reports should present information that is consistent with the organisation’s operations and business strategy.
In most organisations, quarterly or monthly financial accounts are prepared by management. These reports are primarily used for decision making by management, as they explain how an organisation is performing over time and can be used to determine if corrective action is required.
In order to fully comprehend the critical information provided in the reports presented to the board, directors need to understand the processes used to prepare them. The board must consider if the information presented in board reports provide appropriate measures of performance for board oversight of its organisation’s activities. If unsure whether all the relevant information is provided in these reports, directors should request additional information from management.
The results of an organisation’s performance may differ between the management reports and the statutory financial statements. In these instances, it is crucial that directors understand the reason for this difference and are provided an explanation for how the difference is reconciled.
Deciding whether to join a board
Director due diligence is an important process for prospective directors who have been invited to join a board. A prospective director receives a number of documents, including the company’s constitution and most recent annual financial report, and from this information must make an informed decision to accept or decline the offer.
As explored above, these documents provide information pertaining to an organisation’s performance and operational and financial risk over the two years prior. A prospective director must be able to comprehend the language of these reports and understand the organisation’s position, to understand the potential risks involved in joining the board.
A prospective director must have the ‘financial literacy’ to effectively oversee an organisation’s income and expenses, its assets, to implement finance governance practices that are appropriate for the business, and to determine whether it is capable of paying its bills when they fall due. In other words, a director is expected to have the skills and the knowledge commensurate with the operational and financial risks of the organisation.
Depending on the sector and the operations of an organisation, a director will need a different set of skills to execute their responsibilities effectively. For example, a director of a not-for-profit or of an organisation that operates internationally, will require different knowledge to aptly navigate the difficulties faced by those organisations.
A director should be sufficiently financially literate to meet their legislative responsibilities, to understand their organisation’s operations and financial information needs, and to see when a financial expert should be consulted. At the least, a clear understanding of the profit statement, cash flow statement and going concern is an indispensable skill for a director.
Reporting responsibilities of directors
Not every director on a board is expected to be a financial expert, although each board should have at least one director or advisor who is. These experts should be able to identify and recommend appropriate accounting treatments and accounting frameworks used in a financial report. But financially literate directors should understand when that expertise is required and why particular choices are made. Directors must have confidence that the ‘story’ told by the company’s financial statements is true to their understanding of the company’s operations and position.
Financial literacy is just one aspect of the duties of a company director. However, this skill is vital to directors being capable of meeting their statutory obligations to avoid insolvent trading by ensuring the company can pay its debts. Under the Act, no director can delegate their responsibility to approving and signing off on their company’s statutory financial reports.
To satisfy the statutory reporting requirements under the Act, a directors’ report and a directors’ declaration must be submitted along with the corresponding financial report.
The content requirements of the directors’ report differs depending on the type of an entity, but they might include details such as:
The names of each director and the period for which they were a director;
A review of operations;
Principal activities and any significant changes; and
Dividends paid during the year, plus those not yet paid.
The content of a directors’ report generally follow the order of disclosures required by legislation. The extent of information that to be included increases in accordance with the public accountability of the organisation – a listed company, therefore, has the most extensive disclosures.
These are documents which require a director to declare the viability of the organisation and the accuracy of the accompanying reports. Directors must sign to:
Whether, in the directors’ opinion, there are reasonable grounds to believe that the company will be able to pay its debts as when they become due and payable;
Whether the financial statements and notes are in accordance with the Act; and
Whether the company has included in the notes an explicit and unreserved statement of compliance with international financial reporting standards (if applicable).
This document must be made in accordance with a resolution of all the directors, and signed by just one of the directors of the board.
For more information
We have a wealth of resources to assist you in developing your knowledge of financial reporting:
Financial Fundamentals for Directors, authored by S. Dianne Azoor Hughes, aims to help directors better understand financial reports and improve their financial literacy. It can be purchased in e-book or in print from our online Bookstore.
We also have a range of courses designed to increase the foundational knowledge and the advanced financial skills used by directors in the governance of their organisation:
We have a Director Tool for download to help boards of directors on Financial Reporting Requirements. This document provides important practical information and prompts to help directors to understand and assess their statutory responsibilities in financial reporting.
We often hold interactive webinars on pertinent issues of finance governance. Check our list of upcoming webinars to learn more about director concerns related to the role of the board and financial reporting.