Lecture 1 Rev notes PDF

Preview

Summary

rev notes...

Description

Lecture 1: International Financial Reporting Environment – Revision notes Financial Reporting Regulation Sources of Regulation: 1. Company Law  Broad rules – doesn’t govern in detail  E.g. national laws – UK Companies Act 2006 2. Mandatory standards  Detailed rules  Set by private sector standard setters (national/international accounting standards bodies)  UK body = Financial Reporting Committee (FRC) 3. Stock exchange requirements  E.g. FTSE – extra requirements required Why do we need this regulation?  Large companies – SH’s/investors need to regulate/gain accurate picture of company  Management pressures – directors scandals  External users – pensions/public interest – ETHICAL  Capital markets  Understanding by users – common language – even international comps – COMPARE  Information rights of outsiders – protection  Economic & other decision-making purposes – investors need credible info Arguments against regulation?  Why do we have accounting standards? 

Differences in National accounting practises and systems  

National environments have different characteristics; standard setters and accounting bodies have chosen different alternatives for recognition, measurements & presentation of assets, liabilities equity, revenue and expenses Chosen policies best fitted to their national environments

3 Influences on F/R in countries: 1. Different environmental influences 2. Different institutional influences 3. Different cultural influences Reasons for differences: (used TB notes) 1. Provision of finance  Creditors vs. equity  Companies in different countries responded differently to increased need for funds  In countries like Germany, France, Italy & Belgium – banks became major supplier of extra funds. Countries here relied on debt to finance their activities (not equity).  UK & USA – shareholders became source of extra funds – rely on equity for funding  In countries where companies are largely financed through equity (UK & USA) F/S will have an investor/shareholder orientation. (“High quality” acc. Info – allows investors to make investment decisions).  In countries where companies rely more on debt financing, the F/S have a creditor orientation. This info must be useful to judge whether a company is able to repay its debts. Creditor protection becomes important here, and accounting practises will become more prudent/conservative.

2. Existing legal system

1

 2 types of legal system exist: common law system & code law system (Roman law)  Common law system –  Originated in England and developed from case law (in most commonwealth countries).  Legal system that is developed case by case and does NOT prescribe general rules.  Here, accounting rules are NOT part of the law.  In common law countries, accounting regulation in hands of professional organisations in private sector  Common law countries: England, Wales, USA, Australia, Canada, Ireland, Singapore and New Zealand  Degree of enforcement: of investor protection much stricter than code law countries – stricter enforcement = higher qual. acc. info  Code law system (Roman Law System) –  Originated in Roman law and developed in continental Europe.  Characterised by wide set of rules that try to give guidance in all situations  In code law countries – company law is very detailed and accounting standards are often embodied in company law  Accounting regulation is in hands of the government – and financial reporting has to comply with a set of very detailed legal rules  Code law countries: Scotland, France, Germany, Belgium, The Netherlands, Portugal, Spain and Japan 3. Link between accounting and taxation  In some countries, fiscal authorities use info provided in the F/S in order to determine taxable income  In no. of continental European countries – expenses are tax deductible only if they are also recognised in the P&L account  As result, FR becomes tax influenced or even tax biased  In countries like USA & UK, link between taxable Y and accounting income is WEAKER – separate accounts filed for tax purposes (independent)  Dependent countries include Germany, France and Belgium. 4. Cultural differences:  Individualism vs. collectivism  Individualism is where individuals take care of themselves and their immediate families only  Collectivism is where individuals expect their relatives, clan or other in-group to look after them in exchange for unquestioning loyalty  Large vs. small power distance  Power distance = extent to which the members of a society accept that power in institutions and organisations is distributed unequally  Larger power distance societies = accept hierarchal order in which everyone has a place – no further justification needed  Small power distance societies = less hierarchy and power distributed more evenly  Strong vs. weak uncertainty avoidance  Uncertainty avoidance = degree to which the members of a society feel uncomfortable with uncertainty & ambiguity  This feeling leads to beliefs promising certainty and to maintain institutions protecting conformity  Strong uncertainty avoidance societies = maintain rigid codes of belief and behaviour and are intolerant of deviant people and ideas  Weak uncertainty avoidance societies = maintain more relaxed atmosphere in which practise counts more than principles and deviance is easily tolerated  Masculinity vs. femininity

2

 

Masculinity = preference in society for achievement, heroism, assertiveness and material success Femininity = preference for relationships, modesty, caring for the weak and quality of life

5. History 6. Level of Economic Development Models of Accounting: Types: 1. Anglo-American Model // Common Law System // Private sector Acc. standard setting  UK, USA, Australia & Commonwealth countries  Private standard setting goes with a Shareholder Orientation of financial info published  Mostly a common law system  Less detailed rules compared to roman/code law countries  Limited legislation  Law determined on a case by case approach  Principles based approach – accounting profession decides rules  “Fair presentation” of financial info  True and fair view – concerned with professional judgement of accountant 2. Continental European Model // Code law system // Public sector Acc. Standard setting  Detailed accounting rules embodied in law  Creditor orientated financial info  Code law system  Govt sets accounting standards  Govt can manipulate these to fulfil their own needs  FR in these countries = compliance with legal requirements & tax laws

Pressures to reduce differences:  



 

European Union o Don’t like individual differences in countries Increased Globalisation o Capital markets (dual listings – UK comps can now list on New York S/E etc.) o Financial Markets are now global Multinationals o Long term finance needs o Transnational users of accounts – invest not only in domestic markets – comparability Investment interest of investors o Need for comparability & understandability Harmonisation/Standardisation o Comparability/Convergence o Harmonisation = “process of increasing comparability of accounting practises by setting bounds to their degree of variation” o Standardisation = implies more rigid and narrow rules o Convergence = refers to elimination of differences between 2 sets of accounting standards (e.g. IFRS and US GAAP).

EU Accounting Harmonisation:  EU Directive o Directive = binding agreement by all member states of EU that they will introduce the principles set out in the directive into national legislation  Fourth Company Law Directive o 25th July 1978 o Aims to ensure that annual accounts disclose comparable and equivalent info  Seventh Company Law Directive

3



o 13th June 1983 o Extended 4th directive principles to the preparation of consolidated (group) accounts Eighth Company Law Directive o Auditing? o Problems of Directives:  Too complicated  Global harmonisation

International Accounting Harmonisation: Obstacles with EU Directives and Regulations – Strong/big professional accountancy bodies in common law countries (Anglo-Am)  Creation of IASC/IASB – 1st step of IFRS (private sector body, NOT govt controlled)  Globalisation of finance markets (IOSCO)  1995 – IASC entered into agreement with the International organisation of securities commissions (IOSCO) to complete a core set of IAS by 1999  Significance of this agreement great = means 1 set of financial statements, properly prepared in accordance with IAS GAAP would automatically be acceptable for listing purposed without amendment  Acceptance by American SEC for foreign listed companies

IASC    



IASC = International Accounting Standards Committee Created in 1973 Independent of govt Published IAS standards o Issues initially – comparability & understandability issues o Revised core set of IASs in 1999 Objectives: o Formulate & publish in public interest accounting standards o Work for improvement and harmonisation of regulations IASC replaced by IASB - 2001

Conceptual Framework  Defines nature and purpose of general purpose financial reporting  Body of accounting theory that acts as a guide to standard setting – coherent formulation of standards  “A coherent system of inter-related objectives and fundamentals that can lead to consistent standard and prescribes the nature, function and limits of financial accounting and F/S”  Standards based on principles within a conceptual framework

IASB Framework    

Written in descriptive style Not prescriptive with respect to standards Assists with topics not currently dealt with in Standards Objective of F/S is “to provide info about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions”

Scope:  Companies = reporting entities  Objectives of F/S  Qualitative characteristics that determine usefulness of F/S to users o Goal of qualitative C’s = to make F/S useful to wide set of users  Definition, recognition and measurement of F/S elements o Recognition = when should I include it?  Presentation and disclosure of F/S  Concepts of capital ad capital maintenance

4

Users:  Investors, employees, lenders, suppliers, customers, govt and public  Recognised that F/S can’t meet all info needs of these users  “General purpose F/S” – Decision useful Underlying Assumptions: 1. Accruals Basis (v. cash)  Transactions recorded & reported in accounting periods where they relate  Effects of transactions to company when they occur – not when they are paid 2. Going Concern  Entity will continue in operation for the foreseeable future  No intention or need to liquidate

Qualitative Characteristics: Attributes that make F/S useful for economic decision-making 1. Understandability 2. Relevance  Materiality – is it relevant to their economic decision? Only disclose what is relevant  “Capable of making a difference in the decisions made by users” 3. Reliability  Faithful representation o Complete – contains all info needed for users to understand // contains all activities that happened in reporting year o Neutral – unbiased // not manipulated o Free from error o Prudence – caution when making judgements of estimates 4. Comparability L4 – TENSIONS between all above – can you do all????? Enhancing qualitative characteristics: 1. Comparability – compared with other entities as well as itself from past years 2. Verifiability – users have confidence in the faithful representation of the econ info 3. Timeliness – financial info being in time to be capable of influencing decisions 4. Understandability – classifying, characterising and presenting info clearly and concisely Cost constraint on useful FR  Cost is a constraint on info that can be provided by FR

Elements of Financial Statements: 1. Measurement of financial position (Statement of Financial Position // Balance Sheet) a. Assets – controlled by entity b. Liabilities – present obligation c. Equity – residual interest (profit investors made in year on their investments in comp) 2. Measurement of performance (Income Statement // Profit & Loss Account) a. Income – revenue & gains b. Expenses (and losses) Recognition of these Elements in F/S: What do we include?  Incorporate items that meet the definition of an element and satisfies the criteria for recognition  Recognition = “the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the criteria for recognition set out in Paragraph 83” Recognition criteria: an item should be recognised if,  It is probable that any future economic benefit associated with the item will flow to or from the entity

5

 

The item has a cost or value that can be measured reliably Subject to materiality

Recognition of assets: An asset is recognised in the B/S when it is probable that future economic benefits will flow to the entity (as a result of control of the asset) and the asset’s costs or value can be measured reliably Recognition of liabilities: A liability is recognised in the B/S when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount of that settlement can be measured reliably Recognition of income: Recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (or combination of the 2) Recognition of expenses: Recognition of expenses occurs simultaneously with the recognition of increases in liabilities or a decrease in assets (or combination of the 2) - Expenses commonly recognised in I/S on the basis of association (matching) between the incurrence of costs and the earning of specific items of revenue, that result directly or jointly from the same transactions or other events Assets:  Future economic benefit = the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity, including the capability to reduce cash outflows  Have one or more of following capabilities: (creating future econ benefit) o Can be exchanged for other assets o Can be used to settle a liability o Can be distributed to the entity’s owners  Cash possesses all 3 of these capabilities  NCA = an asset the firm intends to use within the business, over an extended period, in order to assist its daily operating activities  CA = an asset likely to change its form An asset is a resource: (All 3 need to be satisfied to recognise something as an asset) a) Controlled by the entity b) As a result of past events, and c) From which future economic benefits are expected to flow to entity Liabilities:  Essential characteristic = entity should have a ‘present obligation’  Obligation = “a duty or responsibility to act or perform in a certain way  The duty/responsibility may arise from law or from normal business practise A liability is: (all 3 need to be satisfied) a) A present obligation of the entity b) Arising out of past events c) The settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits Equity:  Defined as residual interest (assets – liabilities)

IFRS Standards in the EU:   

Harmonisation via Directives ineffective So, adoption of IFRS 2000 – EC selection of international standards

6

 

2002 – Regulation on the application of IFRS o All EU listed companies to published IFRS consolidated F/S on or after 1 Jan 2005 EU Applicability and interpretations Evolutions at the end of the 20th century:  Group 1: companies that made appeal to the international capital market for funds – started to apply accounting rules that would lead to increased comparability of their financial info worldwide. This group started using “high quality accounting standards”.  Nowadays, in more than 100 jurisdictions, listed groups have to comply on a mandatory basis with IFRS  Group 2: non-listed domestic companies, small and medium sized, who continue to comply with national GAAP (not applicable for un-listed companies)

Adoption of IFRS outside EU:  US GAAP  American Sec (still doesn’t apply it)  Convergence - Norwalk Agreement (2002) o Elimination of differences between IFRS and US GAAP o 2007: non USA companies listed on American stock exchanges – IFRS financial statements  Major change in thinking of SEC in 2007 o A view of US companies preparing IFRS complaint financial statements – ENRON  Australia and New Zealand adoption o Mandatory compliance for group accounts of listed companies International dimension (TB): Historically, accounting and reporting grew up largely independently, and often very differently, in different countries. With the global economy, instant communication and a global finance market, this situation has changed sharply and this process of change is continuing. The institutional and regulatory developments in the on-going process of increasing harmonisation, involving the EU and the International Accounting Standards Board (IASB) The speed of this process has increased sharply over recent years; all listed (quoted) companies within the EU are using International Accounting Standards (IASs) for their consolidated financial statements for year-ends beginning on or after 1st Jan 2005. -

Australia swapped to IFRS at same time China adopted something closely related to IFRS in text Many other countries moving closer towards IFRS requirements USA is more complex

By 2012, it became clear, with formal recognition by both the American Financial Accounting Standards Board (FASB) and IASB that full ‘convergence’ was NOT going to happen.

7...