2 BAO2202 Financial Accounting Assignment Sample
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Introduction
This report presents the answers to understand the financial reporting regulation, accounting standard procedure and their principal enforcing body. The answers will comprehend the understanding of these issues and information use and needs for decision makers such as investors, lenders, creditors and accountants and other internal and external users of financial statements. The answers also reflect on the recognition and measurement issues in financial accounting for accounting standards (in particular intangible assets) and limitation on present value as a measurement base with reference to Australia with the use of related and relevant literature.
Answer 1.
Key sources of regulation
The key sources of regulation of financial reporting in Australia are Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC), Australian accounting standards board (AASB), Financial Reporting Council (FRC), Australian Securities Exchange (ASX) Listing Rules, and government legislation.
Australian Prudential Regulation Authority (APRA): On 1 July 1998, this body was established for deposit-taking institutions. It regulates licenses and supervises Authorised Deposit-taking Institutions (ADIs), general, life and private health insurance companies, oversees banks, superannuation industry members, building and friendly societies and credit unions. It acts as an integrated prudential regulator as these institutions needs to periodically report to APRA (Authority, 2012). The APRA issues prudential policies to achieve balance in relation to financial efficiency, financial safety, competitive neutrality and competition. Under the Financial Sector (Collection of Data) Act 2001, most of the investment banks are required to give statistical information to APRA.
Australian Securities and Investments Commission (ASIC): Australia has a country law and the body holds responsibility for monitoring the law in the country to protect consumer and market integrity across the financial system. It holds responsibility to administers and enforces legislative provisions (Davies and Green, 2013). It is concerned with financial markets and products for insurance, investments, deposit-taking activities and superannuation funds and also relates to financial intermediaries. The body requires timely disclosure of market information in compliance with relevant accounting standard by companies to avoid manipulation and promote integrity and fairness in financial information, financial markets and company accounting practices. The body thus, develop policies and guidance for managing laws, licenses and supervise compliance by financial system participants and provide inclusive and accurate information on corporate activities by companies.
Australian accounting standards board (AASB): The body holds responsibility for formulation of accounting standards for different sectors i.e. public, private, and not-for-profit (Iatridis, 2010). It provides a conceptual framework for accounting standards for reporting entities for accounting measurement and information disclosure.
Financial Reporting Council (FRC): This statutory body under the ASIC Act supervise the AASB activities and administers the effectiveness of the financial reporting structure in the country for public and private sector (Beekes et al., 2015). The framework includes overseeing of accounting and auditing standards, offer advice on audit quality to improve affect on the financial reporting. It also monitors the development, promotion and adoption of single set of international accounting and auditing standards for international use issued by International Accounting Standards Board (IASB).
Australian Securities Exchange (ASX) Listing Rules: These rules are applicable to listed companies in Australian security exchange. It provides requirements towards information disclosure in detail under continuous disclosure and periodic disclosure to promote fair and timely reporting and circulation of financial information. It involves information disclosure related to holders of quoted quality securities classes to comply with ASX listing rules (Beekes et al., 2015).
Government Legislation: The key legislation that specifies the requirements of financial reporting is concerned with Corporations Act 2001 in the private sector. Under this act, the reporting entities are required to produce financial report in adherence to accounting standards to present true accounts and fair view of financial information for stakeholders.
Answer 2.
Procedures for preparing accounting standards
The procedures for preparing accounting standards in Australia were initially developed by professional accounting bodies. Since 1996, these bodies operated along with Australian Accounting Research Foundation (AARF) boards to prepare accounting standards for private sector and public sector in Australia. The boards were the Public Sector Accounting Standards Board (PSASB) and Accounting Standards Board (AcSB). The Accounting Standards Review Board (ASRB) was established in 1984 to review the standards and to oblige with company law. In 1988, ASRB merged with AcSB and re-established the Australian Securities Commission Act 1989 and later in 1991 renamed as Australian Accounting Standards Board (AASB) applicable under the Corporations Act 2001. The Australian Accounting Standards Board (AASB) is responsible for the procedures for preparing local accounting standards and international accounting standards development under the International Accounting Standards Committee (IASC).
In 2002, the Financial Reporting Council (FRC) provided strategic direction to the AASB for adoption of International Financial Reporting Standards (IFRS) issued by the IASB for annual reporting periods on or after 1 January 2005 replacing the Generally Accepted Accounting Principles (GAAP) reporting (Iatridis, 2010). The IASB is the standard setting body under IFRS foundation, constituted in year 2009.
The procedure in accounting system preparation initiates with identification of technical issue, request for input from AASB and Australian companies, IASB research on issue along with AASB. This is followed by issue consultation documentation and AASB submission to IASB. In preparing accounting standards, AASB members also participate with Institute of Chartered Accountants (ICAI) and several other accounting regulatory bodies in Australia. The draft of accounting standards by AASB members is provided to designated regulatory bodies for any feedback for the final draft preparation which is submitted to authorise council for approval. Then, the pronouncement of issue final standards is made by incorporation of Australia requirements. This is this implemented by Australian entities and reviewed by AASB and contribute in IASB research for post implementation period. Thus, standards are being developed by International Accounting Standards Board (IASB) to comply the Australian reporting entities with IFRS system.
Answer 3.
Enforcement of accounting standards
In Australia, the international accounting standards under the Corporations Act 2001 are legally enforceable since their adoption from 1st January 2005. According to Holthausen (2009), the accounting standards are enforced through government regulation under the corporation Act 2001 and in support of several accounting bodies in Australia.
The accounting standards are enforced in Australia by the Australian Securities and Investments Commission (ASIC) which are issued by the AASB. It involves application of AASB standards, issue and specifies class order to companies and refers to issues in accounting practices. ASIC ensure that reporting entities is under compliance of the disclosure requirements with accounting standards (Bhaktavatchalam and Somasekhara, 2017). In case of any non-compliance issue, the ASIC looks and directs that the company has revised the reports of the financial statements. This is done by the ASIC members by engaging in direct negotiation with the reporting entity and if necessary the members of the ASIC make use of their power to enforce the law and existing accounting standards (Isidro and Marques, 2015). The ASIC also register the auditors of the company to monitor them to carry out the designated duties in a proper manner and to put into effect the relevant accounting standards.
The ASIC also plays a role to conduct a surveillance program by intelligence team on financial reports from the reporting entities in Australia. This program is initiated based on complaints received by members of ASIC and for the matters noted during the company activities by ASIC members (Isidro and Marques, 2015). The purpose of the surveillance program is to emphases on specific issues that are publically noted indicating reporting entity areas of weakness in their financial statements and to ensure high level of compliance to the accounting standards in preparation of their financial reports. Thus, under the Corporations Act, the Australian Securities and Investments Commission is known to be a key regulator and holds accountability surveillance and enforcement of the accounting standards for financial reporting requirements and enforcement of audit requirements of the reporting entities.
In addition to this, other secondary bodies for supporting the enforcing accounting standards are Australian Accounting Standards Board, Financial Reporting Council (FRC), APRA and Australian Stock Exchange (ASX). AASB supports enforcement of standards for accounting measurement and information disclosure in reporting entities in Australia. To some extent, the FRC supports the enforcement of accounting and auditing standards in the public and private sector to bring effectiveness in reporting structure and quality of audit of the financial information. The APRA under its overseeing responsibility also takes into account to enforce and compliance of authorised deposit-taking institutions, insurers, banks, and other deposit entities in accordance to accounting standards. The ASX concerns the listed public companies to generate comparable general purpose financial statements as per the accounting standards.
Answer 4
Discussion of given statement
Statement: “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.”
For financial information derived from financial reports of a company, there are several users of this information belonging from inside or outside as internal and external users of the reporting entity. The internal users of the financial information are organisational leaders/ senior managers (managing director, board of directors, president, vice-president, etc.) and middle level managers (divisional managers, head of department), supervisors and first line managers (Luca, 2008). The external users of the financial information are investors/shareholders, creditors, lenders, supplier, government, regulators, government agencies, and general public (Luca, 2008). The above statement indicates that the purpose of financial reporting it is directed at target users who are resources to reporting entities and the financial information disclosure assist in making investment related decisions. This also points to towards the identical information needs of the users of financial information.
The study of Chea (2011) mentions the information needs of financial statement users for purpose of accountability and decision making for business continuance and investments. Similarly, the research of Horton et al. (2013) put forward the different information needs under IFRS for primary users of financial statements such as investors, trade creditors, lenders, suppliers, government and their agencies, employees , customers and general public. The trade creditors, lenders and suppliers require information to settle on whether their amounts will be paid on time when due and to make decision on issuing new credit, loan, material/supplies to the entity. In contrast, the existing and potential investors are concerned with risk inherent and on their return on investments, employers draw information about the stability and profitability aspect of their company and government and their agencies require information for resource allocation. The entity customers may have information needs to know about the continuance of the business and general public need information to know entity contribute towards the local economy and environment aspects.
On the other hand, Gray et al. (2011) argue that general purpose financial reports are not specifically develop to fulfil and respond to specific information needs of all users. This is due to the fact that reporting entities prepares the financial reports in a tailored way to meet the information needs of company purpose and key stakeholders. However, the information may be useful for regulators, audit institutions, governing bodies, lending institutions and entity management who are not primary information users. Conversely, Landsman et al. (2012) state that general purpose financial reporting is concerned with providing decision useful information to fulfil the common informational needs of the different users of financial statement. In this context, Leuz (2010) mentions that general purpose financial reporting meet the informational needs of users who are not capable to direct the preparation of financial reports modified to meet their particular informational needs therefore are dependent on the information provided by the company through disclosure of the financial information. In the opinion of Landsman et al. (2012), the financial reports are not prepared for to fulfil all the informational needs but to present common information for use to take decisions about future investments, attract investors considering company value in competitive landscape and to fulfill the company obligation towards relevant laws by financial information disclosure by true and fair representation of their financial accounting and reporting.
However, Cairns et al. (2011) state that the users of financial statements such as creditors, suppliers, investors and lenders make use of the information to take financial decisions about the business entity based on their similar information needs from the general purpose financial statements. The author denotes them as the primary users of the company’s financial settlements for whom the financial information is directed and disclosed in public. It can be said that the usefulness of the financial information is relevant to these primary users as it gives them information about the company financial strength, profitability, performance, stability, the future cash flows, business continuity and aspects of corporate governance. Thus, it fulfils the common informational needs of these primary information users to evaluate a corporate entity and take decisions to engage with entity. In support to this, Okpala (2012) state that accounting information fulfil the common information needs of users of financial statements for economic information as it is related to economic/ financial activities of the entity and the use of the information has relevance for the users to make better financial decisions. In addition, Horton et al. (2013) clarify that the information needs of all internal and external information users is not satisfied by the financial statements but is directed to fulfil the informational needs of privileged users such as investors and creditors. The author states that meeting the informational needs of the privileged users of financial statements meets the common informational needs of other users of the financial information.
Thus, it can be understood that internal users of financial information have common informational needs as the external users related to economic information and financial activities. At the same time, it can be said that the different users of the financial information have additional needs of information for different purpose (Chua et al., 2012). The primary users of the information have the information usefulness for making decisions where as other users may require for general awareness, for stability and continuation of the business and not necessarily for making decisions (Luca, 2008). Thus, the general purpose financial statements take account of common informational requirement fulfilments for the different internal and external users from the different content of the financial statements. The general purpose financial statements provide financial information to ensure the comparability by other companies across countries and assist in provide decision useful information to primary users to take decision based on the information disclosed in the financial reports.
Answer 5
Discussion on Limitations of Present Value as a measurement base
The framework of IFRS acknowledges present value (discounted) as one of the measurement bases that are used in varying combinations in the company financial statements. The present value as a measurement base for assets and liabilities pose several limitations.
Dickinson (2011) viewed that estimates of present value are commonly face significant uncertainty in estimation and has restriction to produce decision-useful information for financial statements users. Therefore, it requires appropriate disclosure to support the present value estimates to recognise and consider being acceptable reliability. In this context, the study of Power (2010) points that the standard setter face challenge in developing standards to meet the condition of reasonable reliability for assets and liability estimates of present value which lack any practicable basis initial recognition determination.
Another limitation is related to present value estimates that will not fulfil the conditions for authentically representing the objectives of fair value measurement in absence of significant market inputs. It can be added that the present value estimates relies on entity specific data and expectation that can’t be justified to hold similarity as the market expectations. According to Dickinson (2011), the present value estimates are suitable as substitutes for some assets and liability whose fair value cannot be estimated in a reliable manner. This is due to absence of comparable market price or lack of observable transactions such as assets retirement and benefit pension plans (Novy-Marx and Rauh, 2009).
The present value for the future cash flow for non-contractual assets cannot be estimated independently poses a limitation (Saunders and Allen, 2010). This requires acknowledgment of assumption (one-to-many allocation) as the non-contractual assets are used with different inputs in the process of cash generation. Such attribution may lead to indeterminacy. Thus, this is a limitation of present value model as a measurement base to measure assets (individual non-contractual assets) as would not generate reliable estimations of their fair value in cash generation process due to one-to-many inputs allocations.
In addition to this, the non-supporters of the present value use in accounting measurements consider that the application of present value as measurement base for financial reporting leads to a decline in reliability aspects of the accounting and financial information. This less reliance affects the decision making by users of the financial information such as investors, creditors, financial analysts, shareholders, etc. Another study by Binsbergen et al. (2010) highlight that calculation by use of present value model needs several estimation in relation to time, interest rate, future cash flow amount and the existing economic conditions. It can be said that the involvement of these estimates pose risk to reliability aspects of the financial information to generate decision-useful information for the intended users of the financial statements. Also, the decision-useful information generation is affected by differing opinion about the future condition predictions which lowers the verifiability of estimates, pose bias risk in estimations and decrease competition neutrality for financial information being provided to users.
Answer 6
Review of AASB 138 ‘Intangible Assets’ and their limitations
The intangible assets refer to non-monetary assets that do not exist physically (Chalmers et al., 2012). These are patents, copyrights, trademarks, software, market share, franchises, brand names, marketing rights, and finance servicing rights, relationship with suppliers and/or customers, customer lists and loyalty of customer. These are difficult to measure and recognise but there measurement is crucial for the purpose of valuation, taxation and financial position. It is essential to recognise the assets as they may require to be expensed which affect the taxable profit. The items that are not classified either intangible assets or tangible assets are to be expected to position under good will remain unrecognised in the financial statements of the reporting entity.
In Australia, the intangible assets are defined by AASB 138 which is an accounting standard adopted by reporting entities for IFRS period since 2005. AASB 138 details out how the companies can recognise and measure an intangible asset. It also laid the requirements for information disclosure for the intangible assets. AASB 138 incorporates International Accounting Standards (IAS) 38 (Intangible Assets) issued by the IASB. The IFRS adoption by Australia impacted the intangible assets. Under AASB 138, the intangible assets that are purchased at cost are only recognised. Under this accounting standard, it is states that internally generated brands, customer lists, publishing titles, mastheads and similar items with no physical substance shall not be recognised under intangible assets. The introduction of IFRS system stress on the need for de-recognition of internally generated assets that were previously recorded as intangible assets. The study of Petkov (2011) mentions de-recognition of internally generated assets (intangible assets) to be essential after 2005. The study of Ji and Lu (2014) specifies that reporting entities in Australia face a major change in financial statements reporting as they would require de-recognising some kinds of intangible assets. For instance, the de-recognition of brand names and similar items where they could represent considerable value proportion for the companies pose an impact the market value on entities.
In addition to this, Cheung et al. (2008) discuss the treatment of intangible assets through written down the historical cost of previously re-valued intangibles assets and later measurement is at cost less the re-valued amount or any depreciation. The historical cost is needed as the reporting entity cannot retain its revaluation except in secondary market and measurement is at cost as there is reliance on active market. The research of Ji and Lu (2014) revealed that effect of AASB 138 in financial statement can be seen in relation to net assets and financial ratio. The study found that for a fictitious entity the net assets decreases and there is increase in the debt to equity ratio as a result of AASB 138.
From the review of AASB 138, it can be said that the accounting standard, AASB 138 has brought fundamental changes in the manner the intangible assets are recognised, treated and measured by reporting entities in Australia.
There are several limitations for AASB 138 ‘Intangible Assets’ for providing decision-useful information to financial statements users. In AASB 138 definition, not all the intangible assets meet the definition of an intangible asset. Only some of intangible assets qualify to be recognised as intangible assets under AASB 138 assets criteria. The study of Stanley and Marsden (2012) remind that internal goodwill generation, publishing titles, internal generated brands and customer lists are not recognised to be assets. Therefore, the limitation is related to the recognition issues for internal generated intangibles assets. On the other hand, Kabir and Rahman (2016) argue that goodwill can be recognised only when it is obtained as a component of business combination and is also measured as per the AASB 3 which denotes business combination. Another related limitation as highlighted in the study of Petkov (2011) is the non-use of fair value for internal generated intangibles as an upper limit on capitalisation cost.
The research of Kang and Gray (2011) recognised that there is a widening gap among the market value of entity and book value of equity. The study also put forward that the accounting standard for intangible assets in financial reporting provides an incomplete view on account of entity value for the entity. This is a limitation AASB 138 in making available decision-useful information to the financial statements users for the impact on intangible asset recognition. It can be added that Zéghal and Maaloul (2011) noted that many traditional entities/companies in Australia have high dependence on the value of intangible assets to generate their value. This also presents a drawback concerning the traditional firms from the omission of assets that are value drivers from the framework of financial reporting.
In addition to this, Chalmers et al. (2012) discuss that accounting standards presents the need of most of the intangible expenditures designate to be expensed as incurred. This also indicates that the information about the internally generated intangible assets is not being recognised in the balance sheet of the reporting entity. This point to AASB 138 limitation for information deficiencies for the financial managers, investors, creditors and policymakers as it does not recognises internally generated intangible assets. It is also argued by Kang and Gray (2011) that the new economy entities/ companies like Microsoft and Google place high relevance on intangible assets in particular the knowledge based assets and on human capital in the process of creating value. It can be understood that the study indicates that new economy companies have high significance for intangible assets more than their financial and tangible assets. This points to the limitation of accounting standards for intangible assets to create a mismatch among the existing accounting principle and intangible assets economic features as it is not being recognised in the balance sheets of companies under IFRS system. This presents a drawback on the AASB 138 as financial statements would no longer reflect the true and real value of a business owing to the impact management and recognition of intangible assets (Halim and Jaafar, 2012). This also poses restriction of the users of financial statement decisions for intangible investments. Thus, the users of financial statements do not get information about some of the most pertinent information about the entity.
Conclusion
In Australian context, the answers discussed to provide knowledge about the key sources of regulation of financial reporting, accounting standards preparation and enforcement authorities. It discussed general purpose financial reporting for users such as investors, creditors and lenders for making decisions and discusses the users for having identical information needs. The answers also reflect on the limitations of present value and AASB 138 ‘Intangible Assets’ for users of financial information. These answers contribute in understanding and management of accounting standards, recognition and management concepts and financial accounting issues for a developed country.
References
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