(a) The above article highlights economic and social consequences of the introduction of IFRS 17. Argue whether accounting standards setters should consider economic and social consequences of accounting regulation. When formulating your answer discuss the pros and cons of accounting standard setters considering economic and social consequences that may be associated with the adoption of their standards.
(b) What qualitative characteristics of general purpose financial reporting are the new IFRS 17 upholding? Explain how IFRS 17 is promoting those qualitative characteristics.
(c) If a reporting entity has a choice of either expensing or capitalising an item of expenditure, and if the entity is subject to a high degree of political scrutiny, then what choice would be predicted by the political cost hypothesis of Positive Accounting Theory (PAT)? Explain your answer.
(d) If senior managers within a company were rewarded by way of accounting-based bonus plans, then would they prefer the use of conservative accounting methods? Explain you answer.
(e) Organisations typically have a number of contractual arrangements with debt holders, with many covenants written to incorporate accounting numbers. Explain using the debt hypothesis of PAT why an organisation would agree to enter into such agreements with debt holders.
Should Accounting Standard Setters Consider Economic and Social Consequences?
Accounting standards are one of the most important aspects of the functioning of any business corporations. Each and every business organisation perform their functions to the best of their abilities. The financial department of each and every business organisation along with the audit committees of the companies take proper care in the implementation and the application of the various kinds of accounting standards for the smooth preparation of the different kinds of financial statements which are prepared by them. In this context, all these business corporations need to take into account the different kinds of financial and various other accounting standards as advocated by accounting standard setters like the AASB. All of these standards of accounting have certain degree of implications on the functioning of the company and on the overall economy of the particular economy (PwC, 2018). These implications are majorly of two types, which are the social and the economic implications. In this paragraph, an argumentative view has been discussed in the context of whether the standard setters around the world, must take into account the various kinds of social as well as economic implications, while performing the task of setting the different kinds of accounting standards. The various kinds of pros and cons of taking into account the social and economic implications of standard setting has been provided below:
- There are many kinds of principles which needs to be adhered to by the standard setters while preparing the different kinds of accounting standards. The two most important principles are principle of objectivity and neutrality, where by the standards must be clearly prepared, keeping in mind, the ultimate objective of providing a good standard which helps in providing a proper transparent statement. Each of these standards have some kind of social; and economic impacts in the context of its implementation, which needs to be kept in mind, otherwise, the creation and implementation exercise of the entire standard would be futile (Pinnuck, 2012). For instance, if the standard setters do not properly frame the standards, taking into account the various kinds of economic impact of the depreciation accounting or topics such as inflation, it could lead to serious kinds of economic implications from the users of the financial statements. Thus, taking note of these implications can lead to better understanding of these standards as a result of which they are also duly followed.
- One of the most distressing disadvantages of not taking into account such kinds of economic and social implications, while making such standards is the economic slowdown of the country. If the standard setters do not take into account the social and economic impact of their standards, they would not be followed properly by the corporates. As a result of which the different stakeholders of the companies would not be able to take independent and logical decisions, which could result in taking wrong decision which would eventually cripple the entire economy.
Thus it becomes necessary to take into account the different kinds of social and economic impacts, while preparing such standards. It would lead to its smooth implementation and effective application.
- b) The new characteristics of general purpose financial reporting which are advocated by the new accounting rules of IFRS 17 (insurance contracts) are as follows:
- Principle of transparency across the reporting chain.
- Principle of consistency has been ensured across finance organisations.
- Principle of relevance and faithful representation has also been vouched for in this new insurance standards.
- Principle of efficient comparability, variability and timeliness and understand ability are some of the principles, which must be followed.
As per the new insurance contract rules as mentioned in the new IFRS 17, the accounting standard setters have ensured that all the principles and features are mandatorily followed and implemented. The setters have ensured that the companies and all the corporations world-wide use a vast and a comprehensive spectrum of data from the current as well as the historical data, for example various kinds of policy and premium data to produce risk adjustments (Kosi and Reither., 2014). This ensures a robust implementation of the transparency process. The setters have also ensured that consistency feature is followed between the financial results and the management information. The new provisions of the standard also full fills all the principles and features of variability, comparability and utmost accuracy by ensuring a central management of all the provision along with the provisions of flexibility and long term sustainability. As a result of which, the corporates are able to implement all these by way of ensuring more transparent contracts in terms of insurance plans.
- According to the studies of Watts and Zimmerman about ‘Positive accounting theory’, the political cost hypothesisforecasts that large firms rather than small firms are more likely to use accountingadoptions that reduce reported profits. Size is deemed to be a proxy variable forpolitical attention in this context, which actually refers to the fact, which is, the larger the corporate entity the more likely it is assumed tobe subject to political scrutiny. If we assume that an entity is subject to a high degree of political scrutiny, and if weassume that high profits will attract unwanted political attention, the entity wouldfind it beneficial to spend that item of expenditure rather than capitalising it.
Qualitative Characteristics of Financial Reporting Upheld by IFRS 17
It is more likely for large corporations and companies rather than the normally small companies to use the different kinds of accounting options which are aimed at reducing reporting profits. Size is considered to be a substitution for political concern - that is, the larger the organization, it is consideredmore likely to be subject to increased amount of political scrutiny. This has been the common observation in this regard. Assuming that any business entity is subjected to a high degree of political scrutiny, as it is assumed that high profits could cause needless political attention, the entity would require spending a spending item ratherthan using it for capitalisation purposes.
- One of the most important characteristics of the conservative method of accounting is the delay in the recognition and type identification of the revenue. It tends to decrease the value of the asset and increase the value of the expense and the liabilities involved. For this scenario, an example would be appropriate, for example, if the assets of any company are measured at the lower amount of their costs or their actual recoverable value, then in that case, any increase in the fair value would not be recognised, whereas, if there is a decrease in the fair value of the asset, it would lead to the recognition of the decrease in the value (PwC, 2018). Thus, it can be seen that the use of fair value technique, gives he managers an upper hand, in dealing with their remuneration practices. This is not possible in the case of the conservative accounting practices. In this case, the usage of the conservative accounting practices would ultimately reduce the opportunistic tendencies of the managers and would debarred them from exerting any kind of influence in the fixation programmes of their salaries, remunerations and bonuses. So in the case, where the managers would be paid their remuneration on the basis of the accounts based practices, they would not be willing to adopt or use the conservatism methods of remuneration. On the other hand, it would be favoured by the directors of the company, who have vested interests in the company and who are not able to exert nay kind of pressure in the internal policies, due to their limitations. This would help them, to keep a check on the malpractices of the managers.
- One of the most significant functions of the Positive Accounting Theory is to make good and accurate predictions of real world events and their eventual translation into actual transactions. Its main objective remains to explain and accurately predict real life accounting practices (Avelé, 2014). It has mainly three kinds of hypotheses on which it is fully based upon, the three hypothesis are as follows:
- Bonus Plan Hypothesis
- Debt Covenant Hypothesis
- Political Cost Hypothesis
One of the most important hypotheses of the positive accounting theory is the debt covenant theory. Initially, light must be thrown on the topic of debt covenants, which is the most important part of this entire hypothesis. Thus, debt covenants are actually certain kind of agreements or covenants, between a company or a business entity and its lenders, which the company would operate within the set of certain rules and regulations set by the lenders. These agreements with the borrowers are also referred to as the banking covenants or financial covenants.
The debt covenant theory aims to decrease the problems with one’s debtors. According to this hypothesis, the primary aim is to ensure that the higher the particular entity’s or firm’s debt ratio, the more likely it becomes for the managers to adopt various kinds of accounting methods that increase the income. In this way, Managers of the business entities exercise their discretion by selecting income growing accounting method, relax the amounts of debt constraints and in this way, ultimately, reduce the expenses of technical default (Kosi and Reither, 2014). Thus, in the scenario of contractual arrangements with the debt holders, by increasing and improving the present or the current earnings, the companies are less likely to debt covenants and as a result of which, the management of the company eventually succeeds in reducing the different kinds of constraints in the smooth running of the company or the business entity.
The role of accountants and the various finance officials in the context of today’s society cannot be undermined in any way whatsoever. The robust and active kind of role played by them in performance of their duties in terms of the society and the economy in general is very important. It has now come into the spotlight, because of the economic and social unrest the global economy is going through. In these testing times, it becomes imperative to build bridges and cooperate with each and every section of the economy. The importance and the role played by these finance professionals and the accountants in the context of the society is very large and diverse (Ball, 2013). An accountant with the help of his or her education, training, analytical bent of mind along with their resourcefulness is one of the best possible resources of the society. Their role has been explained below:
- Maintenance of Accounts:An accountant is proficient in maintaining a comprehensive and systematic record of all the necessary financial transactions during a period and to calculate the financial position of the particular entity as on a particular date. For the accomplishment of the dual purpose of ascertaining the profit or loss and the financial position, it is essential that all transactions be recorded in a organized manner, which can only be done by an accountant.
- Auditing function:One of the most important aspects of the function of any accountant is the performance of the audit of any company. Generally, the auditor, appointed for this purpose actually holds the qualification of an accountant. He or she is entrusted of assessing the accuracy and genuineness of the financial statements of the company. If the accountant fails to effectively assess the companies’ accounts, it is a tantamount to a huge amount of disgrace to the society (Fernando and Lawrence, 2014).
- Taxation:Handling all the tax related activities of the corporate is one of the most important jobs performed by the accountants. He or she also helps in reducing the tax burden by apposite planning of tax affairs. Accountants also have a social commitment of expressing their views and opinions on the prevalent tax policies, upon the different effects of tax rate on the economy in general and also on all other aspects of taxation about which they have astounding knowledge and experience than the general public.
Predicting the Choice of Accounting Method Based on Political Cost Hypothesis of PAT
The role of the accountants towards the economy is also important. They are one of the architects as well as one of the financial doctors of the economy as a whole (AASB, 2018). It is their duty to guide the economy in the arena of financial planning and tax planning and through their various other functions. The prominent roles of the accountants in terms of the economic development of the nation have been mentioned below:
- There are various ways; an accountant helps a modern economy, business analysis and strategy development being one of the many ways.
- Preparation of business plans, carrying out the necessary market research , performing financial as well as risk management and raising of finances are some of the most major activities, performed by them in lieu of major as well as upcoming corporate.
- Meeting of the different kinds of legal requirements is one of the most important functions of the accountants. Assisting in the legal proceedings of the various corporate, acting as active witnesses, providing round the clock sound financial advice on various kinds of compliance issues such as environment issues are some of the most prominent jobs performed by them.
- Effective designing of both the management as well as the accounting information system is one of the most complex tasks performed by them. In the 21stcentury, it has become the need of the hour.
Classical economic theory was first introduced by the ‘Father of Economics’ and renowned economist, Mr Adam Smith. Mr Smith proposed the theory of classical economics which had laid emphasis on the theory of division of labour. His famous book, ‘The Wealth of Nations’ had laid the foundation for this robust economic theory which is still prevalent today. One of the most important aspects of this book, as stated by Smith is the introduction of the division of labour and the importance of free trade. He was of the view that the division of labour is one of the most important aspect of increasing the nation’s wealth. He was of the idea, which stated that the growth and development of any nation depends on the quality of skill of its labour or work force. With this view, he proposed the theory of division of labour, where it is stated that the total work of any economic unit must be divided in order to improve and increase the efficiency of the individual workers (Zehri, and Chouaibi, 2013). If each of the workers work on any particular aspect of the entire production process, it would lead to increased productivity and greater amount of skill development. This would also help in increasing the dexterity of all the workers. It would help in undertaking large amounts of orders, consequently which would lead to increased amount of production and monetary gains for the particular economic unit.
In the context of the capitalistic ideology, the adoption of the international accounting standards education and training for the accountants, all over the world would lead to improved observance of the accounting standards, which consequently would lead to better preparation of the financial statements. In the capitalistic ideology of free market, the independent working of the market forces take place, due to the existence and practice of the market efficiency. This happens due to minimum interference from the government. In the context of the international accounting standard education and training, the same provisions works. The improved amount of education and training of the accountants help in improving the overall mobility of the accountants from one sector or from one economy to the other. The overall quality of the financial statements also improves, which helps in better comparability. By providing quality education and training regarding preparation of financial statements, in accordance with the international accounting standards helps in following of different accounting principles of accountability, variability, comparability and many others. This helps in preparation of accurate and precise financial statements. The role of accounting standards in sustaining the ideology of improved profits and improved financial statements bears testimony to the up gradation of the international accounting standards studies. The implementation of the different kinds of accounting standards would be swiftly possible, only if the accountants and the various finance experts are aware of the new kinds of accounting standards which are to be implemented(Owen, 2013). This entire operation solely depends on the education and the training received by the different accounting experts and finance experts, who are in charge of preparing the different financial statements. Thus, it can be said that the importance of the education of the accountants in respect of the accounting standards is indispensable for the organisations all over the world.
- b) Training of the accountants is very important for the smooth and effective preparation and analysis of the financial statements. They perform the most important aspect of any company’s operations by preparing the financial statements and analyse them. This is a comprehensive process and requires in depth understanding of the different kinds of accounting concepts, procedures and adjustments mechanism. The most important objective of preparing the financial statements is the process of comparing them with the reports of the previous years or with the financial reports of other companies in order to assess the financial items and performance and take required decisions of investment and other important aspects. The training of the accountants would include the following processes:
- Organising seminars and training, aimed at providing special emphasis on the preparation of financial items.
- Providing on the job training by allowing the accountants to approach the senior management and accountants for practically understanding some of the critical aspects of the preparation process of the financial statements.
- Organising executive training of the corporates by sending them back to business schools for sharpening their accounting, management and financial knowledge for improving the critical approach for assessment of the financial statements like the income statements, statement of changes in equity, balance sheet as well as the cash flow statement of the company.
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