HA 3011 Mao and Renneboog The Financial Reporting’s Serves
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 (6 Marks)
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 (4 Marks)
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 (4 Marks)
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?
Answer:
The article named “Unwieldy rules useless for investors”, states that the current financial accounting standards and the IFRS are not fit enough to given the legislation and they have stated a wide variety of reasons behind it. According to Mao and Renneboog (2015), the financial reporting’s serves various objectives which are given as follows:
- They have the capability of providing information while making investment decisions
- They also help in assessment of cash flows
- They help in analysis of the business structure if the organization (Bentley, Omer and Sharp 2013).
The conceptual framework of a financial report must consist of the given points:
- The financial statements needs to be relevant in nature and they will be able to change the decision made by the investors.
- They should have the ability to be compared. This comparison may take place with respect to the statements of the same year or of another year. Statements of the other industries might also be compared accordingly (Wang 2014).
- They need to possess the quality of faithful representation and be true in nature. This means that the statements need to portray the actual condition. The financial statements do not need to lie about anything and for this purpose, they need to be complete. There must also exist prudence in the statements which assist during judgements to be made.
- The financial statements need to be available on time (Scott 2015). They will hold no power to assist any investor in case where the time has already passed. The decision makers will be requires o take effective decision based on their requirements.
- The financial statements need to possess clarity as well. This means that when the investors are making use of it then they should be understandable for all.
If these characteristics are not present, the financial statements go useless. As these concepts need to be present, the given article shares views which are consistent with the view that the financial reports need to possess the given points and it is important for it to given useful information to the different users in regard to assets, liabilities and income statements (Brown, Preiato and Tarca 2014). However, it has also been stated in the article that the stated qualitative characteristics of the financial reporting are not covered under the IFRS and official reporting standards. The given standards are irrelevant and misleading which do not serve their purpose. They lack comparability aspects as well which makes decision making difficult.
Hence, thereby arises a need to improve the given standard and ensure that the financial reports of the different corporates satisfies the above mentioned points and requirements so that it is ensured that the requirements of all the stakeholders are solved adequately.
Assessment Part B
The Public Interest Theory
According to the given theory on Public Interest, there lies an assumption that the capital market does not operate in thee desired manner and that additional importance is given to the different members in an industry rather than giving importance to the members of the society. Hence, for this reason, it is important for the public to keep a check on the different operations of the market and ensure that they perform in favor of the general public as well. For this reason, the public interest theory was formed by A.C.Pigou in 1932. In the given theory, it was stated that the public needs to be aware about these situations and it is increasingly important for them to ensure that there exists no unethical or mal practices. It is the primary responsibility of a regulation to ensure that the society’s interest is held and the government works towards their welfare. The regulatory body in charge needs to ensure that the practices of the organization are in line with the practices of the firm and that the interest of the society is upheld.
A theory stated by Stigler, states the exact opposite of this and it is given that, the efficiency of the different theories is not as important as the fact that the private enterprises make use of the regulations as a barrier for the new firms who are primarily interest in joining the organization (Barth, Landsman and Lang 2008). The main problem in the given scenario is that when the different firms disclose the information about the working of their organizations then they do not portray all the integral sets of information but only the financial ones.
The given theory makes it important for the different firms to portray the financial as well as non-financial aspects which will elaborate upon the harmful activities conducted by the organization and their impacts on the organization in general (Weil, Schipper and Francis 2013). They need to be regulated upon the kind of initiatives which should be taken and how the harmful impacts may be mitigated.
The general public also needs to be made aware about these initiatives so that they are easily able to understand and read the related rules online as well.
Capture theory
The capture theory states that the different workers working for the welfare for a given industry tend to work and safeguard the interests of the industry. The people involved in the industry often go to the extent of contributing towards the jeopardizing the distribution of resources and manipulate them (Teixeira 2014). The given theory states that the workers in an industry tend to form relationships with the ones working in the governmental agencies and through this they tend to manipulate them in order to get certain favors for their organization (Ball 2006).
The employees are bribed and the governmental agencies tend to work towards framing of rules, regulations and other such policies like control of quality and quantity, operating activity regulation and employees` protection standards in the favor of them. The industry has the possession of such experts who have profound knowledge and tend to gain adequate information from the governmental agencies who then tend to become the informers in hope of favors. These areas are the one where the governmental organizations are stated to be captured by the workers in the industry.
Economic interest group theory of regulation
The given economic interest group theory states that there exists different groups in an industry and that these industries tend to form a cluster and use their economic powers in order to influence the various people in order to seek their self-interest. These groups are often in a competition with one another (Ahmed, Neel and Wang 2013). They tend to use this power in order to motivate the employees to make use of these economic powers to influence the decision making of the government and see to it that the government makes decisions which are beneficial for the purpose of the organization.
These groups tend to function in their own interest and do not consider the public`s interest in consideration (Weygandt, Kimmel and Kieso 2015). Their decision making tends to take over the decision of the government and their own interest of getting reelected tends to make them make laws in favor of the groups. The monetary power is used by them and they tend to change the legislation in their favor. These legislations may include legislations like violation of social and environmental laws. The government on the other hand will not be able do anything as they are under the industrialist. This can be described as the vicious cycle of the relationship between the Government and the industry.
Assessment Part C
Revaluation of the assets is considered to be an essential part of an organization and this is what the FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, talks about. According to the given law, the different organizations are not allowed to conduct the revaluation of their assets and instead they are required to take into account the impairment costs of their non-current assets (Nobes 2014). These given rules have been stated down because they assist in the revaluation of the assets which is actually not allowed, but instead the firms are supposed to take into impairment costs into consideration. These rules have been present in order to determine relevance and represents faithfulness of the different financial statements in the United States and countries.
However, the impairment costs which are required to be added tend to reduce the profitability of the company but do not have an impact on the net cash balance (Leuz and Wysocki 2016). The given rules are present because they support a better picture with respect to the ongoing activities which take place in an organization and help the investors in making better decisions. However, in the given scenario, the historical cost perspectives are completely ignored in these statements and the amount of depreciation which is carried forward and adjusted annually keeps changing.
Discussed above were the impacts of the US Financial Standards Board`s impact on the importance and relevance of the financial statements in US.
Assessment Part D
Part A:
The true value of an asset cannot be identified in case the revaluation of an asset has not been done. Hence, revaluation goes a long way in helping a company to find the correct value. The reasons why the revaluation takes place has been given as follows:
- They help in the reflection of true and fair value of the chosen assets
- They reflect the correct rate of return of capital which has been employed currently
- When an acquisition is about to take place, it assists in the negotiation with respect to the pricing of the asset (Williams 2014).
- It helps during the sales of the particular essay
- It also contributes towards decreasing the debt equity ratio of the organization.
Although revaluation has the stated advantages, many companies are not in favor of conducting the business because of the following reasons and they often choose to select the cost model. The reasons are given as follows:
- It reduces the satisfaction level of the investor. In cases where the assets are revalued then the profit of the firm tends to go down which is not favorable from the side of the investor. Hence, when the investors view the reduced profit of the company, it helps in reduced satisfaction (Lequiller and Blades 2014).
- The revaluation of the asset ignores the historical cost perspective. When the assets are lowered in price it leads to further reduction in the profits which ultimately has a bad effect on the sustainability of the organization.
- Conducting revaluation gives rise to higher liquidity in the value of the assets. The assets are quite volatile in nature and tend to fluctuate by larger amounts. This causes incomes which may not be true and may portray false losses as well.
After reflecting upon the given reasons, the directors of the firm do not want to revalue the assets.
Part B:
In case the assets of an organization are not valued effectively, the following may be the impacts. First of all, the organization may not be able portray the true and fair image of the organization. Secondly, due to this, the rate of capital will also not be an honest one. The debt equity ratio will also result in the reflection of a negative amount or a higher rate than it actually is. Thirdly, the shareholders will not be able to exercise their right and the financial statements will not be able to show the true profits which will then result in excessive dividend distribution by the company.
Part C
It is often stated that it is the duty of the share market to reflect the correct share prices, however this is always not the case and very often the investors have to look into the financial reports for assistance. The decrease in the value of the shares might have a huge impact on the share prices and though it may be balanced through an offset, the investors may not get the true picture of the firm. Hence, the inefficiency of the capital market leads to grater disparities during the revaluation of the assets (Jorissen et al. 2013). If the markets will be efficient, it may have little or no impact on the wealth of the different investors.
References
Ahmed, A.S., Neel, M. and Wang, D., 2013. Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), pp.1344-1372.
Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), pp.5-27.
Barth, M.E., Landsman, W.R. and Lang, M.H., 2008. International accounting standards and accounting quality. Journal of accounting research, 46(3), pp.467-498.
Bentley, K.A., Omer, T.C. and Sharp, N.Y., 2013. Business strategy, financial reporting irregularities, and audit effort. Contemporary Accounting Research, 30(2), pp.780-817.
Brown, P., Preiato, J. and Tarca, A., 2014. Measuring country differences in enforcement of accounting standards: An audit and enforcement proxy. Journal of Business Finance & Accounting, 41(1-2), pp.1-52
Jorissen, A., Lybaert, N., Orens, R. and Van der Tas, L., 2013. A geographic analysis of constituents’ formal participation in the process of international accounting standard setting: Do we have a level playing field?. Journal of Accounting and Public Policy, 32(4), pp.237-270.
Lequiller, F. and Blades, D., 2014. Understanding national accounts.
Leuz, C. and Wysocki, P.D., 2016. The economics of disclosure and financial reporting regulation: Evidence and suggestions for future research. Journal of Accounting Research, 54(2), pp.525-622.
Mao, Y. and Renneboog, L., 2015. Do managers manipulate earnings prior to management buyouts?. Journal of Corporate Finance, 35, pp.43-61.
Nobes, C., 2014. International Classification of Financial Reporting 3e. Routledge.
Scott, W.R., 2015. Financial accounting theory (Vol. 2, No. 0, p. 0). Prentice Hall.
Teixeira, A., 2014. The International Accounting Standards Board and evidence-informed standard-setting. Accounting in Europe, 11(1), pp.5-12.
Wang, C., 2014. Accounting standards harmonization and financial statement comparability: Evidence from transnational information transfer. Journal of Accounting Research, 52(4), pp.955-992.
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.
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