Transcript Document

Chapter 4
The regulatory
approach to the
formulation of an
accounting theory
The nature of accounting
standards
Accounting standards usually consist
of three parts:
1. a description of the problem to be
tackled
2. a reasoned discussion on ways of
solving the problem, then,
3. in line with the decision or theory,
the prescribed solution
Requirements under
accounting standards
Edey divides accounting standards into four types:
1. Requires accountants to tell people what they
are doing by disclosing the methods and
assumptions adopted
2. Aims at achieving some uniformity of
presentation of accounting statements
3. Calls for the disclosure of specific matters in
which the user may be called to exercise his or
her own judgement
4. Requires implicit or explicit decisions to be
made about approved asset value and income
determination
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
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
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
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
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
APS1 deficiencies
• APS1 only applied to members of the
profession
• APS1 only required mandatory
disclosure of non-compliance rather
than compliance
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
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
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
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
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
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
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
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 GovernorGeneral on the nomination of the
Commonwealth Attorney-General
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
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
Influence of the accounting
profession on standards
Standards that do not have support from
accountants and/or the business community
could result in:
1. lobbying by particular interest groups
2. non-compliance
3. refusal of companies to contribute to or
participate in the standard-setting process
4. 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
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
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
Finalisation of accounting
standards
• Draft is forwarded to the National Councils of the
Society and Institute and to the Federal AttorneyGeneral’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
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)
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
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
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
Rejection of the Peirson
Report
• The Peirson report was largely rejected
by the Attorney-General’s Department
• Proposals may have been too farreaching 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
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
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:
1. How should existing standard-setting
arrangements and structures be reformed?
2. Should Australia continue to develop its own
accounting standards or adopt international
accounting standards?
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
Changes proposed by CLERP
and 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
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
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
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 managementadvisory services
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
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
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
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 specialinterest groups in order to maximise
their members’ income
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
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
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
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
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
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
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
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
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
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
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
Solutions to the standards
overload problem
The AICAP Special Committee on Accounting
Standards evaluated the following possible
approaches:
• no change
• a change from the present concept of a set
of unitary GAAP for all businesses, to two
sets of GAAP
• change GAAP to simplify application to all
business enterprises
• establish differential disclosure and
measurement alternatives
Solutions to the standards overload
problem (cont’d)
• a change in CPAs’ standards for
reporting on financial statements
• an alternative to the GAAP as an
optional basis for presenting financial
statements
The outcome
• The AICAP Special Committee on
Accounting Standards recommended either
establishing disclosure and measurement
alternatives or adopting an alternative to
GAAP
• The alternative to GAAP rests on three
possibilities:
– a new basis accounting method (BAM)
– the cash or modified cash basis
– the income tax basis
The outcome (cont’d)
• A BAM is out of the question because it
would create more costs than benefits
• The committee suggested that the
issuance of compiled, reviewed or
audited other comprehensive-bases-ofaccounting (OCBOA) financial
statements would help alleviate the
burden of accounting standards
overload for small non-public entities