Regulation of financial reporting

Question 1

what is agency theory?

Answer 1

an economic rationale of audited financial statement

-required for all plc not SMEs

Question 2

what is the principal and agent relationship

Answer 2

separation of owner (shareholders) and manager (directors)

Question 3

what is the model hazard of investment?

Answer 3

will the shareholder act in the best interest of shareholders or themselves
-must reduce moral hazard to reduce risk of investment

Question 4

When is moral hazard high?

Answer 4

• in absence of credible audited financial statements:
  
  • higher returns or
  • lower share price thus
  • higher cost of capital

Question 5

What is the companies act?

Answer 5

dictates all companies must publish audited financial statements to ensure effective capital markets

accounts must give a true and fair representation of state of affairs

Question 6

what is creditor/lendor protection

Answer 6

• limited liability poses more threat to creditors and lenders than unlimited
• need information about financial position of the company from financial statements

SME must file abbreviated unaudited financial statements with Companies House

Question 7

how can companies enact creative accounting

Answer 7

through:

• accounting policy choice (FIFO, LIFO, AVCO)
• estimation and judgement choice (useful life)
• disclosure choice

Question 8

incentives for creative accounting

Answer 8

• management compensation (profit based bonuses; stock options)
• capital market considerations (efficient market hypothesis)
• accounting based covenants (gearing/ leverage clauses)
• corporate control contests (hostile take over; MBO, IPOI)
• tax considerations
• regulatory considerations (energy companies)
• competitive considerations (margins; R&D costs)

Question 9

What is the UK financial reporting regulated by?

Answer 9

-Company Law
-Accounting Standards
-Stock Exchange Rules
(uk companies act 2006)

Question 10

what is company law?

Answer 10

• over-riding requirement- accounts must give true and fair view
• accounts for companies listed on EU stock exchanges to be prepared in accordance with IFRS as endorsed by EU

Question 11

what regulations do listed companies follow?

Answer 11

adopts IFRS as endorsed by EU

Question 12

what regulations do unlisted companies follow?

Answer 12

either IFRS or UK GAAP

- relevant to SMEs

Question 13

IAs and IFRS standards

Answer 13

• authoritative statements of how particular types of transaction and other events should be reflected in financial statements
• ‘user manual’ of accounting
• comply with accounting standards necessary to enable financial statements to ‘present fairly’

Question 14

benefits of accounting standards?

Answer 14

• reduce accounting choice
• improve comparability
• based on the conceptual framework
• improve disclosures
• reduce the opportunity for creative accounting
• overall improve discipline and credibility of financial reporting
• reduce moral hazard

Question 15

role of auditor

Answer 15

enhance degree of confidence of intended users in the financial statements

Question 16

Benefits of IASB’s conceptual Framework

Answer 16

Technical
• Improves quality of accounting standards

• Supports consistency within standards = overarching structure
• Improves speed of development of new or revised standards
• Assists in the defence of standards against challenges
• Enables companies and auditors to account for transactions where there may not be a specific applicable standard
• Improves accounting itself and provides a basis for answering specific accounting questions and problems faced by individuals involved in preparing, auditing or using financial statements

Political
• are independent of political interference= informs economic decisions e.g. invest

Professional
•Protects the professional status of accounting and accountants

Question 17

Criticisms of IASB’s conceptual framework

Answer 17

• Ambiguous and open to interpretation – principles-based which can be considered too vague,
• Meaning of reliability is problematic – particularly in the aspect of ‘represent faithfully’ – this may imply to some that there is a single ‘true’ or correct value for financial items in the accounts.
• Some principles may give rise to conflicts, e.g. the more verifiable the information the more reliable it is, but this may be less timely.
• Allows alternatives, e.g. alternative measurement (valuation) bases given, which leads to reduced comparability

Question 18

define stewardship

Answer 18

making individuals accountable for assets and liabilities

keeping track of assets, prevent their loss/or fraud

Question 19

two characteristics of IASB

Answer 19

• relevance
  (helps predict future events
• faithful representation
  (must be neutral, no errors or omissions, complete)

to enhance above, must have:

• comparability
• verifiability
• timeliness
• understandability