1. Lecture 2 Regulation of Financial Reporting in Australia
AASB

2. Lecture Overview Review of important concepts (module 1)
Financial reporting decisions
Impact of information Asymmetry
Financial reporting discretion (2.1)
Current accounting regulations (2.2)
International harmonisation of accounting standards (2.2)
Rationale for regulation (2.3)

3. Review of Important Concepts
Financial Reporting Decisions
Impact of Information Asymmetry

4. Scope of Financial Reporting
Financial reporting covers more than just financial/company accounting (preparation of financial statements). Although this is an important part of it.
Financial reporting also includes disclosures that may or may not be contained in the financial statements
Examples of disclosures
Environmental disclosures, notes to the accounts regarding the valuation of assets, press releases
Disclosures can be financial and non-financial

5. Financial Reporting Decisions
Financial reporting decisions relate to application of the accruals system as well as disclosure related choices
Five types of financial reporting decisions
Expensing versus Capitalisation of Costs
Accounting Methods
Accounting Estimates
Disclosure versus Recognition
Disclosure Policy

6. Information Asymmetry
Occurs when some parties to a business transaction have an information advantage
adverse selection
one party has knowledge not possessed by the other
moral hazard
arises when some parties cannot observe all the actions of the other parties to the transaction

7. Summary: Information Asymmetry
Adverse selection
(Financial reporting to convert
inside info to outside info.)
Moral hazard
(Accounting to monitor the
behaviour of managers)

8. The Fundamental Problem of Financial Accounting Theory
Provision of relevant
info. to aid investor
Decision making
Provision of reliable
info. to control
management behaviour

9. Relevance and Reliability
A trade-off
Ability of financial reporting to overcome information asymmetry problems depends on its degree of relevance and reliability
Regulation of financial reporting can increase (decrease?) relevance and (especially) reliability

10. Possible solutions
1. Let market forces determine what information is supplied
2. Regulate the provision of financial information

11. Financial Reporting Discretion (module 2.1)

12. Financial Reporting Discretion
Accountants and managers have substantial discretion when making financial reporting decisions
Decisions impact:
Numbers in Financial Statements
What information is disclosed
Decisions of financial statement users
Relates to:
Unregulated financial reporting decisions
Choices available within regulated financial reporting decisions

13. Is financial reporting neutral and unbiased?
Depends on:
Amount of discretion available to managers
How managers exercise their available discretion
efficient motivations (unbiased)
opportunistic motivations (biased)
Concept of self interest

14. Self Interest
An important concept that helps us understand the way the world works
Financial reporting and its regulation are affected by the self interest of the individuals involved
Individuals form into groups to help achieve their objectives

15. Are accounting regulations neutral and unbiased?
Individuals are involved in the standard setting process
scope for self interest to get in the way of “neutral and unbiased” accounting regulations
the individuals that will be regulated by the new accounting standards can have an impact on the standard setting process
Adverse economic and social consequences must be considered

16. Current Accounting Regulations (module 2.2)

17. The Development of Accounting Regulation in Australia
Pre World War 2 - close links with the UK
Subsequent influences:
Development of accounting standards in 1970s
ASRB (now AASB) shifted control of accounting regulation from profession to government in 1984
Corporations Law
application of AASB standards compulsory
continuous disclosure applies

18. History of Accounting Regulation
Three Time Periods:
1. A largely unregulated period (pre 1970)
2. A period of professional regulation
non-compliance problems
3. Current period of regulation by legislation (post 1984)

19. Current Sources of Accounting Regulations in Australia
FRC - Financial Reporting Council
oversight of the standard setting process
AASB - Aust. Accounting Standards Board
technical deliberations about new and changed accounting standards
UIG - Urgent Issues Group

20. International Harmonisation of Accounting Standards (module 2.2 cont.)

21. Globalisation of business
An increasing fact of business
Global capital and product markets
Impact on financial reporting
Need for internationally comparable financial statements?

22. Advantages of internationally comparable accounting standards
Presentation of high quality, transparent and comparable financial information is likely to:
reduce investment risk in foreign companies / lower cost of capital
encourage cross-border investment and result in better allocation of savings to investments

23. How to achieve internationally comparable financial statements
One set of rules / accounting standards?
Where does this leave AASB?
If so, who’s rules?
International Accounting Standards Board
US (FASB/SEC)
other
Should any variation between countries remain?
Adoption versus consistency with global set of standards?
IASB is currently embarking on a program of convergence of accounting standards world-wide

24. International Convergence
The IASB “cooperates with national accounting standard setters to achieve convergence in accounting standards throughout the world”
The AASB has a specific function “to participate in and contribute to the development of a single set of accounting standards for world-wide use”

25. AASB Policy of International Convergence and Harmonisation
International convergence – “working with other standard-setting bodies to develop new or revised standards that will contribute to the development of a single set of accounting standards for world-wide use”
International harmonisation – a process which leads to Australian accounting standards being compatible with IASs

26. What is Harmonisation ?
Harmonisation refers to a process which involves national standard setters adopting or adapting IAS or ensuring their national standards are consistent with IAS
AASB has been adapting Australian approved accounting standards to ensure that they are consistent with IAS
This is different to simply adopting IAS

27. AASB Harmonisation Program
AASB standards amended to be consistent with, but not identical to IAS
involves amending existing standards to conform with existing IAS
adopting / adapting existing IAS for areas not currently addressed by standards in Australia
harmonise new standards with new / revised IAS

28. Status of AASB Harmonisation
Most of AASBs amended to comply with IAS
Difficulties in coming to agreement on certain standards
Full harmonisation not always achieved
Some awaiting IASB completion of IAS

29. Newsflash
Australia will ADOPT International Accounting Standards from January 2005!
First country in the world to make such a statement
However, the European Union has stated that it will require all listed companies to prepare consolidated financial statements in accordance with IAS from 2005

30. Who will benefit from International Convergence?
Primarily, large companies
Currently to list in the US involves companies preparing either a separate set of accounts using US GAAP or a conversion table which provides a translation of key figures from Australian to US GAAP

31. Rational for Regulation (module 2.3)

32. Some Important Questions
Should financial reporting be regulated?
If so:
Who should control the regulatory process?
How much regulation is enough?

33. Arguments for and against regulation
markets for information are inefficient and subject to failure
investors need protection from misleading information
enhanced uniformity / comparability
Against:
markets for information are efficient
regulation leads to decreased relevance of financial reporting

34. Theories of Regulation
Regulation of financial reporting “protects the public”
maximisation of social welfare
Regulation of financial reporting is controlled by the accounting profession
self interest of accountants
Regulation of financial reporting is controlled by company managers
self interest of all individuals involved

35. A political process
Financial reporting regulations have many economic and social consequences
Various interested parties lobby the standard setters (self-interest)
Standards are not set in a political vacuum
To be discussed more thoroughly next lecture…..

36. For Tutorials Required reading Self assessment questions
Text chapter 2
Text chapter 6, pp
Optional reading (harmonisation)
Selected reading 2.1
Remainder of chapter 6
Self assessment questions
Questions from module 2
Answers in tutorials