Comparative Financial Reporting - Essay Example

Supervisor 0 Introduction All companies in the world have a legal requirement to prepare accounts that are in compliance with the law. (McMeeking, 2006). These accounts must be audited by registered auditors to ensure their compliance with applicable laws and accounting standards, as well as ensure that the accounts present fairly the financial performance and position of the companies. (McMeeking, 2006). Only small companies are exempted from statutory audits in some countries e.g., the United Kingdom. Registered auditors are expected to express an opinion on the financial statements on whether they are free from material misstatements. Material misstatements are misstatements that can affect users' decisions on the financial statements of a company. The auditor may either issue an unmodified opinion (when the financial statements are not materially misstated or a modified opinion (when the financial statements are materially misstated). (McMeeking, 2006). This paper examines contemporary issues between International Financial Reporting IFRS and the Generally Accepted Accounting Principles GAAP. 1.1 The IASB / FASB project on revising the conceptual Framework has removed ' substance over form'. (IASB / FASB May 2008, Exposure Draft, Conceptual framework for Financial Reporting ) . The explanation is: BC2.19. The Boards concluded that faithful representation means that financial reporting information represent the substance of an economic phenomenon rather than solely its legal form. To represent legal form that differs from the economic substance of the underlying economic phenomenon could not result in a faithful representation. Accordingly, the proposed framework does not identify substance over form as a component of faithful representation because to do so would be redundant. However, the fair value view assumes that market are relatively perfect and complete and that in such a setting financial reports should satisfy both the interest of passive investors and creditors by stating a current value derived from the current market prices. An alternative view to this doctrine assumes that markets are imperfect and incomplete and that in such a market settings, monitoring requirements of shareholders should be catered for. To conclude therefore, in the words of Whittington (2007), the practical supports of two views is unrealistic as in a realistic market setting; the search for a universal measurement method may be fruitless. According to Whittington (2007), a more appropriate approach to the measurement problem might be to define a clear measurement objective and to select the measurement that best meet the objective. 1. 2.0 Identify and comment on what you regard as the 4 most significant accounting policy differences between IFRS's and US GAAP ' (200 words) International Accounting Standards (IAS/IFRS) are a set of accounting standards promulgated by the International Accounting Standards committee (IASC) and intended to be used as a basis for cross-border capital raising and listing in global financial markets. (Asbaugh, 2001). The main goal of the International set of Accounting Standards is to standardise the financial and accounting method disclosures of firms in different nations. That is, if firms follow the same set of accounting standards, their external financial reports will provide more uniform disclosures and thus investors would make more use of the variables inherent in the financial statements. (Asbaugh, 2001). Also, firms and investors would benefit from financial statements prepared following an international set of accounting standards. (Asbaugh, 2001). In meeting with the above objectives, the European Union issued regulation 1606/2002 of July 19, 2002 requiring that all companies listed in the European Union and European listed companies in other countries to adopt international accounting standards in their Financial statements from 1st January 2005 onwards. The regulation also gave member states the option to or permit the use of IAS and IFRS in the corporate annual accounts. (Haverals, 2007). The Accounting rules in Germany are much oriented towards the protection of the creditor. These rules, which are contained in the German Commercial code (Handelsgesetzbuch, HGB), contrast with those of the generally accepted accounting principles (GAAP) of the United States, which are issued by the Financial Accounting Standards Board (FASB). (Krahnen et al, 2004: 353) Today, the right to protection of creditors over capital market investors (Equity shareholders) is highly questionable and the discussion has been opened about whether other means to achieve creditor protection, such as extended liability of shareholders, might not be more appropriate. (Krahnen et al, 2004: 353) Cash flow statements are required to be presented alongside consolidated financial statements by listed companies in Germany in periods ending after December 31st 1998. However following the joint recommendation of the Schmalenbach-Gesellschaft (SG) and the Hauptfachausschuss (HFA) of the Institut der Wirtschaftspr'fer SG-HFA 1/1995 or following IAS 7 or FAS 95, most major listed companies voluntarily published cash flow statements in 1995. (Leuz et al, 2004). The differences between IFRS and the GAAP are further discussed below. According to IFRS, base value is use on future discounted cash flows; U.S. GAAP uses the undiscounted cash flows to determine if impairment occurred. Goodwill and indefinite intangibles are tested for impairment at the reporting-unit level for U.S. GAAP and at the level of the cash-generating unit for IFRS. Differences also exist in determining if goodwill is impaired. U.S. GAAP requires a two-step method; IFRS use a one-step method. Similar to the treatment of inventory write-downs, U.S. GAAP prohibits the reversal of impairment write-downs; IFRS require recognition of reversals except for goodwil (Haverals, 2007). In addition, two key differences exist in the area of inventory valuation. First, IFRS prohibits the use of the LIFO (Last-in, First-out) inventory valuation method allowed under U.S. GAAP. Second, IFRS requires the reversal of inventory write-downs under certain conditions, whereas reversals are prohibited under U.S.GAAP (Haverals 2007). 3.0 What has been the impact of the Sarbanes-Oxley Act on accounting and auditing in the US' (200 words) The Enron Scandal, the Tyco and the WorldCom case are quite important in that, of late they have not only shaken investor's confidence in the quality and integrity of corporate financial results but portray deficiencies in the accounting standard and governance system that perpetuated the system through which the companies operated (Hensmans, 2003). Enron for example shows how the dual reporting systems and book tax differences enable the misreporting of profits to the capital markets. Tyco exposes how active tax management strategies enable managerial malfeasance and finally, Xerox case indicates how the drive to increase reported earnings engenders tax avoidance activities. Managerial greed and "common sense" replaced Smith concept of prudence in organisation1. In the three cases, the concept of value creation (Corporate value and image) was used as a managerial hide out for managerial earnings manipulation2. The cases emphasize failures of corporate governance, inattentive boards, and ineffective analysts, auditors who neglected their work ethics and principles and excessive use of stock options. Desai (2005) further contends that, the manifestation of the above situations stem mainly from constant change of technological possibilities for characterizing income and exploiting book tax differences. Bush, the then US president passed the Sarbanes-Oxley Act to address the situation and consequently restore confidence into the accounting profession. To strengthen the use and importance of financial results, the Sarbanes Oxley Act of 2002 was adopted to prohibit this. From this dimension, financial results serve as a starting point for the "raise of the eyebrows" of what is actually happening in the company3. Because accounting frauds make the traditional methods of financial analysis ineffective, the Association of Certified Fraud Examiners (ACFE) 2005/2006 fraud reports show that most frauds (40%) are detected by tips. In this regard, ACFE contend that, internal and external audit are ineffective and thus through financial results, ex ante warning signals are set to detect potential fraud for investors and analysts4. Today, section 401 of the Sarbanes-Oxley Act of 2002 requires financial results to disclose all the unconsolidated entities, including the use of special purpose entities. Through this, financial results serve as monitoring speed breaks. Section 402 of the above report went further to stipulate that it is unlawful for an issuer to extend credit to any director or executive officers. By including this in financial results, fraud by auditors, analysts and reviewers of financial statements is reduced and transparency of financial results itself enhanced5. Today, financial results is in the four corners of achieving sustainable growth especially as safeguarding financial stability is now widely recognized as an important part of maintaining macro economic and monetary stability and for achieving sustainable growth. 4How is the influence of the SEC seen in accounting practice of listed companies ' (200 words Recent corporate scandals have highlighted abuses by firms overstating profits to capital markets. Today, it is becoming increasingly common to see financial results presented to capital markets being different from the result presented to the tax authorities6. The issue here is, how could firms be simultaneously be presenting two sets of financial results for different parties' Or why firms or the management should presents a set of accounts different from the true picture of the organisation. Today, the influence of SEC is seen through the different methods used to prepare the income and other statements. Treatment if assets and other deffered items. 5.0 Discuss whether a classification of optimism is appropriate for accounting practice in the US ' (200 words) Under IFRS IAS 40 Investment property mandates that investment property should be recorded at cost but subsequently, reporting entities with investment properties must make a decision as to whether or not to stay with cost and treat the asset as any other property or to adopt the fair value model. The corresponding UK GAAP standard SSAP 19 mandates the same. . (Epstein and Jermacowicz, 2007; Robert, ND). When adopting the fair value model, the company must carry out an annual revaluation of the investment property and any surplus/deficit arising from revaluation is expected to be credited/debited to the income statement for the current period. (Epstein and Jermacowicz, 2007; ). This is unlike the case under the corresponding UK GAAP standard SSAP 19, which mandates that revaluation surpluses/deficits should be credited or debited directly to the revaluation reserve account. Under such a system one can logically state that optimism is unlikely under the current US system. Discuss whether a classification of transparent is appropriate for accounting practice in the US ' (200 words) Standard setting bodies such as the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board set accounting standards that guide companies during the preparation and presentation of financial statements. Publicly traded companies are required to comply with these standards when preparing and presenting their financial statements. For example, companies listed in the EU were required as from 1st January 2005 to prepare accounting standards following International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS). Companies listed in the US are required to prepare financial statements following the US Generally Accepted Accounting Principles (GAAP)7. In addition to standard setting bodies, securities regulators such as the US Securities and Exchange Commission (SEC) prescribes minimum financial information requirements for companies that wish to list securities in the United States8. In addition to preparing financial statements using their national standards, foreign companies listed in the US are required by the SEC to file a separate set of financial statements prepared in accordance with US GAAP. Government Regulation In addition to securities regulation and accounting standard setting, accounting information disclosure is also regulated by the government. In the United Kingdom for example, companies are required to prepare financial statement following the Companies Acts. In addition, tax authorities also regulate the disclosure of information so as to appropriately ascertain the tax liabilities of companies. These three guard for transparency In addition to standard setting bodies, securities regulators such as the US Securities and Exchange Commission (SEC) prescribes minimum financial information requirements for companies that wish to list securities in the United States9. In addition to preparing financial statements using their national standards, foreign companies listed in the US are required by the SEC to file a separate set of financial statements prepared in accordance with US GAAP. Government Regulation In addition to securities regulation and accounting standard setting, accounting information disclosure is also regulated by the government. In the United Kingdom for example, companies are required to prepare financial statement following the Companies Acts. In addition, tax authorities also regulate the disclosure of information so as to appropriately ascertain the tax liabilities of companies. 6.0 US and Adoption of IFRS Although scholars and counselors have long acknowledged through existing literatures a link between US financial principles and the IFRS , little evidence exist to justify how close is the US at adopting the IFRS. However, the aftermath of the Enron collapse has accelerated things. PART C 1. 1. What does the IASB conceptual framework say about "substance over form " ' The existing IASB framework notes that substance over form is a necessary condition of faithful representation. 2.1 What is the stated aim of the Baker and Hayes (2004) in this paper' Their stated aim is to address some of the loopholes in the current accounting regulations and accounting bodies. 3.1What definition of "substance over form" is used by Baker and Hayes' According to Baker & Hayes (2004), when an entity practice the Substance Over Form, it means that the financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events (Form) which underlie them. The researchers caution that, to be able to differentiate Substance over Form, we need to be vigilant, have very good inner knowledge of the company's operation and takes a more investigative in-depth approach so as to seek further evidence or proof. (Baker & Hayes 2004). 4.1How does the attitude of US GAAP to "substance over form " compare with that of IASB ' With the IFRS, investors and creditors would have been provided with a more realistic view of the company's financial position (Baker & Hayes, 2004). IFRS lays a greater emphasis on principles based treatments, as opposed to rules based of the US GAAP. Uniform application of the concept of substance over form would have provided investors and creditors with a more realistic view of the financial position of a company like Enron or the dot com. 5.1 How did Enron use SPEs' Enron group's use of over 3000 Special Purpose Entities (SPEs) structured in such a way as to enable the company to avoid including extensive debt in the consolidated financial statements of the group (Baker &Hayes 2004). 6.1 What was the crucial event in November 2001 that enhanced public concern about Enron and started the rapid slide in share price' Lev (2003) contends that the earnings reported by the company between 1997-2001 were all fabrication and today the actual earnings made by Enron within the period remains a puzzle. Fusaro & Miller (2002) went further to contend that in 2001, Skilling moved from president to CEO and within the same period, the company restructured the special purpose entities known as Raptors to hide US$504millions in losses showing only a US$36.6million credit reserves loss The above episode marked the turning point of Enron, as many commentators start questioning the high price of Enron's shares. 7.1 What question arose over the practice relating to capital stock transaction' Questions of late emphasize the use of technology to manipulate accounting information, The Securities Exchange Commission began an investigation of Enron's off-balance sheet partnerships. The company quickly changed its pension plan preventing employees from selling stock and the shares promulgated to US$1 per share. 8.1 What question arose over the practice relating to revenue recognition' Revenues should only be recognized once they are earned . 9.1 What question arose over the practice relating to equity accounting' All entity to a group should be presented under a consolidated report portraying all equity and debts value. 10.1 What question arose over the practice relating to equity accounting and mark-to-mark accounting ' Why should the two be used' Financial failures highlighted some of the more egregious examples of corporate fraud. But they also brought to mind another concern: aggressive accounting. 11.1 What question arose over the practice relating to footnote disclosure ' Don't you think their smartest people are poring over that footnote disclosure right now' 12 12.What do the authors conclude about the implications of the Enron collapse for US GAAP/ It is worth recalling here that the problem of untrustworthy book profits is the dual of the problem of increased tax avoidance (Desai 2005). The situation is further complicated by the dual nature of corporate profit reporting which to Desai (2005) may be creating a loose, loose situation-that is providing the capital markets with less meaningful profit numbers, lowered corporate tax revenues for government and the allocation of resources to exploitation of the opportunities created by this curious system (Desai 2005). 13What are the implication of Enron case for the future of capitalism' Enron offers a case of earnings manipulation. This is so because in the years before it collapsed, the company was viewed as a "wall street hero" which in real sense it was not. With these avenues still existing within the confines of organization, Desai (2005) contends that, the issue of whether the Enron or Xerox type of fraud, greed, and manipulation is still possible is not debatable. References Asbaugh H. (2001). Non-U.S firms' Accounting Standard Choices. Journal of Accounting and Public Policy. Vol. 20. Pp 129-153. Epstein, B. J., Jermakowicz, E. K. (2007). Interpretation and Application of International Financial Reporting Standards. Wiley and Sons Inc. Haverals J. (2007). IAS/IFRS in Belgium: Quantitative analysis of the impact on the tax burden of companies. Journal of International Accounting, Auditing and Taxation Vol. 16, Pp. 69-89. Robert C, Weetman P and Gordon P (2008) ' International Corporate Reporting : a comparative approach " Fourth Edition . Chapter 11. McMeeking K. (2006). Improving Choice in the UK Audit Market. School of Business and Economics, University of Exeter, Stratham Court, Exeter EX4 4PU. http://www.frc.org.uk/documents/pagemanager/poba/Dr%20Kevin%20McMeeking,%20University%20of%20Exeter.pdf Baker, C.R and Hayes, R. (2004) Reflecting form over substance: the case of Enron Corp. Critical Perspectives on accounting , 15: 767-785.IFRS and US GAAP - A pocket comparison 2008. Desai, A. M. (2005). The Degradation of Reported Corporate Profits. Journal of Economic Perspectives-Vol. 19, N04, Pp.171-192 Hensmans, M. (2003). The Territorialisation of Common Sense. Organisation Speaking out Vo.10(3):561-564, Sage, London Read More