Financial Statements for External Users and How These Are Regulated in the UK - Coursework Example

?Explain why listed companies produce financial ments for external users and how these are regulated in the UK. Over the years, the preparation and the issuance of financial statements have become important processes for many companies around the world. In general, these companies issue financial statements to “provide information that allow users to reach better decisions than they would without it” (Carmichael, Whittington and Graham, 2007). There are various users who derive much needed information from these financial statements: the internal users, such as the managers, the employees, the directors and the stockholders, and the external users, such as the creditors, suppliers, customers and potential investors. According to Tracy, J. (2009), these users are interested in “four basic financial aspects of a business”. These four are the “sales revenue and profit or loss performance”, the “financial condition...in particular the solvency prospects of the company, the capital issued by the company and “any other claims that directly or indirectly participate in the profit of the business” and the sources and uses of the company’s cash flows (Tracy, 2009). Financial statements are especially critical for listed or public companies. These are the companies that are in the centre of the capital market of any country. These capital markets are the source of capital resources, which are needed by any company, in particular, and any economy, in general, to efficiently produce goods and services for the consumption of the public. Thus, the capital market should be effective in order to produce sufficient capital resources. In order to be effective; the participants (i.e., investors) of the capital market must be able to arrive at good investment decisions and must be able to obtain “useful information” from which they can base these good decisions. Financial statements that are accurate and complete are critical sources of this “useful information” (Carmichael, Whittington and Graham, 2007). Thus, part of the requirements for listed companies is to produce accurate, complete and timely financial statements. The United Kingdom’s London Stock Exchange has “the largest equity market in Europe” (Chapman, 2011). Considering its stature, compliance with the reporting and other requirements by the companies listed in this market is of primary importance. Recognising this, the various regulatory bodies (both in UK and in Europe) had emphasized the importance of issuing complete, timely and accurate financial statements by its listed companies. Various rules and regulations have been established to regulate the preparation of these listed companies’ financial statements. Some of these regulations provide general rules and guidelines in the preparation of the financial statements while others are more concerned with ensuring compliance to these rules and guidelines. One such regulation deals with the accounting principles to be utilised by the listed company in the preparation of its financial statement. The most recent regulation that was established for the required accounting principles was the 2002 regulation issued by the European Union (EU). The EU was established “to foster economic cooperation” and had “evolved into an organisation spanning all areas, from development aid to environmental policy” (EU). It helped established common rules and policies for its country members. As a member of the EU, the UK needs to comply with these rules and policies. One such policy had a direct impact on the financial statement reporting process of listed companies and this is the Regulation (EC) No 1606/2002. In this regulation, the EU specifically stated that it aims to contribute to the “efficient and cost – effective functioning of the capital market” and to protect the investors and maintain confidence in the financial markets. To retain the competitiveness of EU’s capital market, it recognises the need to converge the accounting standards used in the preparation of the financial statements. Consequently, it required public companies to prepare financial statements in accordance with the International Accounting Standards on or before 2005. Another regulation, the Companies Act 2006 (the Act), established the general requirements for the issuance of financial statements or “accounts”. Section 394 requires the directors of the companies to “prepare accounts for the company for each of its financial years”. Section 396 lays down the requirements for the composition of individual accounts, while Section 404 lists the composition of group accounts. Section 442.2.b of the Act requires a public company to issue financial statements “six months after” its financial year – end. Listed companies in the UK are required to follow the general rules and guidelines in the preparation of the financial statements as provided for by the EU and the Act. On the other hand, regulatory bodies have been established to ensure the listed companies’ compliance with these rules and guidelines. One such regulator is the Financial Reporting Council or FRC. According to its website, the FRC is “UK’s independent regulator responsible for promoting high quality governance and reporting to foster investment.” It sets, monitors and enforces accounting standards and operates “an independent investigation and discipline scheme for public interest cases” (Gee, 2006). The FRC acts not only as a governing body, it also has jurisdiction over the Accounting Standards Board or ASB, which “develops and issues the Financial Reporting Standards” (Gee, 2006). The EU, the Act and the FRC are more general in nature, that is, they regulate or they provide regulations for the preparation of the financial statements of both listed and private companies. Listed companies, by virtue of the fact that they issue securities that are traded in the stock exchange or financial market, are also regulated by the UK Listing Authority (UKLA), which is one of the roles of the Financial Services Authority (FSA). In this aspect, the FSA is “a securities regulator, focused on the companies which issue the securities traded in the financial market” (FSA, 2011). It has “the authority in the UK for the listing of company shares and other securities for trading on public stock exchanges” (Chapman, 2011). The FSA established the Listing Rules, which contain, among others, the requirements for financial reporting by companies that are either already listed in the London Stock Exchange or are in the process of offering their securities to the public. The UKLA “currently has the power to either suspend or cancel a listing” (Chapman, 2011). In summary, listed companies are required to produce financial statements for external users because these financial statements provide information that are useful to these users in order for the latter to make good investment decisions. This is crucial for ensuring a steady supply or movement of capital resources and maintaining an efficient capital market. In the UK, these listed companies, and their financial statements, are regulated by bodies that establish the required accounting principles for the preparation of the financial statements such as the EU and the ASB. They are also regulated by the relevant provisions of the Companies Act 2006. They are also regulated by the FRC, which ensures that they maintain high quality corporate governance and reporting structures, and the FSA, which is the body directly charged to regulate the companies listed in the London Stock Exchange. The International Convergence Project is considered to be absolutely necessary in this age of globalisation. Discuss. During the last two decades, the world has seen the rising trend of globalisation. With the advances in information technology and the resulting improvements in communication, the costs of transactions have been reduced and increases in economic scales have been achieved (Godfrey and Chalmers, 2007). With this, companies “have grown, not only in size, but also in geographic dispersion” (Godfrey and Chalmers, 2007). As Hammermeister and Zimmerman (2010) pointed out, “globalisation has changed the corporate environment in many ways: corporations are now physically operating around the world in widely extended networks”. They can raise money from other markets and they can trade their stock and other securities in stock exchanges around the world. With the globalisation of business and companies around the world, accounting, as the language of business, is also becoming globalised (Godfrey and Chalmers, 2007). Investors and other stakeholders from around the world are starting to require financial information that are consistent not only within the company but with the company’s international competitors as well. For this financial information to be consistent, similar accounting rules have to be implemented by the companies, no matter their location around the world, a fact that these companies and their stakeholders are growing more and more aware of. According to the American Institute of Certified Public Accountants or AICPA (2011), various concerned parties such as regulators, investors, public and international companies, and auditing firms are now starting to see the merits of having “common standards in all areas of the financial reporting chain”. The same paper also cited a 2007 survey conducted by the International Federation of Accountants (IFAC), which surveyed 143 leaders from 90 countries. Of these 143 leaders, a large majority (about 90%) stated that “a single set of international financial reporting standards was very important or important for economic growth in their countries. The efforts towards establishing common accounting standards have been ongoing for over a decade now. In 2002, the EU issued Regulation (EC) No. 1606/2002 requiring public companies around Europe to adopt the International Accounting Standards (IAS), which was later changed to International Financial Reporting Standards or IFRS. Other countries such as Australia, New Zealand and Israel, soon followed suit. In fact, as written by Schroeder, Clark and Cathey (2011), “the globalisation of business and finance has led more than 12,000 companies in approximately 113 countries to adopt the IFRS”. Countries that have not yet adopted IFRS are also now contemplating to adopt this set of accounting standards. The United States (US) is not immune to the growing trend of the IFRS. In 2002, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) entered into a Memorandum of Understanding or MOU (The Norwalk Agreement) to make the U. S. GAAP and the IFRS “fully compatible as soon as practicable” and to maintain such compatibility in future issuances as well. In 2007, the US Securities and Exchange Commission (SEC) allowed “foreign private issuers to file financial statements prepared in accordance with IFRS as issued by the IASB without reconciliation to U. S. GAAP”. The SEC also expressed its support in the MOU entered into between FASB and IASB (AICPA, 2011). In 2008, FASB and IASB entered into another MOU where they agreed that “a common set of high – quality, global standards remained their long – term priority” and where they “established a plan to align the financial reporting of U. S. issuers under U. S. GAAP with that of companies using IFRS” (AICPA, 2011). With this, the concerned parties reaffirmed their commitment towards the International Convergence Project or the Project. The above activities signify that the accounting standard – setting bodies believe that the Project is necessary in this ever – increasing globalised world. But a lot of people and entities question whether this Project is absolutely necessary in this age of globalisation or whether such Project will actually be successful across the world. In his paper, Ball, R. (2006) agreed that there is no doubt that “at least some convergence of standards seems desirable – and inevitable – in an increasingly globalised world”. He also agreed that the adoption of IFRS by more than 100 countries and the ongoing Project “are testimonies to increased globalisation”. However, he cautioned against complete convergence of accounting standards and stated that the full adoption of IFRS is “an economic and political experiment – a leap of faith”, one that is unproven and maybe affected by local influences as incentives remain localised. Others expressed concerns as to whether the “globalisation of accounting standards” will result to “comparable and consistent financial reports” (Godfrey and Chalmers, 2007), which is really the end – target for adopting uniform accounting standards in a globalised financial and business market. Still others argue that the full convergence of the accounting standards absolutely go hand in hand with this age of globalisation. In their study, Hammermeister and Zimmerman (2010) showed that “there is concurrence of globalisation and accounting harmonisation” in the six countries they tested. They argued that, as globalisation increases pressure to raise equity capital not only from local but also international investors, as well, so does globalisation increases pressure to adopt similar accounting rules. This is in recognition of the fact that investors around the world will demand comparable financial statements from companies located in different parts of the world in order so that they can calculate how much their expected returns are and choose which company to invest in. In addition, the Accounting Today Staff (2010) published the report of the results of its interviews with the Top 100 Most Influential People in Accounting. Many of these people have no doubt that our globalised market needs a single set of globalised accounting standards and they believe that the Project is the way to achieve these globalised accounting standards. They, however, acknowledge that such a convergence may be quite difficult and will take a very long time before this can actually be done. Lastly, the fact that two very large and powerful standard setting bodies (FASB and IASB) are making a serious effort towards removing the differences between the U. S. GAAP and the IFRS, with the goal of having a single set of accounting standards, is a testimony of the fact that these bodies, their decision – makers and various stakeholders believe that achieving this goal is a necessity in view of the increasing seamlessness of the capital market. In summary, there is no doubt that the business environment in various countries is growing in a globalised scale. With this globalisation trend, companies, regardless of their location, now have access to funds, not only in their local stock markets, but also in the international market as well. These companies, however, need to attract international investors to invest in them, instead of their international competitors, thus, they need to present financial statements in a language understood by these international investors. To do this, these companies need to present comparable financial statements using a single set of accounting standards. The International Convergence Project aims to establish such accounting standards. Using this rationale, it can be said that this Project and its goal are absolute necessities in today’s globalised world. But this is easier said than done and there are a lot of people who believe that we can never truly have a ‘single set’ of accounting standards and even if the Project is successful, it does not guarantee that the financial statements will be consistent and comparable. Only time will tell if these beliefs are true but for now, the general perception is that this Project is absolutely necessary in this age of globalisation. References American Institute of Certified Public Accountants (2011). International Financial Reporting Standards (IFRS): An AICPA Backgrounder. Available from: http://econstor.eu/bitstream/10419/41585/1/63559661X.pdf; accessed 11 December 2011. Ball, R. (2006). International Financial Reporting Standards (IFRS): Pros and Cons for Investors. Accounting and Business Research, International Accounting Policy Forum. pp. 5 – 27. Available from: http://www.passmagazine.co.uk/abr/pdf/005-028.pdf; accessed 11 December 2011. Carmichael, D. R., Whittington, O. R. and Graham, L. (2007). Accountant’s Handbook: Financial Accounting Regulations and Organizations. 11th Ed. New Jersey: John Wiley & Sons, Inc. Available from: http://books.google.com.ph/books?id=7I_ yI7jq020C&printsec=frontcover#v=onepage&q&f=false; accessed 11 December 2011. Chapman, R. J. (2011). Simple Tools and Techniques for Enterprise Risk Management. 2nd Ed. West Sussex: John Wiley & Sons, Inc. Available from: http://books.google.com.ph/ books?id=460sgUl92_8C&printsec=frontcover#v=onepage&q&f=false; accessed 12 December 2011. European Union. Basic Information on the European Union. Available from: http://europa.eu/about-eu/basic-information/index_en.htm; accessed 10 December 2011. European Union (2002). Regulation (EC) No 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the Application of International Accounting Standards. Available from: http://www.esma.europa.eu/system/files/Reg_1606_02.pdf; accessed 12 December 2011. Financial Reporting Council (2011). About FRC. Available from: http://www.frc.org.uk/about/; accessed 11 December 2011. Financial Services Authority (2011). UK Listing Authority. Available from: http://www.fsa.gov.uk/pages/doing/ukla/; accessed 11 December 2011. Gee, P. (2006). UK GAAP for Business and Practice. Oxford: Elsevier Ltd. Available from: http://books.google.com.ph/books?id=4GxGOSk9unYC&printsec=frontcover#v=onepage&q&f=false; accessed 10 December 2011. Godfrey, J. M. and Chalmers, K. (2007). Globalisation of Accounting Standards. Norfolk: Edward Edgar Publishing Limited. Available from: http://books.google.com.ph/books?id=U7IR4HAmUhYC&printsec=frontcover#v=onepage&q&f=false; accessed 12 December 2011. Hammermeister, J. H. and Zimmerman, J. (2010). Financial Reporting Demands in a Globalised World: The Harmonisation of Accounting Rules. TranState Working Papers, 125. Available from: http://econstor.eu/bitstream/10419/41585/1/63559661X.pdf; accessed 12 December 2011. Memorandum of Understanding. “The Norwalk Agreement.” Available from: http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175819018817&blobheader=application%2Fpdf; accessed 10 December 2011. Schroeder, R. G., Clark, M. W. and Cathey, J. M. (2011). Financial Accounting Theory and Analysis: Text and Cases.10th Ed. New Jersey: John Wiley & Sons, Inc. Available from: http://books.google.com.ph/books?id=HTXzc5VjT4QC&printsec=frontcover#v=onepage&q&f=false; accessed 11 December 2011. The Accounting Staff (2010). IFRS – Convergence or Adoption? The Accounting Today. Available from: http://www.accountingtoday.com/news/IFRS-Convergence-Adoption-55554-1.html; accessed 12 December 2011. The Companies Act 2006. Available from: http://www.legislation.gov.uk/ukpga/2006/46/ pdfs/ukpga_20060046_en.pdf; accessed 10 December 2011. Tracy, J. A. (2009). How to Read a Financial Report. 7th Ed. New Jersey: John Wiley & Sons, Inc. Available from: http://books.google.com.ph/books?id=9cSsDZYFZocC&printsec= frontcover#v=onepage&q&f=false; accessed 11 December 2011. Read More