Deegan5e Ch01

1-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Chapter 1

An overview of the Australian external

reporting environment


Objectives• Understand the scope of regulation relating to Australian external

financial reporting • Be able to explain the general functions of the Australian

Securities and Investments Commission, the Australian Accounting Standards Board, the Financial Reporting Council and the Australian Stock Exchange

• Be able to explain the general functions of the International Accounting Standards Board and its direct relevance to Australian accounting standard setting

• Understand the role of an accounting standard and the process through which it is developed


Objectives (cont.)• Understand the magnitude of the changes that

occurred in 2003 and 2004 in Australian Accounting Standards as a result of the Financial Reporting Council’s strategic decision that Australia would produce financial reports that comply with standards being issued by the International Accounting Standards Board

• Understand that the practice of financial accounting is quite heavily regulated within Australia, and be aware of some arguments for and against the regulation of financial accounting


Financial accounting defined• Financial accounting is a process involving the

collection and processing of financial information to meet the decision-making needs of parties external to the organisation

• Financial accounting may be contrasted with management accounting, which:– focuses on providing information for decision making by

parties within the organisation– is largely unregulated

• Financial accounting is heavily regulated, and a great deal of regulation changes each year


User demand for general-purpose financial reports• Users include (the ‘Framework for the Preparation and

Presentation of Financial Statements’ (the AASB Framework) released by Australian Accounting Standards Board July 2004):– present and potential investors– employees– lenders– suppliers and other trade creditors– customers– government and its agencies– the public

• Users lack the power to demand specific information to meet their needs – hence the need for ‘general purpose financial reports’


General vs special-purpose reports • General-purpose financial reports

– comply with the AASB Framework and accounting standards– meet the information needs common to users who are unable

to command the preparation of reports tailored to satisfy, specifically, all their information needs

– represent financial statements and supporting notes included within an annual report presented to shareholders at a company’s annual general meeting

• Special-purpose financial reports– designed to meet the needs of a specific group or to satisfy a

specific purpose– example: Bank demanding as part of a loan agreement that

the borrowing entity provide information about projected cash flows


Sources of external financial reporting regulationFive main bodies that formulate and/or enforce

accounting regulations in Australia

1. The Australian Securities and Investments Commission (ASIC)

2. The Australian Accounting Standards Board (AASB)

3. The Interpretations Agenda Committee

4. The Financial Reporting Council (FRC)

5. The Australian Stock Exchange (ASX)


Sources of external financial reporting regulation (cont.)Recent changes in development of reporting regulation:• Over the last 10 to 15 years the development of

accounting standards more in hands of government than accounting profession—reducing ability of accounting profession to ‘self-regulate’

• New accounting standard-setting arrangements were passed by Parliament in October 1999 and came into force 1 January 2000 (see next slide)


Sources of external financial reporting regulation (cont.)Recent changes in the development of reporting

regulation (cont.)• Public Sector Accounting Standards Board (which was

under the control of the accounting profession) was disbanded at beginning of 2000—all responsibilities for developing accounting standards within Australia now with the AASB

• However, AASB now relies on standards being developed by International Accounting Standards Board (IASB) owing to commitment that Australia would comply with International Accounting Standards (now International Financial Reporting Standards) from 1 January 2005


Sources of external financial reporting regulation (cont.)• Financial Reporting Council (FRC)

– broad membership base– oversees activities of AASB– responsible for decision that Australian reporting entities

would adopt accounting standards issued by IASB—major implications for Australian reporting practices

– now oversees Auditing and Assurance Standards Board (AUASB)

• Auditing standards made by AUASB require legislative backing (not the case prior to 2004)


Australian Securities and Investments Commission (ASIC)• Formerly the Australian Securities Commission (ASC)• Name changed in July 1998 to reflect increased

responsibility for regulating investment products• Responsible for administering corporation legislation• Independent of state ministers or state parliaments• Reports to the Commonwealth Parliament and

Treasurer


ASIC (cont.)The Corporations Act (enforced by ASIC)• Outlines the responsibilities of company directors in

relation to various activities, including:– the nature of their conduct– financial statement preparation, lodgment and distribution

• Requires preparation of ‘true and fair’ financial statements by directors of public companies, large proprietary companies, organisations with securities listed on the ASX, and some small proprietary companies. But what do ‘financial statements’ comprise of……..?


ASIC (cont.)Financial statements defined in the Corporations Act (s. 295(2)) as

The financial statements for the year are:(a) The financial statements in relation to the entity reported on that are

required by the accounting standards; and(b) If required by the accounting standards – the financial statements in

relation to the consolidated entity that are required by the accounting standards.

Reference must therefore be made to ‘the accounting standards’Paragraph 8 of AASB 101 states that a financial report comprises:– balance sheet– income statement– statement of changes in equity– cash flow statement– notes, comprising a summary of significant accounting policies and

other explanatory notes


ASIC (cont.)The ‘true and fair view’ requirement is a central component of

Australian financial reporting• Requirement to produce true and fair financial statements

contained in s. 297 of Corporations Act

The financial statements and notes for a financial year must give a true and fair view of:– the financial position and performance of the company, registered

scheme or disclosing entity; and

– if consolidated financial statements are required, the financial position and performance of the consolidated entity.

• No definition of ‘true and fair’ provided in the Corporations Act• If accounts are to be considered ‘true and fair’ they should

include all information of a ‘material’ nature – but what is ‘material’?


ASIC (continued) - MaterialityAASB 1031, par. 4.1, provides that

Information is material if its omission, misstatement or non-disclosure has the potential, individually or collectively, to

a) Influence the economic decisions of users taken on the basis of the financial report, or

b) Affect the discharge of accountability by the management or governing body of the entity

• Contents of AASB 1031 consistent with concept of materiality as per the AASB Framework (pars 29 and 30)

• Unless there are specific requirements that require the disclosure of particular items of expense regardless of amount (as there are for payments made to key management personnel), then separate disclosure will be dependent upon whether the item is deemed to be material – that is, whether, for example, it is considered likely to effect ‘economic decisions’ of financial statement readers.

• Materiality is an IMPORTANT factor in financial reporting


ASIC (cont.)Pursuant to Corporations Act, directors of large and

listed companies, as well as some other entities, are required to attach to financial statements:– Directors’ Declaration – Directors’ Report


ASIC (cont.)Directors’ Declaration• Directors required (s. 295(4) of the Corporations Act)

to– state whether, in their opinion, the accounts are true and fair– give details of any significant after-balance-date events– state whether or not, in their opinion, there are any grounds to

believe that the company will be unable to pay its debts as and when they fall due

• If declaration is made fraudulently, carelessly or recklessly they may be liable for outstanding debts of the company


ASIC (cont.)Directors’ Report (ss. 298–300A of Corporations Act) is

to provide information concerning– names of directors– details of directors’ emoluments– principal activities of the company– review of operations during the year– significant changes in the state of affairs of the company– likely future developments– significant post-balance-date events– compliance with environmental laws


ASIC (cont.)Directors’ Report (cont.)

From July 2004 the Directors’ Report must include an ‘operating and financial review’– information that shareholders of the company would

reasonably require to make informed decisions regarding the operations, financial position, and future strategies of the organisation


Declaration by chief executive officer and chief financial officer

• For entities listed on the ASX• Reinforces the responsibility of the CEO and CFO in

relation to the entity’s financial statements


ASIC (cont.)• Also of relevance to the functioning of ASIC is the

establishment of Financial Reporting Panel in 2004– its purpose is to resolve disputes on a non-binding basis

between ASIC and companies in respect of whether financial statements have been prepared in accordance with accounting standards and whether financial statements present a true and fair view

• ASIC also releases policy statements and guidelines on various issues, including financial reporting


Australian Accounting Standards Board (AASB)

• Began operations in 1991• Functions (under s. 227 of ASIC Act) include

– developing a conceptual framework– making accounting standards that have force of law under s.

334 of the Corporations Act– formulate accounting standards for other purposes:

for entities not governed by The Corporations Law

– participate in and contribute to the development of a single set of accounting standards for worldwide use


AASB (cont.)• From 2000 AASB standards apply to all types of

entities, those regulated under companies legislation and all other types, i.e. responsibility for formulating standards for entities not governed by Corporations Act– PSASB now disbanded

• Majority of standards underwent change in 2003–04• Reports to the Financial Reporting Council (FRC)—

oversight function regarding AASB• Has one full-time chairperson and nine part-time

members appointed by the FRC


AASB and the role of the FRCThe Financial Reporting Council (FRC)• Members are appointed directly by the Federal

Treasurer or the Treasurer may specify an organisation or body to choose a person to represent them

• 14 members are nominated by a number of interest groups (stakeholders)


AASB and the FRC (cont.)Functions and powers of the FRC (s. 225 of ASIC Act)• Provide broad oversight of the process for setting accounting

standards• Appoint members of the AASB• Approve and monitor the AASB’s priorities, business plan, budget

and staffing• Give the AASB directions, advice or feedback on matters of

general policy• No power to direct AASB re-development of particular standards• No power to veto a standard• Powers expanded in 2003 to include overseeing the activities of

AUASB—AUASB moved from the AARF to AASB in 2004


AASB (cont.)Application of AASB standards • Section 231 of ASIC Act requires AASB to carry out

cost–benefit analysis of impact of proposed standard before making or formulating it

• Once the AASB makes a standard it is approved by Commonwealth Parliament

• Once an AASB-developed standard becomes an accounting standard, company directors are required to ensure that the company’s financial statements comply with that standard (s. 296 of Corporations Act)


AASB (cont.)Small proprietary companies• Such companies exempted from complying with

accounting standards (under s. 45A(1) of Corporations Act)

• A proprietary company is considered to be ‘small’ if it meets two of the following three tests:1. Its gross operating revenue is less than $25 million

2. Its gross assets are less than $12.5 million

3. It has less than 50 employees


AASB (cont.)Small proprietary companies (cont.)• Small proprietary company does not have to comply

with particular accounting standards (s. 296 of Corporations Act) ifa) the report is prepared in response to a shareholder direction

under s. 293 (requiring at least 50% of votes)

b) the direction specifies that the report does not have to comply with those accounting standards


The AASB (cont.)Small proprietary companies (cont.)• Do not have to prepare formal accounts, apply

accounting standards, or have their accounts audited, unless so requested by:– ASIC; or– shareholders holding at least 5% of the voting shares.

• If a proprietary company is not considered small, it is classified large and is subject to more stringent disclosure requirements


The AASB (cont.)Public and large proprietary companies have to• prepare financial statements that comply with

accounting standards• have their financial statements audited• have statements sent to shareholders if

– so requested by ASIC; or– so requested by shareholders holding at least 5% of the

voting shares.

• If a proprietary company is not considered small, it is classified large and subject to more stringent disclosure requirements


AASB (cont.)Disclosing entities• Pursuant to s. 285(2) of Corporations Act AASB

standards may apply to some entities not of a corporate form—all ‘disclosing’ entities need to comply with majority of AASB standards

• Disclosing entities include– entities with securities quoted on the ASX– entities with securities issued pursuant to a prospectus– entities with securities issued pursuant to a takeover scheme– entities with securities issued pursuant to a par. 5.1

compromise arrangement– borrowing corporations


AASB (cont.)As a result of the FRC decision in 2002 that Australia

would adopt accounting standards developed by the International Accounting Standards Board the development of accounting standards in Australia is no longer directly under Australian control, except– to the extent that a standard relates to domestic issues and

there is no equivalent IFRS


Interpretations Agenda Committee• Identifies and assesses issues for inclusion in the

AASB’s work program


International Financial Reporting Interpretations Committee (IFRIC)

• Provides interpretations of requirements embodied within IFRSs

• Of relevance to Australia where there are uncertainties about particular requirements incorporated in IFRSs, and therefore, within AASB accounting standards


Australian Stock Exchange (ASX)• One nationally operated stock exchange• In November 1998 the ASX became a publicly listed

company:– The Australian Stock Exchange Limited

• One set of listing rules for all trading floors in each capital city

• Main Board Rules apply to nationally listed securities• Failure to comply may lead to removal from the Board• Rules help ensure that information is disseminated in

an efficient and timely manner


ASX (cont.)• ASX Listing Rules divided into 20 chapters—key

chapters are Chapter 3 (continuous disclosure) and Chapter 4 (periodic disclosure)

• Listing Rule 3.1– once an entity is or becomes aware of any information

concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately inform the ASX of that information


ASX (cont.)Establishment of ASX Corporate Governance Council • ASX has released its ‘Principles of Good Corporate

Governance and Best Practice Recommendations’ • This proposes 10 essential principles of corporate

governance– as stated under Recommendations (p. 5), pursuant to ASX

Listing Ruling 4.10, companies are required to provide a statement in their annual report disclosing the extent to which they have not followed the best practice corporate governance recommendations in the reporting period


ASX (cont.)• Where companies have not followed all of the

recommendations:– they must identity the recommendations that have not been

followed; and– give reasons for not following them

Refer to Exhibit 1.3 on page 25—Essential corporate governance principles identified in the ASX


Process of Australia adopting IFRSs• In 2002 Financial Reporting Council decided to commit

Australia effectively to adopting accounting standards issued by the International Accounting Standards Board (IASB)

• The standards released by the IASB are referred to as International Financial Reporting Standards (IFRSs)—where previously they were referred to as International Accounting Standards (IASs)


Process of Australia adopting IFRSs (cont.)• Catalyst to adopt IFRS within Australia (a directive of

the FRC) was the decision by European Union that all listed companies within Union should adopt IASB standards by 1 January 2005 for the purposes of preparing consolidated financial reports, in order to support the ‘single market objective’

• European Union is to adopt IFRSs directly without modification


Process of Australia adopting IFRSs (cont.)• In Australia: IFRSs turned into Australian (AASB) accounting

standards, each bearing an AASB prefix• Requirement for reporting under IFRS equivalents is extremely

broad—in Australia it applies to all reporting entities under the Corporations Act, listed and unlisted as well as private and public—unlike in Europe where IFRS are mandatory for listed companies only

• AASB standards have general applicability to not-for-profit and local government sectors—material added by AASB that describes the scope and applicability to the Australian context

Refer to Table 1.1, pp. 27—AASB accounting standards and equivalent IAS/IFRS accounting standards. Remember, new standards are continuously being released. All standards can be downloaded from the AASB website


Process of Australia adopting IFRSs (cont.)• In Australia a number of options under IFRSs are

more restricted—but compliance with AASB standard means compliance with IFRS

• Additional disclosures required • AASB issuing standards to match IFRSs, and to cover

areas not addressed by IASB


Process of Australia adopting IFRSs (cont.)The adoption of IFRSs has meant significant changes post-2005 in

some standards and minor changes in others. Significant changes include

• Intangible assets—research, brand names, mastheads—now expensed and not capitalised

• Revaluation of intangible assets greatly restricted, only if there is an active market for assets and associated prices are publicly available

• Amortisation of goodwill abolished—replaced by requirement that annual test be undertaken to determine whether value of goodwill is impaired (impairment testing)

• Revaluation of property, plant and equipment to be done on asset-by-asset basis and not by class of assets for companies


Process of Australia adopting IFRSs (cont.)• Classification of ‘revenues’ restricted to inflows that

relate to ordinary activities of organisation, e.g. sales of assets other than inventory to be classified as ‘gains’ or ‘losses’ in income statement

• Prior period errors—financial statements to be adjusted as if error had not occurred, i.e. opening balances amended retrospectively

• Tests of classifying items as equity vs liability more stringent, i.e. items previously classified equity might now be disclosed as liabilities


Process of Australia adopting IFRSs (cont.)Numbering system to be used for AASB standards

1. AASB standards 1–99 seriesWhere a new IFRS is issued its number will be used by the AASB, e.g. IFRS 1 becomes AASB 1

2. AASB standards 100–999 seriesWhere an equivalent to an existing or improved IAS is issued, e.g. AASB 101 corresponds to IAS 1

3. AASB standards 1000 + seriesApplies to standards on the public or not-for-profit sectors or for areas of domestic application only. Also applies to AASB standards that are maintained as part of the post-2005 standards


Structure of the International Accounting Standards BoardGiven the direct relevance of the IASB to Australia, Australian

accountants should know of its structure

IASB comprises 14 individuals: 12 full time, 2 part time• Each IASB member has one vote on technical and other matters• Publication of standard, exposure draft or final SIC interpretation

requires approval by at least eight board members• Other decisions, e.g. the issue of Draft Statements of Principles

or Discussion Papers and agenda decisions, require a simple majority of Board members present at a meeting attended by 50% or more


Structure of the IASB (cont.)• Board has full control over technical agenda• On publication of a standard, also publishes a ‘Basis

for Conclusions’ to explain publicly how conclusions were reached, background information to assist application, and dissenting opinions. These are available on the AASB website

• IASB has an International Financial Reporting Interpretations Committee


International cultural differences and the harmonisation of accounting standards• Values inherent in accounting subculture 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?


Use and role of audit report• Provides an independent opinion of the financial

information regarding:– true and fair view– compliance with the Corporations Act– compliance with accounting standards

• Helps establish credibility of the financial information• Auditor not responsible for preparation of financial

information• Note: auditing standards have legal backing in the

same way that accounting standards have legal backing


All this regulation—is it really necessary?• Accounting is fairly heavily regulated in Australia by:

– the Corporations Act– accounting standards

• Opinions on the need for regulation vary and range between the ‘free-market’ perspective and the ‘pro-regulation’ perspective


All this regulation—is it really necessary? (cont.)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• Information is produced to reduce conflict between

parties with an interest in the organisation


All this regulation—is it really necessary? (cont.)Free-market perspective on regulation (cont.)• Managers argued to be best placed to determine what

information should be produced• Financial statement audits can also be expected in the

absence of regulation• Without regulation, entities would still be motivated to

disclose both good and bad news– ‘Market for lemons’ perspective


All this regulation—is it really necessary? (cont.)Pro-regulation perspective• Arguments in favour of a ‘free market’ where users are

expected to pay for information break down when we consider consumption of ‘free’ or ‘public’ goods

• Accounting information is a public good– once available it can be used and passed on without payment– parties using without incurring costs are known as ‘free-riders’– in the presence of free-riders true demand is understated


All this regulation—is it really necessary? (cont.)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 might lose as a result of relying upon unregulated disclosures

• Ability to obtain information might depend on the individual’s control of scarce resources required by the entity

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Deegan5e Ch01

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