U1

INTRODUCTION TO
FINANCIAL
REPORTING AND
REGULATION

Unit 1: Introduction to financial reporting and regulation

Unit 1: Introduction to financial reporting and regulation 1.2
 Accounting Financial
Standards Regulation

Govern

Companies Act
Financial Reports

Information
Stock Exchange
Listing
Requirements
Markets

Decisions

Investment, Loans
etc

Unit 1 concept map

This map represents the core concepts that we’ll be covering
in this unit, and the relationships between them.

Unit 1: Introduction to financial reporting and regulation 1.3

Unit 1: Introduction to financial reporting and regulation 1.4
Study organiser
Before you begin this unit, please check through your study organiser. It shows
the topics that we’ll be covering, the skills you need to acquire (the learning
objectives) and the activities you’ll do to help you acquire these skills.

Topic Learning Objectives Activities

1.1 The financial reporting  Describe the financial accounting Activity 1.1
environment environment in Fiji and other
Pacific Island Countries and in
Australia.

1.2 Theories of financial  Explain the theories of accounting Activity 1.2

accounting regulation.

1.3 Sources of financial  Identify the regulatory

pronouncements operating in the Activity 1.3
reporting regulations
Activity 1.4
South Pacific and their relationship
to regulations in other parts of the
world.

You should spend 10–12 hours studying this topic.

Please ensure to refer to the Glossary Section of the textbook for important terms.

Unit 1: Introduction to financial reporting and regulation 1.5

Introduction
AF210 introduces students to financial accounting. Financial accounting is a
process involving the collection, recording and processing of financial
information for the purpose of decision-making. Companies are one of the most
common form of business structure used to conduct business activities in the
Pacific Islands. There are however, other structures like sole proprietorships,
partnerships and joint-ventures. Companies, like other forms of business
organisations, prepare many different types of financial reports. Some of these
reports are for internal use only (e.g., for employees or management), while other
reports are for specific users (e.g., banks).
Many types of legal entities (organisations) are required to prepare general
purpose financial reports, regardless of whether the organisation is private or
public; profit seeking or not-for-profit; or incorporated or unincorporated. This
course deals with the preparation of financial reports for private sector
companies, which generally are profit-seeking enterprises, that is, business
enterprises.
In this unit, you will be introduced to the financial reporting regulatory
environment. We will also explore general purpose financial reporting by
companies and why and how it is regulated. Through this, you will become aware
of the importance of accounting standards, corporation’s law, stock exchange
listing requirements and the company form of business. This unit also introduces
the accounting standards that are used throughout this course. Accounting
standards are essential tools for accountants, and it is important for you to
become familiar with their purpose, content and function in the company context.
The prescribed text book for this course is an Australian text. The text makes
reference to all matters of financial regulation in Australia. While there is great
deal of similarities in some financial regulations, there is a great deal of
differences in others. For example, the accounting standards are very similar but
the listing rules for the South Pacific Stock Exchange in Fiji and Australian
Securities Rules greatly differ. Second, the financial reporting regulatory
environment and the regulatory process also greatly differ. In this unit, we will
identity some of the important differences between some of the Pacific Island
countries and Australia which will be supported by reading materials. Students
are reminded that the general processes and application of financial reporting
regulation still remains the same. That is, the overriding factor being the
provision of true and fair financial reports about the economic activities and
financial performance and position of a given entity. You should now read
Section 1.1 of the Textbook book chapter 1, but before that make a note of the
following references that will be utilized throughout this unit.

Unit 1: Introduction to financial reporting and regulation 1.6

References

Textbook
Chapter One and Three
Australian Financial Accounting, Craig Deegan, 7th Edition, McGraw-Hill.

Legislations
Fiji Companies Act, 1983. Available at: http://www.itc.gov.fj/lawnet/

South Pacific Stock Exchange Disclosure Requirements. Available at:

http://www.spse.com.fj

Accounting Standards
International Accounting Standard 1: Presentation of financial statements, The
International Accounting Standards Board, 2010, Available at:
http://www.iasb.org/home.htm

Unit 1: Introduction to financial reporting and regulation 1.7

1.1 The financial reporting
environment
The financial reporting environment describes how the various financial
regulations are developed, promulgated and applied in the preparation of general
purpose financial reports. The text for this course refers to the Australian
financial reporting environment. We will also refer to the financial reporting
environment for the Pacific Islands, with focus on the Fiji financial reporting
environment. Emphasis is placed on the Fiji financial reporting environment
given that most Pacific Islands follow the Fiji financial reporting regulations.
There are basically three specific sources of financial reporting regulations in
both Australia and Fiji. In Australia these are referred to as the Australian
Accounting Standards, Corporations Act and Australian Securities Exchange
listing requirements. In Fiji, the financial reporting regulations are referred as the
Fiji Accounting Standards (FAS) (Fiji has now adopted the International
Financial Reporting Standards (IFRS) as the local accounting standards), the Fiji
Companies Act (1983) and South Pacific Stock Exchange Listing requirements.

Demand for Financial Statements

External financial reports are used by many stakeholders in making important
business decisions like, advancing loan, opening credit lines, buying and selling
of shares, mergers and acquisitions, liquidation, accepting jobs and many more.
Decisions based on financial reports may lead to financial outlay and
commitment. Demand for financial reports for different user groups can vary
according to the status and relationship of the user to the entity. Some user groups
can successfully demand reports for specific use. For example, a bank can
demand specific financial information as part of a loan agreement. Such financial
reports are referred to as specific-purpose financial reports. However, all user
groups cannot exert the same power to extract financial reports. For example,
potential shareholders do not have any legal power to seek specific financial
information when making investment decisions. In such instances, users have to
rely on general purpose financial reports produced for a broad cross-section of
decision makers. General purpose financial reports are governed by financial
reporting regulations. This course introduces students to the application of
financial rules and laws in the production of general-purpose financial reports.
The following are some of the characteristics of general purpose financial reports:
 they are prepared for users who have no right to special or inside financial
information;
 they are not prepared for internal users, such as employees or
management; and
 they are regular and periodic.

Read Section 1.2 of the Textbook Chapter 1.

Unit 1: Introduction to financial reporting and regulation 1.8

 Activity 1.1

Obtain a copy of a general purpose financial report of a company operating in

your country. A copy of an annual report for a listed company in Fiji is provided
on Moodle which you can download. Briefly browse through the annual report
and note down the main disclosures made in the report. Identify the regulations
applied in preparing the financial statements presented in the annual report.

Why regulate?
Financial information is used in making various decisions which get manifested
in the company’s share price. Positive (negative) financial information increases
(decreases) the listed company’s share price on the stock market. Hence, there are
strong incentives for companies to report good performance. The overall market
performance resulting from the financial information is reflected in the stock
market index. Stock market indexes indicate on average the financial
performance of all companies listed on a stock market.
There is good deal of arguments on why financial reporting must be regulated.
Proponents of financial reporting regulation have always relied on the case of
market failures. Every decade or so there have been financial scandals that
require strengthening of financial regulations. A very good example is the
collapse of the electricity giant Enron in the U.S. Close to US$80 billon was lost
in the Enron financial scandal. The Enron financial scandal gave rise to what is
now known as the Sarbanes Oxley Act, which is a completely new set of financial
reporting regulation for companies listed on the New York Stock Exchange.
Therefore the strongest form of argument for financial regulation is market
failure.
Market failure occurs when sub-optimal investment decisions are made based on
financial reports that are not true and fair and that are sometimes fraudulently
prepared. The sub-optimal investment decisions get manifested in the production
of goods with low quality, leading to company losses and decreases in standards
of living. Company losses get reflected in decrease in investments and
employment. Such a state of reduced economic status is not a desirable outcome
for any government.
However, on the other hand proponents of ‘free market’ argue that financial
information should be treated like any other product in the market place, subject
to market forces of supply and demand. They argue that there are sufficient
incentives for companies to produce true and fair financial information in the
absence of financial regulations. Proponents of free market argue that there are
costs imposed on entities for not providing or providing less then credible
financial information. Cost of capital to entities which supply less then credible
or no financial information will increase. However, despite arguments for no or
reduced regulations, the current economic climate and financial scandals dictates
that financial regulation is here to stay. How and what financial regulations are
developed and promulgated at any point in time is explained by the various
theories of financial regulation.

Read Section 1.8 of the Textbook Chapter 1.

Unit 1: Introduction to financial reporting and regulation 1.9

1.2 Theories of Financial Accounting
Theories of financial accounting help explain the practice of accounting, both in
terms of why an accounting regulation is formulated, who will support it or
oppose it and when and what financial information disclosures will be made.
Theories of financial accounting also help accountants to understand and predict
the outcome of accounting standards and other regulations. Theory that allows the
predictions of which accounting method or approach management is likely to
select in the preparation of financial reports is referred to as positive accounting
theories. An example of positive accounting theory is the agency theory. Theory
that prescribes which accounting methods should be used in the preparation of
financial reports is called normative accounting theories. An example of the
normative theory is the conceptual framework of accounting (the conceptual
framework of accounting will be discussed in detail in Unit 2). There are other
theories that explain how and why financial regulations are developed and
promulgated. Examples of these theories are public interest theory, economic
interest group theory and the capture theory.

Read Section 3.1, 3.2, 3.3, 3.4, 3.5, 3.6, 3.7, 3.8 and 3.9
of the Textbook Chapter Three.
Read Financial Accounting in New 3.1, 3.2, 3.3, 3.4
and 3.5 of the Textbook Chapter Three.

Activity 1.2

Do you expect that we will ever have a single universally accepted theory of
accounting and, if not, why not?

Unit 1: Introduction to financial reporting and regulation 1.10

1.3 Sources of financial reporting
regulations
As mentioned earlier there are three unique sources of financial reporting
regulations and one common source that are used in many countries. In this and
the following sections we will outline the various financial reporting regulations
and the bodies responsible for their development, promulgation and application.
We will first review the Companies Act or the Corporations Law. This will be
followed by accounting standards both local and international and finally we will
look at the stock exchange listing requirements.
In order to understand the financial reporting requirements under a company, it is
important to study the company structure of business organisation.
The main features of a company are as follows:
 a company is a separate legal entity, that is, an artificially created legal
person, and it is a common form of business organisation throughout the
world;
 in most countries, companies are regulated by corporations legislation that
sets down rules for the formation, operation and dissolution of companies,
usually in a Companies Act. (Later in this topic, you will look at some of
the accounting requirements of the Fiji Companies Act 1983 and the
Australian Corporations Act);
 a company is formed by the process of incorporation under the
Companies Act. It will issue ownership interests to individuals in the form
of shares at a price determined by the company. It may also borrow to
finance its operation; and
 the limited liability of individuals owning shares in a company is one of
the main advantages of the company form of business organisation. In this
form of business organisation, individuals are only liable to the extent of
amounts unpaid on their shares if the company is dissolved: They cannot
be required to contribute to the company’s debts.

Reporting requirements of a company

The requirements for general purpose financial reports are usually referred to as
financial reporting regulations. At this point, you should note that the regulations
of a business are not confined to financial reporting.
As you would have noticed when you completed Activity 1.1 there are some
aspects of accounting regulation that relate to non-financial information. For
example, investors will want to know the extent of the directors’ shareholdings in
the company and how many shares they have bought or sold during the year.
Think about this for a moment. Would you be interested in buying shares in a
company when directors have sold off much of their holdings? Their sales imply
that they do not have much confidence in the company’s future.
Generally Accepted Accounting Principles (GAAP’s) are used to regulate
financial reporting. The financial reports of a company must comply with these
GAAP. The GAAP’s are contained in the following:
1. Companies Act or Corporations Law, and

Unit 1: Introduction to financial reporting and regulation 1.11

2. Accounting Standards,
3. Stock Exchange Listing Requirements.

Companies Act or Corporations Law

Most countries have legislation regulating the company form of business
organisation. The Companies Act 1983 is the legislative act that governs the
company form of business in Fiji and is administered by the State. The
Corporations Act is the main source of legislation governing the company form
of business in Australia and is administered by the Australian Securities and
Investments Commission (ASIC). Although there is significant difference in both
the pieces of legislation, the essential focus of both the legislation is the
administration of company form of business including the regulation of financial
reporting. While the text book refers only to the Corporations Act, we will make
reference where applicable to both or either of the legislations.
In respect to accounting and financial reporting, the Fiji Companies Act generally
includes sections on

These
Books of account S149 sections
Financial statements to show a true and fair view S151 refer to the
Requirements to prepare group accounts S152 Fiji
Audit S161 Companies
Disclosure requirements 7th Schedule Act 1983

There is no mention made in the Fiji Companies Act that financial reporting must
adhere to Fiji Accounting Standards. However Section 149 (2) indicates that
financial reports must present a true and fair view of the state of affairs of a
company. The Fiji Companies Act is currently under revision and amendments
will soon be forthcoming.
In Australia, the disclosure requirements for companies are incorporated within
the Corporations Act. Section 295(2) states that financial reports must be
prepared as required by the accounting standards. In Australia, the accounting
standards are released by Australian Accounting Standards Board (AASB). AASB
101 Presentation of Financial Statements clearly indicates the financial reports
that must be prepared by a company. The Corporations Act does not specifically
indicate that financial reports must be true and fair as the case is in the Fiji
Companies Act. What is true and fair financial reporting is subject to heated
debate. In absence of a clear legislative definition, accountants have taken a
general view that true and fair financial reporting is reporting in compliance with
GAAP and the accounting standards.
Other Pacific Island Countries have a Companies Act similar in nature to the Fiji
Companies Act and contain similar provisions in relation to financial reporting.
As expected, disclosure requirements in the Companies Act deal with issues that
shareholders have a legal right to know. For example, the Seventh Schedule of
the Fiji Companies Act states that the auditors’ remuneration must be disclosed. It
is one of the few expenses that must be disclosed. This expense must be disclosed
because the shareholders, not the company, appoint the auditors, and they must
take responsibility for the cost.

Unit 1: Introduction to financial reporting and regulation 1.12

 Read Section 1.3 of the Textbook Chapter 1- pages
6-12

Accounting standards
Accounting standards are documents that set out accounting methods and/or
rules. They may be set by
 national professional accounting bodies;
 government; or
 an international accounting committee.

Their role is to
 ensure that financial reports reflect what is called the economic substance
of transactions;
 ensure objectives of financial reporting are met;
 improve the quality of financial reporting and thus the usefulness of
financial statements to investors and others; and
 enhance the comparability of financial reports.

Accounting standards and this course

Your textbook for this course covers Australian accounting standards. It was
chosen because it provides the most thorough coverage of accounting for
companies. We will however, where applicable make reference to the
International Financial Reporting Standards which are applicable in Fiji. Table
1.1 presents the list of IFRSs that apply in Fiji.
In Australia the history of accounting standards is a little complex. There had
been two sets of accounting standards up until 1999. The government sponsored
body, the Australian Accounting Standards Board issued one set of accounting
standards labeled AASB and the professional accounting bodies, the Institute of
Chartered Accountants and the Australian Certified Public Accountants issued
another set labeled AAS (Australian Accounting Standards). In 1999 the
Financial Reporting Council of Australia (FRC) was set up and AASB was
required to formally report to FRC. The FRC maintains oversight function and
appoints the 12 part-time members of AASB. Since 2000, AASB took over the
sole function of issuing authoritative accounting standards in Australia. The
AAS’s has since been phased out.

Read Section 1.3 Text Book: Chapter 1- pages 12-24

Read Financial Accounting in the News 1.2 and 1.3

Unit 1: Introduction to financial reporting and regulation 1.13

 Table 1.1 List of IFRSs applicable in Fiji
Standard Title
Number

IFRS 1 First-time Adoption of International Financial Reporting Standards

IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements
IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IFRS 13 Fair Value Measurement
IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 7 Statement of Cash Flows
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events after the Reporting Period
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment
IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government
Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Separate Financial Statements
IAS 28 Investments in Associates and Joint Ventures
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 32 Financial Instruments: Presentation
IAS 33 Earnings per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture

Unit 1: Introduction to financial reporting and regulation 1.14

In Fiji, the sole responsibility of producing accounting standards resides with the
Fiji Institute of Accountants (FIA). FIA operates under the FIA Act (1971) and is
lead by a nine member council. The FIA council has established an Accounting
and Auditing Standards Committee (AASC) consisting of six members selected
by the FIA Council representing the various stakeholders. There is no specified
position for any specific stakeholders on AASC. The FIA has decided to adopt
the International Financial Reporting Standards issued by International
Accounting Standards Board (IASB) as the accounting standards for Fiji.
The other South Pacific Island countries have a less developed financial reporting
regulatory environment. All other islands do not have a stock exchange but most
do have an organised accounting profession and some basic committees. In most
instances they follow the International, Australian or New Zealand accounting
standards.

International Financial Reporting Standards

(IFRS’s)
The International Accounting Standards Board is responsible for issuing IFRS’s.
IFRS’s have particularly become important where no country specific accounting
standards have been formulated and where countries did not have any accounting
standards. Most developing countries that do not have or have limited accounting
standards have adopted the IFRS’s as is. However, many developing countries
have also set programs to harmonise their own accounting standards with IFRS,
hoping to capture the perceived benefits of a globally consistent set of accounting
standards. The IASB website gives a comprehensive description of the structure
of IASB and the list of IFRS’s issued to date.

Read Section 1.4 of Textbook Chapter 1 pages 25-34

Read Section 1.5 of Textbook Chapter 1 pages 35-37
Read Financial Accounting in the News 1.4 and 1.5
Chapter 1

Activity 1.3

a) The moodle webpage for this course provides a link to the IASB website.
You can register and download the IFRS’s from this website.
Alternatively, the website address is http://www.iasb.org//home.htm. You
are encouraged to become familiar with these standards, particularly as
you work through the topics that refer to specific accounting standards.
Remember that these standards are important tools for any accountant,
and you should take the opportunity now to begin learning what they
contain and how to use them.
b) Identify which IAS/IFRS applies to:
 the preparation of cash flow statement,
 inventories, and
 property, plant and equipment.

Unit 1: Introduction to financial reporting and regulation 1.15

Relationship between IFRS and national
accounting standards
Recently, a number of countries started to harmonise their accounting standards
with IASB standards. For example, Australia conducted a harmonisation program
that brought Australian accounting standards and IFRS’s into line, which has
resulted in financial savings and improved comparability of financial statements
across countries.
The Fiji Institute of Accountants has also accepted the need to harmonise its
standards with the IASB standards. In order to keep up-to-date with international
developments, it has decided to adopt all the IASB standards as its own and apply
them to reporting periods beginning on or after 1 January 2001. The Institute,
however, realises that not all of the IASB standards are suitable for Fiji. It has,
therefore, produced disclaimers in some cases. A disclaimer will say that a certain
part of a standard does not apply in Fiji. For example, IAS 2 Inventories allows
companies to report the value of inventories in three different ways:
1. the first in first out (FIFO) method,
2. the last in first out (LIFO) method, and
3. the weighted average method.
The Fiji Institute of Accountants has issued a disclaimer that does not allow LIFO
to be used in Fiji.
As you look at individual accounting standards in this course, the significant
differences between standards of various jurisdictions will be highlighted. In
particular, the following differences will be covered:
 situations where IAS standards differ from Australian standards; and
 situations where there is no IAS standards equivalent to the Australian
standard and vice versa.
Although at times the reference to the Australian standards may seem out of
context with the USP region, you must look beyond the standard itself and focus
on its application to the reporting requirements of companies. Irrespective of
which set of standards a country follows, you must know how to apply these
regulations to the company form of business. Above that you must be able to
determine what is true and fair reporting of an economic event. Not in all cases
an application of accounting standard produces a true and fair financial report.
You must exercise professional judgment in application of any accounting
standard.

Impact of culture
In the process of harmonising country specific accounting standards with IFRS,
certain difficulties have been experienced. Differences in legal systems,
economic and financial structures, cultural and political landscapes have impeded
the harmonisation process. However, with the increasing globalisation of
business and the need for financial reporting beyond the country boarders,
benefits of harmonisation will outweigh the problems of harmonisation.
Countries that find great difficulty in total harmonisation have elected to create
exceptions to IFRS.

Unit 1: Introduction to financial reporting and regulation 1.16

 Read Section 1.6 of Textbook Chapter 1 pages 37-38

Stock exchange listing requirements

The only stock exchange operating in the USP region is the South Pacific Stock
Exchange (SPSE) located in Suva. While there are only a small number of listed
companies, the government has established the Capital Market Development
Authority (CMDA) to encourage further listings. Information about CMDA can
be found at www.cmda.com.fj and about SPSE at www.spse.com.fj.
The present requirements for listing include the following:
 provision of half-yearly financial statements;
 provision of annual financial statements within 4 months of the end of
each financial year;
 financial statements must conform to professional accounting standards
and pronouncements and be certified by the company’s auditors;
 provision of a Director’s report; and
 information pertaining to Directors.
In Australia, the listing requirements are issued by the Australian Securities
Exchange (ASX). ASX in turn is regulated by ASIC. ASIC is tasked with the
responsibility to regulate various investment products, superannuation, approved
deposit accounts and retirement savings accounts. The ASIC also monitors the
requirements of the Corporations Act. Extensive details about ASIC can be found
on www.asic.gov.au.

Read Financial Accounting in the news 1.1 Chapter 1

Throughout this course, you will constantly refer to the three types of regulations
discussed above. In addition, you will find a section at the beginning of each
topic that summarises the accounting standards and corporations legislation that
are directly relevant to the theory and application of the concepts discussed in the
topic. Towards the end of each topic, if it is appropriate, there will be a discussion
about the differences between the various types of standards and legislation.

Activity 1.4

You should now spend a few minutes looking through the topics of this course. In
particular, look at the organisation of the topics (presented on the Contents page)
and identify the sections at the beginning and end that refer to accounting
standards and corporations law.
From the above discussions, you can see that there is overlap between the various
sources of regulation over company financial reporting. Overall, these regulatory
mechanisms form the basis for the enforcement of Generally Accepted
Accounting Principles (GAAP) in financial reporting.

Unit 1: Introduction to financial reporting and regulation 1.17

Summary
In this topic, you were introduced to general purpose financial reporting by
companies and how it is regulated. As you proceed through this course, you will
learn the theory and technical competencies required in financial reporting and
become familiar with the role of accounting standards, companies act and stock
exchange listing requirements in a company form of business.

End of Unit Exercise

With all the regulations that companies have to follow, fulfilling the requirements
of corporate reporting is an additional costly activity.

What are some of the possible arguments for and against disclosure regulations?

Unit 1: Introduction to financial reporting and regulation 1.18

Feedback to Activities
Activity 1.1
This activity requires you to select a company and review its annual report. In
general any annual report that you chose will contain various disclosures, some
required by the various legislations governing financial reporting by companies
others not. The disclosures that are made but not required by regulations are
referred to as voluntary disclosures. The annual report would also contain the
financial reports, directors’ reports and the auditors’ reports.

If you are referring to the annual report of a company listed on SPSE, you will
find that from 2008 onwards all listed companies have prepared their financial
reports in accordance with IFRS. The financial reports also have to comply with
the requirements of the Fiji Companies Act (1983). Finally, the annual report
would contain disclosures related to the listing requirements.

Activity 1.2
We live in a world that is complex. Theories are abstractions of reality. We
cannot expect a single theory to perfectly explain and predict all phenomena and
more specifically for accounting theories, all accounting related phenomena. We
also cannot expect a single theory to provide optimal solutions in all cases.
Hence, we should never describe any single theory as the best theory; we should
utilize different theoretical perspectives to gain valuable insights in to accounting
issues which may not be possible if we adopt a single theoretical perspective.

Activity 1.3
a) Please download and review the various accounting standards.
b) IAS 7 prescribes rules for preparation of cash flow statement, IAS 2
prescribes accounting rules for inventories, and IAS 16 prescribes accounting
rules for property plant and equipment.

Activity 1.4
Please review the unit, paying particular attention to the various financial
reporting regulations. You should be able to identify the three sources of financial
reporting regulation as well as understand the scope and limits of these
regulations.

Unit 1: Introduction to financial reporting and regulation 1.19

End-of-unit Exercise Solution
This question may be answered in terms of a ‘free market’ versus a ‘pro-
regulation’ perspective about the provision of accounting information.
Many academics argue in favour of a free-market approach. By this, we mean
that there is a belief the market forces of supply and demand should be allowed to
freely operate to determine the equilibrium amount of accounting information to
be provided. It is considered in this argument that if the users of accounting
reports demand information, but it is not being supplied, then this will be priced
in to the amount they will charge the firm for the factors of production they
supply to the firm (for example, equity capital). If an individual is able to obtain
the demanded information then this may lead them to reduce the risk they
attribute to the investment, which may translate to a lower required return on
their investment. In a sense, the price they pay for the information is the
reduction in required return they demand as a result of being provided with the
information (which reduced their risk). The firm is predicted to supply
information to the point where the benefits of providing the information (perhaps
in terms of lower cost of capital) equals the costs of providing the information
(which of course assumes that the managers of an organisation have quite a
sophisticated grasp of market economics). It has also been argued by proponents
of the ‘free market’ argument that because there will often be conflict between
the various parties associated with an organisation (for example, owners and
managers) the accounting reports will be produced which are designed to
minimise the conflict and the associated costs of the conflict. It has also been
argued that managers are best placed to select accounting methods which best
reflect the financial performance and position of their particular organisation, and
hence it is inappropriate and inefficient to impose regulation upon them which
restricts the accounting methods they might choose to use.

There is also an argument that in the absence of regulation, organisations would

still be inclined to disclose information in case various external parties construe
that the entity has something to hide (the ‘market for lemons’ argument).

Advocates of a regulated approach would, by contrast, argue that a free market

approach is flawed for a number of reasons. Firstly, the producers of the
information cannot typically control its dissemination. Parties, such as
competitors, analysts and the like, will obtain the information, but will not
directly pay for it (they are deemed to be ‘free-riders’). The free-rider problem
may, in an unregulated environment, lead to a reduction in the supply of
information due to an understatement of demand. Further, although in the long
run market forces may operate, it may be that organisations have created
significant social costs in the meantime. For example, the disclosure of
environmental information—that is, pollution emissions, clean-up costs etc is not
currently required in Australia. Research evidence, however, suggests that there
are many accounting report users who may be interested in such information (for
example, to assess the appropriate risk rates). It may be that sooner or later the
market will punish those firms that do not provide information (in the absence of
information the market may assume that there is bad news to report); however,
significant costs may have been imposed on society by this time.

Unit 1: Introduction to financial reporting and regulation 1.20

The ‘free market’ approach to financial reporting also ignores issues associated
with stakeholders’ ‘right-to-know’ about certain aspects of an entity’s operations.
Stakeholders without financial resources (and perhaps the ‘power’ to demand
financial information) may simply be ignored in the information dissemination
process, yet they may nevertheless be impacted by the operations of the
organisation. Introducing regulation might also have the effect of increasing
confidence in the capital markets, which might be construed as being in the
‘public interest’.

Unit 1: Introduction to financial reporting and regulation 1.21

Unit 1: Introduction to financial reporting and regulation 1.22