Assessment Task Part A 

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

However, in the given article, the given individuals quoted that the above qualitative characteristics of financial reporting do not appear to be satisfied by current reporting practices pursuant to IFRS. In the article, it has been mentioned that IFRS adjustments are not relevant, faithful and it is often misleading for the investors. In addition to this, the investors are not being able to compare different companies while making investments (Deegan 2013).

However, these views are consistent with the view that corporate financial reports satisfy the central objective of financial reporting as identified in the Conceptual Framework. The objectives of financial reports is to provide relevant information regarding the assets, liabilities income, expenses, equity of the respective organization to all stakeholders (Scott 2015).

Corporate financial reports needs to satisfy all the above mentioned characteristics of Conceptual Framework, in order to meet the needs and requirements of all the stakeholders of financial statements (Weygandt, Kimmel and Kieso 2015).

Assessment Part B

The given question deals with the amendments of Corporation Act to meet social and environmental responsibilities of the organizations.

Public Interest Theory 

According to the Public Interest Theory, the assumption is that the economic markets are very delicate and are not operating in a manner, which they are designated to operate. They are giving more importance to the people than the society. Hence, there is a need to assess the work performed by the economic markets, and this check and balance can be provided by the government intervention. The theory of public interest was propounded by A.C.Pigou in 1932. According to the author, the development of the regulation takes place once the public raises a demand for these regulations in order to rectify the unethical malpractices. Regulations perform the important task of upholding the society’s interest more than the individual member’s interest and the regulatory body’s duty is to secure the interests of the society. The regulatory body should not indulge in the malpractice of safeguarding the regulators by passing laws in their favor. This theory reflects that the efficiency of regulations is not so significant in the society rather the private enterprises use the regulations as a tool to restrict the new competitors from entering the market. The issue with the corporate enterprises is that while they are disclosing their financial information but at the same time, they are not disclosing the other relevant non-financial details such as the impact their activities have upon the environment and the society (Berry 2015).

It is necessary that based on the public interest theory, legislation should be passed which makes it mandatory for the corporate enterprises to give entire detail about the harm, which is being afflicted upon the environment and the society due to their activities. At the same time, the corporate enterprises should be obliged to state the initiatives, which have been started by them in order to undo the harm caused by their activities. In order to assess the necessity to pass the legislation, conducting a survey by the government can be a viable option and the outcome of the survey can be published online. The Government can make the legislation easily accessible for the common people by making it available online. The people can also post their queries regarding the regulation online and the queries should be assessed by an expert’s panel and answered by them.

Capture Theory

According to the Capture Theory, the industry workers dictate the agencies of the Government and these workers are driven by the motive of safeguarding the interests of the industry. These industrial workers even go to the extent of jeopardizing the equal distribution of resources in the society and they manipulate the distribution in such a manner that the societal needs are not fulfilled. The Capture Theory is based on the nexus amongst the government agencies and the industries. The Government establishes the regulating agencies at the central, state and the local levels and entrusts them with the duty to secure the societal needs and safeguard it from the ill effects of the industrial activities. The Capture Theory states that the discrepancy occurs when the Industrial workers create a correlation with the people working in the Government Agencies. The reason why the industry is so interested in infiltrating the government agencies by bribing their employees is because the government’s regulating agencies can frame rules and regulations such as controlling the price, controlling the quality and quantity, setting the minimum standard for the operating activities and to ensure the employees’ protection standards. The need of the hour is that the regulating agencies have the people who possess expertise and profound knowledge about their area of operation (Hogg 2016).

The industry on the other hand, has people with expertise and profound knowledge working for them. If it so happens that the workers working in the government agencies have been former employees of the industry or are planning to join the industry, then they will become informers for the industry and would work in the hope of deriving some favor from the industry. This is where the government agency are said to be captured by the industrial workers. The above analysis infers that this theory is drive by market forces.

Economic Interest Group Theory Of Regulation

According to the economic interest group theory, the groups in an industry are formed with the aim to secure group’s economic interest. There are many groups in existence and these groups are competing with each other. They lure the government to pass legislations in their favor and which secures their interests. The economic groups are not concerned with the interest of the public and the regulators are only concerned with their self-interest, which is to secure their present position by being elected again. In order to be re-elected, the regulators influence the economic groups because these economic groups have the power to influence the public opinion. The economic group possessing monetary strength and influence will be able to lure the government rather than those economic groups with weak influence and less monetary strength. Thus, the economic interest group theory states that any type of legislation will not be able to hold the corporations accountable for their outright violation of environmental and social norms because the legislations are framed by the government keeping the concerns of the industry in hindsight as the government is established by the support of the industrialist (Berry and Wilcox 2018). This theory is driven by market forces and helps the organization to attain goals and objectives by doing the right thing. The operations of the organizations depends upon the existing market forces.

Part C

As per FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, the organizations are not allowed to revalue their assets, but take into account the impairment costs with the non-current assets. However, these rules have for the relevance and representational faithfulness of US corporate financial statements. The impairment costs will reduce the profits of the companies, however, it will not have any impact upon the net cash balance (Mao and Renneboog 2015). These rules provide the users of the financial statements a better picture about the ongoing activities. However, historical prospective are completely ignored in the financial statements. The total amount of depreciation on assets are adjusted every year as carrying value of the assets changes. These are the impact of US Financial Accounting Standards Board on relevance and representational faithfulness of US corporate financial statements (Weygandt, Kimmel and Kieso 2015).

Assessment Part D

Part A: Motivation behind not revaluing the assets

The process of revaluation of assets is done in order to identify the true value of assets at the current point of time. There are many reasons for revaluation. These are as follows:-

• In order to reflect true and fair value of the assets
• In order to show the current rate of return of capital employed
• Negotiation of asset pricing before any merger or acquisition takes place.
• In order to sale a particular asset
• To decrease the debt-equity ratio of the firm (Khan and Bradbury 2016).

However, it has been seen that most of the companies are not in favor of revaluation of assets (property, plant and equipment). There are several reasons behind the selection of cost model of many modern companies. These are as follows:-

• Reduction of satisfaction of the investor- If assets are revalued, then in many cases it reduces the net profit of the firms. This leads to dissatisfaction of the investors as they want to invest on the basis of profits earned by the organization (Williams 2014).
• Historical perspective is lost- Inmany cases, it has been seen that the assets have been lowered down within the year that further lead to decrease of net profits. This further affects the sustainability of the firm and the historical perspective of the organization is affected (Bradbury 2016).
• Higher liquidity in asset value- In case of many business organizations, it has been seen that the assets are extremely volatile and its value fluctuate by large amounts. This further leads to misleading incomes or losses for the organization during that year (Weil, Schipper and Francis 2013).

Due to the above reasons, the directors of the organization are motivated not to revalue their property, plant and equipment.

Part B: Effects the decision not to revalue the assets in financial statements

There will be several effects if the assets of the firm are not revalued on the basis of fair value of accounting. The financial statements would not show a true and fair value position of the firm. The rate of capital employed will not be true. The debt equity ratio of the firm will reflect a higher rate than its original value. Apart from this, rights issue to the shareholders will not take place. In addition to this, the financial statements of the firm will show inflated net profit margins, assets will be understated and it will further lead to excessive dividends (Henderson et al. 2015). These are the effects the decision not to revalue might have on the firm’s financial statements.

Part C: Effect on the wealth of the shareholders

It can be inferred share prices reflect the information available in the financial statements if capital market is not efficient (Weygandt, Kimmel and Kieso 2015). The decreasing value of assets and net asset backing per share may have an impact on the share prices. However, this may be offset by the total amount of the profit which is expected to be higher. Therefore, it can be inferred that if the capital market is efficient, then, revaluation of assets will not have any impact on stockprices and thus on the wealth of the shareholders (Scott 2015).

References

Berry, J.M. and Wilcox, C., 2018. The interest group society. Routledge.

Berry, J.M., 2015. Lobbying for the people: The political behavior of public interest groups. Princeton University Press.

Bradbury, M.E., 2016. Discussion of ‘Other comprehensive income: a review and directions for future research’. Accounting & Finance, 56(1), pp.47-58.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.
Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Hogg, M.A., 2016. Social identity theory. In Understanding peace and conflict through social identity theory (pp. 3-17). Springer, Cham.

Khan, S. and Bradbury, M.E., 2016. The volatility of comprehensive income and its association with market risk. Accounting & Finance, 56(3), pp.727-748.

Mao, Y. and Renneboog, L., 2015. Do managers manipulate earnings prior to management buyouts?. Journal of Corporate Finance, 35, pp.43-61.

Scott, W.R., 2015. Financial accounting theory (Vol. 2, No. 0, p. 0). Prentice Hall.

Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to concepts, methods and uses. Cengage Learning.

Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & managerial accounting. John Wiley & Sons.

Williams, J., 2014. Financial accounting. McGraw-Hill Higher Education.