Topic 3

1. Topic 3 LectureRegulation of Accounting Dr. Lynn Barkess, S2, 2013

2. 3. explain and relate theories of regulation to financial reporting. Regulation of Accounting -Overall Unit Objective Dr. Lynn Barkess, S2, 2013

3. 1. list and briefly describe Australian and international standards setting bodies 2. briefly describe the ‘due process’ used by IASB to set accounting standards 3. explain the free market and pro-regulation perspectives of accounting regulation 4. apply public interest theory, capture theory and economic interest theory to financial reporting 5. describe the political nature of the accounting standards setting process 6. discuss the concepts of rules- and principles-based regulation. Regulation of Accounting-Lecture outline and learning objectives Dr. Lynn Barkess, S2, 2013

4. Study learning materials 4 hours Read supplied readings 8 hours Undertake activities and review activities 10 hours TOTAL 22 hours Topic 3- Regulation of Accounting -Time allocation Dr. Lynn Barkess, S2, 2013

5. International Accounting Standards Board (IASB) Financial Reporting Council (FRC) Australian Accounting Standards Board (AASB) Regulatory bodies Dr. Lynn Barkess, S2, 2013

6. Australian Stock exchange (ASX) Australian Securities and Investments Commission (ASIC) Regulatory bodies Dr. Lynn Barkess, S2, 2013

7. USA Federal Accounting Standards Board (FASB) See the website for the latest information on the leasing project Securities and Exchange Commission (SEC) Regulatory bodies Dr. Lynn Barkess, S2, 2013

8. Due Process- IASB http://www.ifrs.org From the due process handbook Stage 1: Setting the agenda Stage 2: Project planning Stage 3: Development and publication of a discussion paper Stage 4: Development and publication of an exposure draft Stage 5: Development and publication of an IFRS Stage 6: Procedures after an IFRS is issued Regulatory Bodies Dr. Lynn Barkess, S2, 2013

9. If yes, to what extent? (no definitive answer to this question) Two points of view: Free market perspective versus Pro-regulation perspective Should accounting be regulated? Dr. Lynn Barkess, S2, 2013

10. Accounting information should be treated like other goods, with demand and supply forces allowed to operate to generate an optimal supply That is, accounting should not be regulated, at all. Political nature of the standards setting process - Free market perspective Dr. Lynn Barkess, S2, 2013

11. Agency theory- managers will act in their own self interest- creditors and investors are aware of this and will monitor managers To reduce the cost of contracting and thus the cost of capital mangers will supply accounting information to satisfy creditors and investors. Regulation decreases efficiency Demand for auditing Political nature of the standards setting process - Free market perspective Dr. Lynn Barkess, S2, 2013

12. Market for lemons - Assumptions No information provided- may be interpreted as bad information Therefore Managers Will disclose both good and bad news Political nature of the standards setting process - Free market perspective Dr. Lynn Barkess, S2, 2013

13. Accounting information is a public or ‘free’ good- The may lead to the true demand for information beingunderstated. Since- once disclosed that information can be obtained at no cost. Resulting in an undersupply of accounting information and the concept of “free-riders”. Political nature of the standards setting process- Pro-regulation Dr. Lynn Barkess, S2, 2013

14. Market for lemons and Information Asymetry Managers have access to information that is not available to investors and creditors. Eg. how could the market for lemons work if creditors and investors do not know that ‘bad’ information exists. Political nature of the standards setting process- Pro-regulation Dr. Lynn Barkess, S2, 2013

15. Pro-regulation – criticism Over Production Accounting standards overload Overstatement of needs- difficult to find equilibrium between cost and benefit What level of information is reasonable to provide for various stakeholder groups Political nature of the standards setting process- Pro-regulation Dr. Lynn Barkess, S2, 2013

16. To gain an insight into the political nature of standard setting watch the DVD Bigger than Enron Look for issues relating to stock options cap on auditors’ liability provision of non-audit services Accounting regulation as an output of a political process Dr. Lynn Barkess, S2, 2013

17. Public interest theory Capture theory Economic/Private interest group theory Theories of regulation Dr. Lynn Barkess, S2, 2013

18. Underlying principles Regulation introduced to benefit society and may be required when the markets are identified as being inefficient Regulatory body represents public interests Government/ regulatory body is regarded as a neutral arbiter Theories of regulation- Public interest theory Dr. Lynn Barkess, S2, 2013

19. Economic markets are efficient Regulation is costly Governments are not neutral Public interest theory - criticism Dr. Lynn Barkess, S2, 2013

20. Principles Regulated seek to take charge of (capture) the regulator Rules advantageous to the regulated Difficult for regulator to remain independent Theories of regulation-Capture theory Dr. Lynn Barkess, S2, 2013

21. Principles The regulator is not neutral Regulator motivate to retain position of authority- re-election Regulation serves interests of politically effective groups Theories of regulation-Economic interest group theory Dr. Lynn Barkess, S2, 2013

22. Rules-based regulation Historically- regulations have been rules based – Benefits Rules have been argued to reduce the opportunities of managers to use judgment (Benston et al 2006) Rules are designed to meet the demands of preparers and auditors (Benson et al 2006 p 168) Easier to fend off legal action Finally, standard setters need something to do, so they keep themselves busy by setting standards. Rules based v. Principles Based regulation Dr. Lynn Barkess, S2, 2013

23. see Shortridge & Myring (2004) Impossible to have detailed rules for every event May encourage compliance with the letter of the law rather than the spirit of the law. - Regulation provides a roadmap for non-compliance Procedural activity without an intellectual (theoretical) foundation PriRules-based regulation – criticisms es based regulation Dr. Lynn Barkess, S2, 2013

24. There is no clear agreement on what this means Is not an attempt to tell preparers and auditors what to do, Rather- to provide the tools to guide FS preparers in deciding what needs doing. Principles-based regulationules based regulation Dr. Lynn Barkess, S2, 2013

25. Developed as a response to regulatory failures- Sarbanes Oxley Act 2002, and a move to objectives based accounting regulation. Provides a conceptual basis for accountants to follow instead of a list of detailed rules Shortridge and Myring (2004) Aim- to better reflect the economic substance of the firm Written in plain English; Easily explained; Make intuitive sense; and Easily present the facts. (Sir David Tweedie) Principles based regulationes vs. Rules based regulation Dr. Lynn Barkess, S2, 2013

26. A purely principles-based approach rejected, Will lead to inconsistent application due to differences in interpretations (which may or may not be made in good faith) Results in a loss of comparability PrPrinciples-based regulation - criticisms vs. Rules based regulation Dr. Lynn Barkess, S2, 2013

27. Conceptual Framework Substance over form True and fair view Various stock exchanges’ continuous disclosure rule Principles-based regulation - examples Dr. Lynn Barkess, S2, 2013

28. Elements of both are needed Future of financial reporting is at stake in this debate. Rules- versus Principles-based regulation Dr. Lynn Barkess, S2, 2013

29. True and Fair View Override It is not possible to develop rules that will be relevant to all companies, in all industries in all circumstances. Australian Corporations Law requires compliance with accounting standards- no more true and fair in Australian jurisdiction- for entities under the Corporations Law Rules- versus Principles-based regulation Dr. Lynn Barkess, S2, 2013

30. True and Fair View Override IAS 1 Presentation of Financial Statements- Para 19 In the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 20 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. The override is open to abuse. Rules- versus Principles-based regulation Dr. Lynn Barkess, S2, 2013

31. True and Fair View Override Trans Tasman Convergence Project with NZ AASB required to adopt IAS 1 (17-22) AASB 2011-X Amendments to Australian Accounting Standards arising from the Trans-Tasman Convergence Project Rules- versus Principles-based regulation Dr. Lynn Barkess, S2, 2013

32. Regulation of Accounting Summary Dr. Lynn Barkess, S2, 2013 • Regulatory Bodies • International and Australian • Due process of standard setting • Political Nature of Standard Setting Process • Free Market Perspective- arguments for and against • Market for Lemons • Pro-regulation arguments for and against

33. Regulation of Accounting Summary Dr. Lynn Barkess, S2, 2013 • Theories of Regulation • Public Interest Theory • Capture Theory • Economic Interest group Theory • Principles vs. Rules based approach to regulation • Arguments for and against • True and fair override