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Financial Reporting and its Standards

Discuss about the Regulatory Capture in Financial Supervision.

Financial reporting is the process for communicating the information of financial accounting about any company through annual reports to its external users. The standard for all accounting is not involved in a single document, although the financial accounting standard board produces the electronic database known as financial accounting reporting system (Gitman et al., 2015).

Financial regulations is a form of supervision and regulations that are subjected to financial institutions to guidelines, restrictions and certain requirements for maintaining the integrity of financial system. Division of financial reporting deals with the regulatory framework development that influences the operations of financial sector of particular country. The core function of financial regulations is to develop the appropriate policies to facilitate discipline, prudence and integrity of financial industry (Barbu et al., 2014).

Financial reporting environment is a corporate information environment that is developed endogenously as a consequence of agency issues and information asymmetries between managers, entrepreneurs and investors. A framework is provided by the reporting environment for the analysis of decisions shaping the corporate information environment in a capital markets. Such decisions involve managing disclosure decisions and voluntary reporting, reporting of decisions by third parties intermediaries and regulators mandating disclosures and reporting.

This particular section discusses about the financial reporting system of each country in respect of their perceived problems, development and adoption of financial standards and regulatory environment working.

The Australian standard of financial reporting intends to promote the integrity and confidence of investors in the corporations, economy and capital market. The financial market, corporate and financial services regulator of Australia is the Australian securities and investment commission (ASIC). It is required by companies operating in Australia to lodge and prepare financial reports at the end of financial year with ASIC. Australian accounting standard board set the Australian accounting standard that is legislative requirement for corporations. It is required to apply such standard to all the private and public sector reporting entities. The Australian prudential regulatory environment is faced with the challenge of keeping up with an increasingly complex and rapidly evolving sector of financial services (Gurran & Phibbs, 2015).

The disparity and complexity of the financial reporting framework of Australia is the main problem. Reporting framework gets complicated when different legal obligations are incorporated in the different legal structures (Halligan, 2017). Entities incorporated under the Corporation Act, 2001 are required to identify requirements of specific reporting.

Financial Regulations and their Core Function

IFRS implementation in Australia was viewed with the intention of making an improvement in the financial reporting by way of comparability, transparency and accuracy of financial statements. Nonetheless, the adoption of IFRS was identified with various issues such as specific entities problems, lack of training and issues faced by regulators and auditors concerning the previous accounting standards. For the evaluation of the application of standards, one of the major challenges faced by the regulators was gaining additional knowledge and skills (de Villiers et al., 2014). Moreover, it has been argued by many stakeholders that it is costly for reporting entities to comply with regulations. In this regard, it is required that there can be improvement in the practice in the pace of increased cost due to resulting change. Issues are faced relating to regulation burdening. Some of the issues can be listed below:

  • Lack of time for implementation and consultation of industry and more generally there is inadequate process of consultation.
  • Concerns have been raised about the international standards and impost of foreign regulations especially prudential regulations. It is so because such regulations should be implemented with inclusion of more government policy.

In earlier years, UK government was considering restructuring of its accounting regulatory system as more and more countries were institutionalising the IFRS for their multinational companies. The regulatory framework has been designed in such a way that it is flexible so that to every possible solution faced by company, there is no fixed approach to accounting.

A vast array of rules is necessitated by such approach as the firm would be prevented from adjusting to necessary to emerging developments and environmental circumstances (Elshandidy & Neri, 2015). In this regard, it is required by firms to provide fair reflection of underlying economic reality. Sometimes, such flexibility causes problems that are inevitable. If the flexibility aspect is used by company in accounting in its own interest, it can lead firms to enter into world of fraud, creative accounting and impression management.

The complexity of accounting has been a troublesome and persistent problem. Furthermore, the reporting regulations of UK are expected to be impacted in a limited way due to Brexit. All the listed entities must adhere by regulations of European Union that would be incorporated in the UK law via the repeal bill of EU. However, there are some uncertainties in the pipeline over some items. The reporting has been implemented by UK under the agreement of OECD base erosion and profit shifting. Involvement of UK in the endorsement mechanisms is likely to change after Brexit. In order to replace the current EU regulations, it is required to have some new system of financial reporting. Departure of UK from EU is indicative of the fact that there is a possibility of abandonment of international standards over time (Edwards, 2014).

Financial Reporting Environment and its Corporate Information Environment

The Australian government agency for the financial reporting is AASB and such accounting board also incorporates IFRS. Some modifications have been made to IFRS by the Australian standard accounting boards and this involves addition of some disclosures and removing of some options. Some of the disclosures modified in the standard accounting board are identical to the standards that are issued for profit entities by IFRS. Requirements of non IFRS compliance have been applied for public listed entities and non profit entities. The Reduced Disclosure Requirements' (RDR)” have been adopted by new differential regime of reporting that are published by AASB (Frias et al., 2015). For all the Australian accounting standards, it is required to follow the requirement of measurement and recognition as per RDR.

The banking and financial services of UK is governed by financial services and market Act 2000 (FSMA) that is the primary source of legislation of framework.  Current regulatory framework is derived from implementation of rules and legislation and FSMA. European legislations have the direct impact on UK and this helps in establishing the increasing proportion of the framework. Over the next few years, the architecture of regulatory framework of UK is expected to change considerably. For each regulator, regulatory objectives are set out by prudential regulatory authority. A considerable amount of non based materials is produced by each regulator that helps in establishment of regulatory expectation of banks (Manish & O’Reilly, 2018).

In regard to the adoption of the impact of IFRS on the quality of financial reports of Australia, positive outcomes have been revealed by some studies by way of making improvement in the value relevance of accounting reports and reducing the number of firms that are engaged in earning management.

The adoption of IFRS goodwill impairment has been supported by available research evidence by improving the accounting quality. However, it has been suggested by some studies that accounting quality measures have remained consistent or stable with AGAAP. The adoption of IFRS by Australian companies have contributed positively for analysts and investors based on research (Loyeung et al., 2016).

In United Kingdom, since year 2005, IFRS have been a major part of financial reporting and the regulation requires companies with securities to trade on regulated market for using international accounting standard in preparation of financial statement. IFRS is required to be applied by company operating in UK by applying interpretation that has not been endorsed at the approval date of the financial statements that should not conflict with existing standard that has been endorsed.  The adoption of IFRS in the European Union is indicative of the fact that the overall benefits were across range of benefits such as cost of capital, comparability, transparency, efficiency of corporate investment, international capital flows and market liquidity. Complexities related to adoption of standard is sometimes unavoidable that discourages countries from fully embracing the international standards.

Financial Reporting System and Regulations in Australia

Investors have been able to maintain confidence in the market of UK because of improved transparency and comparability by IFRS. All the domestic companies operating in the country trading their securities in regulated market are required to comply with the IFRS in preparation of financial statements as adopted by the standard. Adoption of the reporting standard by UK has resulting in benefits outweighing cost. Such benefits are attributed in short time period in terms of comparability, transparency, market liquidity and cost of capital. However, it is required by country to adopt the standard in full for reaping the benefits and thereby keeping the local variants of IFRS at its minimum. The crucial importance of mechanism of coordinating and sharing enforcement decisions is demonstrated by critical national enforcement. Political legitimacy of the standard in Europe is established by underpinning legitimacy through endorsement (Poulain, 2017). The adoption of the standard has facilitated making comparisons between organization and it has removed the need for companies with foreign subsidiaries for translating the account of parent company for consolidation.

Regulatory capture theory was introduced in year 1971 by George Stigler that depicts that legislations can benefit the industry if the related regulatory body is captured by it. Agencies helps in regulation of such process which industries requiring legislations dominates. Such capturing of regulations happens when the formation of agency is done for acting in public interests. Rather than benefitting the public as a whole, this particular theory seeks to benefit the industry which it regulates the industry. The regulatory body is set by government that helps in protection of social interests by regulating the behaviour of firms and industries. Such regulatory bodies could be legislations, guiding principles and officers. The aim of introduction of regulation as per capture theory is to provide benefit to public first. However, such aim would fail eventually because with the flow of time, the regulated party control regulators. The development of capture theory was witnessed with the decline of theory of public interest. Main emphasis of capture theory is to emphasize on regulation development rather than description of reason for introducing regulation (Leuz & Wysocki, 2016). Some of the assumptions of regulatory capture theory are as follows:

  • All the related party who are interested has a rational expectation for another party.
  • Customers, regulatory party and regulatory agency are considered greedy and they have the intention of maximizing their own interest.
  • Industries might take huge effort and long period of time for capturing the regulators. It is assumed that the influence of cost to capture to efficiency should be ignored for getting through this theory.

It is mentioned as argument in the theory that regulation harms the interest of regulated party as such party have the intention of getting back its interest and thereby controlling the regulator by seeking such opportunity. Legislation will favour parties that are subjected to regulations as it is expected to be done by controlling of regulator by regulated party. The survival of theory is dependent on satisfying regulatory parties’ expectations by considering regulatory parties expectations (Qiu et al., 2016). Regulators are no longer required if there is no existence of regulated party anymore. Therefore, it can be inferred that the basic aim of regulation to regulate will eventually lost if they will not be able to keep their independence.

Challenges Faced by Australia's Reporting Environment

Capture theory being a part of economic of regulations purports to gives the explanation of rationale and reality of economic regulation. A less benevolent view of the basis for maintenance and initiation of economic regulation of government are provided by capture theory. It is postulated by theory existing participants in the industry seeking government protection initiate most regulations. Moreover, it is also postulated by theory that running of such agency is effectively and ultimately influenced by capture theory. Even it is unlikely that initially events are totally unfavourable to the regulated industry participants; such capturing is regarded as ongoing. The conceptualization of regulation of government has its importance in speciality economics referred to as economic regulation (Hong et al., 2014). Different types of theories are related in the suggestions provided by regulatory environment so that such theories are protected from any external influence. It has been suggested by recent interpretations by considering mature democracies at higher transparency level and exposure to high corruption level of media. If there does not exist any regulations there would be more profits on part of regulatory body. Regulators will not be able to perform their role of regulating industries if the industries succeed in controlling (Gurran & Phibbs, 2015). Furthermore, new decisions will be made by regulators being captured in industries favour rather than in favour of public.

It is depicted by characteristics analysis that with the given literature, regulatory environment might be captured that lead to the identification of several types of regulatory environment for different countries. In several cases, it is presented that the implementation of cost savings is conducive to the IFRS adoption in Australia when preparing the financial report. Organizations in Australia have benefitted by the implementation of the financial reporting standard and its compliance with the exposure draft (Elshandidy & Neri, 2015). After the companies have seen to be controlled by regulatory bodies in industry, such changes have been tracked by captured agencies. In accordance with the requirement of disclosures, identification of regulatory environment is done in compliance with the medium sized environment. Review of literature review on British government has depicted providing benefits that are in the interest of public. Various types of modifications are to be made in the policy of government as identified by the theory. Addressing of issues in terms of regulatory capture by the government is done in compliance with the several applications of statutory changes made in the environment of financial reporting of country (De George et al., 2016).

IFRS Adoption and Issues in Australia

The Australian accounting standard review board (ASRB) was captured on some evidences that are listed below:

  • The procedure was updated by ASRB for ensuring that consultation will help in setting up the priorities and the interest of some other group along with the board was put in the same ground.
  • The regulator lacked criteria of independence as the most members of ASRB were financial directors and professional accountants (Marti & Scherer, 2016).
  • There was lobbying by the accounting professionals during the establishment of ASRB for ensuring that no academic as chairperson and independent capability is provided to the board. This would receive administrative officer instead of research director.

Conclusion:

The above prepared report has helped in explaining the environment of financial reporting of Australia and United Kingdom by illustrating their working environment and issues perceived by system of financial reporting. Several issues are identified in the financial reporting environment of both the countries in terms of regulators, auditors and other parties who are well known with the former accounting standard. The challenge faced by country is in terms of skills and knowledge required for adhering to the evaluation and applications requirement of IFRS. On other hand, it is expected to have considerable degree of changes in the environment of financial reporting of UK due to Brexit as it would no longer a part of European Union. When looking at capture theory and its compliance with the institution of UK, it can be inferred that financial institutions will be able to influence regulations with the help of means at their disposal in their opportunities for impacting some degree of capture regulator. It is also suggest that institutions will be exerting a dominance influence due to regulation in financial sectors. Therefore, it can be concluded that both the countries have complied with the regulatory capture theory.

References list:

Barbu, E. M., Dumontier, P., Feleag?, N., & Feleag?, L. (2014). Mandatory environmental disclosures by companies complying with IASs/IFRSs: The cases of France, Germany, and the UK. The International Journal of Accounting, 49(2), 231-247.

De George, E. T., Li, X., & Shivakumar, L. (2016). A review of the IFRS adoption literature. Review of Accounting Studies, 21(3), 898-1004.

de Villiers, C., Rinaldi, L., & Unerman, J. (2014). Integrated Reporting: Insights, gaps and an agenda for future research. Accounting, Auditing & Accountability Journal, 27(7), 1042-1067.

Edwards, D. (2014). The Link Between Company Environmental and Financial Performance (Routledge Revivals). Routledge.

Elshandidy, T., & Neri, L. (2015). Corporate governance, risk disclosure practices, and market liquidity: comparative evidence from the UK and Italy. Corporate Governance: An International Review, 23(4), 331-356.

Frias?Aceituno, J. V., Rodríguez?Ariza, L., & Garcia?Sánchez, I. M. (2014). Explanatory factors of integrated sustainability and financial reporting. Business strategy and the environment, 23(1), 56-72.

Gitman, L. J., Juchau, R., & Flanagan, J. (2015). Principles of managerial finance. Pearson Higher Education AU.

Gurran, N., & Phibbs, P. (2015). Are governments really interested in fixing the housing problem? Policy capture and busy work in Australia. Housing studies, 30(5), 711-729.

Hadani, M., Doh, J. P., & Schneider, M. A. (2016). Corporate political activity and regulatory capture: how some companies blunt the knife of socially oriented investor activism. Journal of Management, 0149206316638162.

Halligan, J. (2017). Reform design and performance in Australia and New Zealand. In Transcending New Public Management (pp. 55-76). Routledge.

Hong, H. A., Hung, M., & Lobo, G. J. (2014). The impact of mandatory IFRS adoption on IPOs in global capital markets. The Accounting Review, 89(4), 1365-1397.

Kaufmann, W. (2017). Going by the book: The problem of regulatory unreasonableness. Routledge.

Lei, P., Huang, Q., & He, D. (2017). Determinants and welfare of the environmental regulatory stringency before and after regulatory capture. Journal of Cleaner Production, 166, 107-113.

Leuz, C., & Wysocki, P. D. (2016). The economics of disclosure and financial reporting regulation: Evidence and suggestions for future research. Journal of Accounting Research, 54(2), 525-622.

Loyeung, A., Matolcsy, Z., Weber, J., & Wells, P. (2016). The cost of implementing new accounting standards: The case of IFRS adoption in Australia. Australian Journal of Management, 41(4), 611-632.

Manish, G. P., & O’Reilly, C. (2018). Banking regulation, regulatory capture and inequality. Public Choice, 1-20.

Marti, E., & Scherer, A. G. (2016). Financial regulation and social welfare: The critical contribution of management theory. Academy of Management Review, 41(2), 298-323.

Martínez?Ferrero, J., Garcia?Sanchez, I. M., & Cuadrado?Ballesteros, B. (2015). Effect of financial reporting quality on sustainability information disclosure. Corporate Social Responsibility and Environmental Management, 22(1), 45-64.

Poulain, M. (2017). Regulatory Capture in Financial Supervision. In Financial Regulation in the EU (pp. 107-122). Palgrave Macmillan, Cham.

Qiu, Y., Shaukat, A., & Tharyan, R. (2016). Environmental and social disclosures: Link with corporate financial performance. The British Accounting Review, 48(1), 102-116.

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