Financial Reporting – Evolution ofGlobal Standards

Chapter 9

Why are FRSs needed?• Accounting numbers are important when

making contracts. Eg.– Management and directors' pay is often related to the

firm's performance. – The required performance may not be achieved under

one method of producing accounting reports, but it could be under an alternative method.

• With no restraints, the methods used to produce the report can be changed to suit the desired performance requirements.

Role of accounting numbers in defining contractual entitlements – temptation to manage the numbers

Typical ways to influence accounting measures: • Defer discretionary expenditure, for example research,

advertising, training expenditure • Defer amortisation, for example make optimistic sales

projections in order to classify research as development expenditure which can be capitalised and

• Reclassify deteriorating current assets as fixed assets to avoid the need to recognise a loss under the lower of cost and net realisable value rule applicable to current assets.

Role of accounting numbers in defining contractual entitlements – temptation to manage the numbers

Mandatory standards restrict management’s ability to adopt measures such as those listed above.

This affects wealth distribution within the firm. For example, IF managers cannot delay the amortisation of development expenditure, bonuses related to profit will be lower and there will effectively have been a transfer of wealth from managers to shareholders.

Profit before amortisation $10,000 $10,000

Amortisation 2,000 -

Profit after amortisation 8,000 10,000

10% bonus 800 1,000Profit available to shareholders 7,600 9,000

Shareholders are in the dark

• Shareholders are usually unaware that financial statements are inaccurate.

• Only aware in restricted circumstances • When a third party has a vested interest in revealing adverse

facts following a takeover, or

• When a company falls into the hands of an administrator, inspector or liquidator, whose duty it is to enquire and report on shortcomings in the management of a company.

Arguments in support of standards

Comparability

• Need to make valid inter-company comparisons of performance and trends

Credibility• Credibility lost if companies select different

accounting policies for similar events

Discipline

• Comparisons are distorted if companies are permitted to select accounting policies with the intention of disguising changes in performance and trends.

Consensus-seeking• Can lead to the issuing of standards that are over-

influenced by those with easiest access to the standard setters as the subject matter becomes more complex, for example capital instruments

Arguments against standards (Continued)

Overload• Too many standards• Too detailed• Too general-purpose and fail to recognise the

differences between large and small entities• Too many standard setters with differing

requirements, for example FASB, IASB, ASB, national Stock Exchange listing requirements.

Arguments against standards (Continued)

Reasons for differences in reporting

• The character of the national legal system• The way in which industry is financed• The relationship of the tax and reporting systems• The influence and status of the accounting

profession• The extent to which accounting theory is

developed• Accidents of history• Language.

Ways in which industry is financedDifferent information needs

• Equity investors • Objective information for stewardship• Fair information for investment decision-making• Reliance on external information

• Loan creditors• Banks principal lenders and shareholders• Access to internal information• Published disclosures less relevant.

Relationship of the tax and reporting systems

• Reporting and tax separate • Separate rules for computing profit for tax• Financial reporting less prescriptive.

Primacy to taxation rules

- Allowance only if in the financial accounts

- Possible misinterpretation when comparing different countries

- Example: treatment of depreciation.

Influence and status of the accounting profession

• If market-sensitive information has been required

• Reliable and relevant information required• Growth of established profession and audit

function• Impact on accounting regulation.

Where there has been less need for market-sensitive information

- Less need for expertise

- Less need for financial management.

Accidents of history

• Effect of commercial scandals• In US led to SEC being set up• In UK led to publishing accounting standards• Financial reporting less prescriptive

• Pooling resources

• External pressures• Joining EU and becoming subject to Directives• Imposed.

US GAAP

• There has been competition for international supremacy between US GAAP and IFRSs

• UK and the USA systems of financial reporting have much in common, BUTIn the USA • there are more rules than in the UK, and • A greater standardisation and disclosure of information.

Legislation• No direct equivalent of the UK Companies Acts in the

USA• The Securities and Exchange Commission (SEC) is

responsible for requiring the publication of financial information for the benefit of shareholders.Power to dictate the form and content of reportsMonitors financial reports.

US GAAP (Continued)

US GAAP – Standard setting

FASB• The Financial Accounting Standards Board (FASB) sets

accounting standards in the USA, and issues:• Statements of Financial Accounting Standards, which deal

with specific issues

• Statements of Concepts, which give general information

• Interpretations which clarify existing standards

• Emerging Issues Task Force.

US GAAP – other mandatory pronouncements

The APB

The Accounting Principles Board (APB) publishes Opinions

The AICPA

The American Institute of Certified Public

Accountants (AICPA) publishes Accounting Practice Bulletins and Opinions

APB and AICPA pronouncements should all be regarded as mandatory.

The wider reach of IFRS

• Transition to IFRSs occurring in EU and Asian Pacific Region, but different national editions of IFRSs appearing

• China - all listed companies in China must comply with IFRS

• The External Reporting Board (XRB) has issued New Zealand equivalents (NZIFRS) that are fully compliant with IFRS, but are not identical to IFRS – there are specific additional requirements considered appropriate to the New Zealand environment

• This means that New Zealand companies’ accounts will be compliant with IFRS, but foreign companies following IFRS will not necessarily be compliant with NZIFRS.

Progress towards adoption by the USA of International standards

Since 2002, there has been collaboration between the Financial Accounting Standards Board (FASB) and the IASB to the development of high-quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting

Review questions

1. Why is it necessary for financial reporting to be subject to (a) mandatory control and (b) statutory control?

2.‘The most favoured way to reduce information overload was to have the company filter the available information set based on users’ specifications of their needs.’ Discuss how this can be achieved given that users have differing needs.