Ha3011 Advanced Financial Accounting - Assessment Answers

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 satisfv the central obiective 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?

Answer:

Introduction

This paper focuses on qualitative characteristics financial reporting and also has a view of the corporate financial reports with a Conceptual Framework. The other perspectives on the theory are public interest, capture and economic interest group theory of regulation. There is also a regular analysis of relevance and representational faithfulness of US corporate financial statements. A great break down on property reevaluation, plant, and equipment as well as firms financial statements. Shareholders effect on wealth and various decisions concerning financial accounting. The FASB Statement used in the task review; The No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. Given situational analysis on Australian government on corporate social responsibility deciding on market forces with legislation also given a situational outlook on this paper

A detailed analysis of financial reporting is the central focus of the article based on the scenario assessment tasks. Financial reporting can also be viewed as financial statements which are described as a formal record of company’s business and financial activities. The adoption of the financial records of another global market to help investors monitor their activities is picking pace. This is not just an issue that has risen creating a debate on whether it is a relevant measure of gauging global markets activities or a misleading phenomenon. Social corporate responsibility refers to the activities a company does in the name of giving back to the society that will be beneficial to the external shareholders. Abbreviated as CSR, its aim is usually on the social and environmental responsibilities a specific company has to do, according to the set principles of the particular organizations or the Corporations Act as per the company registration guide. The argument in the task assignment creates an angle to be debated on whether the moral act of a company should be forced.

Part A: Qualitative characteristics of financial reporting

According to the conceptual framework of the international financial reporting, millions of dollars have been spent to adopt international standards to help investors make like-for-like comparisons between companies in the global capital market. As per the financial requirements, IFRS contains qualitative financial characteristic of financial reporting to be satisfied by the current reporting practices (Whittington 2008). The qualitative characteristics of financial reporting are as follows;

Understandability: The information must be readily understandable to users of the financial statements. This means that information must be represented, with additional information supplied in the supporting footnotes as needed to assist in clarification. In an article that appeared in the Australian Financial Review on 6 February 2012 (by Agnes King) clearly states that investors rely much on investor reports and management briefings to understand the companies’ numbers, this appears to be satisfied by current reporting practices under IFRS as defined in ED (IASB, 2008).

Relevance: The information must be relevant to the needs of the users, which is the case when information influences the economic decisions of users. This may involve reporting particularly relevant information or information whose omission or misstatement could affect the financial arrangements of the targeted group. Relevance is satisfied by the current reporting practices, and this is helpful to the users as defined in ED (IASB, C.F 2010)

Reliability: The information must be free of material error and bias and not misleading to the target users. Should reflect facts and figures of the finances. Thus, the information should faithfully represent transactions and other events, and prudently represent estimates and uncertainties through proper disclosure (Walton 2018). This is according to Accounting Tools on 11 February 2018, from the Australian Financial Review (by Agnes King) according to Wesfarmers finance director Terry Bowen says the notes are only reliable to the technically trained if not they could be misleading. Thus, reliability appears to be satisfied by current financial reporting as defined in ED (McGregor and Street 2007).

Comparability: The information must be comparable to the financial information presented for other accounting periods so that users can identify trends the performance and financial position of the reporting entity. Allows the targeted uses to be able to compare various previous financial reports before they take action, for investors if it is favorable they invest.

Verifiability: The information must be verified by the specific is institution concerned to make sure the information provided is right and no errors available, this characteristic satisfies the current financial reporting as defined in ED (IASB, 2008).

The Financial characteristics above are consistent with the view that corporate financial reports satisfy the central objective of financial reporting. As the objectives of the financial reporting are as follows:

1. The primary objective of financial reporting is to provide information that is useful to present and potential investors and creditors and other users in making rational Investment, credit, and similar decisions. The information should be Understandable.
2. Financial reporting should provide information to help present, and potential investors and creditors and other users assess the amounts, timing, and uncertainty of prospective cash receipts. The information should be Reliable.
3. The financial reporting should provide information about the economic resources of an enterprise; the claims to those resources; and the effects of transactions, events, and circumstances.

Assessment Task Part B: Public Interest Theory

From a public interest theory perspective, the government would introduce the legislation if they believe that the projected benefits to society exceed the projected costs. Determining cost and benefits is physical exercise, and the assessment necessarily means some parties might benefit while others may bear more cost from the legislation introduced. It is balancing act. Regulation is one of the state’s core functions. It is also its traditional functions; regulations define the border between state and society, government, and market. Therefore, regulation presents governments attempt to set the scope of private activities. If the government produces a good or services under its mandate for example by state-owned enterprises or public hospital, it is not responsible for speaking of regulation. On the other hand, if a private firm provides the same services, say transportation or hospital, schools within the confines defined by legislation, we have to do with regulations. In other words, the importance of regulation as an instrument of public policy is highly variable. It depends on the national context, implying very different conceptions in Australian society and continental Europe (Zhang and Andrew 2014).

Capture Interest Theory

This suggests that ultimately it will be the regulated party that captures the regulatory process to ensure that any subsequent regulation best serves its interests.  The disclosure will have particular implications for the organizations that generate various significant environmental and social impacts. For example, timber and transport industries. Perhaps specific industry associations will take actions to ensure they can impact the regulations through securing the support of people on the regulatory body of maybe gaining membership of the body Scott, W.R., 2015.

Economic Interest Group Theory of regulation

The economic interest group theory of regulation proposes that self-interest drives all people including politicians and regulators. Therefore, from this perspective, the disclosure regulation would only be supported by the regulators if somehow, the regulation provided benefits to them. Because large organizations can tend to have a high level of political power through the financial support of the regulators or related government, or through potential control over a large number of votes we might question whether strong legislation would be enacted that negatively impact large corporations (Tracey 2015).

The theories cover an extended period, public interest regulation up to the 1960s until public choice theory launched its critical attack on established theory. Similarly, the apparent realism and critical stance of the 20th century. Finally, the theory of credible commitment is closely related to the regulatory reforms and that followed from market opening and privatization of public services utilities that took off in the 1990s and has persisted since 2000.common to the three sets of theories are their consistent focus on regulatory administration being its tasks its organization and its performance (Smieliauskas, Craig and Amernic 2017). A further common trait of the three theories is that the theory is that they operate with the concept of the public interest. For any of the three theories, the concept remains elusive, easy to invoke in political disclosure but to challenge to maintain in operational (Schroeder, Clark and Cathey 2011). A solution to this challenge it distinguishes between the interests of regulated business and citizens and those third parties that have a stake in regulated activity affects negatively.

Assessment Task Part C

What implications of rules have for the relevance and representational faithfulness of US corporate financial statements?

The revaluation of fixed assets is the processor decreasing their carrying value in case of significant changes in the fair market value of the fixed asset. International financial reporting standards require fixed assets to be initially recorded at cost, but they allow two models for subsequent accounting for fixed assets which are the cost model and the revaluation model (McGregor and Street 2007). In cost model, the fixed assets are carried at their historical cost less accumulated depreciation and accumulated impairment losses, there is no upward adjustment to value due to changing circumstances. In revaluation model, an asset is initially recovered at cost, but subsequently, its carrying amount is increased to account for any appreciation in value (Berker 2015). The difference between cost model and revaluation model is that revaluation model allows both downward and upward adjustment in the value of an asset while model allows downward adjustment due to impairment loss (Deegan 2013).

Fair value is measured assuming a transaction in the principal market for the asset or the liability. In the absence of a principal market, it is assumed that the transaction would occur in the most advantageous market. This is the market that would maximize the amount that would be received to sell an asset or minimize the amount that would be paid to transfer a liability, taking in to account the transaction and transport cost. In either case, the entity needs to have access to the market, although it does not necessarily have to be able to transact in that market on the measurement date (Bauer, O'Brien and Saeed 2014).

PART D

Factors that might motivate directors not to revalue the property, plant, and equipment.

1. To maintain the leverage ratio (the ratio of debt to equity) on the equipment.
2. To get the fair market value of assets or properties in case of sale and leaseback transaction.
3. To show the real rate of return on capital.

Some of the effects the decision not to revalue might have on the firm’s financial statements.

The decision not to revalue a firm might affect firm’s financial statements in many ways.

1. An increase in the book value of the asset results in an increase in total assets and equity and turn reduces leverage.
2. The decrease in the book value of the asset reduces net income.
3. It decreases the carrying amount resulting in the decline in ROA and ROE in the particular year
4. The profitability appears to maintain and increase in future years. 

The decision not to revalue adversely affect the wealth of the shareholders:

Yes, the decision not to re-evaluate will adversely affect the shareholders; the net income of the shareholders would reduce. During devaluation, the firm could experience losses in due time, and these losses would be shared among the shareholders. Thus the wealth of the shareholders would adversely reduce.

In conclusion revaluation of assets is a vital accounting decision in the firm as it impacts various financial statements.

References

Berker, R., 2015. Conservatism, prudence and the IASB’conceptual framework. Accounting and Business Research, 45(4), pp.514-538.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

IASB, C.F., 2010. The conceptual framework for financial reporting, as in September 2010. International Accounting Standards Board, London, UK.

McGregor, W. and Street, D.L., 2007. IASB and FASB face challenges in pursuit of joint conceptual framework. Journal of International Financial Management & Accounting, 18(1), pp.39-51.

Schroeder, R.G., Clark, M.W. and Cathey, J.M., 2011. Financial accounting theory and analysis: text and cases. John Wiley and Sons.

Smieliauskas, W., Craig, R. and Amernic, J., 2017. GAAP as Ineffective Legal Defense of Financial Reporting: Implications for Truthfulness, Auditability, and the IASB's Proposed 2015 Conceptual Framework.

Tracey, E., 2015. Discussion of ‘Conservatism, prudence and the IASB's conceptual framework’by Richard Barker (2015). Accounting and Business Research, 45(4), pp.539-542.

Walton, P., 2018. Discussion of Barker and Teixeira ([2018]. Gaps in the IFRS Conceptual Framework. Accounting in Europe, 15) and Van Mourik and Katsuo ([2018]. Profit or loss in the IASB Conceptual Framework. Accounting in Europe, 15). Accounting in Europe, pp.1-7.

Whittington, G., 2008. Fair value and the IASB/FASB conceptual framework project: an alternative view. Abacus, 44(2), pp.139-168.

Zhang, Y. and Andrew, J., 2014. Financialisation and the conceptual framework. Critical perspectives on accounting, 25(1), pp.17-26.