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(JPMNT) Journal of Process – New , International Vol. 5, No 2, 2017. AND FINANCIAL REPORTS IN THE FUNCTION OF

Jugoslav Ani čić,1 Dušan Ani čić,2 Aleksandar Majstorovi ć,3 1, “Union-Nikola Tesla University”, Faculty of Entrepreneurial , Serbia 2DSN Consalting, Belgrade, Serbia 3 “Union-Nikola Tesla University”, Faculty for Real Estate Management, Belgrade, Serbia [email protected] ; [email protected] ; [email protected]

Professional Paper doi:10.5937/jouproman5-13302

Abstract: development is made according to the accounting highly dependent upon accounting data reliability standards accepted in most developed and financial report quality because the decide more easily on investments in the market countries. The need for international which had earned trust and safety in the previous standard acceptance has its practical period. Big financial scandals from the beginning dimension because they equalise the of the 21st century and still actual financial crisis at accounting practices around the world, the global level have especially contributed to that. simplify stock exchange business outside The information prepared on the basis of high quality, transparent and comparable international the national borders and enable national standards considerably reduce investment risks as and international market growth, as well as well as the of raising capital. On the other the complete economy. hand, the management of a large number of companies is focused on the creation of -term True and honest financial reporting personal benefits as opposed to the investors represent a first class public so the primarily interested in company survival and principle of the objective reporting should growth, that is, -term goals. Information be the leading principle for the financial asymmetry is often present in the financial markets, reports creators. Blurring and feigning of and its damaging , as a rule, are borne by shareholders and other stakeholders of the the results leads to the decisions of the company. Corporate governance depends on legal, investors, which are not in the function of regulative and institutional environment, and it efficient capital allocation, and we can see should balance the of the shareholders, that in a number of financial in capital owners, managers as well as company large and powerful companies in the business managers. developed countries. The consequences of Key words: accounting, financial reporting, the false representation of successful corporate governance results are the failure of the seemly Introduction successful companies overnight, where the Financial reports represent the basic burden of the great losses is first suffered ways for companies to report on the by shareholders, and then other investors success of their business and financial and as well, and the side effect is the spread of property conditions for external interested distrust in functioning. parties. The companies that want to invest On the other hand, the existence of the in other countries or collect funds in the information asymmetry is a regular international have to catalyst of the market inefficiency and compile financial reports understandable instability of the complete financial for business partners and investors. system. Therefore, the financial reports have to be

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Corporate governance is one of the users. However, the financial reports do key elements in economic efficiency and not offer all the information the users growth improvement, as well as might need to make economic decisions, trust increase. Corporate governance offers because they largely reflect financial the structure with company goals set and effects of the previous events, and they do allocate the resources to achieve the goals not necessarily contain non-financial and performance monitoring. Adequate information; business management should provide the • To show the results of the appropriate encouragement for the board management work, that is, their of directors and management to focus on responsibility for the available resources the goals of interest for the company itself entrusted to them. The users of the as well as its shareholders. The existence information who want to evaluate the work of the appropriate system of corporate or responsibility of the management do governance, within individual companies that in order to be able to make important and the economy as a whole, helps in economic decisions, the trust to the providing a certain level of trust necessary existing management among other things. for the market economy to function in the appropriate way. In order to achieve the above mentioned goals, the information about The importance of accounting and property, liabilities, capital, flow, financial reporting in a market economy income and are contained in the Investors need transparent and financial reports of companies.These reliable information that accurately reflects information, with other data cited in the the financial situation of a company in notes of the financial reports, help the order to enable the smooth functioning of users to understand the company's the market and efficient capital allocation. business in the previous period and predict In the world that is becoming more the future flow of the company's results, globalised, the investors seek opportunities especially the . to compare the companies in important Accounting is the means through parameters in order to make rational which we measure and describe the results business decisions about investments. of the economic activity. It is the way in Accounting is becoming more globalised which the business people define the as the companies are becoming more business goals, measure the achieved multinational, and the scope of and results and assess the future performance. investments between the companies The basic purpose of accounting is to increases all the time. These factors provide the information for the decision reinforce the need for financial reports makers useful for making the vital which will be internationally comparable economic decisions. Therefore, we can and consistent. rightfully say that the economic activity in According to the Committee for the terms of business transactions appears as international frame, the input in the process of accounting, and the point of all financial reports is: the output or is the useful • To present the information on the information (Martac, S. 1998, International financial , business and changes in financial reports – similarities and the financial position of the entity. The differences, XXIX Symposium of the financial reports prepared for these Association of and Auditors purposes satisfy the usual needs of most of Serbia, Zlatibor, Proceedings).

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The primary goal of accounting services and capital. (Lekovi ć, M., consists of providing complete Arsenovi ć, S., (2013). The role and understanding of the nature of the importance of good-quality information, as well as to reporting, Banking, no 4, pp 79-93). nurture the ability to use the information efficiently. It serves as a buckle that Business entities gained access to a directly connects the decision makers with large number of markets around the world the economic activities – and thus, and opportunities to make a geographical indirectly, with the results of such selection at raw material and decisions. The efficient usage of the their own product placement, whereby accounting information assumes the they often decide to do that outside their complete understanding of the nature of own countries. These modern terms of the economic activities included in the doing business offer a whole spectre of financial reports, the understanding of new development and advancement assumptions and measuring techniques opportunities for business entities. used in the accounting process, as well as However, it includes widening the circle of understanding the ways of linking the stakeholders who are trying to gain insight current accounting information with future into the way of doing business within the business decision making. company and its performances. The possession of the relevant information on The purpose of financial reporting is, the efficiency of the use of capital in the primarily, the creation of information company in the previous period, as well as useful for making decisions of financial business potential to be used in the future, nature. Thereby, the decisions of the is of crucial importance for investors when investors, and other external they choose the way for the placement of stakeholders of the company are primarily their funds. taken into (Stefanovi ć, 1995). They have different information needs The investors’ interests are in depending upon the nature of the decisions collision with the differences in the way of made on the basis of the acquired formatting accounting information which information. It is in the investors’ interest makes them one of the key driving forces to make a portfolio which consists of such of change in the system of financial investments that direct the capital towards reporting, demanding its harmonisation. the areas of its most profitable usage. Thanks to the standardised and good- quality financial reporting, information Providing high quality of the asymmetry and negative selection are financial reports, apart from respecting reduced, which offers more security to professional and legal , also investors. This is the way to encourage means respecting ethical norms, that is, investment and greater capital mobility, ethical behaviour of the financial report and the result is also more efficient creators. It is especially important to functioning of the capital market, which harmonise the accounting and auditory represents an important determinant in the practice which facilitates accounting and development of every country. financial among business entities around the world, enabling a To provide a fair and good-quality method to span the accounting obstacles financial reporting implies respecting not that stand in the way of achieving a greater only legal, but also ethical norms. degree of freedom in the flow of goods,

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Professional and legal regulation management, with the specific rights and represent the minimum standards of responsibilities (Vidakovi ć, 2009). The behaviour for professional accountants and role of the accounting itself in all the people taking part in compiling the OECD principles is providing all the financial reports, and the ethics relevant accounting information in order to supplements that (Malini ć, 2011). Blurring protect the equality between domestic and and feigning of the results leads to the foreign shareholders, especially between investors’ decisions which are not in the majority and minority shareholders. The function of efficient capital allocation. accounting profession, apart from its basic True and honest financial reporting role of the stakeholder interest protection, represent a first class public interest should offer information for the basic (Stevanovi ć, 2011), and therefore the functioning of the management, and they principle of objective reporting should be are: corporate governance strategy and the leading principle of the financial report revision, risk assessment, creators. and adoption, company success The financial information prepared control, capital investment control, according to the accounting principles can acquisition control and company sale significantly deviate from the ones based control. on the concept of the economy. That is to The more developed the economy, say, the basic objection to the accounting the greater the importance given to a good- is that it does not take opportunity costs quality financial reporting. Market into account. This is the reason for economy development goes hand in hand correcting the accounting data for the with the pace of the accounting profession investment decision needs, in order to have development and the quality of the a more realistic picture about the financial reporting. This is the reason for efficiency of a certain investment. Some of investors to opt, as a rule, for the markets the characteristic examples include the they know and trust. The investors have differences in the structure of the larger confidence in those countries that economic and accounting gain, economic have already adopted and applied the value added, market value added, etc. international standards for financial (Malini ć, Savi ć, 2011). The above reporting. Providing information on the mentioned economic terms often involve basis of the standards that is of good- the use of dynamic methods and future quality, transparent and comparable gain prediction in decision making. At the largely reduces the investment risk and same time, it causes accounting raising. limitations, and that is being static and not respecting the time value of . The negative effects of the The basic goals of the Principles of information asymmetry in modern corporate governance (Jonston, 2004) are markets reflected in: economic efficiency improvement, business entity and The arguments about the role of the economic growth on one hand, as well as companies in the society are very often. confidence strengthening and financial They are about whether the companies market development on the other. In the should have the exclusive goal to context of the Principles of corporate maximise the value for the shareholders or governance, the accounting profession try to satisfy the interests of all the stakeholders, which are often conflicted. activities are treated as an integral part of

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The shareholders' is based on assessed on the basis of total income, share their primacy, while the stakeholders' in the market or the ratio of prices and net theory claims that the others should also be per share, but on the basis of taken into account. According to the first intellectual capital such as branding, client theory, the duty of the management is to loyalty, organisational culture, etc. It is maximise the return on , while pointed out that the traditional indicators according to the other theory the duty of used in the assessment of non-material the manager is to balance the shareholders' property is outdated and there is an financial interests and the interests of other increasing need for the creation of a new stakeholders, such as the employees, system of assessing non-material clients and local community, even at the investment. Also, important attention is of the reduction in for paid to the problems of inadequate shareholders. (Kothari, J., Barone, E. disclosure and presentation of a non- (2012). Financial accounting, the material property according to the international approach, DATA STATUS, accounting standards, rules and guidelines Belgrade). set by the International accounting The company management has all standards, and business entities have an the information created within the obligation to apply them in the course of organisation at their disposal. The non-material property recognition and decisions of the management are mostly validation. based upon the information originating An important obstacle to the from the accounting system. However, productive use of capital, which enables most of the information available is also hiding the true performances of the delivered to stakeholders outside the company is the information asymmetry. company. There is a logical question of the The information asymmetry makes it kind of safety the users outside the feasible to feign the company’s results and company have about whether the financial that causes sending the wrong signals to reports presented by the management offer the investment public. In these conditions, complete and reliable picture of the seemingly successful companies collapse business results and company's financial overnight, where the burden of great losses position. For the most part, this safety is is taken the shareholders before everyone provided through the auditing of financial else, and then the other investors as well, statements by an independent auditing with the side effect of spreading distrust in company. financial market functioning. The In the modern economy, the sources existence of the information asymmetry is of the competitive advantages are based on a regular catalyst of the market non-material resources, such as workforce inefficiency and instability of the complete skills, reputation, leadership, innovation, financial system. We speak of the etc. The nature of the resources themselves information asymmetry when there is a means that there is a little probability that different level of awareness of the two their value will be revealed in the current sides in an economic transaction. The framework of the financial reporting. asymmetry always goes into the same direction – the seller knows more than the The characteristic of the modern buyer (Ritter et al, 2004). environment is company knowledge in the area of high information , car and pharmaceutical industry. Nowadays, the worth of the company is not only

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The best example is the information price restriction, export reduction, asymmetry between the emitter company ecological standards and other factors on one hand, and the current and potential defining the existing and future position of investors on the other. the company. The additional reason for The information available to the non-disclosure of information is a narrow group of investors put small and possibility of losing the competitive ability unsophisticated investors into the inferior of the company, that is, additional risk position, causing them to suffer a exposure (Bazley et al, 1999). significant damage. It is the reason for the The utility of financial reporting laws which regulate the circulation of should not be appreciated only in relation securities to prohibit the use of the so to the individual users, but also from a called privileged information. The above wider economic perspective, that is, a mentioned privileged information on the social point of view. In terms of the company's business represents a trade financial reporting, apart from other secret, and as such it is not available to the relevant factors, this must be in the focus public. However, their abuse in the capital of the primary goals, to bear in mind the market shows a character of the of higher level of general social information asymmetry, and points to prosperity as the main strategic goal of inadequate legal protection of the investors every society. In other words, it is (Malini ć, Savi ć, 2011). In these conditions, reasonably considered that the quality of the demand for financial information the financial reporting in a country is decreases due to the loss of confidence of directly proportional to the general the investors. economic prosperity of the country When it comes to the incomplete (Milojević, D., (2006). Financial information as a result of the agency reporting, BBA, Belgrade, FTB Belgrade). relations, four following axioms show what happens if the financial reports „do In theory, the shareholders control the not show the whole picture“ (Paul, 2002): company’s business, but in practice, the situation is somewhat different in • incomplete information increase shareholders’ companies. The shareholders uncertainty; only choose and establish the • incompletness creates risk; management, and the managers lead the company’s business. The managers are, in • the risk causes the investors to ask fact, the agents who should do business for a higher yield rate; in the shareholders’ interest, while they are the principals here. The managers often • it further increases the cost of work for their own interests in practice, at capital and decreases the cost of shares. the expense of shareholders and other stakeholders. In practice, the managers The financial reports do not include who continuously make harmful decisions numerous financial, ecological and legal to stakeholders suffer strict sanctions. The aspects of the environment, then the trends companies where the share price and changes that should be considered for represents underestimated value due to the needs of the company's perspective underutilised resources become easy assessment, that is, the chances and targets for the investors interested in the dangers that result from the environment purchase of such companies. where the company exists. The examples include the potential market for products,

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A large number of managers are and factor market. (OECD Principles of focused on creating short-term benefits for Corporate Governance, 2004). themselves, while the investors are primarily interested in the company The corporate governance survival and development, that is, long- framework depends on the legal, term objectives. Successful companies are regulatory and institutional environment. the ones that where the interests of This framework should provide that all the shareholders as capital owners, and the tangible issues about the company are managers as business enterprise managers timely and accurately disclosed, including are in balance. (Žarki ć, J., Benkovi ć, S., the financial situation, business Milosavljevi ć, M., (2013). Financial performances, ownership structure and management, FOS, Belgrade). company management. Furthermore, the factors such as and corporate awareness about the interests of Business reporting and corporate the communities where the company does governance business connected to the social and life Corporate governance is one of the environment can also influence the key elements in economic efficiency and reputation of the company and its long- increase improvement, as well as investor term success. trust increase. Corporate governance Corporate governance refers to a includes a set of relations between the series of rules that a company implements company management, its board of in its business. These rules represent the directors, its shareholders and other guidelines that the managers follow in stakeholders. Corporate governance also achieving various goals of the company, offers the structure where the goals of the including share price maximisation. It is company are set and resources allocated important for the company to clearly for the achievement of the goals and define the structure of its corporate performance monitoring. The adequate governance so that the individuals and business management should provide the entities interested in the prosperity of the appropriate incentive for the board of company can realise the manners in which directors and the management to focus on their interests will be respected. As a result the goals in the best interest of the of Sarbanas-Oxley Act in 2002 and company and its shareholders. The increased pressure of the shareholders, existence of the appropriate system of most of the companies in the USA corporate governance within the individual carefully write out their corporate companies and the economy as a whole, governance policies in order to enable all helps to provide a certain level of stakeholders to realise their rights and confidence necessary for the market obligations in a better way (Besley, S., economy to function in the appropriate Brigham, E., (2015). Business , way. As a result, is reduced, DATA STATUS, Belgrade). and the companies are encouraged to use the resources more efficiently, which lays The studies show that the companies with the foundations of the development. the practice of good corporate governance Corporate governance is only a part of the achieve higher returns for shareholders. larger economic context in which the companies do business, and it includes, for example, macroeconomic policies and a certain level of competition in the product

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They also show that the companies imperfections in corporate management developing the structures of corporate practices. governance make the identifying and Stock exchange and regulatory correcting of the accounting problems bodies across the world tend to set the easier, and they show better performances standards or codices of the best corporate than the companies with weak corporate management practice. The investors governance policies (). started to check the corporate governance According to Vidakovi ć (2007), the goals practice more systematically as a of corporate governance are shareholder component of the decision making process protection, financial and capital market in the companies. The argument on stabilisation and development, and stable corporate governance is increasingly development of the economy. In the taking place outside the limits of the countries of the developed market shareholders of the company and it economy, three systems of corporate involves other stakeholders such as governance are differentiated (Lovre, creditors, buyers, environment and local 2014): community experts. Bad practice of * One-tier corporate governance corporate governance is closely connected system, which is the characteristic of the to bad financial reporting and corporate Anglo-Saxon countries (USA, UK, data disclosure. The basis of any corporate Canada). governance structure is disclosure of * Two-tier corporate governance reliable and authentic financial system, characteristic of and information. Transparency is the basis of Japan. the public confidence in the corporate system, and the funding will pour into the *Mixed model of corporate centres of economic activities that governance where the characteristics of encourage confidence. (Kothari, J., both models are present, accepted in the Barone, E., (2012). Financial accounting – countries in transition the international approach, The awareness about corporate DATASTATUS, Belgrade, pp 326-327). governance and its role in the global There are a number of cases of the economy increases constantly and steadily companies that failed, even went bankrupt, in the recent years. In the developed due to the weaknesses in financial economies, where active markets for management and corporate data corporate control and diversified disclosure: on a world scale, there are ownership structure makes it more difficult famous cases of , WorldCom, Global for the shareholders to monitor the crossing, Tyco, Xerox, Parmalat, Adecco, management, questions about management Vivedni, etc. It had a cumulative negative are asked more often, and the practices of effect on the formation of the expert company management are regularly and opinion on financial reporting. There is a closely monitored by the general public. great concern in terms of market economy Corporate failures of some prominent functioning where the shareholders, companies in the USA and Europe result employees and retired people lost large in increasing attention paid to corporate sums of money, while the ones running the governance as an independent risk factor companies and held responsible for the in the developed markets. Also, in the losses still made money despite the failure markets of the developing countries, of the company. financial crisis discovered great

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In some of the cases, and by the shareholders and investors. The deception spread even to the auditors, legal result of all that is widespread of general advisors and . Financial distrust in the functioning of the financial reports have always been one of the main markets and it is reflected through methods of the company to offer economic activity reduction. information to its shareholders and The usefulness of the financial potential investors. The result of the reporting should be appreciated not only in decreasing interest for financial relation to the individual users, but also information and corporate data disclosure from a wider economic perspective, that is, is sometimes the withdrawal of the social point of view. Financial reporting, investors, which then results in higher apart from a series of other relevant capital costs. That is why the productivity factors, should have the provision of as of the company decreases and threatens to high level of general social prosperity as endanger the smooth functioning of the possible in the focus of its primary goals. market economy. The investors’ interests are in collision Reporting on financial and other with the differences in the methods of corporate information is an interactive accounting information formatting, and process, and it includes constant that is why they become one of the key communication and contact between a drivers of change in the financial reporting number of participants. The process flow system, demanding its harmonisation. begins with corporate management, and Thanks to the standardised and good- ends with the investors and stakeholders, quality financial reports, the information who are the information users. Along the asymmetry and negative selection are course of the process, there are some of the reduced, and it offers more security to the bodies setting up the rules and standards, investors. This is the way to encourage regulatory authorities applying them, legal investments and better capital mobility, and other advisors in the process. The and the result is also a more efficient development of information technologies functioning of the capital market, which provides access to financial information represents an important determinant of the and its use for the investors. in every country. Conclusion The appropriate system of corporate governance in the economy as a whole can The skepticism of external users provide a certain level of trust necessary concerning truthfulness and objectivity of for the market economy to function in the the financial reports, that is, fair and appropriate way. As a result, capital cost is honest representation of the company reduced, and the companies are performances is understandable, bearing in encouraged to use the resources more mind a large number of manipulations, efficiently and to focus on the goals in the fraud and accounting tricks with the aim of interest of the company and its covering up the real position of the shareholders, which lays the foundations company and showing its more favourable of the development of society. The . Managers and accountants reporting on financial and other corporate use in order to get to information is an interactive process, and it new more easily, attract new involves constant communication and investors, achieve higher bonuses and contacts between many participants. compensations, etc. The brunt of the financial manipulations, which ultimately often lead to the company failure, is borne

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