The Regulatory Framework

THE REGULATORY FRAMEWORKTHE REGULATORY FRAMEWORK

LECTURE 2

LEARNING OBJECTIVESLEARNING OBJECTIVES` Identify and evaluate the functions of profit measurement` Appreciate and critically assess the need for and role of

accounting standards` Outline the historical development of accountancy bodies

and standards` Understand and evaluate the concepts and principles

upon which accounting is based

WBS, 2013-14Panagiotis Dontis Charitos2

IN TODAYS LECTUREIN TODAY S LECTURE...` Topics` Ways in which profit figures are useful` Reasons for, and role of accounting standards` Historical evolution of accounting bodies and standards` Accounting concepts and conventions


WHY MEASURING PROFIT IS IMPORTANTWHY MEASURING PROFIT IS IMPORTANT...` Facilitates dividend decisions` Dividends paid out of realised profit, not capital` Depreciation charge ensures capital maintenance` The Companies Act (limit on dividends)` Accumulated profits + Realised profits Accumulated losses

` Indicates amount of cash generated` Profits not necessarily cash` Inventories, receivables, long-term debt...

` The Companies Act` Dividends paid from realised profit` Dividends paid from realised profit` Quiz...

Upward (downward) revaluation of assets = profit (loss) ??


p ( ) p ( )

WHY MEASURING PROFIT IS IMPORTANTWHY MEASURING PROFIT IS IMPORTANT...` Indicates degree of management success` Shareholder value maximisation` Moral hazard (principal-agent) issues?

` F b i f t ` Forms basis for tax purposes` HMRC rules for profit measurement differ from financial

reporting rulesreporting rules` Facilitates investment decisions` Current and prospective ownersp p

` Monitoring by creditors` Indicates economic efficiencyy` Maximisation of ratio of output to input

` Can be used in many different contexts


NEED FOR ACCOUNTING STANDARDSNEED FOR ACCOUNTING STANDARDS` Users depend on financial information` Decision making

` Information should represent true position of firms` Minimisation information asymmetries

` Managers prone to overstating performance/profitsg p g p p` Interaction between regulation and directors` Series of Companies Acts` Series of Companies Acts` Requirements for published information` Not tight accounting rules prone to creative accountingot t g t accou t g u es p o e to c eat ve accou t g` Governments unable to respond to changes`` Need for Accounting StandardsNeed for Accounting Standards


gg

EVOLUTION OF ACCOUNTING STANDARDSEVOLUTION OF ACCOUNTING STANDARDS` Accounting Standards Steering Committee (1969)` Intention Guidance beyond requirements of Companies Acts Additional definitions and rules for measurement and disclosure Aim to reduce variations in accounting practice

` Structure and problem areas` Structure and problem areas Creation of number of professional accountancy bodies 25 Statements of Standard Accounting Practice (SSAPs) Effective in definitions

No consistency - room for alternative treatments

Absence of legal backing / enforcement mechanism Absence of legal backing / enforcement mechanism

Discredited by scandals and creative accounting...Discredited by scandals and creative accounting...


EVOLUTION OF ACCOUNTING STANDARDSEVOLUTION OF ACCOUNTING STANDARDS` Accounting Standards Board (1990)` Intention To provide a tighter reporting framework

` Structure and problem areas` Structure and problem areas Supervised by Financial Reporting Council (FRC) & Financial Reporting

Review Panel (FRRP)Fi i l R i E D f (FRED ) Financial Reporting Exposure Drafts (FREDs)

Consultation Financial Reporting Standards (FRSs) More effective than previous regime More consistency - less room for alternative treatments Audit of statements More legal backing FRRP as enforcement mechanism

British origin different systems elsewhere Globalisation Globalisation need for international accounting standardsneed for international accounting standards


EVOLUTION OF ACCOUNTING STANDARDSEVOLUTION OF ACCOUNTING STANDARDS` Evolution of two main approaches by beginning of 21st century` US Financial Accounting Standards Board (FASB)` International Accounting Standards Board (IASB) Formed in 1973 as International Accounting Standards Committee 41 International Accounting Standards (IASs)

R i d IASB i 2001 Reconstituted as IASB in 2001 Issues International Financial Reporting Standards (IFRSs) Adopted existing IASs Adopted existing IASs Issued 8 IFRSs by 2009


EVOLUTION OF ACCOUNTING STANDARDSEVOLUTION OF ACCOUNTING STANDARDS` Need for convergence` Companies following both approaches

` Memorandum of Understanding (MOU, 2006)` Signed between FASB and IASB` Development of convergence programme` IFRSs increasingly converge with FASBs accounting standards

` Increasing effectiveness of accounting standardsg g` However...` Still room for truly international standardsSt oo o t u y te at o a sta a s


FUNDAMENTAL ACCOUNTING CONCEPTSFUNDAMENTAL ACCOUNTING CONCEPTS

Definition:

The term accounting concepts refers to the e te accou t g co cepts efe s to t e axioms or basic assumptions underlying the fi i l tfinancial accounts


FUNDAMENTAL ACCOUNTING CONCEPTSFUNDAMENTAL ACCOUNTING CONCEPTS` Going concern` Assumes the company will continue to trade for the

foreseeable future and that the fixed assets and stock will be d i th l f t dused in the normal course of trade

` Used to justify showing assets at cost (- depreciation)` A l` Accruals` Revenues and costs recognised as earned or incurred and

matched with one another in the period to which they relate matched with one another in the period to which they relate. Profit measurement based on accruals and matching, not when cash is received or paid` Cost of unsold inventories is treated as expense only when the latter

are sold


FUNDAMENTAL ACCOUNTING CONCEPTSFUNDAMENTAL ACCOUNTING CONCEPTS` Consistency` Consistency in accounting treatment of similar items within

each accounting period and from one period to the next` All vehicles to be depreciated in similar fashion` All vehicles to be depreciated in similar fashion` Not acceptable to change depreciation method from one period to

the next` E bl bilit` Enables comparability

` Prudence` Revenues and profits are only recognised when realised (sale is ` Revenues and profits are only recognised when realised (sale is

made). Expenses and losses are recognised whether amount is known with certainty, or is best estimate

` Ensures that revenues profits and assets (losses and liabilities) not overstated (understated)


FUNDAMENTAL ACCOUNTING CONCEPTSFUNDAMENTAL ACCOUNTING CONCEPTS` Separate Valuation` Value of each item on financial statements should be estimated

independentlyO h ld b ff h` One item should not be offset against another` Fleet of cars should not be valued as a whole, rather each car should

be valued separately and then added togetherbe valued separately and then added together


QUALITATIVE CHARACTERISTICSQUALITATIVE CHARACTERISTICS` British ASB Statement of Principles for Financial Reporting

(1999)(1999)` Identifies four objectives to be met by accounting practice` Relevance` Relevance` Important to users in predicting future or confirming present/past

` Reliability` Transactions are represented faithfully, information is neutral, free from

errors, complete, and estimates are made with caution` Conflict between relevance reliability...

` Comparability` Facilitates cross section comparison (disclosure, consistency)

` Understandability` Understandability` Users with reasonable knowledge in business, economics and accounting

should be able to understand content of financial statements


QUALITATIVE CHARACTERISTICSQUALITATIVE CHARACTERISTICS` Collaboration between FASB and IASB` New conceptual framework emerging` New conceptual framework emerging` Likely to include four principal qualitative objectives

characteristics of accounting informationR l` Relevance

` Faithful representation` Replaces reliability` Measures and descriptions in financial statements should correspond to economic

phenomena they represent` Comparability` U d t d bilit` Understandability

` Subject to constraints` Materiality` Benefits that justify costs` Trade-off between producing better information and respective cost


READING LISTREADING LIST` Core reading` Perks and Leiwy` Chapter 3 sections 3.2 to 3.4

` Further reading` Perks and Leiwy` Chapter 8

` Atrill and McLaney` Ch t 1` Chapter 1


UNTIL NEXT WEEKUNTIL NEXT WEEK...Three candidates are short listed for a job. During the interview j gprocess the chairman asks each the question "what is two and two?"

The mathematician replies..."Four"The statistician replies...Statistically anything between3 999 and 4 0111"3.999 and 4.0111The accountant stands up, shuts the curtains and then approaches the chairman and whispers into his the chairman and whispers into his ears...." What do you want it to be Mr Chairman??"


Documents

The Regulatory Framework