8/10/2019 IA L5 1314 Teaching

1/28

1

P14B28

International AccountingLecture 5

The regulation and diversity of accounting

8/10/2019 IA L5 1314 Teaching

2/28

8/10/2019 IA L5 1314 Teaching

3/28

Positive Accounting Theory

3

8/10/2019 IA L5 1314 Teaching

4/28

4

Analysis of principal agent relations, Jensen and Meckling,

1976. .. most organisations are simply legal fictions which serveas a nexus for a set of contracting relationships between

individuals Principals: lenders and owners Agents: management and auditors

Agents maximise their own utility e.g. will diversify toreduce the risk of unemployment, have nice offices, companyaeroplanes, smooth income etc

Principals anticipate the self interest of agents and try toprotect themselves.

Basis of Positive Accounting Theory Principal Agent Analysis

8/10/2019 IA L5 1314 Teaching

5/28

5

Principal Agent Analysis

Mechanisms for aligning incentivesbetween owners and managers

Performance related pay (part fixedsalary, part commission) Share options Audited financial statements

8/10/2019 IA L5 1314 Teaching

6/28

6

Framework for the Preparation andPresentation of Financial Statements

1. Regulatory Framework2. Conceptual Framework of Accounting

8/10/2019 IA L5 1314 Teaching

7/28

7

1. REGULATORY FRAMEWORK

Three Sources of Accounting Rules: Company Law eg. Companies Act 2006 in the UK The Stock Exchange Listing Requirements

Accounting Standards International Accounting Standards Board (IASB) we

study this! Accounting Standards Board (ASB) in the UK

Financial Accounting Standards Board (FASB) in US China Accounting Standards Committee (CASC) under

MoF in China

8/10/2019 IA L5 1314 Teaching

8/28

8

IASB & IFRS

International Accounting Standards (IAS) were issued by IASC andhave been adopted or amended by IASB

International Financial Reporting Standards (IFRS) have been issuedby the IASB List of current standards is available at:

http://www.ifrs.org/IFRSs/IFRS.htm

http://www.ifrs.org/IFRSs/IFRS.htmhttp://www.ifrs.org/IFRSs/IFRS.htmhttp://www.ifrs.org/IFRSs/IFRS.htm

8/10/2019 IA L5 1314 Teaching

9/28

9

2. IASB FRAMEWORK

What is a conceptual framework? Statements of principles for financial reporting that set out

the concepts that underlie the preparation and presentationof financial statements for external users.

Their primary purpose is to provide a coherent frame ofreference for standard setters to use in the development andreview of accounting standards.

In particular, the framework provides a basis for choosingbetween alternative accounting treatments.

Empirical evidence is not provided they are normativestatements of intent

8/10/2019 IA L5 1314 Teaching

10/28

10

IASB FRAMEWORK

PurposeTo assist IASB in setting standardsTo serve as a basis for harmonisationTo assist national standard-settersTo assist preparers, auditors and usersTo assist in understanding of standard-setting

ScopeObjective of general purpose financial statementsQualitative characteristics that determine usefulness of information

Definition, recognition and measurement of the elements of financialstatementsConcepts of capital and capital maintenance

Living document Conceptual Framework for Financial Reporting 2010

8/10/2019 IA L5 1314 Teaching

11/28

11

IASB Framework ChaptersChapter 1 The objective of financial statements

to provide information about the financial position, performance and changes in

financial position that is useful to a wide range of users in making economicdecisions

Chapter 2 The Reporting Entity

Relates to definitions of subsidiary, associate, joint venture (not yet released)

Chapter 3 Qualitative characteristics of financial information

Financial information is useful when it is relevant and represents faithfully what itpurports to represent. The usefulness of financial information is enhanced if it iscomparable, verifiable, timely and understandable.

Chapter 4 Definition, recognition and measurement of the elements offinancial statements

covers the elements of financial statements, their recognition in financialstatements and the measurement of profit (will be revised over the next ten years!)

Chapter 5 Concepts of capital and capital maintenance

http://www.iasplus.com/en/standards/other/framework

http://www.iasplus.com/en/standards/other/frameworkhttp://www.iasplus.com/en/standards/other/framework

8/10/2019 IA L5 1314 Teaching

12/28

International

harmonization ofaccounting standards

12

8/10/2019 IA L5 1314 Teaching

13/28

Local GAAP

Each country has its own generalaccepted accounting principle(GAAP) eg.

US GAAP by Financial Accounting Standards Board(FASB)

UK GAAP by Accounting Standards Board (ASB) China GAAP (CAS) by Ministry of Finance (MoF)

13

8/10/2019 IA L5 1314 Teaching

14/28

14

Class ActivityTalk to your neighbour(s) for three minutesand try to identify at least three reasons for

international accounting differences whydifferent countries tend to have differentaccounting standards, policies andpractices?

8/10/2019 IA L5 1314 Teaching

15/28

Reasons for international accounting differences

Numerous explanatory factors have been suggested: The nature of legal, political and tax systems

including the role of the government in the economy

Level of education/accounting technology Level of economic development The nature of business ownership and financing

systems History and colonial inheritance The strength of the accounting profession Culture, language and religion 15

8/10/2019 IA L5 1314 Teaching

16/28

Two main models of financial accountingas many of the influences overlap they have tended to besimplified (over-simplified?) into two models:-

1) the Anglo-American (or Anglo-Saxon) Model in whichaccounting:-

is strongly influenced by professional accounting bodiesrather than government,emphasises the importance of capital marketsemphasises true and fair and applies considerations ofeconomic substance over legal form

2) the Continental European Model in which accounting:-has relatively little input from the accounting professionplaces little reliance on a qualitative true and fair view is strongly reliant on government and the legal framework 16

8/10/2019 IA L5 1314 Teaching

17/28

IFRS and Local GAAP Approximately 120 nations and reporting

jurisdictions permit or require IFRS fordomestic listed companies. Note that localGAAP still apply to unlisted companies andSMEs in most jurisdictions

IFRS adoption by countryhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtml

More and more countries are adopting or willadopt International Financial ReportingStandards (IFRS), which leads to internationalharmonization .

17

http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtmlhttp://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-status-country.jhtml

8/10/2019 IA L5 1314 Teaching

18/28

Why harmonisation?

If there are good reasons for differentaccounting practices which suit therequirements of individual countries, there

need to be incentives for giving up nationalstandards ... Talk with your neighbour(s) for three minutesand list at least three merits of internationalharmonisation of accounting standards.

18

8/10/2019 IA L5 1314 Teaching

19/28

Merits of international harmonisationof accounting standards

These might include: Easier access to foreign capital Reduced costs for companies with listings on

international stock exchanges Reduced accounting costs and problems for

multinationals Increased comparability between companies,

benefitting investors More cost-effective accounting regulation 19

8/10/2019 IA L5 1314 Teaching

20/28

Talk with your neighbour(s) for three minutesand list at least three barriers to harmonisation

in international financial reporting.

20

(Perceived?) economic consequences of new standards Political acceptability - the perception that IFRS derive from anAnglo-American accounting framework Vulnerability to lobbying Relevance in some countries Education/training issues The complexity of particular standards Problems in ensuring consistent application Language or cultural difficulties

8/10/2019 IA L5 1314 Teaching

21/28

The role of the EU in harmonisation

One of the founding principles of the EU wasfreedom of movement of people, goods andcapital

Harmonisation in accounting clearly links to this

principle Historically the EUs approach to harmonisationwas to issue prescriptive directives

In 2002 the EU agreed that groups listed in the

EU would have to apply IFRS from 2005 EU adoption of IFRS was the catalyst for other

countries to adopt21

8/10/2019 IA L5 1314 Teaching

22/28

8/10/2019 IA L5 1314 Teaching

23/28

8/10/2019 IA L5 1314 Teaching

24/28

Principles versus Rules-based debate

IFRS (and UK standards) are typically describedas PBS and US standards as RBS

This debate is about the nature of accountingstandards and not the need for them

Its accepted in the US that deficiencies inaccounting standards contributed to the wave ofcorporate scandals in the late 1990s and early2000s

If there is to be a single global set of standards itwill be important to reduce or eliminate thedifferences between IFRS and US GAAP - so thenature of standards matters 24

8/10/2019 IA L5 1314 Teaching

25/28

What do we mean by principles and rulesin practice?

Principles: conventions such as fair presentation;definitions of elements of financial statements;concepts such as prudence, matching,consistency, comparability - i.e. the keyassumptions which underpin financialstatements (which we would expect to find in the

conceptual framework) Rules: specific criteria, thresholds, detailed tests,

restrictions, exceptions, detailed implementation

guidance

25

A l f i i l d l i

8/10/2019 IA L5 1314 Teaching

26/28

An example of principles and rules inpractice: depreciation

The underlying principle: matching - the need tomatch revenues against the costs incurred ingenerating those revenues

RBS -A hard or bright -line rule: annual

depreciation for all fixed assets is to be 10 per centof the original cost of the asset until the asset isfully depreciated

PBS - A soft rule: depreciation expense for the

reporting period should reflect the decline in theeconomic value of the asset over the period Note: a comprehensive standard would also need

to define terms such as fixed asset, economicvalue, cost etc.

26

8/10/2019 IA L5 1314 Teaching

27/28

8/10/2019 IA L5 1314 Teaching

28/28

Reading Whittington, G. (2005), The Adoption of International

Accounting Standards in the European Union, European Accounting Review , Vol. 14, No. 1, pp. 127-153(Section 2. The Demand for International Accounting Standards iscompulsory reading, and the rest of this paper is optional.)

Ball, R. (2006), International Financial Reporting Standards(IFRS): Pros and Cons for Investors, Accounting and BusinessResearch , Special Issue, pp. 5-27(A speech given by Prof. Ray Ball at ICAEW conference 2005. You might

find the IFRS history in his speech interesting, but try to focus on hiscomments on the pros and cons of IFRS. )

Sunder, S. (2011), IFRS monopoly: the Pied Piper of financialreporting Accounting and Business Research, Vol. 41, No. 3,pp. 291-306(This paper provides a rather cynical perspective over theconvergence between IFRS and US GAAP, and hopefully you can thenappreciate why its difficult to proceed with this particular agenda )

28