Advanced Financial Accounting: The Reporting Standards - Assignment Example

Assignment for Advance Financial Accounting Question Outline three options open to country C for the development of a set of high quality local accounting standards. Identify one advantage and one disadvantage of each option. The following are the options of country C in terms of the development of its accounting standards and their advantages and disadvantages. The first option is to adopt a “rules-based” type of accounting standards such as the United States Generally Accepted Accounting Principles or US GAAP. Under this type, detailed rules are set and must be followed when preparing the financial statements. An advantage of applying the US GAAP is that it is applied by the biggest economy in the world, the United States. This will make it easier for country C’s companies to expand in this country since they can show financial statements that can be understood by the US investors. Country C may also attract investors from the US to invest in its local market since US investors can understand the financial statements of country C’s publicly-listed companies. Literature concerning the various accounting principles used in the US also abound, making it easier for country C’s accountants and finance heads to access information about these standards. A disadvantage of this type of accounting standards is that these standards can be quite long and complex. Adopting these standards may cause confusion among country C’s accountants, finance people and its standard-setting body. This complexity may also lead companies to structure their transactions in such a way as to justify favorable accounting treatment and to eliminate the accountant’s or auditor’s judgement. The second option is to adopt the International Financial Reporting Standards or IFRS, which is formulated by the International Accounting Standards Board. The IFRS is a “principles-based” set of accounting standards, which “provides a conceptual basis for accountants to follow” (Shortridge and Myring, 2004). The advantage of these standards is that they are short, simpler and “easier to comprehend”. Because of their simplicity, they can be applied to a wide variety of transactions and can be flexible enough to accommodate future developments of country C’s capital market and business environment. The disadvantage of this is that, since IFRS is still considered to be a relatively young set of accounting standards, there’s a lack of educational materials and examples that can be used to enhance the knowledge of country C’s accountants and the financial statement readers, which may lead to misunderstandings and a weak grasp of the IFRS. The third option contemplates two sets of accounting standards. For its big companies or publicly-listed companies, country C may opt to adopt internationally – accepted accounting standards such as the IFRS or the US GAAP. For those companies that are small and medium-sized and have no plans to go public in the future (or SMEs), country C may opt to develop its own standards or customize the IFRS or the US GAAP. The advantage of this option is that country C will have the best of both worlds. Adopting internationally-accepted accounting standards for its big or publicly-listed companies will enable these companies to issue financial statements that are comparable to other companies in other parts of the world and will open up country C’s capital markets to international investors who can understand such financial statements. For the SMEs, they will be spared the high administrative costs associated with the adoption of these accounting standards while still issuing financial statements that are compliant to the accounting regulations of country C. The disadvantage of the third option is it may become time-consuming and costly. Country C’s accounting standard-setting body will have to rigorously study internationally-accepted accounting standards in order to determine if such standards can be applied for the SMEs or to develop entirely new sets of accounting standards for these SMEs. Thus, it may take a long time before accounting standards for SMEs can be issued. Accountants will have to learn two sets of accounting standards so that they can accommodate the accounting needs of either big companies or SMEs. This type of education may prove to be costly. On the other hand, choosing to specialize in just one set of accounting standards may result to these accountants having limited options in the practice of their profession. Question 2.i. In relation to International Financial Reporting Standards, outline and explain the circumstances where a company is deem to have control of another company and hence required to prepare consolidated financial statement for the group. International Accounting Standards (IAS) 27, Consolidated and Separate Financial Statements, defines control as “the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities” (IAS 27.4). There are two circumstances where control is contemplated: 1. Where the parent or the owner-entity owns more than half or more than 50% of the voting shares of the subsidiary or owned-entity, control is presumed to exist. This majority ownership will include those voting shares that are directly owned by the parent company and those voting shares that are indirectly owned by the parent company through its other subsidiaries or associates (Alfredson, et. al., p. 639). With this majority ownership, the parent company can effectively direct the subsidiary’s financial and operating policies in order to maximize the benefits it can derive from its ownership of the subsidiary. 2. The second circumstance will entail judgement on whether or not the entity (the Parent) has control over another entity. This pertains to the Parent’s less than 50% ownership in another entity. According to IAS 27.13, the owner may still have control over the subsidiary if, despite the less than 50% ownership, the former has the power: a. Over more than half of the voting rights by virtue of an agreement with other investors; or b. To govern the financial and operating policies of the other entity under an agreement; or c. To appoint or remove the majority of the board of directors (BOD); or d. To cast the majority of votes at a meeting of the BOD. According to Alfredson, et. al., in order to assess if there is indeed control even if the Parent holds less than 50% of the voting rights of the subsidiary, consideration should be given to the actions of other owners or parties. For the first two letters above, the presence of a contract or agreement will signify the existence of the control. However, the contract should be kept current and should be updated whenever there’s a change in the issued voting shares. The second factor that should be assessed, still according to Alfredson, et. al. is the “dispersion of other shareholders”. A well-dispersed (in terms of location) group of shareholders may mean that these shareholders cannot attend annual meetings and cast their votes; thereby leaving the decision to the Parent, who owns less than 50% but is the majority owner as far as these annual meetings are concerned. The same is true if the other shareholders own only small percentages of the voting shares, making the Parent the major decision-maker or voter. The third factor is the “level of disorganization or apathy” of the other owners which may result to them not acting on their voting rights and leaving the decisions to the Parent, despite the absence of the majority ownership of the latter. Question 2.ii. Identify and explain the requirements of IAS 1 Preparation of presentation of financial statement. The following identifies and explains the requirements of IAS 1: 1. International Accounting Standards (IAS) 1 requires a complete set of financial statements. For financial statements to be complete, these should include a statement of financial position; a statement of comprehensive income; a statement of changes in equity; a statement of cash flows and notes to financial statements, which comprise a summary of accounting policies and other explanatory notes (IAS 1.8). Failure to include all of these components in the financial statements will make the financial statements not in compliance with International Financial Reporting Standards or IFRS. 2. IAS 1 also requires the financial statements to be fairly presented (IAS 1.13). This is “achieved by compliance with applicable IFRSs” (IAS 1.15). Fair presentation is also achieved when the accounting policies chosen by the reporting entity are in accordance with IFRS; when information are presented in a “relevant, reliable, comparable and understandable” manner (IAS 1.15.b) and when the entity provides additional information to enable users to better understand the entity’s transactions. 3. Another requirement is for the entity to use the accrual basis of accounting, except for the statement of cash flows, in the preparation of the financial statements (IAS 1.25). Under this requirement, the elements of the financial statements will be recognized “when they occur (and not as cash or its equivalent is received or paid)” and they are recorded and reported in the proper period (Framework, par. 22). This is required in order that the financial statement users will be informed of any obligations to pay, to deliver goods or to render services in the future, as well as any rights to receive cash, services or goods in the future. 4. IAS 1 also requires the presentation of comparative information in the financial statements (IAS 1.36), which entails presentation of corresponding information for the preceding periods, alongside the information for the current period. This will ensure that financial statement users will be able to compare the entity’s current financial information with the corresponding information in preceding periods and establish trends on the entity’s financial position and results of operations. 5. Corollary to number 4, IAS 1 also requires consistency in the presentation of the financial statements (IAS 1.27). This means that the items in the financial statements will be classified in the same manner from one year to another to ensure that the comparability of financial information will be retained. An entity is only allowed to reclassify the items or change the presentation when it will enhance the presentation of the financial statements or when the entity is required to do so. In such cases, IAS 1 requires the entity to disclose in the notes the reclassified items, the amount reclassified and the reason for the reclassification (IAS 1.38). References Alfredson, Keith; Leo, Ken; Picker, Ruth; Pacter, Paul and Redford, Jennie. (2005). Applying International Accounting Standards. Australia. John Wiley & Sons Australia, Ltd. Pages 638 – 640. Framework for the Preparation and Presentation of Financial Statements. 2001. International Accounting Standards Board. International Accounting Standards (IAS) 1: Preparation of Financial Statements. 2001. International Accounting Standards Board. IAS 27 Consolidated and Separate Financial Statements. 2008. Deloitte Touche Tohmatsu. Available from: . [Accessed: December 17, 2008]. Must Accounting Rules be Global? (2005). Knowledge @ Wharton. University of Pennsylvania. Available from: < http://www.wharton.universia.net/index.cfm?fa=viewfeature&language= english&id=965>. [Accessed: December 17, 2008]. Shortridge, Rebecca Toppe and Myring, Mark. (August 2004). Defining Principle – Based Accounting Standards. The CPA Journal. Vol. 74, No. 8. Available from: . [Accessed: December 17, 2008]. Summary of IAS 1. 2008. Deloitte Touche Tohmatsu. Available from: . [Accessed: December 17, 2008]. Read More