ACCG224 Intermediate Financial Accounting

1. ACCG224 Intermediate Financial Accounting Session 1, 2013

2. Welcome to ACCG224 ☺ • Your lecturers are: • RajniMala (Tuesday 15.00 to 17.00) and • Thomas Kern (Thursday 18.00 to 20.00). • Your tutorials start next week. Important!If you need to change your tutorial class contact Cissy via accg224@mq.edu.auDeadline: 8thMarch 2013!

3. Our view of Intermediate Financial Accounting • Not onlyhow we record transactions and prepare financial statements, • but alsowhy do we it the way we do: • How and why is financial accounting regulated? • Why is communication/disclosure so important? • Why do we measure assets the way we do? • What is the role of professional judgement? • Therefore be prepared for conceptual as well as technical issues.

4. Overview of Unit Guide – Continuous Assessment/Final Exam • Class Participation – 10%; • Oral presentation (linked to Research Report) – 5%; • Research based case study and report – 15%; • Two short in-class tests – 20% (10% each); • Final exam – 50% (compulsory to pass).

5. How to study ACCG224 • Read the relevant textbook chapters before the lecture; • Come to the lectures • but don’t expect that by coming and listening you will get all you need to know! • Prepare all tute questions (homework); • Actively participate in tutorials; • Attend consultations; • Read the financial press; • Prepare for the in-class tests; • Undertake research for the research based case study; • Seek help early • Faculty: http://www.businessandeconomics.mq.edu.au/new_and_current_students/undergraduate • University: http://students.mq.edu.au/support/ Peer Assisted Learning PAL: check out on iLearn!

6. ACCG224 – New Text • New Custom Publication (EVERYONE MUST BUY THE NEW TEXT) • Additional materials • one chapter will be provided on iLearn • Bring your text to both lectures and tutorials!

7. Your first point of call: the unit’s iLearn site • Here you can find: • the Unit Guide, • staff consultation hours and contact details, • all relevant materials (incl. iLectures), • selected tutorial solutions, • detailed information on all assessments, • important announcements, • your grades, • forums to discuss your general or topic related questions with your fellow students. • So, it is important to check the unit’s iLearn site frequently!

8. Week 1 Introduction to the Regulatory Environment: Including Theories of Regulation and Political Influence

9. Learning objectives You should have an understanding of • theories of regulation that are relevant to accounting and auditing. • how theories of regulation apply to accounting and auditing practice. • the regulatory framework for financial reporting. • the institutional structure for setting accounting standards.

10. What is regulation? • Regulation is overseeing, according to predetermined rules, an activity by an entity not directly involved in the activity. • For example: • the government is deliberately intervening in the production of general purpose financial statements; • this control is through a standard setting body: Australian Accounting Standards Board(AASB) which is supposed to be independent of the government. Other examples: • Australian Prudential Regulation Authority (APRA) • Australian Communications and Media Authority

11. Introduction to the regulatory environment – Who/what regulates accounting? • Corporations Act 2001: • has the accounting requirements about the way financial data are recorded in the accounting system; • has requirements about accounting reports. • Supervised and enforced by Australian Securities and Investments Commission (ASIC) under the ASIC Act 1991: • investigates companies suspected of non-compliance with the Corporations Act or accounting standards; • issues its own interpretations of the financial reporting requirements of the Corporations Act; • is also called the corporate watchdog.

12. Introduction to the regulatory environment – Who/what regulates accounting? (cont’d) • Australian Securities Exchange (ASX): • has listing and trading rules; • plays an important role in developing Australian financial reporting requirements. • Financial Reporting Council (FRC): • oversees standard setting; • 17 members appointed by Federal Govt or nominated by approved organisations (ASIC, ASXetc.); • advises government on standard setting; • appoints members to AASB; • monitors AASB and gives direction; • no veto power on standards – the Federal Parliament has; • AASB must follow its broad strategic plan.

13. Introduction to the regulatory environment – Who/what regulates accounting? (cont’d) • Australian Accounting Standards Board (AASB): • transforms International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) into Australian standards; • ‘Australianises’ the International Accounting Standards Board’s (IASB’s) Framework; • drafts new standards when commissioned by IASB; • undertakes public consultation on draft standards.

14. Introduction to the regulatory environment – Who/what regulates accounting? (cont’d) • International Financial Reporting Standards Interpretations Committee (IFRSIC): • principles based international accounting standards require global interpretation; • consistency of interpretation is the key challenge for the accounting profession.

15. Institutional structure for setting accounting standards • Formation of International Accounting Standards Committee (IASC) – 1973. • Aimed to develop accounting standards for use throughout the world. • Criticism that IASC was not independent → restructured in 2001 into the International Accounting Standards Board (IASB). • In 2005, the European Union (EU) decided to adopt IASB standards. • From January 2005 Australia adopted IAS and IFRS developed by the IASB.

16. Politics of standard setting • Standard setting is a political process because it can affect many conflicting and self-interested groups. • The regulator must make a political choice. • The regulator must have a mandate to make social choices. • Example: • The recognition of doubtful debts can affect entities differently.

17. Politics of standard setting (cont’d) • IASB sets accounting standards – AASB Australianises them. • What are the opportunities for lobbying? • There is an Australian member of the IASB; • Europe is a powerful bloc; • the U.S. American standard setter, the Financial Accounting Standards Board (FASB) is resisting and wants U.S. Generally Accepted Accounting Principles (US GAAP) to dominate; • multinational businesses – including big 4 accounting firms; • politicians; • responses to Exposure Drafts.

18. Independent enforcement bodies • Independent enforcement bodies: • EU • Securities market regulators: • EU: Committee of European Securities Regulators (CESR); • U.S.: Securities Exchange Commission (SEC); • Australia: ASIC. • The need for consistent enforcement across countries.

19. Rules vs principles in standard setting • IASBfollows a principles-based approach to standard setting. • Constructed in a broad framework that is not focussed on specific rules under specific circumstances • Allows for professional judgement in relation to substance rather than form • Relates to the conceptual framework (more next week). • Broad guidelines that can be applied to different situations. • Comparability is a problem as is the potential for bias.

20. Rules vs principles in standard setting (cont’d) • Currently FASB follows rules-based approach. • Constructed in a framework that is focussed on specific rules under specific circumstances. • Misuse in corporate collapses means that FASB is reconsidering if they should move to principles-based standards. • Rules-based standards can be very complex and become confusing. • Open to manipulation.

21. Role of professional judgement • Accounting treatment of some transactions is unregulated (eg. depreciation, residual value). • Difficult to accept that accounting standards are neutral and unbiased due to the economic and social consequences of standard setting. • Different accounting assumptions and judgements can lead to differences in reporting profits/losses.

22. The IASB and FASB convergence program • FASB formed in 1973. • Regarded as the leading standard setter. • Power delegated to FASB by SEC. • Convergence program commenced in 2002 • Norwalk agreement. • Convergence is a complicated process. • In 2007, SEC allowed non-U.S. companies to use IFRS for listings on U.S. stock markets. • FASB/IASB: common project on Conceptual Framework.

23. The theories of regulation relevant to accounting and auditing • Managers have incentives to voluntarily provide accounting information, so why do we observe the regulation of financial reporting? • Explanations are provided by: • theory of efficient markets; • agency theory; • theories of regulation.

24. Theory of efficient markets • The forces of supply and demand influence market behaviour and help keep markets efficient. • This applies also to the market for accounting information and should determine what accounting data should be supplied and what accounting practices should be used to prepare it.

25. Theory of efficient markets (cont’d) Criticisms: • the market for accounting data is not efficient; • the ‘free-rider’ problem distorts the market; • users cannot agree on what they want; • accountants cannot agree on procedures; • firms must produce comparable data. The government must therefore intervene.

26. Agency theory • Demand for accounting information: • for stewardship purposes; • for decision-making purposes. • A framework in which to study the relationship between those who provide accounting information (e.g. a manager) and those who use it (e.g. a shareholder or creditor).

27. Agency theory (cont’d) • Because of imbalances between data suppliers and data users, uncertainty and risk exist • Resources and risk are likely to be mis-allocated between the parties • To the extent the market mechanism is inefficient, accounting regulation is required to reduce inefficient and inequitable outcomes.

28. Theories of regulation • There are three theories of regulation: • public interest theory; • regulatory capture theory; • private interest theory.

29. Public interest theory • Government regulation is required in the ‘public interest’ whenever there is market failure (inefficiency) due to: • lack of competition (monopoly, oligopoly); • barriers to entry; • information asymmetry between buyers and sellers of certain market signals; • public-good product.

30. Public interest theory (cont’d) • Governments intervene: • to get votes • because public interest groups demand intervention • because they are neutral arbiters as they do not have any independent role to play in the development of regulations, they intervene at the request of public interest agents.

31. Application of public interest theory • The Sarbanes-Oxley Act (U.S., 2002): • new financial reporting and corporate governance requirements were introduced as well as new standards and oversight structures were created for auditors. • Accounting Standards Review Board (ASRB) (Australia, 1984): • government’s intervention in the accounting standard setting process. • But: • Managers have incentives to voluntarily correct market failure perceptions about their firms.

32. Regulatory capture theory • The public interest is not protected because those being regulated come to control or dominate the regulator. • The regulated protect or increase their wealth. • Assumes the regulator has no independent role to play but is simply an arbiter between battling interest groups.

33. Application of capture theory • Is international harmonisation evidence of capture by large companies, the ASX and the accounting profession? • Has the IASB been captured by the FASB?

34. Private interest theory • Governments are not independent arbiters, but are rationally self-interested. • They seek re-election. • They will ‘sell’ their power to coerce or transfer wealth to those most likely to achieve their re-election (if they are elected officials) or increase their wealth (if they are appointed officials) or both.

35. Application of private interest theory • The private interest theory could be applied to the establishment of the Accounting Standards Review Board (ASRB). • The ASRB was dependent on and susceptible to influence from several interest groups.

36. What is behind the regulation of accounting in Australia? • Corporate failures; • wide reaching effects of accounting; • government intervention to increase its regulatory role; • legal enforcement of financial reporting and auditor independence.

37. Why is accounting so regulated? • Agency problem; • reporting needs to be monitored; • protection of owners and creditors; • complexity of entities and transactions; • governments act in the public interest to ensure efficient market for information; • accounting is a complex product.

38. Rationale for regulation • Regulation is necessary because: • markets for information are inefficient and not enough good information will be made available; • average efficiency in the market puts at risk the savings of investors who rely on unregulated disclosures; • those with limited power may be unable to get information; • investors need protection against misleading information – public confidence; • Regulation leads to uniformity.

39. Rationale for regulation (cont’d) • Regulation is not necessary because: • financial information is a good and people are prepared to pay for it – this will lead to an optimal supply of information; • failure to supply information will mean the organisation will be punished by the capital market (market for lemons); • regulation leads to an over-supply of costly information; • it restricts accounting choice and leads to a ‘one size fits all’ problem; • it encourages lobbying.

40. Concluding comments • Accounting is highly regulated by government regulatory bodies. • Accounting standards have gone global but are regulated locally. • There are arguments that regulation has failed – just look at the corporate collapses. • Does accounting in Australia require more or less regulation? • Does the production of General Purpose Financial Statements (GPFS) require more or less accounting standards?

41. Summary In this chapter: • we reviewed theories proposed to explain the practice and regulation of financial reporting and auditing; • we reviewed the regulatory framework for financial reporting and the institutional structure for setting accounting and auditing standards.