Reducing the Use of Off-Balance Sheet Liabilities - Essay Example

Choose a current international accounting standard(IAS) or international financial reporting standard (IFRS). Briefly summarise its provisions and assess whether the standard can be considered to be "principles-based" or "rules-based", explaining your reasons. 1.0 Introduction The desire to achieve comparability and its over-time counterpart, consistency, is the reason to have reporting standards. Recognition and measurement requirements of accounting standards are to be based on the qualitative characteristics of accounting information laid out in Concepts Statement. Following a series of recent discussion after the collapse of some large companies such as the Enron a recent discussions of the United States (US) financial reporting include implicit or explicit recommendations that the U.S. abandon the current allegedly "rules-based" system in favor of a "principles-based" system, with the implication that some or all of the current difficulties facing U.S. financial reporting would be alleviated or even eliminated by such a shift (Chand 2005). In addition, Section 108 of the Sarbanes-Oxley Act of 2002 instructs the Securities and Exchange Commission (SEC) to conduct a study on the adoption of a principles-based accounting system (Chand 2005). 1.1 IAS 36 International accounting standards (IAS 36) requires companies to test assets for impairment. Basically, the standard requires that tangible assets should be tested for impairment when there is an indication that an asset might be impaired. (Epstein and Jermacowicz, 2007). IAS 36 Impairment of Assets was issued in March 2004. It is applied to goodwill and intangible assets acquired in business combinations after 31 March 2004, and to all other assets for annual periods beginning on or after 31 March 2004. IAS 36 prescribes the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. According to Epstein and Jermacowicz, (2007), IAS 36 applies in accounting for impairment of all assets other than : - Inventories (IAS 2 Inventories); - Assets arising from construction contracts (IAS 11 Construction Contracts); - Deferred tax assets (IAS 12 Income Taxes); - Assets arising from employee benefits (IAS 19 Employee Benefits); - Financial assets within the scope of IAS 39 Financial Instruments: Recognition and Measurement; - Investment property measured at fair value (IAS 40 Investment Property); - Biological assets related to agricultural activity that are measured at fair value less estimated point-of-sale costs (IAS 41 Agriculture); - Deferred acquisition costs and intangible assets, arising from insurance contracts within the scope of IFRS 4 Insurance Contracts; and - Non-current assets (or disposal groups) classified as held for sale in accordance Epstein and Jermacowicz, (2007) further states that, the recoverable amount of an asset is measured whenever there is an indication that the asset may be impaired. At each reporting date, an entity assesses whether there is any indication that an asset may be impaired. However, intangible assets having an indefinite useful life must be tested annually for impairment. The impairment test is required to be applied to a cash generating unit, that is, the smallest group of assets for which the entity has identifiable cash flows. Here the impairment test carried out according to Cairns (2005), If the recoverable amount of an asset is less than the asset's carrying amount the asset is impaired the asset's carrying amount should be reduced to recoverable amount debit expense, credit asset In other words, the carrying amount of an asset or group of assets in the cash generating unit is compared with the fair value or value in use ( calculated as the present value of the cash flows expected to be generated from using the asset). The higher of value in use and fair value is taken and compared with the carrying amount and an impairment loss is recognized if the carrying amount is higher than the higher of fair value and value in use. (Epstein and Jermacowiz, 2007). In other words, using the following example, an assets will be considered impaired if Cost 1,000 Accumulated depreciation 400 Carrying amount 600 Net selling price 200 Value in use 100 Recoverable amount 200 Asset is impaired According to IAS 36, companies are required to determine at each reporting date whether there are conditions that would indicate that impairment may have occurred and further provides a set of indicators of potential impairment some of which include (Epstein and Jermacowiz, 2007: p. 247): Market value declines for specific assets or cash generating units, beyond the declines expected as a function of asset aging and use; Significant changes in the technological, market, economic, or legal environments in which the enterprise operates, or the specific market to which the asset is dedicated; Increase in the market interest rate or other market-oriented rate of return such that increases in the discount rate to be employed in determining the value in use can be anticipated, with a resultant enhanced likelihood that impairments will emerge; Declines in the (publicly-owned) entity's market capitalization suggest that the aggregate carrying value of assets exceeds the perceived value of the enterprise taken as a whole; There is specific evidence of obsolescence or physical damage to an asset or group of assets; There have been significant internal changes to the organization or its operations, such as product discontinuation decisions or restructurings, so that the expected remaining useful life or utility of the asset has seemingly been reduced; and Internal reporting data suggest that the economic performance of the asset or cash generating unit is, or will become, worse than previously anticipated. From the foregoing, we can conclude that impairment of assets has a negative impact on the non-current assets of a listed entity. This is true given that impairment leads to loss recognition and a subsequent reduction in the value of the asset which in turn reduces the total asset base. Impairment of assets also enables the company to show the true value of the company and increases investor's reliability on the financial statements. International accounting standards are developed under the assumption that they are guided by accounting principles. If little value is attached to having the same accounting treatment applied to identified classes of similar items, then preparers of financial reports could reasonably be left to choose the reporting that best suited their own communication strategies. Once it is agreed that comparability is desirable, relevance and reliability assist in deciding which standards to have--that is, what the requirements for recognition, measurement, and disclosure should be (Chand 2005, Duangploy & Gray 2007). To the extent U.S. GAAP is aimed at providing comparable, relevant, and reliable financial reporting, it is principles-based. Off-balance sheet assets and liabilities refer to assets and liabilities that are not disclosed in the balance sheet. These types of assets and liabilities have been found to be damaging given that they enable company management to manipulate investor's beliefs about the contents of financial statements. For example, a company may have an incentive to hold off-balance sheet assets if it wants to understate earnings so as to enable it overstate them in future (conservative accounting). Today, a growing dialogue has developed in recent years about the future of financial reporting and in particular the relevance and complexity of today's reporting model. Large accounting firms have engaged in discussions with stakeholders around the world on a number of issues critical to the long-term strength and stability of the capital markets, including financial reporting. The large firms develop and publish a white paper to use in developing principles-based standards and suggest changes needed on the part of participants in the financial reporting process to support such a system (Chand 2005, Duangploy & Gray 2007). Conclusion To a greater extent one can see that the new accounting standards have helped to reduce the use of off-balance sheet liabilities. This has greatly increased the relevance and reliability of financial statements since users can now better understand, the financial position, performance and cash flows of an entity before making investment decisions. IAS 36 is principle based because it applies both a bottom-up and a top-bottom analysis References Ding Y., Hope O., Jeanjean T. Stolowy H. (2007). Differences between domestic accounting standards and IAS: Measurement, determinants and implications. Journal of Accounting and Public Policy 26, pp. 1-38 Ding Y., Jeanjean T. Stolowy H. Why do national GAAP differ from IAS The role of culture The International Journal of Accounting, vol. 40 pp. 325- 350 KPMG (2006) IFRS 7 for Corporates. International Financial Reporting Standards. www.kpmg.com Delloite Touche Tomatsu (2008). IAS 39 Financial Instruments: Recognition And Measurement http://www.iasplus.com/standard/ias39.htm Ndubizu G. A., Sanchez M. H. (2006). The valuation properties of earnings andnbook value prepared under US GAAP in Chile and IAS in Peru Journal of Accounting and Public Policy 25 (2006) 140-170 Chandra U., Ettredge M. L., Stone M. S. (2006). Enron-Era Disclosure of Off-Balance-Sheet Entities. Accounting Horizons, vol. 3, No. 3, pp. 231-252. Delloitte Touche Tomatsu (2001). Financial Instruments, Applying IAS 32 and IAS 39. Summaries, Guidance and US GAAP Comparisons. Delloite Touche Tomatsu. Hong Kong. Fontes A., Rodrigues L. L, Craig R. (2005). Measuring convergence of National Accounting Standards with International Financial Reporting Standards. Accounting Forum, vol. 29, pp. 415-436 Chand P. (2005). Impetus to the success of harmonization: the case of South Pacific Island nations Critical Perspectives on Accounting, vol. 16 (2005) 209-226 Duangploy O., Gray D. (2007). ''Big Bang'' Accounting Reforms In Japan: Financial Analyst Earnings Forecast Accuracy Declines As The Japanese Government Mandates Japanese Corporations To Adopt International Accounting Standards. Advances in International Accounting, Vol. 20, pp. 179-200 Zeghal D., Mhedhbi K. (2006). An analysis of the factors affecting the adoption of international accounting standards by developing countries . The International Journal of Accounting vol. 41, pp. 373-386 Rodrigues L. L., Craig R. (2007). Assessing international accounting harmonization using Hegelian dialectic, isomorphism and Foucault. Critical Perspectives on Accounting, vol. 18, pp. 739-757 Read More