Lecture 2 Standard Setting

Question 1

What are two possible objectives of financial reporting?

Answer 1

• Stewardship or accountability objective of financial reporting
• Valuation or decision-usefulness objective of financial reporting

Question 2

What are rules-based standards?

Answer 2

• Sets of detailed rules
• Must be followed when preparing financial statements

Question 3

What are principles-based standards?

Answer 3

• Based on a conceptual framework
• Provides a broad basis for accountants to follow
• Focus on:
  o Economic substance of transaction
  o Engaging professional judgement and expertise

Question 4

What are the advantages of rules-based standards

Answer 4

• Improved guidance:
  – When there is a lack of a clear and appropriate principle
  – Where standards are inconsistent with the conceptual frameworks.
• Increased comparability between financial statements.
• Improved accuracy with communication of:
  – Intentions
  – Requirements.
• Reduced:
  – Imprecision (affecting reporting)
  – Opportunities for earnings management through judgements
  – Exposure to litigation.
• Increased:
  – Verifiability for auditors and regulators.

Question 5

What are the disadvantages of rules-based standards?

Answer 5

– Rules-based standards can be very complex.
– Organisations can structure transactions to circumvent unfavourable reporting.
– Standards are likely to be incomplete or even obsolete by the time they are issued.
– Manipulated compliance with rules makes auditing more difficult.

Question 6

What is the definition of regulation?

Answer 6

rule or order regarding conduct which is prescribed by an authority. Elements are:
1. Intention to intervene
2. Restriction on choice to achieve certain goals
3. Exercise of control by a party independent of those directly involved in the activity.

Question 7

What is signalling theory?

Answer 7

Reporting entities increase value through financial reporting. - sophisticated investors. Regulation not necessary.

Question 8

What is public interest theory?

Answer 8

Regulation is supplied in response to demands of the public for the correction of inefficient or inequitable market practices. It assumes that

• economic markets are not perfect and that signalling theory relies on this
• regulation is virtually costless

Question 9

Capture theory

Answer 9

Regulation is response to demands of self-interested groups. Coercive power of government can be used to give valuable benefits to particular groups - governed by laws of supply and demand.

Question 10

What is bushfire theory

Answer 10

Regulations tend to arise from crisis and take into account reactions of users/society and failures in regulatory process. Resulting rules gain media exposure but do not necessarily address the issues that caused the crisis.

Question 11

Ideology theory of regulation

Answer 11

Relies on market failure and that lobbying is a mechanism through which regulators are informed about policy issues - lobbying influences the actions of regulators.
- political ideologies of regulators
- impact of special interest lobby groups

Question 12

Advantages of regulation

Answer 12

Increased efficiency in allocating capital.
Cheaper production.
Check on perquisites.
Public confidence.
Standardisation:
- Comparability
- Understandability.
Public good

Question 13

Disadvantages of regulation

Answer 13

Difficult to achieve efficiency and equity.
Determining the optimal quantity of information is problematic.
Regulation is difficult to reverse.
Communication is restricted.
Reporting entities are different.
There is lobbying.
Monopolisation of accounting standards.