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Question
HA 3011 Advanced Financial Accounting
Assessment item 2 — Assignment
Due date: 11.59 pm Friday Week 10
Weighting: 20%
Assessment Task Part A (6 Marks)
In an article entitled ‘Unwieldy rules useless for investors’ that appeared in the Australian Financial Review on 6 February 2012 (by Agnes King), the following extract appeared. Read the extract and then answer the question that follows.
Millions of dollars have been spent adopting international financial reporting standards to help investors make like-for-like comparisons between companies in global capital markets. But CFOs say they are useless and have driven financial disclosures to unmanageable levels. The criticism comes as the United States, the world’s largest capital market, decides whether to retire its domestic accounting standard (US GAAP) and adopt IFRS.
“In seven years I never got one question from fund managers or investment analysts about IFRS adjustments,” former AXA head of finance Geoff Roberts said. “Investors...rely on investor reports and management briefings to understand companies’ numbers.”
If analysts did delve into IFRS accounts, they would most probably misinterpret them, according to Wesfarmers finance director Terry Bowen. “Once you get into the notes you have to be technically trained. If you’re not, lot of it could be misleading,” Mr Bowen said.
Commonwealth Bank chief financial officer David Craig said IFRS numbers were disregarded by investors because they could actually obscure an institution’s true position.
Required:
You are required to explain which qualitative characteristics of financial reporting, as per the conceptual framework, do not, in the opinion of the above quoted individuals, appear to be satisfied by current reporting practices pursuant to IFRS. Also, you are required to consider whether the views are consistent with the view that corporate financial reports satisfy the central objective of financial reporting as identified in the Conceptual Framework.
Assessment Task Part B (6 Marks)
In 2006 the Australian Government established an inquiry into corporate social responsibilities with the aim of deciding whether the Corporations Act should be amended so as to specifically include particular social and environmental responsibilities within the Act. At the completion of the inquiry it was decided that no specific regulations would be added to the legislation, and that instead, ‘market forces’ would be relied upon to encourage companies to do the ‘right thing’ (that is, the view was expressed that if companies did not look after the environment, or did not act in a socially responsible manner, then people would not want to consume the organisations’ products, and people would not want to invest in the organisation, work for them, and so forth. Because companies were aware of such market forces they would do the ‘right thing’ even in the absence of legislation).
Required:
You are required to explain the decision of the government that no specific regulation be introduced from the perspective of:
(a)Public Interest Theory
(b)Capture Theory
(c)Economic Interest Group Theory of regulation
Assessment Task Part C (4 Marks)
The US Financial Accounting Standards Board does not allow revaluation of non-current assets to fair value, but it does make it compulsory to account for the impairment costs associated with non-current assets as per FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets.
Required:
What implications do you think these rules have for the relevance and representational faithfulness of US corporate financial statements?
Assessment Task Part D (4 Marks)
Many organisations elect not to measure their property, plant and equipment at fair value, but rather, prefer to use the ‘cost model’. This will provide lower total assets and lower measures, such as net asset backing per share.
Required
You are required to answer the following questions:
(a)What might motivate directors not to revalue the property, plant and equipment?
(b)What are some of the effects the decision not to revalue might have on the firm’s financial statements?
(c)Would the decision not to revalue adversely affect the wealth of the shareholders?
| Subject | Article Analysis | Pages | 9 | Style | APA |
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Answer
Advanced Financial Accounting
Assessment Part A
The financial statements that are published are required to have particular qualities that make them useful to investors and other users. The US Generally Accepted Accounting Standards provides such information on its standards accounting framework. International Accounting Standards Board’s Conceptual Framework defines and categorizes concepts into basic qualitative characteristics as listed below;
a). Relevance
b). Materiality
c). Comparability
d). Timeliness
e). Faithful Representation
f). Understandability
g). Verifiability
Financial information must be relevant and useful to the users such as the investors while the materiality concept requires the information reported by auditors to be effective, material and useful to the decision makers or users of the financial statement. The financial statements must be comparable and uniform. All the periods and statements must be comparable across all the company statements being compared (Barth, Landsman, and Lang, 2008).Timeliness concept requires all the financial statements to be prepared when required any undue delays should be avoided. Faith representation in financial statement publication is a concept requires the financial statements to be free from any misstatements and they should be true, fair and accurate. The statements should be clear and understandable. They should also be verifiable. The information provided on the financial documents should be verifiable from particular sources especially critical issues like bank balances, debtors and creditors balances, Assets, liabilities and other company properties like building and plants (Barth, Landsman and Lang, 2008).
IASB conceptual framework clarifies the importance and need of the financial reporting standards. The conceptual framework provides opportunities for accounting standards to be developed for the benefit of users. However the application of some aspects of conceptual framework that have drawn a lot of controversies and confusion especially with the advent of numerous financial scandals that have rocked the financial world in the US and other developed cities of the world.
The objective of the conceptual framework was basically to enhance financial statement reliability, enhance quality and also to maintain confidence in investors’ minds and other users of financial information. However, the spate of financial scandals that have occurred in the last decade and half have left the financial world with so many doubts and questions casting a lot of doubt on the audited financial statement’s quality of reporting in the finance world (Tasios and Bekiaris, 2012). The SOX Act of the year 2002 requires external auditors and their respective audit committees to ensure audited financial statement maintain high quality in all aspects of financial accounting as espoused by the conceptual framework (Chen, 2012). Several models have been forwarded to measure the quality of financial reporting like a) accrual models b). Value relevance c) Qualitative characteristics model and particular requirements in annual reports.
Accrual model assumes that financial managers have the discretion of deciding the basic accounting concept to apply. Selective discretionary concepts allow earnings management which has lately been associated with a lot of controversies in financial accounting (Chen, 2012).
Assessment Part B
Public Interest Theory
Public Interest Theory explains that regulation protects the interest of the public. The other aspect clarifies that public interest theory ensures that when markets fail then the government should regulate the market in order to protect the welfare of its citizens. Public interest theory can be described in three ways;
a). Public Goods – Public service are like the national defense which is ostensibly for defending the interest of the public or country. Others are like the legal system which ensures that the national defense is not misused or turns out to be a military dictatorship.
- b) Economic Regulation – In public view the regulation of the economic markets to prevent monopolies and also the implementation of anti-trust laws to prevent collusive business practices that exploit the public (Van Beest, Braam and Boelens, 2009).
c). Social & environmental regulation ensures that issues like child labor, animal cruelty are discouraged for public interest.
Public interest regulations are principally for protecting the interest of citizens. However, in the case of Corporate Social Responsibility, the regulation has been left to the public. The companies that fail to satisfy the public that they are doing much for the public interest then the public if not convinced by their actions will boycott the products of the company hence the company will incur losses (Maloney, 2001). To void the losses the company managers have to follow the wishes of the public to implement the various aspects Corporate Social Responsibility (CSR).
Capture Theory
Capture Theory expresses a situation where a government has introduced regulatory measures and which have consequently failed to protect the public’s interest and instead they advance the interest of a special group. Regulatory capture is characterized by firms that dominant others at the expense of the public. The government agencies that are supposed to protect the interest of the public are captured. The CSR initiative by the government to allow the market to regulate itself may not work as captured government agencies may only work for their own interests and not the interest of the public. The private companies will not be under any pressure to adopt good policies of CSR as the regulating agencies will in fact favor the companies in order to advance their own interests. Captured state agencies make it difficult for the public as the regulators side with the companies to be regulated in order to frustrate the public even further. It is better for the government to avoid regulation altogether if the regulators would be captured by vested interests.
Economic Interest Group Theory of regulation
The theory attests that policies should be driven by interest groups who should be on the demand side while the government should be on the supply side. The regulations should be developed by the players in the industry concerned hence creating advantages to the whole group. Economic Interest Group Theory of regulation theory posits that the industry should be left alone to design its own regulations that the market should adopt. The groups regulating the market should be small in numbers to minimize administrative costs (Greg, 2013). Producers should regulate their own markets just as much as consumers should also regulate their own market. The major advantage of the Economic Interest Group Theory of regulation is that respective industries are allowed to design and implement its strategies and rules. The government is tasks with the responsibility of ensuring that the rules that have been developed by the industry are implemented. However the major disadvantage is that the selected group can favor particular group or groups of companies. If the companies can regulate themselves then it would ideal as the public interest would be taken care of as the companies would take measures to market their goods at all costs including adoption of CSR policies.
Assessment Part C
Any company that applies the GAAP-based financial statements are required by law to comply with the provisions of SFAS 144 that in now known as the ASC 360. The provision identifies impairment as a condition or process of carrying over the amount of a long term asset and which has exceeded its fair value. Impairment loss can only be recognized when the carrying amount cannot be recovered and exceeds the assets fair value. The statement further states that after an impairment loss, an asset is considered to have adopted a new cost basis and it cannot revert back to fair value once it has been recorded. Under GAAP it is prohibited to revert back to fair value once an asset has been impaired. The relevance & representational of faithfulness does not apply as far as this rule is concerned (Deloitte Touché, 2017). When preparing financial statements once the records have been updated then the question of reverting back to fair value even when genuine mistakes were made is prohibited by GAAP. The argument faithful representation does not hold any basis on this GAAP provision.
Assessment D
Once an asset has been recognized by an entity in its books, there are two ways to account for it either on its acquisition or before the assets disposition. These methods are cost and revaluation model. The cost model requires an asset to be carried forward using its cost less its accumulated depreciation and other impairment losses. The carrying amount equals to Cost less accumulated depreciation less accumulated impairment losses. The cost of an asset is its historical figure and it does not change.
Revaluation model entails the recognition of an asset at a revalued cost less accumulated depreciation and other impairment losses. The carrying amount equals to revalue cost less accumulated depreciation less accumulated impairment losses. The cost of an asset is its revaluation cost. The revalued amount refers to the assets fair value at the time or date of revaluation. When an assets has been revalued and its value increases due to the revaluation the increase in value is recognized as other comprehensive income and also it is accumulated under company equity as revaluation surplus.
a). The decision not to revalue assets by directors may be motivated by the need avoid the payment of extra taxes. Revaluation of assets largely results in increase of an asset’s fair value which is recognized as the other income in comprehensive income statement. The extra amount means more profit which is taxable. Directors may be motivated to avoid revaluation to avoid the payment of extra taxes.
b). The decision not revalue assets may result in undervalued assets which may discourage the investors. Undervalued assets may result in undervalued firm hence it may attract less investors. Revalued assets reflect the fair value of the assets in the market hence attracting more investors.
c). The decision of the directors not revalue may have a negative impact on the value of the firm and adversely affect the shareholders wealth in the company. The value of the company is usually equity to the shareholders total equity and liabilities. Undervalued assets means the shareholders equity would also be undervalued.
References
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Barth, M., Landsman, W. and Lang, M. (2008). International Accounting Standards and Accounting Quality, Journal of Accounting Research, 46(3): 467-498. Chen, T. (2012). Analysis on Accrual-based Models in Detecting Earnings Management. Lingnan Journal of Banking, Finance and Economics, 2 (5): 1-11. Deloitte Touché (2017) Impairment f Long-Lived Assets held and Used or to Be Disposed of By Sale Key Differences between US GAAP and IFRS retrieved May 15, 2018 from https://www.iasplus.com/en-us/standards/ifrs-usgaap/impairment-of-assets Greg (2013) Economic Interest Theory and regulation retrieved May 19, 2018 from http://greg-accounting.blogspot.co.ke/2013/01/economic-interest-theory-and-regulation.html Maloney (2001) The Theory of Government retrieved May 15, 2018 from http://maloney.people.clemson.edu/827/19.pdf Tasios, S. and Bekiaris, M. (2012). Auditor’s Perceptions of Financial Reporting Quality: The Case of Greece. International Journal of Accounting and Financial Reporting, 2 (1): 57-74. Van Beest, F. V., Braam, G. and Boelens, S. (2009). Quality of Financial Reporting: Measuring Qualitative Characteristics. Working Paper, Radboud University, Nijmegan, Netherlands, pp. 1-108.
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