According to Statement of Financial Accounting Concepts (SFAC), the primary objective of financial reporting is to communicate financial information about a business entity to its external users such as present and potential investors and creditors. Financial reporting also provides information to help the users assess the amount, timing and uncertainty of future cash flows. Another objective is to present information about an entity’s economic resources and changes in the resources resulting from financial effects of the business transactions and events, etc. Due to the existence of information asymmetry, external users know less about the entity and its operations than management. They need to rely on information that the management provides to make rational business and economic decisions. Financial reporting assists external users, particularly investors and creditors, with deciding expectations about the entity’s future performance and identifying the entity’s financial strengths and weaknesses. When they are confident in its ability to generate favorable cash flows, from which they will obtain interests and benefits, they will provide resources such as investment and loan funds for entity’s development.
The objectives of financial reporting do not address specific solutions for the Polluter Case, but they do provide some guidance. Purchase and sale of emission allowances for Polluter Corporation can possibly be classified as investing activities (as intangible assets) or operating activities (as inventory) in the statement of cash flows. SFAC defined that financial reporting is to provide information that is useful in making decisions and the information should be reliable and faithfully represented to depict the entity’s financial condition. Therefore, I think as long as it is applied consistently and adequately disclosed by the management to guarantee the