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Chapter 4

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Chapter 4

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  1. Chapter 4 The regulatory approach to the formulation of an accounting theory

  2. The nature of accounting standards • Accounting standards usually consist of three parts: • a description of the problem to be tackled • a reasoned discussion on ways of solving the problem, then, • in line with the decision or theory, the prescribed solution

  3. Requirements under accounting standards Edey divides accounting standards into four types: • Requires accountants to tell people what they are doing by disclosing the methods and assumptions adopted • Aims at achieving some uniformity of presentation of accounting statements • Calls for the disclosure of specific matters in which the user may be called to exercise his or her own judgement • Requires implicit or explicit decisions to be made about approved asset value and income determination

  4. Reasons for establishing standards • To provide users with information about a firm’s financial position, performance and conduct • To provide public accountants with guidelines and rules of action • To provide the government with databases on variables that are deemed essential to the conduct of taxation, regulation of enterprises, planning and regulation of the economy, and enhancement of economic efficiency and other social goals • To generate interest in principles and theories among all those interested in the accounting disciplines

  5. Approaches to accounting policy questions • A representational faithfulness approach: • favours neutral reporting and the pursuit of faithful representations through the standard-setting process • An economic consequences approach: • favours the adoption of standards with good economic consequences

  6. Pre-1999 standard-setting arrangements • Australian Accounting Standards Board (AASB) was created in 1989 • The AASB replaced the Accounting Standards Review Board (ASRB) • The AASB has similar standard-setting functions, but broader responsibilities than the ASRB

  7. The ASRB • The ASRB was created in 1983 to improve the enforceability of Australian accounting standards • At this time, the rules governing compliance were outlined in APS1: • members of the accounting profession responsible for financial statement preparation were to attempt to ensure that any departures from accounting standards were adequately disclosed in the accounts

  8. The ASRB (rules governing compliance cont’d) • members of the accounting profession who were auditors were required to issue qualified audit reports if a departure from an accounting standard undermined the presentation of a true and fair view • if APS1 was not observed by members of the profession, then the councils of the two accounting bodies could take disciplinary action

  9. APS1 deficiencies • APS1 only applied to members of the profession • APS1 only required mandatory disclosure of non-compliance rather than compliance

  10. Legislative backing of the AASB • In contrast to other boards of the AARF, the AASB had a line of authority to the government and not to the accounting profession • The accounting standards of the AASB have legal backing • If publicly listed companies do not comply, they risk punitive action from the Australian Securities Commission • The Attorney-General and federal cabinet must approve all 11 members of the AASB and appoint the chairman

  11. Functions of the AASB • To develop a conceptual framework, not having the force of an AASB standard, for the purpose of evaluating proposed AASB standards • To review proposed AASB standards • To sponsor or undertake the development of possible AASB standards • To engage in such public consultation as may be necessary to decide whether or not it should make a proposed AASB standard • To make such changes to the form and contents of a proposed AASB standard as it considers necessary

  12. The Public Sector Accounting Standards Board (PSASB) • Created in the early 1980s by the ASCPA and the ICAA as a board of the AARF • It reviewed the standards for relevance and applicability to the public sector • It developed a conceptual framework and accounting standards that were compatible with private-sector standards

  13. Responsibilities of the PSASB • To devise and implement a process for the formulation and maintenance of AASs, statements of accounting practice (SAPs) and SACs of relevance to public sector reporting entities • To prepare AASs, SAPs and SACs of relevance to public sector reporting entities • To prepare and issue accounting guideline releases and exposure drafts of AASs, SAPs and SACs • To keep under review existing AASs, SAPs, SACs and accounting guideline releases

  14. Other boards of the AARF • The Auditing Standards Board (AuSB) is responsible for promulgating statements of auditing practice and a conceptual framework for auditing practice • The Legislative Review Board (LRB) reviews relevant companies’ legislation for consistency and applicability to existing accounting standards

  15. The AARF • Funded jointly by the ASCPA and the ICAA • Primary function is to act as secretariat to the AASB, PSASB and other AARF boards

  16. Principal duties of the AARF • To provide the boards with relevant technical advice on accounting and policy matters • To develop and write technical discussion papers and accounting-theory monographs • To develop, write, expose and issue exposure drafts to provide whatever other technical assistance the boards require. and to release statements of accounting concepts, accounting standards and other releases on behalf of the boards

  17. The Australian Securities and Investment Commission (ASIC) • Founded in 1991, the ASIC is the supreme corporate regulator in Australia, and is comparable to the Securities Exchange Commission in the USA • The ASIC oversees the administration and compliance of the Corporations Law and companies’ legislation generally • Members are appointed by the Governor-General on the nomination of the Commonwealth Attorney-General

  18. Interpretation of accounting standards • The ASIC delegates responsibility for standard setting for the AASB, however company compliance with AASB standards is enforced by the ASIC • It is not always clear whether the AASB as opposed to the ASIC should be clarifying or interpreting accounting standards • It has been argued that if the AASB sets the standards then it should interpret their meaning and applicability

  19. The Urgent Issues Group (UIG) • Formed by the AARF and its boards early in 1995 • The UIG’s main function is to provide timely guidance releases on urgent accounting issues • Any decision of the UIG can be vetoed by the AASB and PSASB

  20. Influence of the accounting profession on standards Standards that do not have support from accountants and/or the business community could result in: • lobbying by particular interest groups • non-compliance • refusal of companies to contribute to or participate in the standard-setting process • threat of governmental regulatory intervention It is in the AARF’s best interests to issue standards that are accepted by the business community and the accounting profession

  21. Consultative groups • Each board consults with members of its consultative group to increase the involvement of interested groups in the standard-setting process • Consultative group members include representatives of the parties interested in and affected by accounting standards

  22. Exposure drafts • Draft exposure drafts are prepared by the boards and refined through discussion • The draft is then issued as an exposure draft by the AARF, which invites comment from all interested parties, usually over a period of at least three months

  23. Finalisation of accounting standards • Draft is forwarded to the National Councils of the Society and Institute and to the Federal Attorney-General’s Department and the Australian Securities Commission • After the exposure draft and consideration of comments are received, a draft statement of accounting concepts (or draft accounting standard) is prepared • A 30-day review period applies • Statements of accounting concepts are issued by the AARF and the AASB • The AARF issues AASs • The AASB makes and issues AASB standards

  24. Comparability with International Accounting Standards • This is an important aspect of accounting standard setting in Australia • Australian Accounting Standards carry an endorsement indicating compatibility with International Accounting Standards • Where an Australian Accounting Standard differs from an International Accounting Standard, reasons for material differences are given (where appropriate)

  25. Peirson Report 1990 • Commissioned to recognise defects in standard setting by reviewing existing institutional arrangements for accounting standard setting in Australia • Reviewing comparable arrangements internationally • Recommending appropriate arrangements for Australia

  26. Recommendations of the Peirson Report • The formation of two broadly constituted consultative groups, one for the private sector and one for the public sector • Replacement of the AARF with a reconstituted Australian Accounting Standards Foundation, which would be independent of the accounting profession, business and government • The merging of the AASB and the PSASB into a single national accounting standards-setting body of the AASF

  27. Benefits of the reforms • Accounting standard setting will be independent of interest groups including the accounting profession, business and government • There will be a significant increase in the numbers involved in the standard-setting process • Merging the PSASB and the AASB will enable more efficient use of the scarce resources available for standard setting • There will be a coordinated national approach to setting accounting standards • Legislative backing for accounting standards will continue • The funding for the AASF will be broadly based, insuring its independence

  28. Rejection of the Peirson Report • The Peirson report was largely rejected by the Attorney-General’s Department • Proposals may have been too far-reaching and ambitious • There may have been a perception that the status quo was working satisfactorily • It is most likely is that the government did not wish to relinquish its control over the standard-setting process

  29. Changes effected by the Peirson Report • In 1994, broad-based consultative groups were established • Membership of the AASB was increased from nine to 11 members • The Attorney-General’s Department supported a merger of the AASB and PSASB

  30. Post-1999 structure and the Corporate Law Economic Reform Program Act • The Corporate Law Economic Reform Program (CLERP) was announced in 1997 • Under the new legislation, standard setting is now within the domain of the federal treasurer • Two questions addressed in CLERP Position Statement No. 1 were: • How should existing standard-setting arrangements and structures be reformed? • Should Australia continue to develop its own accounting standards or adopt international accounting standards?

  31. Reforms to institutional arrangements • Perceived deficiencies of the present system according to CLERP • Existing arrangements for accounting standards setting are confusing and inefficient • There is duplication between the AASB and PSASB • Australian Accounting Standards are not well understood internationally • The standard-setting process is perceived to be dominated by the accounting profession and there is no real accountability to its users • Accounting standards do not reflect modern business practices

  32. Changes proposed by CLERPand adopted by the 1999 Act • Creation of the Financial Reporting Council (FRC) to oversee the setting of accounting standards • Creation of a new AASB • The new AASB will follow the strategic direction determined by the FRC • Project advisory panels of experts on particular subjects are to be used in the development of standards • The FRC will appoint members of the AASB

  33. International harmonisation Major recommendations by CLERP • Australia should continue to harmonise its standards with the International Accounting Standards • The prime focus of the AASB should be to influence the development of high-quality and relevant IASC accounting standards • A key role of the FRC should be to ensure that the AASB is committed to and works towards the adoption of IASC standards

  34. Benefits of adopting IASC standards • Many of Australia’s trading partners in Asia have now adopted IASC standards • Foreign-listed companies are permitted by the Australian Stock Exchange to register using IASC standards • The international profile of Australian companies needs to be lifted to facilitate access to foreign capital markets at a lower cost • Harmonisation will facilitate creation of a common language around the world

  35. Public accounting firms • The most influential public accounting firms are: • Ernst & Young • Arthur Andersen • Coopers and Lybrand • KPMG Peat Marwick • Price Waterhouse • Deloitte Haskins & Sells • Touche Ross • Lavanthol & Horwath • The work of public accounting firms consists of auditing, accounting, tax and management-advisory services

  36. Users of financial statements Direct users include: • the owners of a corporation and its shareholders • creditors and suppliers • the firm’s management • the firm’s workers • taxing authorities • customers

  37. Indirect users of financial reports Indirect users include: • financial analysts and advisers • stock exchanges • lawyers • regulatory or registration authorities • the financial press and reporting agencies • trade associations • labour unions • competitors • the general public • other government departments

  38. Different users’ needs • Direct and indirect users have different information needs • Three kinds of financial statements may be prepared: • general purpose financial statements that meet the common needs of the users • specific purpose financial statements that meet the needs of specific user groups • differential disclosures may present different figures for the user to select

  39. Theories of regulation Two major categories • Public interest theories: • maintain that regulation is supplied in response to a public demand for the correction of inefficient or inequitable market prices • Interest group or capture theories: • maintain that regulation is supplied in response to the demands of special-interest groups in order to maximise their members’ income

  40. Arguments against regulating accounting • Arguments for an unregulated market use the agency theory to question the existence of incentives for reliable and voluntary reporting to owners • Firms have an incentive to report voluntarily to the capital market because they compete for scarce resources: failure to report might be interpreted as bad news

  41. Arguments for a regulated market • Those arguing for a regulated market use a public interest argument • Either market failures or the need to achieve social goals dictates regulation of accounting • Causes of market failures include: • a firm’s reluctance to disclose information about itself • the occurrence of fraud • the underproduction of accounting information as a public good

  42. The free-market approach • Assumes that accounting information is an economic good that: • is subject to the forces of demand and supply • results in an optimal amount of information disclosed at an optimal price • Advocates of a regulatory approach maintain that there are market failures in the private market for information

  43. Market failures • Explicit: In explicit market failure, the quantity and quality of information differ from the social optimum • Implicit: Implicit market failures focus on the following defects: • monopoly control over information by management • naïve investors • functional fixation • misleading numbers • diversity of procedures • lack of objectivity

  44. Private-sector regulation of accounting standards Advantages • The AASB is responsive to various constituents • The AASB attracts as members people who possess the necessary technical knowledge to develop and implement alternative measurement and disclosure systems • The AASB is successful in generating a reasonable amount of response from its constituency base and in responding to this input

  45. Private-sector regulation of accounting standards Disadvantages • The AASB lacks statutory authority and faces the challenge of being overridden by government • The AASB has been accused of lacking independence from dominating interests, such as the accounting profession • The AASB has often been accused of responding too slowly to major issues that are of crucial importance to some of its constituents

  46. Public-sector regulation of accounting standards Arguments in favour • The ASIC acts as ‘creative irritant’ and as a catalyst for change, since the private sector and market forces do not provide the leadership necessary to effect such change • The structure of securities regulation established by the 1991 Corporations Law serves to protect investors against perceived abuses

  47. Public-sector regulation of accounting standards (cont’d) Arguments in favour (cont’d) • The ASIC is motivated by the desire to create a level of public disclosure deemed necessary and adequate for decision making • Unlike the AASB, the ASIC is secured greater legitimacy through its statutory authority • Private-sector objectives may sometimes contradict the public interest

  48. Public-sector regulation of accounting standards (cont’d) Arguments against • There is a high corporate cost for compliance with government regulation of information • Bureaucrats have a tendency to maximise the total budget of their bureau • There is the danger that standard setting may become increasingly politicised • Government regulation backed by police power may hinder the conduct of research and experimentation of accounting policy and is not essential to achieving standardisation of measurement

  49. Accounting standards overload • Too many standards • Too detailed standards • No rigid standards, making selective application difficult • General-purpose standards fail to provide for differences in preparers’, users’ and CPA’s needs • General-purpose standards fail to provide for differences between: • public and non-public entities • annual and interim financial statements • large and small enterprises • credited and non-audited financial statements • Excessive disclosures and/or complex measurements

  50. Effects of accounting standards overload • Accountants may lose sight of their real jobs because of the excessive data required to comply with standards • Audit failures may result because the accountant may forget to perform basic audit procedures • The proliferation of complex accounting regulations may lead to non-compliance