Lecture 2 Regulation of Financial Reporting in Australia

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Lecture 2Regulation of Financial Reporting in
Australia
AASB
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Lecture Overview

• Review of important concepts (module 1)
• Financial reporting decisions
• Impact of information Asymmetry
• Financial reporting discretion (2.1)
• Current accounting regulations (2.2)
• International harmonisation of accounting
  standards (2.2)
• Rationale for regulation (2.3)

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Review of Important Concepts

• Financial Reporting Decisions
• Impact of Information Asymmetry

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Scope of Financial Reporting

• Financial reporting covers more than just
  financial/company accounting (preparation of
  financial statements). Although this is an
  important part of it.
• Financial reporting also includes disclosures
  that may or may not be contained in the financial
  statements
• Examples of disclosures
• Environmental disclosures, notes to the accounts
  regarding the valuation of assets, press releases

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Financial Reporting Decisions

• Financial reporting decisions relate to
  application of the accruals system as well as
  disclosure related choices
• Five types of financial reporting decisions
• Expensing versus Capitalisation of Costs
• Accounting Methods
• Accounting Estimates
• Disclosure versus Recognition
• Disclosure Policy

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Information Asymmetry

• Occurs when some parties to a business
  transaction have an information advantage
• adverse selection
• one party has knowledge not possessed by the
  other
• moral hazard
• arises when some parties cannot observe all the
  actions of the other parties to the transaction

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SummaryInformation Asymmetry
Adverse selection (Financial reporting to
convert inside info to outside info.)
Moral hazard (Accounting to monitor the behaviour
of managers)
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The Fundamental Problem of Financial Accounting
Theory
Provision of relevant info. to aid
investor Decision making
Provision of reliable info. to control management
behaviour
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Relevance and Reliability

• A trade-off
• Ability of financial reporting to overcome
  information asymmetry problems depends on its
  degree of relevance and reliability
• Regulation of financial reporting can increase
  (decrease?) relevance and (especially)
  reliability

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Possible solutions

• 1. Let market forces determine what information
  is supplied
• 2. Regulate the provision of financial information

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Financial Reporting Discretion(module 2.1)
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Financial Reporting Discretion

• Accountants and managers have substantial
  discretion when making financial reporting
  decisions
• Decisions impact
• Numbers in Financial Statements
• What information is disclosed
• Decisions of financial statement users
• Relates to
• Unregulated financial reporting decisions
• Choices available within regulated financial
  reporting decisions

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Is financial reporting neutral and unbiased?

• Depends on
• Amount of discretion available to managers
• How managers exercise their available discretion
• efficient motivations (unbiased)
• opportunistic motivations (biased)
• Concept of self interest

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Self Interest

• An important concept that helps us understand the
  way the world works
• Financial reporting and its regulation are
  affected by the self interest of the individuals
  involved
• Individuals form into groups to help achieve
  their objectives

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Are accounting regulations neutral and unbiased?

• Individuals are involved in the standard setting
  process
• scope for self interest to get in the way of
  neutral and unbiased accounting regulations
• the individuals that will be regulated by the new
  accounting standards can have an impact on the
  standard setting process
• Adverse economic and social consequences must be
  considered

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Current Accounting Regulations(module 2.2)
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The Development of Accounting Regulation in
Australia

• Pre World War 2 - close links with the UK
• Subsequent influences
• Development of accounting standards in 1970s
• ASRB (now AASB) shifted control of accounting
  regulation from profession to government in 1984
• Corporations Law
• application of AASB standards compulsory
• continuous disclosure applies

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History of Accounting Regulation

• Three Time Periods
• 1. A largely unregulated period (pre 1970)
• 2. A period of professional regulation
• non-compliance problems
• 3. Current period of regulation by legislation
  (post 1984)

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Current Sources of Accounting Regulations in
Australia

• FRC - Financial Reporting Council
• oversight of the standard setting process
• AASB - Aust. Accounting Standards Board
• technical deliberations about new and changed
  accounting standards
• http//www.aasb.com.au/
• UIG - Urgent Issues Group

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International Harmonisation of Accounting
Standards(module 2.2 cont.)
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Globalisation of business

• An increasing fact of business
• Global capital and product markets
• Impact on financial reporting
• Need for internationally comparable financial
  statements?

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Advantages of internationally comparable
accounting standards

• Presentation of high quality, transparent and
  comparable financial information is likely to
• reduce investment risk in foreign companies /
  lower cost of capital
• encourage cross-border investment and result in
  better allocation of savings to investments

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How to achieve internationally comparable
financial statements

• One set of rules / accounting standards?
• Where does this leave AASB?
• If so, whos rules?
• International Accounting Standards Board
• US (FASB/SEC)
• other
• Should any variation between countries remain?
• Adoption versus consistency with global set of
  standards?
• IASB is currently embarking on a program of
  convergence of accounting standards world-wide

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International Convergence

• The IASB cooperates with national accounting
  standard setters to achieve convergence in
  accounting standards throughout the world
• The AASB has a specific function to participate
  in and contribute to the development of a single
  set of accounting standards for world-wide use

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AASB Policy of International Convergence and
Harmonisation

• International convergence working with other
  standard-setting bodies to develop new or revised
  standards that will contribute to the development
  of a single set of accounting standards for
  world-wide use
• International harmonisation a process which
  leads to Australian accounting standards being
  compatible with IASs

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What is Harmonisation ?

• Harmonisation refers to a process which involves
  national standard setters adopting or adapting
  IAS or ensuring their national standards are
  consistent with IAS
• AASB has been adapting Australian approved
  accounting standards to ensure that they are
  consistent with IAS
• This is different to simply adopting IAS

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AASB Harmonisation Program

• AASB standards amended to be consistent with, but
  not identical to IAS
• involves amending existing standards to conform
  with existing IAS
• adopting / adapting existing IAS for areas not
  currently addressed by standards in Australia
• harmonise new standards with new / revised IAS

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Status of AASB Harmonisation

• Most of AASBs amended to comply with IAS
• Difficulties in coming to agreement on certain
  standards
• Full harmonisation not always achieved
• Some awaiting IASB completion of IAS

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Newsflash

• Australia will ADOPT International Accounting
  Standards from January 2005!
• First country in the world to make such a
  statement
• However, the European Union has stated that it
  will require all listed companies to prepare
  consolidated financial statements in accordance
  with IAS from 2005

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Who will benefit from International Convergence?

• Primarily, large companies
• Currently to list in the US involves companies
  preparing either a separate set of accounts using
  US GAAP or a conversion table which provides a
  translation of key figures from Australian to US
  GAAP

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Rational for Regulation(module 2.3)
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Some Important Questions

• Should financial reporting be regulated?
• If so
• Who should control the regulatory process?
• How much regulation is enough?

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Arguments for and against regulation

• For
• markets for information are inefficient and
  subject to failure
• investors need protection from misleading
  information
• enhanced uniformity / comparability
• Against
• markets for information are efficient
• regulation leads to decreased relevance of
  financial reporting

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Theories of Regulation

• Regulation of financial reporting protects the
  public
• maximisation of social welfare
• Regulation of financial reporting is controlled
  by the accounting profession
• self interest of accountants
• Regulation of financial reporting is controlled
  by company managers
• self interest of all individuals involved

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A political process

• Financial reporting regulations have many
  economic and social consequences
• Various interested parties lobby the standard
  setters (self-interest)
• Standards are not set in a political vacuum
• To be discussed more thoroughly next lecture..

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For Tutorials

• Required reading
• Text chapter 2
• Text chapter 6, pp. 192 - 195
• Optional reading (harmonisation)
• Selected reading 2.1
• Remainder of chapter 6
• Self assessment questions
• Questions 1 - 7 from module 2
• Answers in tutorials