Chapter 1 - The Need to Regulate Financial Reporting

Question 1

What is the role of a regulatory framework in the preparation of financial statements?

Answer 1

• Regulation of FS - through financial reporting standards (IFRS, UK GAAP etc.)
• Objective reporting - relevant, reliable and faithfully represented info to aid decision making
• Adequate minimum level of info for users of FS
• Comparable and consistent financial info in the relevant economic arena
• Improve transparency and credibility of financial reports
• promote user confidence in the financial reporting process
• regulate behaviour of companies and directors through corp governance framework
• achieve social goals through environmental and CSR reporting

Question 2

Role of financial accounting standards

Answer 2

• Improve transparency. Makes financial info reliable, relevant and easier to understand
• Reduce risk of creative accounting
• Easy to compare (against different periods or similar companies)
• Increase credibility of FS by improving uniformity of accounting treatment between companies
• Provides quality financial reports/accounting info which can be relied upon for consistency, commonality and transparency.

Question 3

Principles based vs rules based systems

Answer 3

Principles based = IFRS. Uses conceptual framework to provide underlying set of principles within which standards are developed.

Rules based = UK GAAP. Where there is no framework, rules have to be developed to cover every eventuality. Exercise of judgement is minimised and preferred by auditors who fear litigation. Can also lead to large regulatory matters which does not always detect irregularity and is therefore sometimes more controversial.

Question 4

Arguments against accounting regulation

Answer 4

1) Too rigid = detrimental effect in the long term and influence of political, economic and cultural climate of countries is often ignored. One reporting regulation may not fit all countries when disclosing regulation
2) Frameworks apply to entities from various industries and the tendency to enforce standardisation may not be suitable for those on the margins. The choices provided on accounting treatment can be somewhat arbitrary and there is considerable disagreement in relation to the methods used as this can distort the comparability of companies’ FS
3) Concern amongst professionals that standards remove the need for accountants to exercise their judgement.
4) Gives an illusion of precision and comparability – not 100% justified in view of wide range of subjective decisions that need to be made
5) Too many standards

Question 5

Environmental reporting - Economic implications

Answer 5

1) Risk management: financial, legal and reputation implications
2) Marketing advantages: public image and brand enhancement by demonstrating environmental responsibilities. Environmentally irresponsible businesses are likely to lose market share
3) Legal needs: businesses may be legally required to provide environmental reports. Legal requirement for quoted companies that carry on insurance market activity
4) Competitive advantage: improves relationships with key stakeholders such as investors, suppliers and the wider community. Improved environmental performance should lead to cost savings.
5) Ethics: showing a commitment to accountability and transparency
6) Compliance and accounting requirements: annual review is expected to include environmental matters including the companies impact on the environment
7) Green (ethical) investors: companies with environmental disclosures are in a better position to be considered in investment decisions. (e.g. UK pension fund trustees must disclose how they have considered social, economic and environmental matters and therefore would only invest in ethical companies)
8) Employee interests: applicants increasingly look at the environmental performance
9) Value-added reporting: environmental KPIs are now used to report on environmental matters to add value to corporate reports and to communicate to wide ranges of stakeholders
10) Integrated reporting: moving towards integrated reporting on CSR and environmental issues allow interactivity on web-based publications. Standalone environmental reporting is primarily web-based disclosure which is separate from the annual report.

Question 6

What is social reporting?

Answer 6

CSR is a commitment by businesses to behave ethically and contribute to economic development whilst remaining sensitive to the needs of all stakeholders.

CSR is built on the foundation of profit and is generally considered to increase long-term profits through management control and accountability.

Question 7

What are the 4 sections of Caroll’s CSR pyramid?

Answer 7

1) Economic: Responsibility to be profitable and benefit society in the long term. Customers demand quality at a fair price. Creating share value = link between corporate success and social welfare. For society to thrive, profitable businesses must be developed to create income, provide jobs, tax revenue and philanthropy for society. In return, businesses rely on a healthy, educated workforce and adept government to operate efficiently.
2) Legal: Observance of laws and regulations (e.g. competition, employment, health and safety laws)
3) Ethical: Acting morally and ethically in issues such as treatment of employees and suppliers
4) Philanthropic: Discretionary behaviour to improve the lives of others. Includes charitable donations in areas such as arts, education, housing, health and social welfare, non-profit organisations, communities and the environment. Excludes political contributions and commercial event sponsorship.

Question 8

List 5 areas covered by IFRS conceptual framework

Answer 8

• The objectives of financial reporting;
• The underlying assumptions;
• The qualitative characteristics;
• The elements of financial FS; and
• The concepts of capital and capital maintenance.