Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
& REGULATION
AC2091 FINANCIAL REPORTING

LEARNING OUTCOMES

• Discuss the character and role of accounting in society

• Explain the different levels of authority in the UK
regulatory framework
• Explain and discuss the implications of the IASB
• Discuss arguments for and against accounting standards
• Discuss accounting regulation

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 Session 1: Financial Reporting & Regulation

DEFINITION OF ACCOUNTING

• An information system that identifies, records, analyses

and reports financial information about an organization’s
business activities for the purpose of decision making
o Identify : Selecting relevant transactions
o Record : Chronological log of events
o Analyze : Interpreting information collected
o Report: Preparing accounting reports

MANAGERIAL
& FINANCIAL ACCOUNTING

ACCOUNTING

Managerial Financial
Accounting Accounting

Focus on Focus on
internal users external parties

Information for decision Decision making by external users

making by business

Regulatory purposes (e.g. tax)

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 Session 1: Financial Reporting & Regulation

FINANCIAL ACCOUNTING
& FINANCIAL REPORTING

• Some view financial accounting as a broader activity (e.g.

recording) and reporting is a branch of it
• Others equate financial reporting to a broader external
reporting that need not be restricted to the financial,
whereas financial accounting (or simply accounting) is
understood to be restricted in this way
• In some usages, they are taken to be the same or at least
substantively so

Source: UOL Study Guide

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OBJECTIVES
OF FINANCIAL REPORTING

• Provide information about business

organizations to
people outside the management function
o Information should be useful in making decisions about
providing resources to the entity.
o Users need information about:
 Economic resources of the business
 Claims against entity
 Changes in entity’s economic resources & claims

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 Session 1: Financial Reporting & Regulation

TYPES OF FINANCIAL REPORTS

• Special purpose financial statements (SPFS)

o Financial statements designed to meet the needs of a specific
group, or to satisfy a specific purpose.
• General purpose financial statements (GPFS)
o Financial statements that comply with accounting standards
and which are intended to meet the information needs
common to users of financial information who are unable to
command the preparation of statements tailored to suit their
own specific information needs.

GENERAL PURPOSE
FINANCIAL REPORTING

• The objective of general purpose financial reporting1 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.
• Those decisions involve buying, selling or holding equity
and debt instruments, and providing or settling loans and
other forms of credit

Source: IASB Conceptual Framework (2010)

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 Session 1: Financial Reporting & Regulation

GENERAL PURPOSE
FINANCIAL REPORTING
• Main functions include:
o Accountability
 Responsibility for actions and consequences
o Stewardship
 Use of resources and subsequent financial performance
o Resource allocation decision making
 Allocate scarce resources to the most productive and efficient uses
o Efficient contracting
 Between entity and management  incentives and monitoring
 Between entity and lenders  covenants and other terms
o Reconciliation of conflicting interests of stakeholders
 E.g. fairness and transparent computation of dividends to protect
interests of shareholders and lenders
Source: Alexander, Britton et (2017) 9

USERS OF
FINANCIAL INFORMATION

Managers

Competitors Shareholders

Organization
Lenders Employees

Customers /
Public Suppliers Government

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 Session 1: Financial Reporting & Regulation

USERS OF
FINANCIAL INFORMATION

User Group Information Needs

Shareholders Return on the investment and risk involved

Lenders Possibility to repay loans and pay interest

Employees Stability and profitability of the firm,

employment and remuneration
opportunities
Suppliers and trade creditors Ability to pay the amounts due

Customers Going concern of the enterprise, corporate

responsibility

Source: Alexander, Britton et (2017) 11

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USERS OF
FINANCIAL INFORMATION

User Group Information Needs

Competitors Performance of the competition

Government To determine taxable income, to supervise

regulation, to judge efficient allocation of resources

Public The viability of the company, the corporate

responsibility

Financial analysts Information to advise whether to hold, buy or sell

shares
Competitors Performance of the competition

Source: Alexander, Britton et (2017) 12

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION

• Regulatory framework is needed to ensure relevant and

faithfully presented financial information to meet the
needs of users
• Financial reporting regulatory framework varies from
country to country and depends on:
o Influence of tax rules
o Type of legal system
o History and influence of accounting profession

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FINANCIAL REPORTING
REGULATION [UK]

• Regulatory framework developed over many years and

consists of a mass of rules and regulations - some
statutory, some mandatory and others customary
• Impetus for regulation usually comes from well
publicised scandals which may indicate:
o Misinterpretation or misuse of accounting standards
o Inherent gaps or lack of depth in current standards

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION [UK]

Regulations for larger UK companies

Statutory Mandatory Stock

legislation regulation exchange
• Companies Act • Financial listing rules
1985 & 1989 Reporting • Imposed on
(Revised) Standards (FRS) companies listed
issued by on London Stock
Accounting Exchange
Standards Board
(ASB)

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FINANCIAL REPORTING
REGULATION [UK]

• Statutory legislation
o Standardised formats for the income statement and balance
sheet
o True and fair view of state of affairs of the company as at the
end of the financial year [balance sheet] as well as profit and
loss of the company for the financial year [income statement]
 Achieved by regulating:
 Format of accounts
 Certain accounting principles
 Valuation rules
 Information disclosure

Source: UOL Study Guide

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION [UK]

• Mandatory legislation
o Accounting standards set by accounting bodies or authorities
 1970: Accounting Standards Steering Committee (ASSC)
established with various accounting bodies to develop and issue
Statements of Standard Accounting Practice (SSAP)
 1976: ASSC renamed as Accounting Standards Committee (ASC)
 1990: Financial Reporting Council (FRC) established to promote
good financial reporting through its subsidiary bodies
 Accounting Standards Board (ASB) replaces ASC as the standard-
setting body to issue Financial Reporting Standards (FRS)
 Financial Reporting Review Panel (FRRP) examines material
departures from standards by large companies

Source: UOL Study Guide

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FINANCIAL REPORTING
REGULATION [UK]

• Stock Exchange
o Regulations concerning listed companies’ published accounts
 Provision of more information, and more frequently, than either
the law or the UK ASB requires
 E.g. companies are required to publish interim accounts and provide
more detail regarding certain liabilities (e.g. bank loans)
o Compliance with the Corporate Governance Code
 General guidance on governance and internal control for
organisations

Source: UOL Study Guide18

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION
• Arguments for regulation
- Required in order to provide a ‘level playing field’ due to
existence of market failure or imperfections
o Uneven distribution of information among stakeholders
 Individual’s control of scare resource required by entity (e.g.
finance providers such as equity and debt holders)
o Incomplete and asymmetric information
 Management possess superior knowledge of operations
 Tendencies of managers not to disclose unfavorable information
o Improve market efficiency
 Especially for markets with imperfect competition (e.g. monopoly)

Source: Alexander, Britton et (2017) / Deegan (2016)

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FINANCIAL REPORTING
REGULATION
• Arguments for regulation
- Required in order to provide a ‘level playing field’ due to
existence of market failure or imperfections
o Accounting information as a public or free good
 Information can be used and passed on without payment
 Leads to externalities and free riders
 True demand is understated in the presence of free-riders and
thus information is under-provided

Source: Alexander, Britton et (2017) / Deegan (2016)

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION
• Arguments for regulation
- Improves quality of accounting information
o Establish minimum standard for quality, quantity and
presentation of useful financial information
 Enhance comparability and analysis of financial statements
through accounting standards
 Reduces information asymmetry between managers, investors,
lenders and other users of financial statements
 Resource allocation decisions are improved

Source: Alexander, Britton et (2017) / Deegan (2016)

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FINANCIAL REPORTING
REGULATION
• Arguments against regulation
- Free market leads to pursuit of self-interest that benefits society
o Accounting information should be treated like normal good
 Demand and supply forces should be allowed to operate to
generate an optimal supply of information
o Organisations have incentives to provided information
 Lowers cost of raising capital (debt and equity)
o Entities still motivated to disclose both good and bad news
 No information is equated to bad information

Source: Alexander, Britton et (2017) / Deegan (2016)

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 Session 1: Financial Reporting & Regulation

FINANCIAL REPORTING
REGULATION
• Arguments against regulation
- Free market leads to pursuit of self-interest that benefits society
o Conflicts between stakeholders drive need for information
 E.g. agency issue between owners, lenders and management
o Free goods may be overproduced as a result of regulation
 Public overstates their need for accounting information

Source: Alexander, Britton et (2017) / Deegan (2016)

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FINANCIAL REPORTING
REGULATION
• Arguments against regulation
- Free market leads to pursuit of self-interest that benefits society
o May led to decreased relevance of financial reporting
 Restrictions on management in providing useful information when
they are arguably best placed to determine what information
should be produced
o Increases cost for firms
 E.g. competitors take advantage of mandated disclosures,
compliance costs

Source: Alexander, Britton et (2017) / Deegan (2016)

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 Session 1: Financial Reporting & Regulation

ACCOUNTING STANDARDS

• Minimum requirements for quality, quantity and

presentation of useful financial information
o Improve transparency to create a more level playing filed for
investors
o Prevent capital markets from breaking down due to lack of
public confidence
• Can be prescribed by law or by independent professional
bodies (and subsequently backed by law)

Source: Alexander, Britton et (2017) 25

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ACCOUNTING STANDARDS

• Types of accounting standards with different levels of

details and prescription
o Type 1
 Basic disclosure rules to ‘tell people what you have done’
o Type 2
 Uniformity and consistency in presentation of financial results
o Type 3
 Disclosure of specific matters in certain cases
o Type 4
 Specification of considerable details
Stronger regulation is characterised by more detailed and
less flexible requirements.
Source: UOL Study Guide
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 Session 1: Financial Reporting & Regulation

ACCOUNTING STANDARDS

• Arguments for
o Improve published financial reports
o Supplement company law with fuller, clearer and more
consistent figures
o Foster comparability, which in turn would help analysts and
potential investors compare and evaluate firms
o Force weaker accountants to improve their work
o Provide a defence for accountants in court, and strengthen
resistance to undue presssure
o Enhance credibility to profession
o Provide discipline in preparation of financial statements
Source: UOL Study Guide
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ACCOUNTING STANDARDS

• Arguments against
o Costly and bureaucratic
o Difficulty in standardization due to differences among
industries as well as user needs
 Standards may be suitable for the average firm but not others
o Can lead to inconsistencies in accounting treatment
 Similar items treated differently due to application of different
rules
o Development of accounting standards may be merely
consensus seeking
 Standard setting process may be subject to political pressure

Source: UOL Study Guide

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 Session 1: Financial Reporting & Regulation

ACCOUNTING STANDARDS

• Arguments against
o May lead to reduction in professional judgement
 Emphasis is placed on compliance with and understanding
existing systems rather than on bettering accounting systems
o False sense of security among users
 Standards involve different estimates or even choices
o May result in adverse allocation effects
 Sub-optimal company behaviour purely to ensure that accounting
earnings are not reduced
o Overload of standards or interpretation problems
 Too detailed regulations or rules that are not specific enough

Source: UOL Study Guide

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INTERNATIONAL
ACCOUNTING STANDARDS

• Generally Accepted Accounting Practice (GAAP)

o Rules, from whatever source, that govern accounting
o Different views of GAAP in different countries
o Principles-based vs. rules-based systems
 Principles-based: works within set of defined principles
 Rules-based: regulations for issues set as they arise
• International Accounting Standards Committee (IASC)
formed in 1973
o Accounting standard setting duties assumed by International
Accounting Standards Board (IASB) from April 2001

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

• Objectives of IASB
o To develop, in the public interest, a single set of high quality,
understandable and enforceable global accounting standards
that require high quality, transparent and comparable
information
o To promote the use and rigorous application of those standards
o To bring about convergence of national accounting standards
and IAS and IFRS to high quality solutions

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INTERNATIONAL
ACCOUNTING STANDARDS

• Harmonisation
o Increasing the compatibility of accounting practices by setting
bounds to their degree of variation
o Through the EU-Directives of financial reporting

• Standardisation
o Imposition of a more rigid and narrow set of rules
o Requirement to publish consolidated accounts in compliance
with IAS/IFRS for listed groups for accounting periods on or
after the 1 January 2005

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

• Barriers to harmonisation
o Different purposes of financial reporting in different countries
(e.g. tax assessment vs. investor decision making)
o Different legal systems may prevent development of certain
accounting practices or restrict options available in accounting
treatment
o Different user groups with varying levels of prominence in
different countries
o Different stage of development in financial regulation and
accounting standard setting

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INTERNATIONAL
ACCOUNTING STANDARDS

• Barriers to harmonisation
o Resistance to adopt another country’s standard or accounting
practice due to nationalistic sentiments
o Differing objectives for accounting systems due to cultural
differences
o Unique situations faced by countries
o Lack of strong accountancy bodies required to press for better
standards and greater harmonisation

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

Source: Alexander, Britton et (2017)

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INTERNATIONAL
ACCOUNTING STANDARDS

International Accounting Standards (as of 1 Jan 2021)

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

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

International Accounting Standards (as of 1 Jan 2021)

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

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INTERNATIONAL
ACCOUNTING STANDARDS

International Accounting Standards (as of 1 Jan 2021)

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
* Replaced by IFRS 15 Revenue from Contracts with Customers w.e.f 1 Jan 2018
# Replaced by IFRS 16 Leases w.e.f 1 Jan 2019

@ Replaced by IFRS 9 Financial Instruments w.e.f. 1 Jan 2018

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

International Financial Reporting Standards (as of 1 Jan 2021)

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 Resource
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements

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INTERNATIONAL
ACCOUNTING STANDARDS

International Financial Reporting Standards (as of 1 Jan 2021)

IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IFRS 13 Fair Value Measurement
IFRS 14 Regulatory Deferral Accounts
IFRS 15 Revenue from Contracts with Customers
IFRS 16 Leases
IFRS 17 Insurance Contracts
* Replaced by IFRS 17 Insurance Contracts w.e.f 1 Jan 2023

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

• Main advantages of adopting IFRS/IAS:

o Business can compare its performance against its foreign
competitors as it presents its financial statements on the same
basis
o Cross-border listing is facilitated, making it easier to raise
capital abroad
o Common accounting language for companies with foreign
subsidiaries
o Oversea targets for takeovers and mergers are more easily
assessed

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INTERNATIONAL
ACCOUNTING STANDARDS

• Main disadvantages of adopting IFRS/IAS:

o Costs incurred in implementing IFRS/IAS
o Lower level of detail in various IFRS
o Companies in countries with prescriptive standards may be
uncomfortable with principles-based IFRS (e.g. due to risks of
litigation and ensuing defence mechanisms)

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 Session 1: Financial Reporting & Regulation

INTERNATIONAL
ACCOUNTING STANDARDS

Other benefits of harmonisation of standards

• Investors
o Able to compare financial information of different companies
internationally for decision making
• Government
o Able to control activities of foreign multinational companies
through adoption of common standards
o Easier to calculate tax liability of investors
• Regional economic groups
o Promote trade in the region aided by common accounting
practices

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QUESTIONS

• Discuss the arguments for and against the regulation of

financial reporting. (UOL 2008 ZB Q6)

• What are accounting standards? Discuss the arguments

for and against accounting standards. (UOL 2007 ZA Q6)

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 Session 1: Financial Reporting & Regulation

Q&A
THANK YOU

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