Chapter 1 - Regulatory Framework and IFRS Flashcards
What is the main purpose of IFRS?
Global harmonisation (cross-border markets etc.) of financial reporting/information.
What is the role of the regulatory framework regarding the preparation of financial statements?
- Ensure regulation of financial reporting through financial reporting standards (UK or US GAAP / IFRS )
- Ensure financial info reported objectively – reliable/relevant/faithfully represented information that allows users to make financial decisions
- Provide adequate minimum level of information for users of FS
- Ensure financial info comparable / consistent in relevant economic arena (ex. growth of multinationals and international investments)
- Ensure & improve transparency/credibility of financial reports – promote user confidence in process
- Regulate behaviourof companies/directors through the CG FRAMEWORK
- Achieve desired social goals – ex. environmental and ESG reporting
Why are accounting standards so useful to the regulatory framework?
- Some content re FS is prescribed in law - laws are rigid and take a long time to be changed
- Accounting standards therefore have taken on the core devolved responsibility for allowing framework to evolve in a structured way to changing economic conditions/events (ex. collapse of major international companies)
What is the overall main role of financial reporting? &***
To provide useful financial information about the reporting entity to shareholders, as well as other users of financial statements who use the information to make financial decisions.
What is the difference between rules-based/principles-based approach?
- Rules-based - rules designed to cover every aspect and eventuality of financial reporting (ex. US GAAP)
- Principles-based - acts as a ‘conceptual framework’. This will provide an underlying set of principles within which standards are developed (ex. IFRS) - key benefit is that it allows for flexibility
What are the advantages and disadvantages of a rules-based approach?
The use of judgement / level of objectivity can be seen as both a benefit and drawvback of rules-based systems
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Pros
- Preferred by auditors who fear litigation
- Lessens the potential use of judgement
- Often seen as the best approach for ‘controversial’ areas of accounting
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Cons
* Excess regulatory measures which do not detect/prevent financial irregularities
* A rigid regulatory system will have detrimental effect in the long term
Which elements typically make up the regulatory structure
for accounting?
- National/company law: ex. CA2006 in the UK
- Financial reporting standards body- FRC to be ARGA in UK. Having a single body overall responsible allows for GAAP to envolve in a structured way in response to changes in economic conditions
- Market regulations: legislation from other markets may affect accountability in the global market (ex. SOX2002)
- Industry-specific/Securities Exchange rules - ex. LSE Rules and FCA oversight of financial services industry
- CG Frameworks: seek to enhance financial reporting by improving confidence to the users of accounting information. Aim to align the interests of directors, management and shareholders in pursuing the success of the company (as a whole)
- Environmental/sustainability reporting (national and international standards) - a move to IR and for example Denmark/Netherlands/Sweden require environmental reports by law, particularly in environmentally sensitive industries
What is Agency Theory? ***
Developed by Jensen & Meckling 1976
Defines the characteristics of a public company –
Modern corp based on principal-agent relationship
Managers act as agents of the principal (the shareholders)
Contract between the two – manager acts for custodian to protect assets/aim to maximise the owners’ wealth
What is the Agency problem?
Agency problem – conflict of interests.
Manager/agent may pursue own interests at expense of principal
KEY CASE – Madoff Scandal (2009)- created a shame business ultimately costing many small investors their entire savings. Total worth of nearly $16.9 billion.
What are the key solutions to the ‘agency problem’?
Solutions to the Problem
Agency costs: incurred by Principal to monitor agent activities/take any corrective action
o Direct/indirect costs arising from disagreement/inefficiency of the relationship
Ex. use of resources for agent’s own benefit (ex. excessive director pay)
Monitoring costs- ex. fees payable to external auditor (main objective of external to audit to protect shareholders by independently reporting on state of the company’s finances)
* Auditor also ensures board has accurate/reliable info
* Makes assessment on appropriateness of accounting principles used
* Results in an ‘audit opinion’ if FS give a ‘true and fair’ view
o Indirect costs = loss of opportunity arising from conflict
No direct quantifiable value
In order to reduce risk of conflicting interests and so minimise agency costs – the ‘contracting parties’ should seek to optimise their relationship
What is the role of Corporate Governance in financial reporting?
Part of the monitoring process
Internally adopted mechanism – directors control/oversight of managers & their activities
Internal rules/policies and processes determining how company is directed
CG frameworks can help better understanding of directors’ oversight role
Seeks to enhance financial reporting by providing degree of confidence to the users
What are the key objectives of financial reporting and accounting standards?
- Improve financial reporting transparency – make info reliable/relevant/easier to understand
- Reduce risk of creative accounting
- Make the FS’ for different periods/entities comparable
- Increase FS credibility by improving the uniformity of accounting treatment between companies
- Provide quality financial reports/accounting info that can be relied on for consistency, commonality and overall transparency
What are the aim of IFRS?
The achievemnt of comparable financial reporting across borders
What are some of the main arguments against accounting regulation? **
- Rigid nature could have poor effect in long-term and influence of political/economic/cultural climate of different countries often ignored. One regulation may not work for all when considering disclosure regulation (Bushman and Landsman)
- Frameworks apply to entities from various industries – tendency to enforce standardisation may not be suitable for ‘those on the margins’.
- The choices given by accounting standard setters such as valuation of inventories, can be arbitrary
- Disagreements as to the methods of valuation etc., can distort comparability of financial statements
- Some are concerned that standards tend to remove need for accountants to exercise judgement – others say there is still plenty of scope for this.
- Key criticism of standardisation- it gives an illusion of precision/comparability. However this is debateable / not fully justified in view of wide range of subjective decisions to be made
- Complexity – simply too many
What are the main distinctions between company types under CA2006?
- Private v public
- PIEs/non-PIEs
- Traded or untraded
- Quoted or unquoted
- Micro, small, medium, large
