Deegan5e Ch01

Chapter 1 An overview of the Australian external reporting environment

Objectives Understand the scope of regulation relating to Australian external financial reporting Be able to explain the general functions of the Australian Securities and Investments Commission, the Australian Accounting Standards Board, the Financial Reporting Council and the Australian Stock Exchange Be able to explain the general functions of the International Accounting Standards Board and its direct relevance to Australian accounting standard setting Understand the role of an accounting standard and the process through which it is developed

Objectives (cont.) Understand the magnitude of the changes that occurred in 2003 and 2004 in Australian Accounting Standards as a result of the Financial Reporting Council’s strategic decision that Australia would produce financial reports that comply with standards being issued by the International Accounting Standards Board Understand that the practice of financial accounting is quite heavily regulated within Australia, and be aware of some arguments for and against the regulation of financial accounting

Financial accounting defined Financial accounting is a process involving the collection and processing of financial information to meet the decision-making needs of parties external to the organisation Financial accounting may be contrasted with management accounting, which: focuses on providing information for decision making by parties within the organisation is largely unregulated Financial accounting is heavily regulated, and a great deal of regulation changes each year

User demand for general-purpose financial reports Users include (the ‘Framework for the Preparation and Presentation of Financial Statements’ (the AASB Framework) released by Australian Accounting Standards Board July 2004): present and potential investors employees lenders suppliers and other trade creditors customers government and its agencies the public Users lack the power to demand specific information to meet their needs – hence the need for ‘general purpose financial reports’

General vs special-purpose reports General-purpose financial reports comply with the AASB Framework and accounting standards meet the information needs common to users who are unable to command the preparation of reports tailored to satisfy, specifically, all their information needs represent financial statements and supporting notes included within an annual report presented to shareholders at a company’s annual general meeting Special-purpose financial reports designed to meet the needs of a specific group or to satisfy a specific purpose example: Bank demanding as part of a loan agreement that the borrowing entity provide information about projected cash flows

Sources of external financial reporting regulation Five main bodies that formulate and/or enforce accounting regulations in Australia The Australian Securities and Investments Commission (ASIC) The Australian Accounting Standards Board (AASB) The Interpretations Agenda Committee The Financial Reporting Council (FRC) The Australian Stock Exchange (ASX)

Sources of external financial reporting regulation (cont.) Recent changes in development of reporting regulation: Over the last 10 to 15 years the development of accounting standards more in hands of government than accounting profession—reducing ability of accounting profession to ‘self-regulate’ New accounting standard-setting arrangements were passed by Parliament in October 1999 and came into force 1 January 2000 (see next slide)

Sources of external financial reporting regulation (cont.) Recent changes in the development of reporting regulation (cont.) Public Sector Accounting Standards Board (which was under the control of the accounting profession) was disbanded at beginning of 2000—all responsibilities for developing accounting standards within Australia now with the AASB However, AASB now relies on standards being developed by International Accounting Standards Board (IASB) owing to commitment that Australia would comply with International Accounting Standards (now International Financial Reporting Standards) from 1 January 2005

Sources of external financial reporting regulation (cont.) Financial Reporting Council (FRC) broad membership base oversees activities of AASB responsible for decision that Australian reporting entities would adopt accounting standards issued by IASB—major implications for Australian reporting practices now oversees Auditing and Assurance Standards Board (AUASB) Auditing standards made by AUASB require legislative backing (not the case prior to 2004)

Australian Securities and Investments Commission (ASIC) Formerly the Australian Securities Commission (ASC) Name changed in July 1998 to reflect increased responsibility for regulating investment products Responsible for administering corporation legislation Independent of state ministers or state parliaments Reports to the Commonwealth Parliament and Treasurer

ASIC (cont.) The Corporations Act (enforced by ASIC) Outlines the responsibilities of company directors in relation to various activities, including: the nature of their conduct financial statement preparation, lodgment and distribution Requires preparation of ‘true and fair’ financial statements by directors of public companies, large proprietary companies, organisations with securities listed on the ASX, and some small proprietary companies. But what do ‘financial statements’ comprise of……..?

ASIC (cont.) Financial statements defined in the Corporations Act (s. 295(2)) as The financial statements for the year are: (a) The financial statements in relation to the entity reported on that are required by the accounting standards ; and (b) If required by the accounting standards – the financial statements in relation to the consolidated entity that are required by the accounting standards . Reference must therefore be made to ‘the accounting standards’ Paragraph 8 of AASB 101 states that a financial report comprises: balance sheet income statement statement of changes in equity cash flow statement notes, comprising a summary of significant accounting policies and other explanatory notes

ASIC (cont.) The ‘true and fair view’ requirement is a central component of Australian financial reporting Requirement to produce true and fair financial statements contained in s. 297 of Corporations Act The financial statements and notes for a financial year must give a true and fair view of: the financial position and performance of the company, registered scheme or disclosing entity; and if consolidated financial statements are required, the financial position and performance of the consolidated entity. No definition of ‘true and fair’ provided in the Corporations Act If accounts are to be considered ‘true and fair’ they should include all information of a ‘material’ nature – but what is ‘material ’?

ASIC (continued) - Materiality AASB 1031, par. 4.1, provides that Information is material if its omission, misstatement or non-disclosure has the potential, individually or collectively, to Influence the economic decisions of users taken on the basis of the financial report, or Affect the discharge of accountability by the management or governing body of the entity Contents of AASB 1031 consistent with concept of materiality as per the AASB Framework (pars 29 and 30) Unless there are specific requirements that require the disclosure of particular items of expense regardless of amount (as there are for payments made to key management personnel), then separate disclosure will be dependent upon whether the item is deemed to be material – that is, whether, for example, it is considered likely to effect ‘economic decisions’ of financial statement readers. Materiality is an IMPORTANT factor in financial reporting

ASIC (cont.) Pursuant to Corporations Act , directors of large and listed companies, as well as some other entities, are required to attach to financial statements: Directors’ Declaration Directors’ Report

ASIC (cont.) Directors’ Declaration Directors required (s. 295(4) of the Corporations Act ) to state whether, in their opinion, the accounts are true and fair give details of any significant after-balance-date events state whether or not, in their opinion, there are any grounds to believe that the company will be unable to pay its debts as and when they fall due If declaration is made fraudulently, carelessly or recklessly they may be liable for outstanding debts of the company

ASIC (cont.) Directors’ Report (ss. 298–300A of Corporations Act ) is to provide information concerning names of directors details of directors’ emoluments principal activities of the company review of operations during the year significant changes in the state of affairs of the company likely future developments significant post-balance-date events compliance with environmental laws

ASIC (cont.) Directors’ Report (cont.) From July 2004 the Directors’ Report must include an ‘operating and financial review’ information that shareholders of the company would reasonably require to make informed decisions regarding the operations, financial position, and future strategies of the organisation

Declaration by chief executive officer and chief financial officer For entities listed on the ASX Reinforces the responsibility of the CEO and CFO in relation to the entity’s financial statements

ASIC (cont.) Also of relevance to the functioning of ASIC is the establishment of Financial Reporting Panel in 2004 its purpose is to resolve disputes on a non-binding basis between ASIC and companies in respect of whether financial statements have been prepared in accordance with accounting standards and whether financial statements present a true and fair view ASIC also releases policy statements and guidelines on various issues, including financial reporting

Australian Accounting Standards Board (AASB) Began operations in 1991 Functions (under s. 227 of ASIC Act ) include developing a conceptual framework making accounting standards that have force of law under s. 334 of the Corporations Act formulate accounting standards for other purposes: for entities not governed by The Corporations Law participate in and contribute to the development of a single set of accounting standards for worldwide use

AASB (cont.) From 2000 AASB standards apply to all types of entities, those regulated under companies legislation and all other types, i.e. responsibility for formulating standards for entities not governed by Corporations Act PSASB now disbanded Majority of standards underwent change in 2003–04 Reports to the Financial Reporting Council (FRC)— oversight function regarding AASB Has one full-time chairperson and nine part-time members appointed by the FRC

AASB and the role of the FRC The Financial Reporting Council (FRC) Members are appointed directly by the Federal Treasurer or the Treasurer may specify an organisation or body to choose a person to represent them 14 members are nominated by a number of interest groups (stakeholders)

AASB and the FRC (cont.) Functions and powers of the FRC (s. 225 of ASIC Act ) Provide broad oversight of the process for setting accounting standards Appoint members of the AASB Approve and monitor the AASB’s priorities, business plan, budget and staffing Give the AASB directions, advice or feedback on matters of general policy No power to direct AASB re-development of particular standards No power to veto a standard Powers expanded in 2003 to include overseeing the activities of AUASB—AUASB moved from the AARF to AASB in 2004

AASB (cont.) Application of AASB standards Section 231 of ASIC Act requires AASB to carry out cost–benefit analysis of impact of proposed standard before making or formulating it Once the AASB makes a standard it is approved by Commonwealth Parliament Once an AASB-developed standard becomes an accounting standard, company directors are required to ensure that the company’s financial statements comply with that standard (s. 296 of Corporations Act )

AASB (cont.) Small proprietary companies Such companies exempted from complying with accounting standards (under s. 45A(1) of Corporations Act ) A proprietary company is considered to be ‘small’ if it meets two of the following three tests: Its gross operating revenue is less than $25 million Its gross assets are less than $12.5 million It has less than 50 employees

AASB (cont.) Small proprietary companies (cont.) Small proprietary company does not have to comply with particular accounting standards (s. 296 of Corporations Act ) if the report is prepared in response to a shareholder direction under s. 293 (requiring at least 50% of votes) the direction specifies that the report does not have to comply with those accounting standards

The AASB (cont.) Small proprietary companies (cont.) Do not have to prepare formal accounts, apply accounting standards, or have their accounts audited, unless so requested by: ASIC; or shareholders holding at least 5% of the voting shares. If a proprietary company is not considered small, it is classified large and is subject to more stringent disclosure requirements

The AASB (cont.) Public and large proprietary companies have to prepare financial statements that comply with accounting standards have their financial statements audited have statements sent to shareholders if so requested by ASIC; or so requested by shareholders holding at least 5% of the voting shares. If a proprietary company is not considered small, it is classified large and subject to more stringent disclosure requirements

AASB (cont.) Disclosing entities Pursuant to s. 285(2) of Corporations Act AASB standards may apply to some entities not of a corporate form—all ‘disclosing’ entities need to comply with majority of AASB standards Disclosing entities include entities with securities quoted on the ASX entities with securities issued pursuant to a prospectus entities with securities issued pursuant to a takeover scheme entities with securities issued pursuant to a par. 5.1 compromise arrangement borrowing corporations

AASB (cont.) As a result of the FRC decision in 2002 that Australia would adopt accounting standards developed by the International Accounting Standards Board the development of accounting standards in Australia is no longer directly under Australian control, except to the extent that a standard relates to domestic issues and there is no equivalent IFRS

Interpretations Agenda Committee Identifies and assesses issues for inclusion in the AASB’s work program

International Financial Reporting Interpretations Committee (IFRIC) Provides interpretations of requirements embodied within IFRSs Of relevance to Australia where there are uncertainties about particular requirements incorporated in IFRSs, and therefore, within AASB accounting standards

Australian Stock Exchange (ASX) One nationally operated stock exchange In November 1998 the ASX became a publicly listed company: The Australian Stock Exchange Limited One set of listing rules for all trading floors in each capital city Main Board Rules apply to nationally listed securities Failure to comply may lead to removal from the Board Rules help ensure that information is disseminated in an efficient and timely manner

ASX (cont.) ASX Listing Rules divided into 20 chapters—key chapters are Chapter 3 (continuous disclosure) and Chapter 4 (periodic disclosure) Listing Rule 3.1 once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately inform the ASX of that information

ASX (cont.) Establishment of ASX Corporate Governance Council ASX has released its ‘Principles of Good Corporate Governance and Best Practice Recommendations’ This proposes 10 essential principles of corporate governance as stated under Recommendations (p. 5), pursuant to ASX Listing Ruling 4.10, companies are required to provide a statement in their annual report disclosing the extent to which they have not followed the best practice corporate governance recommendations in the reporting period

ASX (cont.) Where companies have not followed all of the recommendations: they must identity the recommendations that have not been followed; and give reasons for not following them Refer to Exhibit 1.3 on page 25—Essential corporate governance principles identified in the ASX

Process of Australia adopting IFRSs In 2002 Financial Reporting Council decided to commit Australia effectively to adopting accounting standards issued by the International Accounting Standards Board (IASB) The standards released by the IASB are referred to as International Financial Reporting Standards (IFRSs)—where previously they were referred to as International Accounting Standards (IASs)

Process of Australia adopting IFRSs (cont.) Catalyst to adopt IFRS within Australia (a directive of the FRC) was the decision by European Union that all listed companies within Union should adopt IASB standards by 1 January 2005 for the purposes of preparing consolidated financial reports, in order to support the ‘single market objective’ European Union is to adopt IFRSs directly without modification

Process of Australia adopting IFRSs (cont.) In Australia: IFRSs turned into Australian (AASB) accounting standards, each bearing an AASB prefix Requirement for reporting under IFRS equivalents is extremely broad—in Australia it applies to all reporting entities under the Corporations Act, listed and unlisted as well as private and public—unlike in Europe where IFRS are mandatory for listed companies only AASB standards have general applicability to not-for-profit and local government sectors—material added by AASB that describes the scope and applicability to the Australian context Refer to Table 1.1, pp. 27—AASB accounting standards and equivalent IAS/IFRS accounting standards. Remember, new standards are continuously being released. All standards can be downloaded from the AASB website

Process of Australia adopting IFRSs (cont.) In Australia a number of options under IFRSs are more restricted—but compliance with AASB standard means compliance with IFRS Additional disclosures required AASB issuing standards to match IFRSs, and to cover areas not addressed by IASB

Process of Australia adopting IFRSs (cont.) The adoption of IFRSs has meant significant changes post-2005 in some standards and minor changes in others. Significant changes include Intangible assets—research, brand names, mastheads—now expensed and not capitalised Revaluation of intangible assets greatly restricted, only if there is an active market for assets and associated prices are publicly available Amortisation of goodwill abolished—replaced by requirement that annual test be undertaken to determine whether value of goodwill is impaired (impairment testing) Revaluation of property, plant and equipment to be done on asset-by-asset basis and not by class of assets for companies

Process of Australia adopting IFRSs (cont.) Classification of ‘revenues’ restricted to inflows that relate to ordinary activities of organisation, e.g. sales of assets other than inventory to be classified as ‘gains’ or ‘losses’ in income statement Prior period errors—financial statements to be adjusted as if error had not occurred, i.e. opening balances amended retrospectively Tests of classifying items as equity vs liability more stringent, i.e. items previously classified equity might now be disclosed as liabilities

Process of Australia adopting IFRSs (cont.) Numbering system to be used for AASB standards AASB standards 1–99 series Where a new IFRS is issued its number will be used by the AASB, e.g. IFRS 1 becomes AASB 1 AASB standards 100–999 series Where an equivalent to an existing or improved IAS is issued, e.g. AASB 101 corresponds to IAS 1 AASB standards 1000 + series Applies to standards on the public or not-for-profit sectors or for areas of domestic application only. Also applies to AASB standards that are maintained as part of the post-2005 standards

Structure of the International Accounting Standards Board Given the direct relevance of the IASB to Australia, Australian accountants should know of its structure IASB comprises 14 individuals: 12 full time, 2 part time Each IASB member has one vote on technical and other matters Publication of standard, exposure draft or final SIC interpretation requires approval by at least eight board members Other decisions, e.g. the issue of Draft Statements of Principles or Discussion Papers and agenda decisions, require a simple majority of Board members present at a meeting attended by 50% or more

Structure of the IASB (cont.) Board has full control over technical agenda On publication of a standard, also publishes a ‘Basis for Conclusions’ to explain publicly how conclusions were reached, background information to assist application, and dissenting opinions. These are available on the AASB website IASB has an International Financial Reporting Interpretations Committee

International cultural differences and the harmonisation of accounting standards Values inherent in accounting subculture influenced by society-wide values Accounting systems cannot be considered to be ‘culture free’ Should different countries with varying cultural values adopt internationally uniform accounting practices?

Use and role of audit report Provides an independent opinion of the financial information regarding: true and fair view compliance with the Corporations Act compliance with accounting standards Helps establish credibility of the financial information Auditor not responsible for preparation of financial information Note: auditing standards have legal backing in the same way that accounting standards have legal backing

All this regulation—is it really necessary? Accounting is fairly heavily regulated in Australia by: the Corporations Act accounting standards Opinions on the need for regulation vary and range between the ‘free-market’ perspective and the ‘pro-regulation’ perspective

All this regulation—is it really necessary? (cont.) Free-market perspective on regulation Demand and supply forces should be allowed to operate to generate an optimal supply of information Even in the absence of regulation there are private economics-based incentives to provide information Information is produced to reduce conflict between parties with an interest in the organisation

All this regulation—is it really necessary? (cont.) Free-market perspective on regulation (cont.) Managers argued to be best placed to determine what information should be produced Financial statement audits can also be expected in the absence of regulation Without regulation, entities would still be motivated to disclose both good and bad news ‘ Market for lemons’ perspective

All this regulation—is it really necessary? (cont.) Pro-regulation perspective Arguments in favour of a ‘free market’ where users are expected to pay for information break down when we consider consumption of ‘free’ or ‘public’ goods Accounting information is a public good once available it can be used and passed on without payment parties using without incurring costs are known as ‘free-riders’ in the presence of free-riders true demand is understated

All this regulation—is it really necessary? (cont.) Pro-regulation perspective (cont.) Regulation required to alleviate the effects of market failure Arguments that ‘on average’ the market is efficient ignore the rights of individual investors who might lose as a result of relying upon unregulated disclosures Ability to obtain information might depend on the individual’s control of scarce resources required by the entity

Deegan5e Ch01

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Deegan5e Ch01