 The Regulatory Framework For Financial Reporting

In the preceding discussion, we have refered to many parties with an active role within
the financial reporting environment. They include the prepares of the financial reports
(company directors and their executives and managers) and a company’s external
auditors as well as the rule makers, such as private sector groups, strock exchanges and
governments and their agencies. The activities of these parties will be influenced by the
environtment in which financial reporting takes place; that is, its legal, economic political
and social setting. The specific environmental features of the financial reporting
environment make up what can be called the regulatory framework of financial reporting.
While regulatory frameworks vary between countries, they often have common elements.
We outline these elements below to provide an overview of the regulatory framework for
financial reporting ( that is, a performa regulatory framework) and to demonstrate how
the elements of the regulatory framework influence the output of the financial reporting
process – the financial statements. The elements of the regulatory framework which we
discuss are:
- Statutory requirements
- Corporate governance
- Auditors and eversight
- Independent enforcement bodies

1. Statutory requirements
The key partisispants in the production of financial reports are corporate directors
(and their executives and managers) and independent auditors. Else where in this
book, we have explained that there are many motivations for managers to voluntarily
provide financial information and to have that information independently verified
through the audit process. Now we turn to the role of statutory requirements as an
incentive to produce financial statements and have them audited. In many countries
company law mandates that directors provide audited accounts. Thus a primary
influence on directors and auditor is the need to fulfil statutory reporting
requirements, as contained in company law. One the one hand, company law will
likely mandate basic requirements relating to which reports are to be prepared and
 their frequency of preparation. But it may also include particular requirements
relating to the information to be included; for example, in Australia companies must
disclose information about their environmental performance. In some jurisdictions,
notably the united states, reporting requirements are derived predominantly from
securities market law rather than company law.
Additional financial reporting requirements are derived from specific accounting
standards and in many jurisdictions these standards have the force of law. For
example, listed companies in the European union that prepare consolildated financial
statementas are required by law to use IASB standards adopted by the EU. In
Australia, company law requires all reporting entitites to follow legally endorsed
IASB-based accounting standards. Taxation law is another statutory influence on
financial accounting in many countries, notably those following a French or german
accounting tradition. In these countries, for single entity reporting, the financial
accounting rules are the same as tax rules. Company law, in turn, forms part of a
wider legal system, which is likely to include ways of monitoring compliance with
statutory requierments. For example, the FEE reports that many European countries
have a body responsible for checking lodgement of accounts. In addition, the judicial
system provides sanctions and penalties that promote compliance with company law.

2. Corporate governance
Another important element within a country’s regulatory framework is the system of
corporate governance. Davis takes a broad view of corporate governance and states
that it refers to the structures, processes and institutions within and around
organizations that allocate power and resource control among participants. Some
corporate governance practice are derived from laws which require directors to caary
out specific actions in relation to the management for their companies. For example,
requirements to hold meetings with shareholders and to disclose matters of interest
such as directors remuneration and related party transactions are basic corporate
governance matters which may be covered by company law.
However, a regulatory framework may contain additional corporate governance
guidance and rules, arising from both private sector voluntary recommendations and
 stock exchange listing rules. Corporate governance quidance may take the form of
voluntary best practice recommendations, which encourage directors to adopt
appropriate governance mechanisms, to best suit the situation of their individual
company. Both supranational and national bodies have produced corporate
governance recommendations. The international federation of accountants (IFAC)
guidelines are an example of the former and corporate governance codes issued in the
united kingdom and Australia are examples of the latter. Governance requirements
relating to financial reporting can be enforced by the stock exchanges or the
government body responsible for enforcement of financial reporting requirements.
For example, in the united kingdom and Australia, the respective stock exchanges
recommend compliance with the corporate governance codes and require companies
not in compliance to provide wxplanations of the reasons for non compliance, the so
called ‘if not, why not’ rule. EU directives on corporate governance can be enforced
through member states legal systems.

3. Auditors and oversight

In many countries auditors perform a vitally important function in providing
assurance about the quality of information provided by companies in their financial
statements. It is common for the auditing profession to be regulated in some way. The
most basic form of regulation of the profession is limiting of membership to person
with particular qualifications and experience and requiring registration to practice.
Other forms of regulation involve requiring membership of a professional body and
commitment to an ethical code of conduct. Professional bodies may also sanction
members in breach of their rules.
Many of these forms of regulation are self imposed because a profession may
agree to follow a body of rules to maintain its privileged position and to protect its
right to practice as a profession. For example, private sector self regulation of the
accounting profession is an early form of auditor oversight. In the past, professional
bodies have taken their role of oeversight of the profession seriously, devoting
considerable resources to developing standards for professional conduct at a national
and international level. Many national bodies representing auditors have voluntarily
 adopted international standards of auditing (ISA) as an indication of their
commitment to providing a high quality service and demonstrating behavior
appropriate to members of a profession.
Self regulation of the auditing profession has been widely observed, but there are
some notable examples where regulation was form early times the responsibility of
state authorities. For example, in france and Italy regulation of auditors was the
responsibility of their repective independent enforcement bodies (the securities
market regulators……). In the case of the AMF and its predecessor organitation
commission des operations de bourse (COB), the regulator works closely with the
compagnie nationale des commisssares aux comptes or CNCC, the body representing
the auditing profession in the process of accying out oversight of auditors activities.
The location of responsibility for auditor oversight with a statutory body, rather
than alloawing self regulation, provides (at least in theory) for more independent
regulation. The coice of a statutory regulator rather than self regulation may reflect
economic or political differences in approaches to management of capital markets.
For example, until 2005 the united kingdom had a longstanding tradition of self
regulation of auditors, consistent with a cultural position of minimizing intervation in
the operation of the capital market. Statutory regulation of auditors is consistent with
a more centralized interventionist approach to regulation of business observed in
france and Italy. In recent years, many countries have introduced statutory bodies
responsible for auditor oversight, as discussed in the final section of this chapter.

4. Independent enforcement bodies

A study by the FEE includes an independent enforcement body as part of the overall
system for enforcement of financial reporting requirements. The role of such a body
in the regulation of financial reporting is to promote compliance with the regulations
governing the production of financial statements, which are contained in law, and
accounting standards. An independent enforcement body is an extension of
lodgement supervision, a basic part of the regulatory framework. While many
countries have a body responsible for lodgement supervision, setting up an
independent enforcement body is a more recent event, linked to the adoption of IFRS
in 2005. Because of the importance of comprehensive and consistent application of
IFRS in achieving the goals of IFRS adoption, each EU member state was equired to
set up an independent enforcement body. The committee of European securities
regulators (CESR) reposted that by 2006, 20 of the 27 EU member states had set up
an enforcement mechanism that met, at least in part, the requirements laid down by
CESR standards for enforcement.
A securities market regulator is the most commonly observed form gor an
independent enforcement body. Examples include the AMF in france, the consob in
Italy, (financial market authority) in the Netherlands, the securities exchange
commission in the united states and ASIC in Australia. Independent enforcement
bodies may have extensive duties and powers in relation to the regulation of securities
markets, which extend far beyond the monitoring of financial reporting. Nevertheless,
such bodies can be very active in enforcing financial reporting requirements
contained in law and accounting standards. The SEC is a notable example of an active
market regulator, which is involved in setting accounting requirements (either directly
or through a delegated committee, FASB), providing interpretation advice and taking
legal action against firms for non compliance. Theory in action 3.3. explores the role
of both the FASB and the SEC in relation to the issue of backdating of stock options
in the united states. We consider the extent to which FASB and/or the SEC can be
considered responsible when there is non compliance with an accounting standard.