Lecture 2Lecture 2Regulation of Financial Regulation of Financial Reporting in AustraliaReporting in Australia

AASB

Lecture OverviewLecture 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)

Review of Important Review of Important ConceptsConcepts

Financial Reporting Decisions

Impact of Information Asymmetry

Scope of Financial Scope of Financial ReportingReporting

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

Financial Reporting Financial Reporting DecisionsDecisions

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

Information AsymmetryInformation AsymmetryInformation AsymmetryInformation 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

Summary:Summary:Information AsymmetryInformation Asymmetry

Adverse selectionAdverse selection(Financial reporting to convert(Financial reporting to convert inside info to outside info.)inside info to outside info.)

Moral hazardMoral hazard(Accounting to monitor the(Accounting to monitor thebehaviour of managers)behaviour of managers)

The Fundamental Problem The Fundamental Problem of Financial Accounting of Financial Accounting TheoryTheoryProvision of relevantProvision of relevantinfo. to aid investorinfo. to aid investorDecision makingDecision making

Provision of reliableProvision of reliableinfo. to controlinfo. to controlmanagement behaviourmanagement behaviour

Relevance and Relevance and ReliabilityReliability

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

Possible solutionsPossible solutions

1. Let market forces determine what information is supplied

2. Regulate the provision of financial information

Financial Reporting Financial Reporting DiscretionDiscretion

(module 2.1)(module 2.1)

Financial Reporting Financial Reporting DiscretionDiscretion

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

Is financial reporting Is financial reporting neutral and unbiased?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

Self InterestSelf 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

Are accounting Are accounting regulations neutral and regulations neutral and unbiased?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

Current Accounting Current Accounting RegulationsRegulations(module 2.2)(module 2.2)

The Development of The Development of Accounting Regulation in Accounting Regulation in AustraliaAustralia

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

History of Accounting History of Accounting RegulationRegulation

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)

Current Sources of Current Sources of Accounting Regulations Accounting Regulations in Australiain 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

International International Harmonisation of Harmonisation of

Accounting StandardsAccounting Standards(module 2.2 cont.)(module 2.2 cont.)

Globalisation of Globalisation of businessbusiness

An increasing fact of business Global capital and product markets

Impact on financial reporting Need for internationally comparable

financial statements?

Advantages of internationally Advantages of internationally comparable accounting comparable accounting standardsstandards

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

How to achieve How to achieve internationally comparable internationally comparable financial statementsfinancial statements

One set of rules / accounting standards? Where does this leave AASB?

If so, who’s 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

International International ConvergenceConvergence

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”

AASB Policy of AASB Policy of International Convergence International Convergence and Harmonisationand 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

What is Harmonisation ?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

AASB Harmonisation AASB Harmonisation ProgramProgram

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

Status of AASB Status of AASB HarmonisationHarmonisation

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

NewsflashNewsflash

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

Who will benefit from Who will benefit from International International Convergence?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

Rational for Rational for RegulationRegulation

(module 2.3)(module 2.3)

Some Important Some Important QuestionsQuestions

Should financial reporting be regulated?

If so: Who should control the

regulatory process? How much regulation is

enough?

Arguments for and Arguments for and against regulationagainst 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

Theories of RegulationTheories 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

A political processA 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…..

For TutorialsFor 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