Week 2: Regulation, Standard setting and the effects of International financial reporting standards

(IFRS)

Accounting Standard Setting

Arguments for anti regulation

- Private based economic incentives: The argument is that all parties are self interested and
that if they do not provide financial information capital will be hard to attract and be more
expensive as such they will provide efficient financial information
- Market for managers: a managers value is measured by financial performance as such
oinformation is produced voluntarily
- Market for takeover: if a firm underperforms a takeover bid will occur and the management
team will be dispensed of
- Market for lemons: If a company provides no information then the market will penalise you
assuming that the market will think youre a lemon.

Pro Regulation perspective

- Accounting information is a public or free good, demand does not automatically produce
enough information
- In the perspective of free riders demand and supply would undersupply information

Theories of why standards are introduced

- Public interest theory

o Regulators are motivated if social benefits outweigh social costs
o Assumes government is a unbiased voice of the people
- Capture theory
o Regulators advance interests of dominant groups
o Is the industry that strong
- Private interest theory
o Groups will form to protect particular economic interests.
o No notion of public interest at all
o The regulator itself may be seen to be a self-interested group in regards to re
election

Why is accounting regulated?

- Stops any company from hiding true financial performance of the entity
- Forces entity to show true financial position giving greater investor confidence promoting an
efficient allocation of capital
- Regulation protects the public from investing in ventures that are undertaking fraudulent
activity/financial reporting
- I would take a pro-regulation standpoint as without efficient regulation companies for profit
motive is too strong and this would lead to a distortion in information, leading to inefficient
information being provided that is bad for financial decision making.

Public interest theory of regulation:

- States that regulation is suppliec in response to demand from the public for the correction of
inefficient or inequitable market practices
 - Regulation is initially put in to benefit society as a whole, rather than particular vested
interests
- Regulatory body is considered a netural arbiter

In the capture theory of regulation it is assumed that the regulator has been ‘captured’ by dominant
groups ie the industry is that strong. Due to this the regulator advances the interests of these
dominant groups. The organisations that the regulator is there to regulate will come to control the
regulator

What assumptions are made about the regulator in the economic (private) interest theory of
regulation?

- There will be groups with different economic interests that will come into conflict and lobby
the regulator in different ways ie consumers could lobby for price protection where
producers could lobby for tariff protection

International Financial Reporting Standards (IFRS)

Harmonisation vs standardisation

- Harmonisation is bringing standards closer together.

- Standardization is bringing the standards together, making them the same

Standardisation

- Makes companies operating in more that one setting only have to produce one set of reports
- Benefits of standardisation are hard to quantify as they have not occurred yet, the benefits
can only be looked upon retrospectively and is retrospection this is still hard to quantify
- Australia decided to harmonise and standardise to IFRS in the 2000’s
- The US has not yet decided to standardise to IFRS
- Amendments are made at local levels to IFRS standards hence not 100% uniform

International application problems

- Problems with standardising practice

- This is due to differences in accounting requiring from societal, cultural, financing, owning
structure and religious values

The key points

- There are many explanations for international differences in accounting practices

- There are global issues with IFRS
- We currently do have an approach to using IFRS in Australia
- International application of IFRS does not necessarily mean that they will be applied
uniformly.

Has the adoption of standardisation to IFRS in Australia as of 2005 allowed for easier investment
into Australia?

This is a difficult question to answer as there is no scenario where Australia did not do this however
the decision to standardise to IFRS is Australia likely had a number of benefits for foreign investors.
 - It made it easier for foreign investors to evaluate Australian companies financial performance
from their financial reporting compared to a global companies as the information is directly
comparable.
- The direct comparability to foreign companies makes it easier for investors to allocate capital
efficiently to well performing companies, hence increasing the amount of investment
- The adoption of IFRS likely increased investor confidence in Australian companies as well as it
increases the reputability of their financial reporting
- The international orgnaisation of security commissions (IOSCO) restricts companies listing on
foreign exchanges unless they compy with IFRS hence this would limit Australian companies
if we did not comply.

Why has the united states delayed from adopting the IFRS?

- The US regulatory and legal system is different from those of other countries, which has
made it difficult to adopt
- IFRS is a principles based accounting system
- US is a rules based system in GAAP
- The Public companies in the US seem reluctant to deviate from their sophisticated GAAP
model that they have developed and implemented
- There are concerns that IFRS is not compatible with the US tax and legal systems
- Implementing it would be costly
- The US is a dominant economy and will get foreign investment regardless
- The IASB seems to be funded and relies upon the big 4 accounting firms as such there are
concerns that this organisation could become captured by these firms
- There is a lack of enforcing IFRS is countries said to be adopting IFRS
- There have been changes to IFRS made at local levels not making it truly uniform.

What are the main differences between rules based and principles based accounting

I would say some key differences between rules based and principles based accounting are:

- Focus: Rules based accounting focuses on specific rules and guidelines, principles based
accounting focuses on broader accounting principles and concepts
- Flexibility: Rules based accounting is more rigid allowing for less judgement in accounting
transactions, principles based accounting is more flexible allowing for more interpretation
and professional judgement
- Complexity: Rules based accounting are much more specific and have detailed guidance
hence they are more complex than principles based accounting which can require more
professional judgement’
- Transparency: rules based accounting can be more transparent as the way in which financial
information must be presented is more rigid, this may better reflect the substance of
transactions being presented. There is less room for manipulation in rules based accounting

What are some advantages of adopting accounting standards set by the IASB?

- Increased comparability for the financial information to international companies

- Increased credibility for the companies in that country as they must adhere to an
international standard that is thought of highly
- It can reduce reporting costs for companies operating in more than one country
 - It can improve access to capital as investor confidence is improved by adopting the standards
and it allows foreign investors access to information that is more comparable, transparent
and credible.

Limitations of the global adoption of IFRS?

- Cultural and political differences: Accounting standards are shaped by the legal, economic
and political environments in which they are formed a global standard is not shaped by this
hence is may not suit all countries
- Enforcement: the IASB is essentially a toothless tiger trusting individual countries to enforce
the standards if they do not wish to do this or have a weak regulatory system then this will
not occur.
- As IFRS is a principles based approach is relies on interpretation and application of it rather
than specific rules. This can lead to vast differences in how the standards are applied
resulting in significant inconsistencies in financial reporting
- There is a limited focus on non-financial information in the IFRS hence this reporting may not
fully capture the companies non-financial assets or if it will be a stable company long term
due to its environmental impact.