Literature review on IFRS PDF

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A Literature Review on adoption of IFRS and capture theory

Executive Summary International Financial Reporting Standards have positively affected the economies in Australia and India. Foreign capital is attracted and comparability of financial reports have been the major reasons. Capture theory represents the efforts made to influence the regulators by the ones being regulated to influence their decision making on their interest. The regulators in Australia and India can be said to be captured in some ways to benefit the industry.

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Table of contents 1. 2. 3. 4. 5. 6. 7. 8. 9.

Introduction…………………………………………………..4 Australian financial reporting environment………………….4 Adoption of IFRS in Australia……………………………….5 Indian financial reporting environment………………………5 Adoption of IFRS in India…………………………………....6 Capture theory………………………………………………..7 Usefulness of capture theory………………………………....7 Characteristics of capture theory…………………………..…8 References……………………………………………………10

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1. Introduction Rules-based accounting requires a given set of a particular treatment to all the activities (Schipper, 2003). Previous events show that rules-based standards provide a prescribed way of dealing with a particular accounting activity which is less intended to the act of communication. It can get itself into a circle of complexity trying to comply with the rules and regulations and not being able to fulfill its expectations. A study conducted by SEC shows that principle-based accounting standards may be difficult to give a proper guidance as there is less structure provided so that the professionals can make their professional judgment. Rules-based standards give a prescriptive method to be followed by all the entities which are not to be changed. The study concludes that standard setting is more based on the principle (SEC, 2003). Rules-based accounting is said to support the arrangement of financial outputs in such a way to achieve desired results. It is easy to manipulate information under such accounting. Whereas, the principles-based approach is said to give too much emphasis on the professional judgment which reduces uniformity among the accounting information (Nobes, 2004). International Financial Reporting Standards (IFRS) is issued by International Accounting Standard Committee (IASC). The standards issued are principle-based. They provide a broad set of rules for decision making. It does not prescribe a set of regulations to its users. It has been advancing towards the globalization of financial reporting standards(Sambaru, & Kavitha, 2014). This literature review provides the introduction to Australian financial reporting environment and elaborates on the adoption of IFRS and its effects on the economy. Later, it discusses Indian financial environment and effects of IFRS adoption. Capture theory is discussed along with its characteristics. The literature review ends with the discussion of evidence showing that the regulators in India and Australia are captured or not. 2. Australian financial reporting environment The beginning of standard setting in Australia started formally since 1966 when professional bodies like Accounting Standards Board (AcSB) and Public Sector Standards Board (PSASB) merged to set standards in Australia operating under one name of Australian Accounting Research Foundation (AARF). Later in 1984, Australian Standards Review Board (ASRB) was founded which was backed up by Companies Act 1981 to enforce the law for companies and securities which was renamed as Australian Accounting Standards Board (AASB) in 1991. AASB was again reestablished in 2000 as per Australian Securities and Investments Commissions Act 1989 (AASB, 3

n.d ). Financial Reporting Council (FRC) is responsible for surveillance of standard-setting activities in Australia. It regulates AASB and Auditing and Assurance Standards Board (AUASB) who develop standards for auditing applied under company law. Both of these organizations operate under Australian Securities and Investments Commission Act 2001. Australian Securities and Investments Commission (ASIC) implements the standards issued by AASB under Corporations Act 2001. Australian Stock Exchange (ASX) provides a platform to buy and sell the shares of the listed companies and require the companies accounting reports to comply with AASB standards. Australian Prudential Regulations Authority (APRA) is in charge of insurers, banking sector and approved deposit-taking institutions (AASB, 2014). 3. Adoption of IFRS in Australia Australia decided to adopt International Financial Reporting Standards (IFRS) by the beginning of 2005 (Armstrong et al., 2010) making it the first country outside European Union to adopt IFRS. Studies have shown that the firms have been able to recognize the possibility of risk in advance with better income management after the adoption of IFRS. The information flow in the market is much better and reliable. There has been a positive impact on an Australian accounting (Chua, Cheong, & Gould, 2012). IFRS was adopted by Australia with the aim of attracting capital. It aimed to decrease the costs for the financial report preparers, auditors and the users of the information provided by the business entities. It also aimed to bridge flaws that existed in Australian regulations (AASB, 2009). It is also evident that Australian standard setters have a lesser impact on the standards that are to be used within Australia which is more favorable to local conditions. Some Australian standards were of better quality than of IFRS, which has weakened the standards of the regulation (Chapple, 2014). It has been seen that IFRS has had a positive effect on the Australian market which can be supported by various studies conducted by scholars. The accuracy of analysts has improved which has provided better information for investors. Some studies have shown that accounting reporting has significantly improved whereas some doubt saying that treatment of identifiable intangible assets using Australian Generally Accepted Accounting Principles (AGAAP) to be better. The comparability of financial reports to other international companies has improved along with the quality of the reports though they have increased in length ( AASB Research Report No 3, 2016). 4. Indian financial reporting environment Financial reporting is governed under section 211, schedule VI of the Companies Act 1956 in India. Institute of Chartered Accountants of India (ICAI) overlooks the bookkeeping activities in the country. Securities and Exchange Board of India (SEBI) guides the activities for corporate 4

disclosure of the companies. India previously had its own set of standards for financial reporting which was called National Accounting Standards formulated by Accounting Standard Board (Aggarwal, 2016). Insurance companies in India are governed by Insurance Act, banking companies are governed by Banking regulations Act 1949, non-banking finance (NBFC) companies are governed by NBFC act, limited liability partnership (LLP) by LLP act 2000. Partnership firms by partnership act and trust by Indian trust act. At present, two types of accounting standards exist in India. AS with 31 standard and Ind-As with 41 standards both based on IFRS. There is no given set of standards for unorganized sectors for financial reporting. However, it is governed by Income Computation and Disclosure Standards (ICDS) (Amritt, 2018). 5. Adoption of IFRS in India India is a fast-growing country which has its business spread all over the world. IFRS would provide a similar set of rules and is adopted by 150 countries around the globe. This provides a very good business perspective for Indian business. This would allow the companies to raise foreign capitals, cost reduction in accounting practices, reduce accounting complexities for multinational companies and of course provide better opportunities around the globe (Athma & Rajyalaxmi, 2013). India's adoption of IFRS was postponed to 2015 from 2011 as planned earlier. The adoption of IFRS in India is divided into two phases: phase I and phase II. Phase I involves the mandatory adoption of Indian based IFRS called Ind-AS by the companies who have net worth INR 500 crore or more by 1 April 2016. This is applicable to the companies who have share being listed or listed in the share market inside or outside India. Phase two involves companies with a net worth less than 500 crores who are listed in the stock market in India or outside India (Misra, & Aggarwal, 2014). Since the adoption of IFRS, there have been many challenges associated with it. The major challenges are related to major changes from Indian GAAP to IFRS. Some of them can be listed as use of fair value replacing historical cost. Implementing of IFRS is more costly as new software and additions human expertise is needed. Many investors are unaware of the new standards which reduce their capacity to compare and analyze for investment decisions. With the adoption of IFRS, new technology and skills have to be adopted by the company and the staffs which will take some time (Sruthiya, & Akhin, 2017). In-spite of several deviations between AS and IFRS, there are major areas such as "leasing, revenue recognition, foreign currency convertible bonds, current vs noncurrent liabilities, bargain purchases". There continuous attempts being made to harmonize the differences to reach the total adoption of IFRS. IFRS adoption is still to be done to the banks in India which will start from April 1, 2018. It is believed that total IFRS adoption in India will be done within 5 years (Srivats, 2016). 5

6. Capture Theory Posner (1974) presented that the group that is being regulated wants the regulations to be developed to protect or promote their self-interest as every person does so on a normal day to day life. Stigler suggested that rules and regulations are created to fulfill the demands of the ones that are being regulated. Capture theory posits that the lawmakers or the regulators are finally controlled or influenced by the ones who are to be regulated by the regulations they make. The government is captured by the industry and heavily influence the standard making decisions of the government. Government is the ultimate source of authority, the ones who are going to be affected by the regulations are capable of influencing them and use them to serve their interest (Stigler, 1971). Capture theory was first introduced by George Stigler in 1982. Regulations provide protection to the customers, but the industry also has interest in the regulations made. The regulations can be made in their favor such as add complexities in the rules which discourages new entrants to the industry. This will also demoralize them allowing the existing companies to keep their grip on the market and earn profits. Standard setters are supposed to work in favor of consumers who have the voting power to demand. However, financial aids provided by the industry wins the struggle between consumers and industry which may result in industry capture (Dowding, 2011). 7. Usefulness of Capture theory Capture is usually looked in a negative way. There are some suggestions that capture can be useful to the economy. Ayres and Braithwaite (1991) proposed that some types of capture can be of positive nature that boosts social welfare supported by an example that the industries and regulators work together and adopt the regulations without much hassle. It reduces the differences among the regulators and the ones being regulated and work as per the law made. Another study conducted in Australian nursing homes suggested that way of looking at capture should be changed. It has to be viewed in more dynamic way consisting deep considerations towards problems faced by the industry, working with industry to find the problems and not being too forceful while implementing regulations (Makkai, & Braithwaite, 1992). The collaboration between industry and regulators have a fair amount of advantages for the state. The industry has a vast amount of information that can help in making better regulations. They would provide such information to the regulators if they are close to each other, as it would make better environments for them to operate in. Enforcement of law can be way efficient in terms of cost 6

and implementation. Voluntary acceptance of regulations can be achieved reducing the problems to be created in case of non-acceptance (Reiss, 2012). 8. Characteristics of a captured regulatory environment A regulatory environment can be said to be captured when a lobbyist is able to influence the drafting of the legislation. A lobbyist acts as a mediator between the government and the industry while formulating regulations. Capture usually occurs after the regulation is made. There are continuous efforts made by the industry to amend it or weaken as far as possible if it adversely affects them. Enforcement of regulations is made difficult or their consequences are made of mild effect. For example, reduction of penalty to be paid in case of any particular crime. Sometimes, the regulations are taken off the books by the industry by lobbying the regulators. In some cases, if the regulator cannot be influenced, the industry changes its regulator by going to a new environment by changing its type. A high increase or decrease in the rates or prices which adversely affects the consumers can be a sign of captured regulatory environment (Etzioni, 2009). When we look at Indian regulatory environment through the lens of capture theory, there can be various examples found which shows that the regulators have been captured. The case of Tariff Authority for Major Ports (TAMP) can be seen as one of the examples. TAMP regulates the tariffs among the ports who refused to allow Chennai Container Terminal Limited to consider its royalty payments as costs in 2005. The government made a rule that the royalty payments after July 29, 2003, would not be treated as a cost, however, if royalty payments before this date result in loss then it would be treated as a cost. TAMP denying this rule allowed Nhava Sheva International Container Terminal (NSICT) to treat its royalty payments of 30 years as costs which would give them the benefit of $1.46 billion. The regulators of TAMP were captured by the NSICT (Jain, n.d). The case of Satyam Computer Services Ltd can also be considered as an example of regulators being captured. The company committed a fraud consisting of $1.47 billion. It traded in the New York and Bombay Stock Exchanges. The company was let free facing minimal consequences. The auditing company PricewaterhouseCoopers (PWC) paid the minimal amount of fine for misrepresenting the information of Satyam Computer Services Ltd. This slight slap to the culprits by the regulators shows that the regulators are captured in the Indian regulatory environment (Pai, & Tolleson, 2015). Meanwhile, in Australia, a decision passed by the court which established a regulation related to electricity billing. The new law would make consumers pay a higher amount of electricity in coming days. NSW coalition premier Mike Baird did not allow the privatization of poles and wires and helped the distributors challenge Australian Energy Regulator ruling in the court which would 7

have reduced 30% of energy costs to consumers in 5 years' time. It is clearly visible that, the regulator has acted in the interest of industry only (Toohey, 2017). Australian Prudential Regulation Authority (APRA) has been facing criticism for hampering small business and hurting customers with its activities. This has benefited the big banks who earn higher rates from investors and investors use it for their tax returns which cost AUD500 million to ATO (Macrobusiness, 2018). IFRS has been continuously trying to create a similar standard for all the countries and trying to lead them to harmonization. This process has been ongoing ever since its establishment. It has been successful in some sense but needs to improve and adapt itself with respect to different conditions in various countries. There are many good signs of IFRS adoption which are already seen in Australia. The financial reporting has been more comparable and understandable by different stakeholders around the world. India's decision to adopt IFRS has been a fruitful one for the economy. Reports have shown an increase in capital inflow and the economy in overall has grown. Regulators are always an on target for lobbying. It is possible in most cases that being captured might have been good but most of the time it only serves the industry's interest neglecting the public's interest.

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9. References AASB Research Centre (2016). AASB Research Report No. 3. Retrieved from: http://www.aasb.gov.au/admin/file/content102/c3/AASB_RR-12_10_16_IFRS_Lit_Review.pdf Australian Accounting Standard Board (AASB), (n.d). For students. Retrieved from: http://www.aasb.gov.au/About-the-AASB/For-students.aspx#qa1442 Aggarwal, S. (2016). International financial reporting standards: An Indian perspective: a roadmap. Journal of business and management, 18(1), 1-5. Doi: 10.9790/487X-18110105 Amritt (2018). Business laws & regulations in India. Retrieved from: https://amritt.com/services/india-business-consulting/business-laws-regulations-in-india/ Athma, P., & Rajyalaxmi, N. (2013). Accounting standards in India: Adoption of IFRS. Journal of Commerce and Accounting Research, 2(2). Retrieved from: http://web.b.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=1&sid=2c69546d-7cae-4418-9397966ee1fba417%40sessionmgr103 Armstrong, C. S., Barth, M. E., Jagolinzer, A. D., and Riedl. E. J. (2010). Market reaction to the adoption of IFRS in Europe. Accounting Review, 85: 31–61. Doi: 10.2308/accr.2010.85.1.31 Australian Accounting Standard Board, (2009). IFRS adoption in Australia. Retrieved from http://www.aasb.gov.au/admin/file/content102/c3/IFRS_adoption_in_Australia_Sept_2009.pdf Australian Accounting Standard Board (AASB), (2014). Statement of intent- The Australian Accounting Standard Board. Retrieved from: http://www.aasb.gov.au/admin/file/content102/c3/AASB_Statement_of_Intent.pdf Ayers, I. & Braithwaite, J. (1991). Tripartism: Regulatory capture and empowerment. Law & Social Inquiry, 16(3), 435-496. Retrieved from: http://heinonline.org.ezproxy.cqu.edu.au/HOL/Page? public=false&handle=hein.journals/lsociq16&page=435&collection=journals Chappel, S. H. (2014). Adoption of international financial reporting standards in Australia: Structure, agency and unintended consequences. Retrieved from: http://ro.uow.edu.au/cgi/viewcontent.cgi?article=4991&context=theses

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Chua, Y. L. (Elaine), Cheong, C. S., & Gould, G. (2012). The impact of mandatory IFRS adoption on accounting quality: evidence from Australia. Journal of International Accounting Research, 11(1), 119-146. DOI: 10.2308/jiar-10212 Dowding, K. (2011). Encyclopaedia of power. Sage. Retrieved from: https://books.google.com.au/books? hl=en&lr=&id=gao_w6kQEykC&oi=fnd&pg=PR1&dq=Dowding,+K. +(2011)&ots=UK1lEZF0bD&sig=-wLd9BN0zsaMXFruFyXr1xFh2fk#v=onepage&q=Dowding %2C%20K.%20(2011)&f=false Etzioni, A. (2009). The capture theory of regulations-revisited. Society, 46(4), 319-323. Retrieved from: https://link.springer.com/article/10.1007/s12115-009-9228-3 Jain, S. (n.d). Is India's regulatory system bust? Retrieved from: http://thesuniljain.com/files/Is %20India%E2%80%99s%20regulatory%20system%20bust.pdf Macrobusiness (2018). Australia's captured financial regulators need policing. Retrieved from: https://www.macrobusiness.com.au/2018/02/australias-captured-financial-regulators-need-policing/ Makkai, T., & Braithwaite, J. (1992). In and out of the revolving door: making sense of regulatory capture. Journal of Public Policy, 12(1), 72-73. Retrieved from: http://www.jstor.org/stable/4007430?casa_token=XL28_EwU_5kAAAAA:RKbtFKCdj8n8RCfHbHnFo4HOOQrC7qDKeaMOyaEGKtPc4UQ30AgeHeXxvfFAPfMK7VsjXh7mGuhp48Rbx Napo11-IvC_1kpvE4letQJnv1z4VNC3_3w&seq=1#page_scan_tab_contents Misra, S. K., & Aggarwal, V. (2014). Strategies, benefits and challenges of adoption of IFRS in India. International Journal of Accounting and Financial Management Research, 4(6), 17-26. Retrieved from: http://www.academia.edu/1046...