International Financial Reporting Standard & Exposure Draft - Essay Example

INTERNATIONAL FINANCIAL REPORTING STANDARD & EXPOSURE DRAFT TABLE OF CONTENT PAGES Introduction 03 International Accounting Standard 27. 03 Control Definition 04 Control Principal 04 Requirements and Guidelines Regarding Assessing Control 05 Options and Convertible instruments 06 Voting Right Proposal 07 Structured Entity 07 Assessment Of control of Structured Entity 08 Risk and Reward Fall Back test 09 Proposed Disclosure Requirements 10 Reputational Risk 11 Conclusion 11 Reference 12 INTRODUCTION This paper highlights the use of special purpose entities that have been kept off-balance sheet. Before getting into further details, we must have a very good idea of International Accounting Standard (IAS) 27, which pertains to consolidated and separate financial statements. Let’s discuss the IAS 27 in detail. INTERNATIONAL ACCOUNTING STANDARD (IAS) 27: The objective of IAS 27 is to enhance the relevance, reliability and comparability of the information that a parent entity provides in its separate financial statements and in consolidated financial statements for a group of companies under its control. IAS 27 elaborates that a parent company will regulate their subsidiary entities to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Decision making and financial analysis will become relatively convenient, if one has consolidated financial information regarding the entity (IFRS, 2007). Consolidated financial statements are the financial statements of a group presented as those of a single economic entity. The group which regulates is referred to as the parent while the rest ones are its subsidiaries. An entity combines the financial statements of the parent and its subsidiaries line by line by adding together items like assets, equity, income, liabilities and expenses at the end of the reporting period while preparing consolidated financial statements (Lewis, 2004). An entity must disclose the information about the nature, relationship and ethics between the parent entity and its subsidiaries. DEFINITION OF CONTROL: ANS 1) International Accounting Standard (IAS 27) elaborates control as the power to influence the entities to follow financial and operating policies, which are made by the parent company for their subsidiaries in order to regulate them properly. I think the proposed control definition is not justifying all the entities because the definition apprise to only those firms who have a regulating body, let say the parent entity, on their heads which are responsible to keep a critical eye to make sure that their subsidiaries are in compliance with the financial and operating policies which IAS governs. Exposure draft (E.D) does not consider the fact when an entity is not being regulated by a control entity like sole proprietors or private companies. CONTROL PRINCIPAL: ANS 2) Yes, the control principal as articulated in the draft IFRS is appropriate because it states that control and power can be achieved in many ways, rather emphasizing only on the financial and operating policies as stated in International Accounting Standard (IAS – 27). Drafts manifest that a reporting entity can have the power to direct or govern the activities to another entity by different means. They may control by having voting rights, by having options or convertible instruments, contractual agreements or by accumulation of all these. REQUIREMENTS AND GUIDANCE REGARDING ASSESSING CONTROL: ANS 3) I am satisfied with the related arrangements and requirements of assessing control but little bit uncomfortable with the guidelines the International Accounting Standard Board (IASB) have provided for the assessment. Although exposure draft have some thought provoking points in it which are no doubt beneficial, like the point which considers power and return together and consideration of all relevant facts and circumstances when assessing control. Continuous control assessment is also a positive point to direct the subsidiary entity pertinently to affect the return. The major concern is the evaluation and the firmness of the reporting entity because, as per the exposure draft fluctuation will occur in the assessment of control if any subsidiary entity’s return fluctuated. It may return to complete loss of control from a subsidiary entity. More precisely, we can say that fluctuation or cease of receiving return from entities will stress the control process to be eliminated which is equally harmful for the entity as well as the accounting regulatory bodies. So according to my analysis, the IASB should omit the point which considers the fluctuation with respect to the fluctuation in all relevant facts which may push the control process to be weak. OPTIONS AND CONVERTIBLE INTRUMENTS: ANS 4) Yes, I agree with the International Accounting Board proposal regarding options and convertible instruments while assessing control of an entity because the Exposure draft (E.D) states that, if a reporting entity have options or convertible instruments then they have the power to direct the activities of another entities, but if and only if certain conditions follow. The reporting entity must have sufficient voting rights with options and convertible instrument in order to determine that the strategic operating and financial policies are implemented in the subsidiary entity by a governing body. Any counterparty to an option agreement that has the vote rights and acts as an agent for the reporting entity and aggregately their voting rights will become adequately enough to determine the entity’s strategic operating and financing policies. The proposal of board regarding the option and convertible instruments gives the legal rights to the reporting entity, which relates to the strategic operating and financing policies and empowers the reporting entity to direct the activity of the subsidiary entity through any action. VOTING RIGHTS PROPOSAL: ANS 5) Some contradictions are found in the International Accounting Standard Board’s (IASB) proposal for situations in which a party holds voting rights both directly and on the behalf of other parties as an agent. The ambiguity arises in identification of the benefits because sometimes it can be difficult to identify, weather a reporting entity that holds voting rights either directly or on the behalf of other party uses the rights of the agent for its own benefits or intend to give benefit to the party. To Become the independent decision maker and policy determiner, reporting entities exclude the voting rights of the agent, from the voting rights the reporting entity has in its basket which sometimes condense the voting rights for the reporting entity even below the benchmark; only then the reporting entity is not eligible to assess control. I think the reporting entity must be independent to control and direct the subsidiary entity on the activity to be implemented on the strategic operating and financial policies. STRUCTURED ENTITY: ANS 6) I do not agree with the definition of structured entity mentioned in the paragraph 30 of the exposure draft (E.D). If I opt to describe such an entity then I would define it in this manner. “Such entities which are not directed through the exercise of voting rights and other arrangements are referred as structured entities”. Due to the current global financial crisis, involvement of structured entities with reporting entities are mandatory to disclose in the financial statements which contain the information regarding the nature of the risk. An important aspect that should be kept in mind is that the extra involvement of structured entity in the disclosure directed reporting entity is not control. ASSESSMENT OF CONTROL OF STRUCTURED ENTITY: ANS 7) I agree with the requirements and guidelines mentioned in the exposure draft (E.D). E.D states that while assessing control of a structured entity we have to consider and identify the return which belongs to the activity of the entity and its sharing. Certain points have to be kept in mind while assessing the control of the structured entity. A proper understanding of purpose and design of a structured entity will help to assess the sharing returns among the entity’s shareholders or participants and direct the entity to follow the strategic operating and financing policies. The reporting entity’s exposure is more than that of any other party that is why reporting entity must have sufficient power to direct the activities of a structured entity which induces the return to vary. Control of structure entity is in a limited range of activities. It pertains to direct that a particular range of activity and the return which may generate from the course of action. A reporting entity isn’t to be bothered for the limited issue. Let’s say the only receivable in a company balance sheet is an asset which causes the returns to vary; then structure entity will come into play rather than the reporting entity. A reporting entity has the power to direct and dissolve the activities of a structure entity by holding liquidation, redemptions or with the help of other rights but it only happens when the reporting entity has the legal right as well as the ability to change the restrictions or strategic organizing and financing policies according to which the structured entity operates. A reporting entity has the power and legal right to change the charter and by laws of the structured entity. RISK AND REWARD FALL BACK TEST: ANS 8) If power can not be assessed then the entities are bound to be proposed a risk and return reward which is termed as ‘fall back’ testing to assess the consolidation that occurs in the financial statements because it is the perception of some people that the consolidation of a structured entity can be easily disguised and in order to consolidate the structured entity, the reporting entity have to proposed a fall back test. As per the approach, if a structured entity is at the level of variability of return then the reporting entity will consolidate entity. In my view, the International Financial Reporting Standard (IFRS) in consolidated financial statements should include a risk and reward ‘fall back’ test up to a particular level of variability of return of a structured entity. In order to calculate the variability of return I’ll consider fixed and variable cost are my key elements, then I’ll calculate the total fixed and variable costs incurred in the accounting year and the ratios between them because fluctuation of cost will cause the net income or return to increase. Obviously increasing variable and fixed cost tries to mitigate the return and on the contrary, effective cost management tries to increase the surplus. I believe that in order to avoid the disguising of power, it is appropriate to have an exception to the principal that consolidation is on the basis of control. PROPOSED DISCLOSURE REQUIREMENTS: ANS 9) Due to the global financial crisis, an entity needs a better disclosure for the nature and risk associated with the reporting entity. Certain below mentioned points are included in the Exposure Draft. Detailed information must be included in the financial statements on which a subsidiary entity assess or control the accounting consequences. Information about the assets and liabilities as well as their restriction which were held in subsidies must be disclosed. As per my assumptions the entity must also disclose the following: Major investment in assets which has taken place and which are about to be take place must be disclosed. The risk associated with these investments and projects. Must elaborate the accounting procedures and disclosures which the entity is using; this will help to increase the graph of the profit and minimize the risk as well. Details of proportion of fixed and variable costs must be disclosed which helps the management to take measures and relevant decisions. REPUTATIONAL RISK: ANS 11) Management is first intended to consider the reputational risk which might be helpful for consolidation but then the board observed that the financial institutions that were exposed to reputational risk can’t control their structured securities. Due to the reflection only on management intentions, I think that reputational risk is not an adequate basis for consolidation. Yes I do agree with the proposed disclosure in paragraph 47. CONCLUSION: As we are well aware of the fact that the International Accounting standard (IAS) 27 elaborates us about the consolidated financial statements and the main objective of this IAS is to enhance the relevance, reliability and comparability of the information that a parent entity provides in its separate financial statements and in consolidated financial statements for a group of companies under its control. Due to the current financial crisis Australian Accounting standard board (AASB) intends to change the reporting style of financial statements. AASB committees will issue an exposure draft which they wish to be criticized and desperately need comments on it. After analyzing the exposure draft which the board has been issued, I found it fine but there are some major points not taken into consideration; like the voting rights and structured entities. After doing an immense study and research I include some of my points which can enhance the reporting. Above mentioned each heading is a consequence of exceptional research and deep study which includes information regarding the exposure draft and its relevant issues with their remedies. REFERENCES: IFRS, (2007). International Financial Reporting Standard Volume : 1 & 2 Lewis, R & Pendrill, D (2004). Advance Financial Accounting Edition: 7, British Library. Bierman, H (2008). Accounting Finance Lesson of Enron, Cornell University, USA. Sims, Michele A. & Clift, R. C. (2000). Corporate Accounting. McGraw-Hill. Read More