Stakeholders and the Financial Status of the Organization - Report Example

Do financial reports really help stakeholders in taking decisions? Financial reports and annexed disclosures oftentimes confuse and mislead stakeholders instead of providing a true and fair view of the economic status of an organisation. Introduction Any business has several categories of stakeholders and all of them are primarily interested in the financial status of the organisation. Financial reports happen to be the only reliable and easily available source of such information and almost all categories stakeholders blindly rely on information provided in those reports. However, these figures depend entirely on the accounting policies adopted by the organisation and in many instances lead to completely misleading and sometimes even erroneous information. (Mueller, Gernon and Meek 1994) The best example of such a confusing scenario is observed in case of certain Chinese companies that issue A, B, and H categories of shares meant for three different markets and three different categories of shareholders. While ‘A’ shares are traded in domestic stock exchanges of Shanghai and Shenzhen by domestic investors, ‘B’ shares are traded in these same markets but by foreign investors, and, ‘H’ shares are traded outside Chinese mainland in Hong Kong share markets. Thus, companies issuing ‘A’ category of shares follow Chinese Accounting Standards (CAS) while for ‘B’ category of shares International Accounting Standards (IAS) is followed and Hong Kong Accounting Standards (HKAS) is adopted by companies that issue ‘H’ category shares. So, a multiplicity of accounting standards, quite obviously, generates financial information of disparate levels of transparency and detailing. Hence it is becoming increasingly difficult for stakeholders to unquestioningly rely on information provided in the financial statements. (Chen and Wei 2008) Such a lack of divergence among various accounting standards surely lead up to an extremely confusing scenario especially in an era of globalisation when capital is freely flowing across continents and frontiers. Though one cannot disregard the local expediencies there must still be sufficient disclosures so that the stakeholders are able to glean the information that is necessary for them to take decisions. (Meek and Saudagaran 1990) Areas in which different accounting policies are put in use The following areas are most susceptible to different accounting policies: Methods of depreciation and amortisation Valuation of Inventories Valuation of Investments Valuation of Fixed Assets Treatment of Goodwill Treatment of Contingent Liabilities The Institute of Chartered Accountants of India in Accounting Standard (AS) 1 has clearly stated that the main considerations while choosing an accounting policy should be: Prudence: Since future is uncertain, earnings that are realised and not merely anticipated should be taken into account while provision should be made for all liabilities even when the exact quantum of such liabilities might not be known at the time of drawing up the accounts. More emphasis should be given to substance rather than blindly adhering to form as relevant information is what is important irrespective of whether it is presented strictly in accordance with a predetermined format. Materiality of information that is disclosed is also of vital importance. Any information that is considered to be vital in properly evaluating the financial status of the organisation must be voluntary disclosed in an annexure to the main financial statements. If there has been a change in accounting policy during the current year, it must be disclosed along with the impact in financial terms such a change might have had on the figures presented in the financial statements that have been prepared for the current year. (Institute of Chartered Accountants of India 2005) International Accounting Diversities There are vast differences in accounting principles in different countries and this makes it almost impossible to directly compare international financial reports and the depreciation is possibly the most inconsistently applied accounting standard in the entire world. Moreover, the valuation bases of fixed assets also vary from country to country. Some countries like the USA and Japan values their assets on the basis of historical cost while with scope of downward valuation in cases of perceptible decline in the productive value of the asset, some other countries like UK, Netherlands and Australia also permit upward revisions in value if such a revision truly reflects the current market conditions. Though such diversities can be intelligently used by financial mangers to provide an additional gloss to financial statements, one must admit that these differences have arisen over time and is oftentimes reflective of the uniqueness of the economic structure and societal forces at work in different societies. (Abdel Khalik ed. 1999) Securities Markets Financial reporting serves various constituencies and it has been observed that in economies where businesses garner funds mainly from investors through the mechanism of stock markets, the accounting standards try to ensure that the financial statements indeed portray a “fair view” of financial status of corporate entities. Economies of USA and UK provide nearly 63% of world’s equity capitalisation and mandatory economic disclosures in these two countries are heavily inclined towards providing a fair view of the economic state of affairs of the corporate houses. (Pownall 1993) However, if one examines the disclosure patterns in Japan and Germany one would find the prevalence of “stewardship” model where the accounting standards are more rigid and conservative, actually in line with the creditors’ requirements of a more conservative valuation of assets that underlie their loans. Actually one of the most conspicuous differences between International Accounting Standards Committee (IASC) and the Financial Accounting Standards Board (FASB) of US is that while IASC values “prudence” as one of the primary qualities of an accounting policy, FASB is not, it seems, at all bothered about either “prudence” or “conservatism”. Japanese industries have traditionally depended on credit financing and the economy also has a thriving stock market. So, Japanese companies have perfected the art of dual reporting: one for the traditional and conservative constituency and the other for the equity investors. (Gray and Roberts, East-west accounting issues: A new agenda 1991) Taxation In most countries the financial accounting system and taxation rules are structurally linked to each other so that a company pays tax on the net profit as reported in its financial statements. This is most evident in European and Scandinavian countries where managers hesitate to employ income increasing accounting policies as they increase the tax burden too. However in the USA, taxes and financial reporting are interlinked only for the purpose of inventory costing and this probably explains the surfeit of accounting standards in that country to prevent managers from overstating the actual income. As an example one may state that in the USA, expenses incurred in Research and Development must be charged to revenue expense. But this is never a compulsion anywhere in Europe, possibly because no manager in Europe would ever capitalise this expense as it would unnecessarily increase the tax burden. (Gray, Toward a theory of cultural influence on the development of accounting systems internationally 1988) Reserves and Intercompany Transfer Pricing The alignment of financial reports and taxation in European and Scandinavian countries has in all probabilities led to ubiquity of reserves that dominate the owners’ equity section of balance sheets of companies from that region. Reserves are an accountant’s tool to apportion profit into predetermined slots to avoid taxation on the entire quantum of profit. Though some apportionments are done from profits of US companies, the presence of reserves in Balance Sheets is nowhere near that found in European companies. Intercompany transfer pricing is also sometimes influenced by tax as companies try to distribute their total profit among several countries in such a manner that their global tax burden is reduced. The favourite tool for such a manipulation of profit is intercompany transfer pricing which is deliberately kept high for countries with a steep tax rate to ensure there is not much profit in operations within those countries. (Wallace and Gernon 1991) Bibliography Abdel Khalik (ed.), A. Rashad. The Blackwell Encyclopedic Dictionary of Accounting. Wiley-Blackwell, 1999. Chen, Kevin C. W., and John K. C. Wei. "Does quality of accounting standards improve value-relevance of accounting information in emerging markets? : evidence from Chinas A-, B-, and H-share markets." Biblioteca.net. December 18, 2008. http://hdl.handle.net/1783.1/2166 (accessed July 05, 2009). Gray, S. J. "Toward a theory of cultural influence on the development of accounting systems internationally." Abacus, April 24, 1988: 1-15. Gray, S. J., and C. B. Roberts. "East-west accounting issues: A new agenda." Accounting Horizons - 5, March 1991: 42-50. Institute of Chartered Accountants of India. "Disclosure of Accounting Policies." Accounting Standard (AS) 1. New Delhi: Institute of Chartered Accountants of India, July 9, 2005. Meek, G. K., and S. M. Saudagaran. "A survey of research on financial reporting in a transnational context." Journal of Accounting Literature - 9, 1990: 145-182. Mueller, G. G., H. Gernon, and G. K. Meek. Accounting: An international perspective. Burr Ridge, IL: Buisness One Irwin, 1994. Pownall, G. "Discussion of the relative informativeness of accounting disclosures in different countries." Journal of Accounting Research - 31, Supplement, 1993: 224-229. Wallace, R. S. O., and H. Gernon. "Frameworks for international comparative financial reporting." Journal of Accounting Literature - 10, 1991: 209-264. Read More