Explanation of qualitative characteristics of financial reporting
1. Explanation of qualitative characteristics of financial reporting and also state the consistency of views on the corporate financial reports satisfy the central objective of financial reporting
2. You are required to explain the decision of the government that no specific regulation be introduced from the perspective of:
(a)Public Interest Theory
3. What implications do you think these rules have for the relevance and representational faithfulness of US corporate financial statements?
4.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?
The Comparability is one of the qualitative features of financial reporting, in which financial reports of two or more companies are compared with each other to know the actual position of an entity in the external market (Beyer, Cohen, Lys and Walther, 2010). With the help of comparison feature, the differences and similarities among the comparison companies will find out to improve the conditions of an enterprise.
In the current case, the chief financial officer of an entity criticises the feature of comparability of the financial reports with other company as they think this will reveal the financial and sensitive information in the form of financial disclosures which further leads to non-controllable situations in managing all the risks incurred by an entity (Barth, 2018). Ratio analysis is a measure which an entity used to know its financial as well as non-financial positions by comparing its existing respects with its previous records to determine the increasing or decreasing performance from one period to another.
Just like ratio analysis, financial reporting compares one company’s financial statements with another company by using internationally recognized measures in identifying the position of the firm in the external market (Rodrigues and Rodrigues, 2018).
Faithful representations of all the items in a financial statement are essential to determine the financial position of the company by disclosing all the accounting items clearly in front of the internal as well as the external users (Palmrose and Kinney, Jr, 2018). It includes the aim and purpose of an entity by disclosing all the financial information clearly as their motive is to satisfy the investors, shareholders, employees and third part associated with the company whether directly or indirectly.
Consistency of views on corporate financial reports with the central objective
The faithful representation concept is ignored in the case study where the management think that notes to accounts attached at the end of the financial statements do not read by all the managers as they require additional technical experience to read the information attached to the financial statements (Qualitative characteristics of financial reporting, 2017). The reading of the information will mislead an entity in understanding all its goals, and the objective develops on the interpretation of the results. Faithful representation is further segregated into three criteria’s such as completeness, neutrality, and error free. It is important to include the complete information in the financial statements to convey the completed information to the top management in crafting strategies based on this information (Warren and Jones, 2018). Data included in the statements should be non-bias to reflect the actual position of the company without any kind of data manipulation. Arithmetic accuracy is important in the financial reports presented to all the investors to guide them whether to invest or divest its shares in the company.
The corporate financial reports prepared by an entity includes the standard set of the financial statements such as income statements, balance sheet, cash flow statement and changes in equity depicts the true picture of the business. As per the views in the current case study, the opinion of CFO of Commonwealth bank states that the corporate financial reports do not achieve the central objectives of financial reporting of an entity. The CFO finds inconsistency in accomplishing all the goals and the objectives of the bank (Landrum and Ohsowski, 2018). International financial reporting standards used by an entity in improving the existing position of the company. Views of management CFO shows that the central objectives of the company will not get accomplished on time as due to arithmetic errors it could affect the overall performance of an entity. David Craig, a chief financial officer of the bank, find difficulty in achieving the financial performance of an entity as an entity shows the deficiency of bank.
The Public Interest Theory of regulation states that, the regulation attempts to protect public while providing them with the optimal benefit. This theory has assumed that the government who is a regulation plays an independent and important role in the overall development of regulation. The regulator acts as an unbiased authority operating at the public and agents requests (Stiglitz, and Rosengard, 2015). The self-interest is not involved in this process; the government does not operate for own benefit while it considers the benefit of the public as a whole.
Implications of the government decision not to introduce specific regulations
According to CPA Australia, there is a risk of enabling excessive views and subjectivity to affect the vast affirmative economic efforts and commercial given by companies. In a situation where there is mistreatment of company forms or not able to meet the expectation of public, then the solutions are targeted in a most appropriate manner to drive a positive change. Two approaches are determined to build awareness which are; interest group empowerment and managerial voluntarism in order to ensure better organizational openness top wards corporate social responsibility (Rosenbloom, 2016). Public interest theory is a concept based on economics and highly associated with Welfare economics, offering justifications and findings in a theoretical manner for viable regulation. It states that regulate must seek to search for effective market solutions that are economically efficient.
Capture theory: According to Capture theory, regulations are influenced to suit well the requirements of those impacted by them. Under this theory, that over the time of regulations, which had delivered the best interest of the concerned industries. Corporate social responsibility has turned out to be a considerable increasing phenomenon in the country and across the world. The major intentions and rationales are also clearly stated in this theory (Potter, Olejarski and Pfister, 2014). The individuals who are impacted by the regulations are engaged directly in the establishment of such regulations. Thus, there is an adequate representation of the politicians as well as the interest groups since the regulations are drawn for their needs.
The capture theories totally focus on the public good and the benefits of the society as a whole. With this aspect, Government of Australia has set major guidelines which a regulation has to follow to ensure social benefit and the decision on conducting the same in what ways is based on regulations (Yildirim, 2016). A. However, whatever they decide must be beneficial for society by complying with the general guidelines of CSR developed by Australia.
Economic Interest Group Theory of regulation: According to theory, regulations are a set of policies followed by supply and demand forces. On the supply side, the government is positioned while on the demand side, interest groups are positioned on the supply side (Berry and Wilcox, 2018). Further, the theory suggests that industry develops the regulation and the main aim of regulations is to form benefits to the concerned industry. Therefore rigid guidelines for the corporate social responsibility had been avoided, and authority to companies has been provided to determine the activities and projects to be conducted for social benefits so that proper and innovative measures can be taken.
Motivations of directors not to revalue property, plant, and equipment
Fixed asset valuation is said to be a conflicting issue for the individuals setting standards. Fixed asset accounting at past costs reduced the possibility of manipulation, whereas doing account at the fair value of fixed assists offers reliable information to financial statement users. In accordance with the US GAAP, accounting of all fixed assets for implementing past cost model, stipulating that initially the non-current assets are realized at fair value and later conducted at less value taking depreciation and impairment losses into account. Any of the upwards adjustments held because of changing situations are banned (Gordon and HSU, 2017). Further, the costs model enables merely downward adjustments because of impairment losses. As a result, the lasting working life of assets must be put for impairment if situations symptoms that their carrying amount is excessive of market value. According to GAAP, the impairment losses for the long-term working life of assets are measured as the assets amount excessive of fair value (Choi and et al. 2013). Generally, As per US GAAP provisions, there are some situations indicating the requirement for impairment, and the same are enumerated as below:
- Substantial contrary modifications in the economic, technological or legal environment;
- Substantial unforeseen reduction in the market value of the asset
- A material reduction in perpetual performance of the asset
- There has been the probability that more than 50% of that particular asset will be sold prior to the end of its estimated useful life.
This valuation principle is influenced by the theory of prudence in which probable losses are to be recorded, but probable profits are not accounted for. This ensures reliability and accuracy that unnecessary upward revaluation is not done. However; it does not show the fair value of assets in which they are a long-term increase in the value of the asset which affects the overall valuation of the company and does not show true disclosure to the shareholders (Watts and Zuo, 2016). This aspect shows that these rules have partially adverse impact on the relevance and representational faithfulness of corporate financial statement of US. Further, this effect can be compensated by providing additional disclosure in notes to accounts to deliver viable information to the users of financial statements.
In the situation of revaluation of the asset is done, and then contracting costs can be deteriorated by making a reduction in debt risk of contractual breach, reflecting significant information to mitigate the risks and impacts of information unevenness, and thereby declining political pressures. These assets revaluations are attached with the future performance of the firm in a positive manner, stating that the director’s main motivation for the fixed asset upward revaluation has been considered to suggest the fair value of assets to the users of financial statements (Watts and Zuo, 2016). For the revaluation of assets, one other motivation is the improvement in the lending capacity of the firm. It can be said that a considerable positive lion k between revaluation and return on the stock is when there are appropriate revaluations done by directors aligning the market assessments. Further, the revaluation would result in the hostile reported performance of profitability, if not done appropriately, but still, firms and directors use this accounting procedure.
Effects of the decision not to revalue on financial statements
If the revaluations of assets are not done, then it might affect the financial statement of the firm by understating the assets and due to low depreciation profit will be higher.
In a situation when an asset is purchased, then it is generally recorded at the price of cost. It is expected that the market value of the asset will have a change over the time, further firms can select if or if not to continue the valuation of the asset at its past cost or if or if not to employ revaluation approach (Barth, 2018). Without revaluation, firms are not able to do negotiation of the price before the merger, or acquisition by another firm. Along with this, the firm will no more be capable of revealing the updated market value of assets, and it is not possible for the firm to ensure sufficient availability of funds to change fixed asset when their estimated useful life is ended.
The answer to this question depends on the effectiveness of capital market in a situation where efficiency in the market does not exist then share prices are reflected by information covered in financial statements. Further, it can result in lowering the assets and thereby reduced net asset backing on each share; it might be retained at share price. Conversely, some part of the reduction in the share price might be balanced by the higher profit which is reported (Gitman, Juchau and Flanagan, 2015). On the other hand, is the market is efficient then the emphasis is not given on the fact if or if not the financial statement’s status shows the current value of asset, as long as there is publicly accessible information regarding the net market value of the asset. Since the information is accessible in the working more of the financial statement, then it is believed that there is efficiency in the market and there be less or no obligation on the share prices with fair accounting treatment.
Barth, M. E., 2018. The Future of Financial Reporting: Insights from Research. Abacus. 54(1). pp.66-78.
Barth, M.E., 2018. The Future of Financial Reporting: Insights from Research. Abacus, 54(1), pp.66-78.
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Choi, T.H., Pae, J., Park, S. and Song, Y., 2013. Asset revaluations: motives and choice of items to revalue. Asia-Pacific Journal of Accounting & Economics, 20(2), pp.144-171.
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.
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Potter, M.R., Olejarski, A.M. and Pfister, S.M., 2014. Capture theory and the public interest: Balancing competing values to ensure regulatory effectiveness. International Journal of Public Administration, 37(10), pp.638-645.
Rodrigues, L. and Rodrigues, L., 2018. Economic-financial performance of the Brazilian sugarcane energy industry: An empirical evaluation using financial ratio, cluster and discriminant analysis. Biomass and Bioenergy. 108. pp.289-296.
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Watts, R.L. and Zuo, L., 2016. Understanding practice and institutions: A historical perspective. Accounting Horizons, 30(3), pp.409-423.
Watts, R.L. and Zuo, L., 2016. Understanding practice and institutions: A historical perspective. Accounting Horizons, 30(3), pp.409-423.
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