HA 3011 The IFRS Practices
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 purpose of financial reporting is to provide a true picture of the organization in front off its stakeholders. The objectives of the financial are many and as follows:
- Helps in the assessment of the business structure of an organization.
- Helps in future assessment of the cash flow of the future (Ahmed, Neel and Wang 2013).
- Provides useful information to support different investing decisions.
It is important that the primary conceptual framework of any organization’s statement comprises of the following:
- The information provided needs to be comparable in nature. This means that they can be easily compared with other elements in the same year or could be compared with other values during different years.
- The statements must have the capability of faithfully representing the actual information of the given organization. This means that the data needs to be free, completeness, neutral in nature. The statement also needs to be prudent in nature so that the judgements are made carefully (Deegan 2013).
- The information available must be in context of the decision which need to be made at present and also should be available whenever required.
- The information present needs to be clearly portrayed and must be understood carefully by the users. It should not have an impact on the investor’s decision making.
It is a fact that if these information are not present, the purpose of financial statement goes for a toll.
Howeve
r, in the given article, `Unwieldly rules useless for investors` it has been recorded that the different requirements and statements of essential components which has been stated does not appear to be satisfied by the current reporting practices, which have been undertaken by the IFRS practices. The article critically analysis the current practices and states that the current adjustments are not faithful and relevant and tends to lead to misleading information. Furthermore, due to this they are not being able to compare the different companies and make sound investments.
The views stated in the article state that it is very important for the financial reports to satisfy the requirements in the conceptual framework and that it is the duty of the statements to provide useful information with regard to liabilities assets, incomes and equity (Christensen et al. 2015). It is important for the financial reports to satisfy all the characteristics of the framework and the article provided a critical analysis of how they were unable to do so and that the requirements of all stakeholders were not being met.
Answer to Question 2
Public interest theory
The Public Interest Theory states that the economic markets are quite delicate and thus it is the duty of the market to convey information about the security and share prices. However, they do not operate in a manner in which they are supposed to be operating and this leads to a misbalance. The industry gives more importance to the people and economic entities rather than the society. Hence, due to this misbalance it is important that the economic markets and their operations are assessed through government intervention (Hoyle, Schaefer and Doupnik 2015).
The given theory was developed by A.C.Pigou in 1932. The author stated that it is the public needs to raise their voice and also ensure that the development of the regulation takes place so that the activities of the market are kept in check. It is the regulations which contribute well and tend to ensure that in a given society, the interest of the public is greater than that of the individual and the government needs to contribute effectively to this. The government enterprises are bodies of trust and it is their duty to see to it that they do not engage in mal practices. The regulations tend to uphold the society’s interest and they should secure this interest.
Another economist, Stigler in the year 1972 stated that it is the duty of the public to ensure that the resources are distributed equally and that they must insist that the information relevant to their investment is disclosed to them in an efficient manner.
Hence, based on the legislation theory, various legislations must be passed so that the corporate houses disclose all necessary information about their work and that they are provided with all relevant details and the various harms which they put on the society.
The enterprises also need to oblige by this and ensure that the interest of the society is upheld and they do not engage in harmful activities. To gain public support, organizations need to ensure that they are able to publish the information online where the people can read and pass comments as well. The experts shall clear their view on the given requirements as well. This initiative assures that the government engages in transparent activities and that the public is made to be aware about the activities of the firm at large.
Capture theory
The Capture theory states that there exists a relationship between the industry workers and the factory workers is a deep one. Hence, they have the power to dictate the different agencies of the Government and tend to mislead them in order to ensure that they work in the interests of the industry. They tend to destroy the equal distribution of resources in the given society and change the relationships in such a manner that the needs of the society go deployed. The given theory talks about the nexus which takes over the government agencies and the different industries (Hogg 2016).
The government has establishes various centers in the local, state and regional level and they have the duty if looking after the needs of the individuals, however, there takes place a discrepancy when the industry workers tend to strengthen their relation with the governmental agencies. The employees in the government are bribed in order to make different rules with respect to the pricing, control and quality (Christensen, Hail and Leuz 2013). The agencies which have people with expertise in order to ensure they have sufficient interest of the given area of operation.
In a different light, the people in the industry have people with expertise and when the people in the agencies have prior experience in the industry or have future intentions to join, they become the informers for the industry and conduct operations in their favor. Hence, the government agency has been captured in this manner (Weil, Schipper and Francis 2013).
Economic interest group theory of regulation
The economy interest group theory of regulation underlines the fact that in a given industry there exists various groups and investors who work in their own interest and tend to serve in their interest only. The groups are competitive in nature and due to the majority they are able to enforce their pressure on the government so that they are able to enforce laws which are beneficial for them and which tend to act in their favor (Brown, Preiato and Tarca 2014). The main purpose of the group is to gain the group`s economic interest, however, these groups are not concerned with the society at large and are primarily just concerned with their interest and the government as well tends to support these people in order to remain in power and get reflected easily.
These groups tend to overpower the interest of the society and as these groups have monetary as well as social influence, they can lure the government easily. Hence, the theory states that any legislation cannot hold the corporation easily for the outright of various laws which are environmental and social oriented because the government looks after the interest of these groups in their support (Weygandt, Kimmel and Kieso 2015).
Answer to Question 3
The FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets is a developed in order to provide a set of guidelines to the users of the system in order to guide them and help them to take into account the fact that their assets in the organization cannot undergo revaluation but they need to be impaired (Scott 2015). They are required to take into consideration the impairment costs and in this case, these impairment costs are reflected in the financial statements of the organization. The given rules hold relevance and represent faithfulness of financial statements in the United States corporations.
Although this helps in representation of faithfulness, this tends to have a negative impact on the organization`s profits and tends to make it lower than the actual amount. This discourages the various investors of the company and they lose trust and interest in the organization. However, this does not impact the net cash balance in any way (Berry and Wilcox 2018). This also helps in portraying a better picture of the organization with respect to the current activities of the firm. One negative aspect about this is that the historical prospective undergoes a change and due to the depreciation of the financial assets, their value keeps changing throughout. Hence, it is relatively important to adjust impairment costs and the above stated were the impacts of the United States FASB on the concept of representational and relevant faithfulness of the financial statements.
Answer to Question 4
Part A:
Many believe that the revaluation of the assets does not hold any relevance, however this is not the case and the process of revaluation of the assets needs to be conducted in order to understand the fair and actual value of the assets at the given point of time. There exists various reasons why the revaluation of the assets is important to conduct (Mao and Renneboog 2015). These reason are as follows:
- It helps in reflection of fair and actual value of the assets
- It helps in reflecting the present rate of return with respect to capital which is employed
- It comes in useful when the sales of a particular asset takes place (Ball 2006).
- It contributes towards the reduction of the debt equity ratio of the given organization
- In case any merger or acquisition takes place, it helps in the concerned negotiation.
Although the given method is quite beneficial, however, it is not adopted with the different companies and they tend to adopt the cost model of the modern companies. This is because of the following reasons:
It helps in reduced satisfaction of the different investors of the firm. In case the assets are revalued in the current scenario, then the profits of the firms takes a new low and this tends to disappoint the investors as their decision is based on the profits which the organization earns (Khan and Bradbury 2016.)
When the assets are impaired it leads to further reduction in the value of the assets which further contributes towards the reduction of profits (Bradbury 2016). The sustainability of the firm takes a toll and the organization is affected in the given scenario.
As the assets are highly liquid in nature it can be a scenario where the value of the assets are affected severally and they fluctuate to larger amounts. The firm may then achieve the wrong information in such a scenario. In such a case, the various decision makers of the firm tend not revalue their properties which comprise of plant, equipment and other such assets.
Part B:
When an organization decides to not revalue their assets, this has several consequences in the business organization. The consequences may be as follows:
- The financial statements may fail to present a true picture of the organizations accounting system.
- The financial statements will reflect a higher debt to equity rate than the actual one.
- There will exist a faulty rate of capital
- The rights which the shareholders have will not be effective.
- Lastly, the net profit margin reflected in the paper will be inflated and the assets will show an understated value which shall reflect excessive dividends
Part C:
If the assets are not valued then the information which is available in the financial statements are not efficient enough. They reflected inflated profits and lowered value of the assets. Hence, this decreased value of the assets and the low asset backing impacts the share prices in a negative manner. As stated earlier, although this gets balanced by the profit which is expected to be higher, but the bottom line is that the true value of the organization is not portrayed. This can lead to faulty information to the various customers.
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.
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.
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.
Christensen, H.B., Hail, L. and Leuz, C., 2013. Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics, 56(2-3), pp.147-177.
Christensen, H.B., Lee, E., Walker, M. and Zeng, C., 2015. Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), pp.31-61.
Deegan, C., 2013. Financial accounting theory. Graw-Hill Education Australia.
Hogg, M.A., 2016. Social identity theory. In Understanding peace and conflict through social identity theory (pp. 3-17). Springer, Cham.
Hoyle, J.B., Schaefer, T. and Doupnik, T., 2015. Advanced accounting. McGraw Hill.
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.
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