An overview of the New Zealand external reporting environment

1
Chapter 1

• An overview of the New Zealand external
  reporting environment

2
Objectives

• Understand the extent of regulation relating to
  which New Zealand external financial reporting is
  subject.
• Be able to explain the general functions of the
  Accounting Standards Review Board, the Financial
  Reporting Standards Board and the New Zealand
  Stock Exchange.
• Understand the role of a financial reporting
  standard and the process by which it is developed.

3
Objectives (cont.)

• Be able to explain the five elements of
  accounting and be aware of the respective
  recognition principles.
• Be able to explain the objectives and potential
  shortcomings of the New Zealand Statement of
  Concepts for General Purpose Financial Reporting.

4
Objectives (cont.)

• Understand the role of the International
  Accounting Standards Board and be aware of the
  program, currently in place within New Zealand,
  to harmonise New Zealand financial reporting
  standards with pronouncements issued by the
  International Accounting Standards Board and the
  Australian Accounting Standards Board.

5
Financial accounting defined

• Financial accounting is a process involving the
  collection and processing of financial
  information to assist the decision-making needs
  of parties external to the organisation.
• Contrasted with management accounting
• focuses on providing information for decision
  making by parties within the organisation
• largely unregulated.
• Financial accounting heavily regulated.

6
User demand for general purpose financial reports

• Users may be defined to include
• present and potential investors
• employees
• lenders
• suppliers and other trade creditors
• customers
• government and its agencies
• the public.
• Only certain users may have the power to demand
  specific information to meet their needs.

7
Sources of external financial reporting
regulations

• The Accounting Standards Review Board (ASRB)
• The Financial Reporting Standards Board (FRSB)
• The New Zealand Stock Exchange (NZSE)

8
Background to NZ accounting standard-setting
process

• Until 1993 regulation of accounting profession
  was in the hands of the private sector.
• 1987 share market collapse led to an inquiry to
  review share market law and recommend changes to
  ensure the existence of a fair and efficient
  market.

9
Background to NZ accounting standard-setting
process (cont.)

• A number of recommendations made, including
• legal backing be given to accounting standards
• an Accounting Standards Review Board be
  established to approve accounting standards
• sanctions be put in place for non-compliance with
  standards.

10
Accounting Standards Review Board (ASRB)

• Financial Reporting Act 1993 (FRA) is the primary
  statute governing the establishment of accounting
  standards.
• ASRB constituted as a body corporate under the
  FRA.
• Functions of ASRB provided by section 24
• of FRA.

11
Application of financial reporting standards

• Financial reporting standards approved by the
  ASRB normally apply to all financial statements
  prepared by all reporting entities or groups.
• However, financial reporting standards may be
  expressed to apply to specific classes of issuers
  or companies (e.g. by size of the entity).

12
Application of financial reporting standards
(cont.)

• Financial statements means statements
  comprising
• a statement of financial position
• a statement of financial performance (or an
  income and expenditure account)
• a cash flow statement
• explanatory notes.

13
Application of financial reporting standards
(cont.)

• An issuer includes companies that have allocated
  securities to the public.
• Issuers include
• entities that have allocated securities to the
  public by way of a registered prospectus
• unit trusts
• registered banks.

14
Application of financial reporting standards
(cont.)

• Small companies are treated as an exempt
  category.
• Company or issuer is exempt if
• total assets did not exceed 450 000
• turnover did not exceed 1 000 000
• the company was not a subsidiary
• the company did not have subsidiaries.

15
Framework for differential reporting

• Applies to general purpose financial reports
  only.
• Under the framework, qualifying entities are
  granted full or partial exemption from complying
  with certain financial reporting standards.
• The frameworks use is justified on the grounds
  that accounting standard overload and compliance
  costs are reduced.

16
Financial reporting standards, GAAP and the true
and fair view

• GAAP describes the basis on which general purpose
  financial reports are normally prepared.
• It encompasses specific rules, practices and
  procedures relating to particular circumstances
  and broad concepts and principles of general
  application.

17
Financial reporting standards, GAAP and the true
and fair view (cont.)

• Financial statements comply with GAAP only if
  those statements comply with
• applicable financial reporting standards or
• where there are no applicable financial reporting
  standards or rule of law, with accounting
  policies that are appropriate to the
  circumatances of the reporting entity and have
  authoritative support within the accounting
  profession in New Zealand.

18
Financial reporting standards, GAAP and the true
and fair view (cont.)

• Compliance with GAAP usually means that financial
  statements give a true and fair view of an
  entitys financial position, performance and cash
  flows.
• Financial statements must provide a true and
  fair view.
• No legal definition of true and fair view.

19
Financial reporting standards, GAAP and the true
and fair view (cont.)

• Two views on true and fair view
• could be met by companies complying with
  financial reporting standards when preparing
  general purpose financial reports or
• could imply more than simply complying with
  financial reporting standards.
• Financial statements should include all
  information of a material nature.

20
Directors responsibilities

• Directors of a company are responsible for the
  maintenance of accounting records.
• Although not specifically required, a number of
  New Zealand companies include a section in their
  directors reports dealing with directors
  responsibilities.

21
Directors report

• No formal requirement for a directors report.
• Section 211(1)(a) of Companies Act 1993 requires
  that every annual report
• be in writing
• be dated
• describe the state of the companies affairs
• will not be harmful to the business of the
  company or any subsidiary or
• change during the accounting period in
• the nature of the business
• the classes of business in which the company has
  an interest

22
Directors report (cont.)

• A number of additional items must be disclosed,
  including
• particulars of entries in the interests register
  made during the accounting period
• names of persons holding office as directors at
  end of and during the accounting period.

23
Financial Reporting Standards Board (FRSB)

• FRSB is a board of ICANZ.
• Members are appointed by the Council of ICANZ.
• FRSB is responsible for developing and revising
  financial reporting standards, sources of
  authoritative support, maintance of the Statement
  of Concepts, guidance notes and technical
  practice aids.

24
Development of a financial reporting standard

• Until 1997, financial reporting standard projects
  originated from
• outcomes of IASC work programs
• harmonisation with Australia
• issues raised by ICANZ members
• responses to changes or new developments
• review of changes to existing financial reporting
  standards in response to the continued
  development of the Statement of Concepts.

25
Development of a financial reporting standard
(cont.)

• In 1997 the FRSB decided that future financial
  reporting standards would be developed based on
  those issued by the IASC or AASB.
• A discussion paper would accompany the exposure
  draft in which the implications for New Zealand
  entities would be outlined.

26
Urgent issues group (UIG)

• No formal UIG exists in New Zealand.
• FRSB directs those seeking clarification on a
  financial reporting standard to
• amendments to standards
• interpretations to standards
• guidance notes.

27
New Zealand Stock Exchange (NZSE)

• For entities listed on NZSE there are additional
  reporting requirements contained in Listing
  Rules.
• NZSE can also require compliance with a
  particular accounting standard, for example IAS
  33 Earnings Per Share.

28
The Conceptual Framework (CF)

• FRSB is responsible for the maintenance of the
  Statement of Concepts.
• Framework seeks to define the nature, subject,
  purpose and broad content of general purpose
  financial reporting.
• Argues that Statement of Concepts is not a CF
  because a cohesive set of principles to guide
  financial reporting has not been established.

29
The Conceptual Framework (CF) (cont.)

• Central goal in establishing CF is general
  consensus on
• scope and objectives of financial reporting
• qualitative characteristics that financial
  information should possess
• elements of financial reporting.

30
Benefits of Conceptual Framework

• More consistent and logical financial reporting
  standard can be developed.
• Increased international comparability.
• The Boards should be more accountable for their
  decisions.
• Enhanced process of communication between the
  Boards and constituents.
• More economical accounting standard development.

31
SC 2 Reporting entity

• A reporting entity exists where it is reasonable
  to expect the existence of users dependent on
  general purpose financial reports (GPFRs) for
  information which will be useful to them.
• GPFRs provide information to meet the needs of
  external users unable to acquire, or contract
  for, special purpose financial reports.

32
SC 3 Objectives of GPFRs

• To provide information to assist users in
  assessing the reporting entitys
• financial and service performance, financial
  position and cash flows
• compliance with legislation, regulations, common
  law and contractual arrangements and
• making decisions about providing resources to, or
  doing business with, the entity.
• Financial reporting has an accountability and an
  information or decision-making role.

33
SC 4 Qualitative characteristics

• Identifies the characteristics of financial
  information necessary to allow users to make and
  evaluate decisions about the allocation of scarce
  resources.
• Primary qualitative characteristics
• relevance
• reliability

34
SC 4 Qualitative characteristics (cont.)

• Information is relevant if it can be used to
• confirm or correct prior expectations about past
  events (feedback value)
• assist in forming, revising or confirming
  expectations about the future (predictive value).
• Information is reliable when it
• corresponds with actual underlying transactions
  and events (representational faithfulness)
• is capable of independent verification
  (verifiability)
• is free from bias (neutrality).

35
SC 5 Assumptions underlying the preparation of
GPFRs

• Three basic assumptions underlie GPFRs
• going-concern assumption
• period reporting assumption
• accrual-basis assumption.
• Where assumptions are not appropriate or have not
  been used, the alternative assumptions used must
  be disclosed.

36
SC 6 Influences on qualitative characteristics

• Four significant influences in adopting
  particular characteristics
• balance between qualitative characteristics
• balance between benefit and cost
• materiality
• Prudence.

37
SC 6 Influences on qualitative characteristics
(cont.)

• GPFRs should include all financial information
  that satisfies the concepts of relevance and
  reliability, to the extent that such information
  is material.
• Materiality is a matter of professional judgement
  although SSAP-6 does provide guidance on base
  amounts.

38
SC 7 Definition and recognition of assets

• Assets are defined as
• service potential or future economic benefits
  controlled by the entity as a result of past
  transactions or other past events.

39
Definition and recognition of assets (cont.)

• Three key characteristics of definition
• there must be service potential or future
  economic benefits
• the reporting entity must control the service
  potential or future economic benefits and
• the transaction or other event giving rise to the
  control must have occurred.

40
Definition and recognition of assets (cont.)

• An asset shall be recognised in the financial
  statements when
• it is probable that the service potential or
  future economic benefits embodied in the asset
  will eventuate and
• it possesses a cost or other value that can be
  measured with reliability.
• probable is defined as more likely rather than
  less likely.

41
Definition and recognition of liabilities

• Liabilities are defined as
• future sacrifices of service potential or future
  economic benefits that the entity is presently
  obliged to make to other entities, as a result of
  past transactions or other past events.

42
Definition and recognition of liabilities (cont.)

• There are three main characteristics
• the entity is presently obliged to act or perform
  in a certain way
• the action will have adverse financial
  consequences for the entity
• a past transaction or other event must have
  occurred to create the obligation.

43
Definition and recognition of liabilities (cont.)

• Recognition in financial statements again
  requires two tests to be met
• it is probable that the future sacrifice of
  service potential or future economic benefits
  will be required and
• the amount of the liability can be measured
  reliably.

44
Definition and recognition of liabilities (cont.)

• If a liability cannot be measured reliably but is
  potentially material it should be disclosed
  within the notes to the accounts.

45
Definition and recognition of expenses

• The definition is dependent upon the definition
  of assets and liabilities.
• Expenses are defined as
• consumptions or losses of service potential or
  future economic benefits in the form of
  reductions in assets or increases in liabilities
  of the entity, other than those relating to
  distributions to the owners, that result in a
  decrease in equity during the reporting period.

46
Definition and recognition of expenses (cont.)

• Expenses are recognised when
• it is probable that the consumption or loss of
  service potential or future economic benefits
  resulting in a reduction in assets and/or
  increase in liabilities has occurred and
• the consumption or loss of economic benefits can
  be measured with reliability.

47
Definition and recognition of revenues

• Again the definition is dependent on asset and
  liability definitions.
• Revenues are defined as
• inflows or other enhancements, or savings in
  outflows, of service potential or future economic
  benefits in the form of increases in assets or
  reductions in liabilities of the entity, other
  than those relating to contributions by owners,
  that result in an increase in equity during the
  reporting period.

48
Definition and recognition of revenues (cont.)

• Revenues can be recognised in the financial
  statements when
• it is probable that the inflow or other
  enhancement or saving in outflows of service
  potential or future economic benefits has
  occurred and
• the inflow or other enhancement or saving in
  outflows of service potential or future economic
  benefits can be measured with reliability.

49
Definition of equity

• Equity is defined as
• the residual interest in the assets of the entity
  after deduction of its liabilities.
• Directly a function of the definition given to
  assets and liabilities.

50
Critical review of the Conceptual Framework (CF)

• Objective of GPFRs in CF implies that financial
  reports should be primarily economic in focus.
• Should social issues be ignored in the annual
  report?
• An individual's view of business responsibilities
  directly impacts on the perceptions of
  accountability.

51
Critical review of the CF (cont.)

• In determining whether an entity is a reporting
  entity, is the need for information to enable
  informed resource allocation decisions the only
  or dominant thing to consider?

52
Critical review of the CF (cont.)

• Economic focus of GPFRs ignores transactions or
  events not resulting from market transactions or
  an exchange of property rights.
• Ignores environmental externalities caused by
  business.

53
Critical review of the CF (cont.)

• Financial statements included within reports only
  reflect financial performance and do not provide
  a means of assessing social performance.
• Financial press also generally uses financial
  indicators as a guide to a firms success.

54
Critical review of the CF (cont.)

• The Conceptual Framework simply codifies existing
  practice.
• Conceptual frameworks have been used as devices
  to legitimise the existence of the accounting
  profession.

55
Harmonisation of New Zealand and International
Accounting Standards

• Since 1993 ASRB required to liaise with
  Accounting Standards Board in Australia to
  harmonise New Zealand and Australian financial
  reporting standards.
• Harmonisation compatibility but with some
  variations.

56
The International Accounting Standards Committee
(IASC)

• Established in 1973.
• Aims to bring together parties from throughout
  the world to develop accounting standards that
  apply internationally.
• Representatives from over 100 countries.
• Replaced by International Accounting Standards
  Board (IASB) in April 2001.

57
Importance of International Accounting Standards

• Referred to as indication of possible best
  practice when standards being developed by
  countries with their own standard-setting process
  in place.
• Useful guidance when no domestic standard relates
  to a particular accounting issue.
• Have been directly adopted by countries which do
  not have their own accounting standards.

58
Structure of new IASB

• Group of trustees responsible for appointment of
  IASB members.
• IASB has 12 full-time members and 2 part-time
  members.
• Publication of IAS or exposure draft requires
  approval by at least 8 Board members.

59
Harmonisation with IASC standards

• IAS issued by IASB are deemed to have
  authoritative support in New Zealand.
• Inconsistencies between NZ financial reporting
  standards and IAS (and Australian accounting
  standards) are highlighted in conformity
  statements included as appendixes to financial
  reporting standards.

60
New Zealand representation on the IASB

• NZ does not have strong representation on the
  IASB.
• IAS development process does allow for New
  Zealand input.

61
Rationale for harmonisation

• If New Zealand retains unique accounting
  standards, inflow of foreign investment will be
  restricted.
• Need for common accounting language to facilitate
  investor evaluation of domestic and foreign
  corporations.
• Avoids costly accounting conversions by foreign
  listed companies.

62
Implications of harmonisation

• Numerous changes to New Zealand financial
  reporting standards in recent years, and still
  ongoing.
• Numerous new standards to cover issues not
  previously addressed by financial reporting
  standards.

63
Perceived benefits of harmonisation

• Improve quality of financial reporting.
• Increase comparability of financial reports
  prepared in different countries means better
  quality information to participants in
  international capital markets.
• Remove barriers to international capital flows.

64
Perceived benefits of harmonisation (cont.)

• Reducing financial reporting costs for both New
  Zealand and foreign multinationals.
• Facilitating more meaningful comparisons of New
  Zealand and foreign public sector entities.

65
New Zealand adoption of IFRS

• October 2002 ASRB announces that from 2007,
  listed issuers would be required to comply with
  IFRS.
• Issuers would be permitted to adopt them from
  2005.

66
Recent developments financial reporting
structure

• November 2002 the FRSB agreed that the New
  Zealand financial reporting structure should be
  aligned as closely as possible with the
  Australian structure.
• Based on the reporting entity concept.

67
Barriers to harmonisation

• Perceived barriers to harmonisation
• different business environments
• different legal systems
• different cultures and
• different political environments across
  countries.
• Culture is an expression of norms, values and
  customs, which reflect typical behavioural
  characteristics.

68
Culture and harmonisation

• Values inherent in accounting sub-culture
  influenced by society-wide values.
• Accounting systems cannot be considered to be
  culture free.
• Should different countries with varying cultural
  values adopt internationally uniform accounting
  practices?

69
Use and role of audit reports

• Provides an independent opinion of the financial
  information, regarding
• true and fair view
• compliance with financial reporting standards.
• Helps establish credibility of the financial
  information.
• Auditor not responsible for preparation of
  financial information.

70
The need for regulation

• Accounting is fairly heavily regulated in New
  Zealand
• The Financial Reporting Act 1993 and
• Companies Act 1993
• Financial reporting standards.
• Opinions on the need for regulation vary, and
  range between the free-market perspective and
  the pro-regulation perspective.

71
Free-market perspective on regulation

• Demand and supply forces should be allowed to
  operate, to generate an optimal supply of
  information.
• Even in the absence of regulation there are
  private economics-based incentives to provide
  information.

72
Free-market perspective on regulation (cont.)

• Produced to reduce conflict between parties with
  an interest in the organisation.
• Managers argued to be best placed to determine
  what information should be produced.

73
Free-market perspective on regulation (cont.)

• Financial statement audits can also be expected
  in the absence of regulation.
• If no regulation, entities are still motivated to
  disclose both good and bad news.
• market for lemons perspective

74
Pro-regulation perspective

• Arguments in favour of a free market, where
  users are expected to pay for information break
  down when consumption of free or public goods
  is considered.

75
Pro-regulation perspective (cont.)

• Accounting information is a public good.
• Once available, it can be used and passed on
  without paying.
• Parties using without incurring costs are known
  as free-riders.
• In the presence of free-riders, true demand is
  understated.

76
Pro-regulation perspective (cont.)

• Regulation required to alleviate the effects of
  market failure.
• Arguments that on average the market is
  efficient ignore the rights of individual
  investors who may lose as a result of relying
  upon unregulated disclosures.

77
Pro-regulation perspective (cont.)

• Ability to obtain information may depend on the
  individuals control of scarce resources required
  by the entity.