AC200

Accounting Theory and Practice

Week 1:
Financial reporting and the
regulatory framework
 Session outline
• Introducing AC200
• Closing our expectations gap…?
• Brief recap of the role of financial reporting
• Regulating accounting
• Accounting and financial markets
• Accounting beyond ‘numbers’ – employee,
environment, social, governance [EESG]
matters (CSR and sustainability)
 Introducing AC200
• Course outline and reading list

• Assessment information document

• Group allocation (TBC by week 3)

 AC200: My expectations
My expectations of you:
- attend all seminars
- come to seminars on-time and prepared
- bring with you an open and critical mind
regarding accounting and financial reporting
- engage with the course materials, your peers
and teachers
- Learn and work together
AC200: What can you expect from me?
You can expect me to:
- help you achieve the aims and objectives of the course
- assist you in learning the key knowledge and skills
- be available for your questions during ASk hours or other
convenient meeting time
- respond to your emails as soon as I can (will be slower on
Mondays, Tuesdays and Wednesdays in the MT)
- make accounting and financial reporting interesting (let
me know if I failed, and we can work on this together!)
- Anymore?
 Accounting
• Count: measure and quantify

• Account: acknowledge, identify and describe

the existences of events during the economic
cycle of an organisation

• Accountable: to explain what one has done

with resources one was entrusted with and
take responsibility for the consequences
Why is financial accounting (FA) important?

• Why should you invest valuable time to learn

about the principles of financial accounting?
• Why should one be concerned with the
quality of information provided by an entity?
Answer:
• Accounting produces a social good:
____________________
• It is important to ensure i__________
d__________ m_________
 Understanding FA
• Financial accounting principles provide the
_________________ for the conveyance of financial
information about organisations.
• Entities/companies prepare __________ as a means
of accounting for and reporting of their performance.
• Accounts – or financial statements – are usually
prepared by _______________.
• Who are the target audience?
– The mainstream view is those who fund the company
– A less mainstream but increasingly popular view holds that
anyone affected by the firm’s activity
 Other uses of FA information
• Input to valuation models
– IRR and NPV models, option valuation models
– Economic income models
• Making earnings/forecasting predictions
– Financial modelling
– P/E Multiples
• Performance measurement/bonus
payments
• Managers to evaluate market competitions
 FA and financial reporting (FR) as a
communication function
• Owners ≠ managers (or owner-manager can own the firm
with other people)

Owners Managers

Actions
Group activity: Flows of FR
 Financial accounting & reporting
• Financial accounting is:
– the process of collecting, measuring and recording
financial information to produce financial statements.
• Financial statements vs. annual report

• Financial reporting is:

– the process of analysing and ____________________
included in the financial statements (e.g., about a
firm’s profitability) to relevant stakeholders.
• Financial accounting & reporting is a tool of
____________, and is accounting for
____________decision makers.
 Regulating financial reporting
• In preparing a set of financial statements,
certain conventions / principles / rules / formats
are followed.
• Why?
_______________________________________
_______________________________________
• These principles, rules and regulations
collectively are commonly referred to as
________________________.
 Regulatory framework
• In the UK, company law (since 18th century):
– The Royal Exchange and London Assurance
Corporation Act 1719,
– The Joint Stock Companies Act 1844,
– today: The Companies Act 2006 (>760 pages)
• Accounting conventions/principles (also the
“generally accepted accounting practice” (GAAP)
and Conceptual Framework)
• Modern financial accounting/reporting standards
(since 1970s)
• Stock exchange listing requirements (public listed
entities)
 Group activity
Visit the ‘Companies Act 2006’ website and
answer the following questions:
a) Who are the members of a company?
b) Does a company need to have a director?
c) Who has the duty to prepare individual
company and/or group accounts?
d) What is the meaning of ‘true and fair’?
e) What are the information needed to be
included in individual company and/or group
consolidated accounts?
 Accounting principles and standards
• Accounting principles (covered in AC100/AC102)
plays a role in ensuring the quality of financial
accounting and reporting processes, but general in
nature and leave room for interpretations.
• To create comparability within a country: local
rules/standards were developed (local GAAP).
• GAAP and ‘standards’ outlines and prescribes
– how a transaction should be presented
– how items are measured
– what needs to be included
– what could be omitted
• Part of the function of the accounts preparer and
auditor is to ensure that these standards are
adhered to by public entities/companies.
 UK: sources of authority

Set by the
Financial
Reporting
Approved & Council (FRC)
required by or going to be
the Audit,
FRC/going Reporting and
to be ARGA Governance
Authority
(ARGA)
 ‘Global’ financial reporting rules
• Main accounting ideas and concepts are the same, e.g., profit,
revenue, assets, liabilities, equity, BUT
• why many companies’ accounts will have different ‘numbers’ if
they were being prepared using a different set of accounting
rules/standards/principles compared to their required
rules/standards?
______________________________________________________________
______________________________________________________________
______________________________________________________________
______________________________________________________________
• Is this a problem?
______________________________________________________________
______________________________________________________________
______________________________________________________________
______________________________________________________________
 ‘Global’ financial reporting rules
• The __________________________________________
today prepares International Financial Reporting
Standards (IFRSs) and amend IASs.
• Since ______, all EU countries adopted IASB standards.
• In many countries, IASB standards are adopted and used
for public listed firms but not for private firms.
– Generally, private firms have a choice: to use IFRSs or to use
local standards (local GAAP)
– In the UK, following Brexit (from 1 January 2021), listed
companies which previously required to apply IFRSs endorsed
by the EU in their consolidated financial statements will need
to apply the ‘UK-adopted international accounting standards’
endorsed by the UK Endorsement Board (UKEB) or a choice for
other and private firms to apply UK GAAP.
 Group activity
Visit the IFRS Foundation/IASB website and
answer the following questions:
a) How many IFRSs/IASs have now been issued?
b) What is the difference between IASs and
IFRSs?
c) How many jurisdictions have adopted IFRSs
where IFRSs are required for local listed
companies?
d) What is the aim of the IASB?
e) Why IFRS Foundation/IASB promotes a set of
common accounting standards?
 ‘Global’ financial reporting rules
• Today, 144 jurisdictions use IFRSs, including the UK, the EU
and many Asian and African countries but NOT the USA
(but USA is allowing foreign companies listed in the USA to
use IFRSs).
– There are some complexities with regards to the use of
international standards – for the purposes of this course, we will
follow IFRSs/IASs.
• The IASB does not have the power to enforce accounting
standards, this is left to local authorities, such as:
– Stock exchange (for listed companies)
– Company registrars
– National governments (via Company Law or similar acts)
– Transnational bodies (e.g. EU)
You can check if a country uses IFRS on
http://www.iasplus.com/en/resources/ifrs-topics/use-of-ifrs
 Regulating financial reporting
What happens if a ‘company’:
- makes a financial reporting mistake?
- commits a financial accounting fraud?
- bends the rules or stretch the rules to a
maximum?
Joining the long list of world large accounting scandals:
Wirecard AG
• Revealed in January 2019 by FT (read more here).
• Accounting manipulations dated since 2008 (read more
here).
• Dubbed the ‘Enron of Germany’.
• Growth of intangible assets “customer
relationship”/goodwill, but these were treated as tangible
assets.
• €1.9 billion of cash balances were missing.
• Regulator – the German BaFin, and group accounts are
prepared using IFRSs… Others in different parts of the
world?
• Auditors – EY since 2008 and provided unqualified
opinions ever since, except 2019.
 Joining the long list of world accounting scandals:
Luckin Coffee
• Revealed in April 2020 (read more here).
• Overstatement of sales and transactions were fabricated.
• 2.2 billion yuan (£250m/$310m) of fabricated sales
transactions, which approx. to 40% of its estimated
annual revenues.
• Listed in Nasdaq since 2019 but Nasdaq to delist Luckin in
May 2020 following the revelation of the accounting
scandal.
• Regulators – the Chinese regulators (Ministry of Finance,
the State Administration of Market Regulation) and the
US regulators (SEC and Nasdaq Exchange)
• Auditors – EY since Luckin was founded in 2017. EY says
‘it first found accounting issues in Luckin”
 One of the largest UK corporate scandals:
Carillion plc
• Revealed in January 2018.
• Britain’s 2nd biggest construction company.
• Three profit warnings since July 2017.
• Internal board minutes show the board were
aware of concerns about “aggressive accounting”
methods on revenue recognition (i.e. stretching
what is reasonably allowed by accounting
standards to recognise revenue upfront).
• Growing net debt and pension deficit
 Findings of BEIS and WP Committees (1)
• Board of directors are both responsible and
culpable of Carillion’s failures.
• Internal and external checks and balances
system failed (House of Commons, 2018:4):
– Accounts “were systematically manipulated to
make optimistic assessments of revenue, in
defiance of internal controls”.
– “In failing to exercise professional scepticism
towards Carillion’s accounting judgements over
the course of its tenure as Carilion’s auditor,
KPMG was complicit in them”.
House of Commons (2018) Business, Energy and Industrial Strategy and
Work and Pensions Committees: Carillion, 16 May, HC 769.
Findings of BEIS and WP Committees (2)
– Carillion’s “shareholders suffered from an absence
of reliable information and were ill-equipped to
influence board decision-making”.
– “The key regulators, the Financial Reporting
Council (FRC) and The Pensions Regulator (TPR),
were united in their feebleness and timidity. The
FRC identified concerns in the Carillion accounts in
2015 but failed to follow them up. TPR threatened
on seven occasions to use a power to enforce
pension contributions that it has never used.
These were empty threats; the Carillion directors
knew it and got their way”.
House of Commons (2018) Business, Energy and Industrial Strategy and
Work and Pensions Committees: Carillion, 16 May, HC 769.
 Group activity
Carillion: summary of key issues
Another one of the biggest accounting
scandals: Tesco plc
• Revealed in September 2014
• Britain’s biggest retailer had overstated its
profits by £263m by “accelerated recognition
of commercial income and delayed accrual of
costs” (The Guardian, 22 September 2014).
• What do you understand by the above
highlighted phrase? Will learning more about
accounting helps?
 Fraud investigation (Theft Act & Fraud Act)
• On 9 September 2016, the Serious Fraud Office
(SFO) has charged three former senior Tesco
executives in a fraud and false accounting case that
has roiled the UK’s biggest retailer since it revealed a
£263m hole in its accounts in 2014.
• The trio — Carl Rogberg, the former finance director
for Tesco UK, Christopher Bush, the ex-UK managing
director, and John Scouler, who was UK commercial
director – were cleared over fraud and false
accounting and the case brought by SFO was
dismissed (Wood and Butler, The Guardian, 23
January 2019).
 Accounting and the 2007-2008
banking crisis
• A subject of heated debate during the banking crisis
is the role of accounting rules in causing the financial
meltdown:
– Financial instruments, including securitised loans from
mortgages of high-risk homeowners, were valued at ‘fair
value’, i.e., value the security could fetch in the open
market
– As borrowers defaulted, the securities lost value which lead
to its ‘fair value’ losing value, which in turn made the
financial assets of banks worthless
• Opinions are still divided on this: was it or was it not
accounting’s fault?
 Group activity

To what extent do you believe that the existing

accounting regulations and standards are
capable of dealing with accounting errors,
manipulations and fraud? Discuss.
 Approach to answer question
• Introduction: what are the existing accounting
regulations and standards?
• Discussions:
– Arguments for (with relevant evidence and
examples)
– Arguments against (with relevant evidence and
examples)
• Conclusion – what is your “stand”?
 Accounting and financial markets
• Financial reporting and stock prices, markets
and corporate value
– Accounting numbers provide information about
firm performance and potential earnings.
– Banks, financial analysts and other investors use
financial reporting to assess firm performance,
which then assists in making informed decision.
– Research shows that markets react to accounting
information released by firms.
• Good news vs bad news
 Self-study/study group activity
Identify two companies where their shares are
affected by their recent announcement, and
describe the announcement:
• Good news:

• Bad news:
 Accounting beyond ‘numbers’
• UK Companies Act 2006, Chapter 2 General duties of
directors, section 172 “Duty to promote the success of the
company”:
– Employees, suppliers, customers, community, environment, high
standard of business conduct.
• Sustainability reporting: environmental, social and
governance (ESG) impact disclosures/reports
• EU Non-financial reporting Directive 2014/95/EU Section (6)
• Integrated reporting: financial, environmental, social and
governance reporting
• Sustainability standards/frameworks? A number of voluntary
frameworks exists (e.g. Global Reporting Initiative (GRI)
Standards (‘global standards for sustainability reporting’,
Sustainability Accounting Standards Board (SASB) Standards)
• IFRS Foundation was in consultation to set up International
Sustainability Standards Board (ISSB) – to announce in
November 2021.
 Things to think about
• Accounting does not have a theoretical basis
until much later; instead, its practices are
derived from how things are normally done.
• Accounting is not an exact science – there are
many answers to a single question or problem,
and one can still be correct on all counts…
Some other questions to think about??
• To what extent do you believe that financial
statements have lost their values and relevance?
• To what extent do you believe that Carillion’s and
Tesco’s directors have fulfilled their duties?
• To what extent do you believe that EESG factors
have no economic consequences to a company and
society?
• To what extent do you believe that an international
regulatory framework on sustainability reporting
will benefit investors, creditors, employees,
community, and the environment?
 Summary
• Financial accounting vs. reporting
• Financial accountability vs. social responsibility
• Do we need financial accounting? If yes, why?
• Do we need financial accounting/reporting
rules? If so, why?
– Businesses/entities/organisations are getting very
complex and financial accounting too becomes
dynamic and complex.
• Similarly, do we need non-financial
accounting/reporting rules? If so, why?