In an article entitled ‘Unwieldy rules useless for investors’ that appeared in the Australian Financial Review on 6 February 2012 (by Agnes King), the following extract appeared. Read the extract and then answer the question that follows.
Millions of dollars have been spent adopting international financial reporting standards to help investors make like-for-like comparisons between companies in global capital markets. But CFOs say they are useless and have driven financial disclosures to unmanageable levels. The criticism comes as the United States, the world’s largest capital market, decides whether to retire its domestic accounting standard (US GAAP) and adopt IFRS.
“In seven years I never got one question from fund managers or investment analysts about IFRS adjustments,” former AXA head of finance Geoff Roberts said. “Investors...rely on investor reports and management briefings to understand companies’ numbers.”
If analysts did delve into IFRS accounts, they would most probably misinterpret them, according to Wesfarmers finance director Terry Bowen. “Once you get into the notes you have to be technically trained. If you’re not, lot of it could be misleading,” Mr Bowen said.
Commonwealth Bank chief financial officer David Craig said IFRS numbers were disregarded by investors because they could actually obscure an institution’s true position.
Required:
You are required to explain which qualitative characteristics of financial reporting, as per the conceptual framework, do not, in the opinion of the above quoted individuals, appear to be satisfied by current reporting practices pursuant to IFRS. Also, you are required to consider whether the views are consistent with the view that corporate financial reports satisfy the central objective of financial reporting as identified in the Conceptual Framework.
Assessment Task Part B
In 2006 the Australian Government established an inquiry into corporate social responsibilities with the aim of deciding whether the Corporations Act should be amended so as to specifically include particular social and environmental responsibilities within the Act. At the completion of the inquiry it was decided that no specific regulations would be added to the legislation, and that instead, ‘market forces’ would be relied upon to encourage companies to do the ‘right thing’ (that is, the view was expressed that if companies did not look after the environment, or did not act in a socially responsible manner, then people would not want to consume the organisations’ products, and people would not want to invest in the organisation, work for them, and so forth. Because companies were aware of such market forces they would do the ‘right thing’ even in the absence of legislation).
Required:
You are required to explain the decision of the government that no specific regulation be introduced from the perspective of:
(a)Public Interest Theory
(b)Capture Theory
(c)Economic Interest Group Theory of regulation
Assessment Task Part C
The US Financial Accounting Standards Board does not allow revaluation of non-current assets to fair value, but it does make it compulsory to account for the impairment costs associated with non-current assets as per FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets.
Required:
What implications do you think these rules have for the relevance and representational faithfulness of US corporate financial statements?
Assessment Task Part D
Many organisations elect not to measure their property, plant and equipment at fair value, but rather, prefer to use the ‘cost model’. This will provide lower total assets and lower measures, such as net asset backing per share.
Required
You are required to answer the following questions:
(a)What might motivate directors not to revalue the property, plant and equipment?
(b)What are some of the effects the decision not to revalue might have on the firm’s financial statements?
(c)Would the decision not to revalue adversely affect the wealth of the shareholders?
Relevance and faithful representation lacking in IFRS adoption
The failure of International Financial Reporting Standard (IFRS) can be seen from the provided situation to represent the correct financial standings of the companies in the presence of the fact that the companies have spent millions of dollars for its adoption so that financial reporting can be improved. Different famous business personalities have indicated in their statement that the IFRS adopted financial statements are missing the required qualitative characteristics of general purpose financial reporting that converts the financial statements more acceptable for the major users of them. The conceptual framework of Australian Accounting Standard Board (AASB) has mentioned that relevance and faithful representation are the fundamental qualitative characteristics; and comparability, verifiability, timeliness and understandability are the enhancing qualitative characteristics of financial statements (Warren and Jones 2018). The following discussion sheds light about the missing qualitative characteristics of financial reporting:
The fact is evident from the statement of Mr. Roberts, Former Head of Finance of AXA that there have not been any single questions from the fund manager and the financial analysts about the quality of financial information obtained from the financial statements developed in accordance with the IFRS standards. This aspect helps them in comparing the financial statements of the companies with another one; at the same time, they can gain understanding about the different financial aspects of the companies to understand their financial performance and financial standings. This scenario states that these financial statements have two of the most important qualitative characteristics of financial reporting; and they are comparability and understandability. The information of the financial statements becomes more purposeful in the presence of these two enhancing qualitative characteristics. However, the recent year’s shows major decrease in the quality of financial information in the IFRS adopted financial statements. Hence, it can be said that both comparability and understandability is lacking in the current financial reporting of IFRS (Openshaw 2013).
The opinion of Terry Brown, Finance Director of Wesfarmers, shows that one cannot eliminate the chance of misinterpreting the notes to the financial statements of the business entities developed as per the regulation of IFRS in case the financial analysts try to analyze them in the absence of effective technical knowledge. In the presence of the qualitative characteristic ‘verifiability’, the users of the financial information can apply their knowledge and observation for gaining insight about the financial performance as well as financial standings of the entities from analyzing both the financial statements and the note to the financial statements. From the statement of Mr. Brown, one major concern is there that the users are not able to understand and verify the financial notes and statements of the companies by applying the general knowledge as the IFRS financial statements require high financial understanding. Thus, from this, the absence of verifiability and understandability can be seen in the IFRS adopted financial reporting framework (Waegenaere, Sansing and Wielhouwer 2015).
Comparability and understandability missing in current financial reporting
The statement of David Craig, Chief Financial Officer of Commonwealth Bank, shows the ignoring behavior of the investors towards the financial information from the IFRS adopted financial statements as these statements are providing misleading pictures about the financial performance and standings of the companies. In case the financial statements of the business organizations lack two major fundamental qualitative characteristics like relevance and faithful representation, the investors will not be able to gain insight about the financial performance as well as financial position of the business entities. Thus, the financial information must be relevant and faithfully represented in order to be useful for the users of the financial statements. Thus, based on the above discussion, it can be said that the current financial reporting framework pursuant to IFRS lacks both relevance and faithful representation (Trucco 2015).
Now, it needs to be mentioned that providing the correct financial information about the companies through financial statements is the main objective of general purpose financial reporting in order to provide the users with the correct picture about the financial performance as well as financial standings of the companies (Amoako 2013). However, it is not possible to fulfill this objective in the absence of these major qualitative characteristics.
In the year 2006, a major decision was taken from the side of the Australian government related to the not amendment of the Corporations Act with the introduction of any regulation relating to socials and environmental responsibilities. Moreover, the Australian government decided to leave the matter on the market forces for handling. Three popular theories of regulations can be used for the analysis and evaluation of this decision of the Australian government and they are discussed below:
The principles of the public theory support the fact that there is a major requirement for the introduction of necessary regulations for fulfilling the demand of the public. This theory provides great importance to the regulations by stating the fact that the regulations play an integral part to promote the general welfare of the common people and does not serve for any specific group of stakeholders for fulfilling their interests. This theory eliminates the fact that market forces have role to play in satisfying the interest of the public. This theory states that the government of the countries must intervene into the market condition for addressing related to the imperfection of market or market failure (Deegan and Ward 2013).
Verifiability and understandability absent in IFRS adoption framework
With the application of this theory in the situation of the Australian government, the scenario can be analyzed and evaluated. According to the public interest theory, the Australian government took one wrong decision by not intruding any regulation in the Corporations Act in spite of the fact that the presence of regulations ensures the betterment of the public. In this situation, there would be large promotion of the social and environmental responsibilities among the public in case the Australian government intervenes into the matters by introducing regulation. In this manner, addressing the market imperfections would be possible related to the Corporations Act (Wang 2014).
The capture theory of regulation can be placed at the opposite of the public interest theory as this theory eliminates the role of the regulations for satisfying the demand of the public. The principles of this theory put emphasis on the market forces for the satisfaction of the needs of common people. Capture theory points towards an important aspect that the regulators have the capability to manipulate the regulations for their own interest so that they can fit in the requirements of the regulators. At the time, it is possible for the identification of the affected parties by the introduction of regulations with the help of the principles of capture theory. This theory indicates towards the intention of the regulators to include themselves in the regulation development process for better satisfying their personal needs. Thus, it is better to rely on the market force for getting the solution (Nilsson and Stockenstrand 2016).
The principle of capture theory can be applied to the present situation. The principle of this theory supports the decision of the Australian government not to introduce any regulation in the Corporations Act for promoting social and environmental responsibilities. The absence of regulations would eliminate the possibility of manipulation with the regulations by the regulator for satisfying their personal interest. The market forces would play an integral part in the promotion of the responsibilities (Hope, Thomas and Vyas 2013).
The concept of this theory of regulation is different from the above-discussed theories. The principles of this theory identifie the business industries as the developer of the introduced regulations so that they can make the businesses beneficial with these introduced regulations. With the application of the principles of these theories in case of the Australian government, it can be said that it would be necessary for the government of Australia to introduce regulation as a part of the Corporations Act so that the social as well as environmental responsibilities can be promoted. With the introduction of the regulations, the business organizations of Australia would be under the obligation to follow all the regulations related to the social as well as environmental responsibilities (Chhabra and Pattanayak 2014).
Importance of relevance and faithful representation in financial reporting
The provided situation mentions about a specific regulations of US FASB that wants the companies not to make the revaluation of their non-current asset, but to take into consideration the impairment charges associated with these non-current assets. This particular regulation has specific implications for the relevant and faithful representation of the financial statements of the US companies and they are discussed below:
- The users of the financial statements like the investors, creditors and others can become able to make the identification of the major similarities and differences in the accounting treatments related to the non-current assets in the presence of this specific regulation of asset revaluation. This aspect helps in providing relevant information about the assets (Chan 2015).
- The accountants of the companies use different accounting framework or model for the correct accounting treatment of the non-current assets. This aspect creates accounting complexities while complying with these accounting models for the revaluation of non-current assets. However, by following the regulation of FASB for asset revaluation, the accountants can reduce these complexities and inconsistencies around the revaluation of the non-current assets (Ungureanu 2013).
- The accountants have to deal with some specific issues at the time of the accounting treatment of the implementation of non-current assets and these issues create major effects on the financial position of the companies related to the non-current assets. However, the new regulation of FASB for asset revaluation puts an obligation on the companies to must comply with the asset revaluation related standards. Thus, in the presence of these factors, it has become easier for faithfully represented the financial statements by complying with all the regulations (Florin-Constantin 2013).
- With the help of this regulation of asset revaluation, FASB has become able to establish a single framework for completing the accounting treatments of non-current asset revaluation. This has made the job easier for the accountants of the companies.
Requirement [a]
The main motivations for the directors are discussed below:
- Adoption of the asset revaluation process puts the obligation on the directors of the companies to carry on the revaluation process of property, plant and equipment on a regular basis. Thus, the directors can obtain the fair value of the assets (Magnan, Menini and Parbonetti 2015).
- In case the directors have the fair value of their property, plant and equipment, they become able to do negotiation on the value of these assets at the time of merger and acquisition. Thus, it is required for the directors to adopt the asset revaluation process for getting the fair value of property, plant and equipment (Florin-Constantin 2013).
- In case the directors involve in the revaluation process of property, plant and equipment, they become able in getting the true rate of return on capital employed.
Requirement [b]
Financial statements of the companies get affected by the decision not to revalue the property, plant and equipment. The values of the property, plant and equipment will become stagnant in the absence of asset revaluation process. Thus, the sales procedure of these assets would generate abnormal amount of profit or loss that will eventually reduce the earnings of the companies. In addition, the reduction in the earnings of the companies would end up in reduced profitability for the businesses (Waegenaere, Sansing and Wielhouwer 2015).
Requirement [c]
Apart from the earnings and profitability, the wealth of the shareholders gets affected with the decision not to make the asset revaluation. The shareholders of the business organizations considers the financial statements of the companies before making the investment decisions so that they can obtain understanding about the financial performance as well as financial standings of the business entities. Due to the decrease in the earnings as well as profitability of the companies, the companies cannot provide the actual return on investment to the shareholders. This aspect would lead to the reduction of the wealth of the companies (Waegenaere, Sansing and Wielhouwer 2015).
References
Amoako, G.K., 2013. Accounting practices of SMEs: A case study of Kumasi Metropolis in Ghana. International Journal of Business and Management, 8(24), p.73.
Chan, J.L., 2015. New development: China promotes government financial accounting and management accounting. Public Money & Management, 35(6), pp.451-454.
Chhabra, K.S. and Pattanayak, J.K., 2014. Financial accounting practices among small enterprises: Issues and challenges. IUP Journal of Accounting Research & Audit Practices, 13(3), p.37.
Deegan, C. and Ward, A.M., 2013. Financial accounting and reporting: an international approach.
Florin-Constantin, D., 2013. The users of accounting information and their needs. Anale. Seria Stiinte Economice. Timisoara, 19, p.200.
Hope, O.K., Thomas, W.B. and Vyas, D., 2013. Financial reporting quality of US private and public firms. The Accounting Review, 88(5), pp.1715-1742.
Magnan, M., Menini, A. and Parbonetti, A., 2015. Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies, 20(1), pp.559-591.
Nilsson, F. and Stockenstrand, A.K., 2016. Financial Accounting and Management Control. Springer International Publishing: Imprint: Springer,.
Openshaw, K., 2013. Cost and financial accounting in forestry: a practical manual. Elsevier.
Trucco, S., 2015. Financial Accounting and Alignment to Management Accounting in the Italian Context. In Financial Accounting (pp. 83-132). Springer, Cham.
Ungureanu, M., 2013. Financial Analysis from an Accounting Point of View. CES Working Papers, 5, pp.138-148.
Waegenaere, A., Sansing, R. and Wielhouwer, J.L., 2015. Financial accounting effects of tax aggressiveness: Contracting and measurement. Contemporary Accounting Research, 32(1), pp.223-242.
Wang, C., 2014. Accounting standards harmonization and financial statement comparability: Evidence from transnational information transfer. Journal of Accounting Research, 52(4), pp.955-992.
Warren, C.S. and Jones, J., 2018. Corporate financial accounting. Cengage Learning.
