Public Interest and Accounting Information - Assignment Example

Name Institution Course Date ABSTRACT This report starts with discussing and analyzing the relationship between the notions of public interest and decision usefulness of accounting information. It contends that the development of accounting standards in the public interest is strongly consistent with the decision usefulness of accounting information. The second part analyze and discuss the notion that using International Accounting Standards (IAS) compared to national or domestic accounting standards has reduced the cost of capital of publicly listed firms. The last part reviews the latest annual financial statements of Australian Fortescue metal group and discusses the quality of financial disclosure by the firm with reference to corporate governance standards. It attempts to find out whether these disclosures are sufficiently clear to be understood by a common user. Question A: Notions of Public Interest and Accounting Information The debate surrounding the need for regulation in the accounting sector has persisted for many decades. Indeed, many arguments have been put forward in support of heavy regulation and those with dissenting opinions. Proponents of regulation argue that the best interest of society is not always achieved since markets do not operate in its interest all the time. As a result, intervening in form of regulation is necessary. However, those believing in markets efficiency argue that regulating the market is not necessary since forces in the market automatically operates in serving the best interest of society and lead to optimization of resources (Kaidos 2008, p. 05). The notions of public interest in accounting have become an important issue especially after the global economic depression of 1920-30s. The main goal of information provided by accountants is to provide information to interested parties needing this kind of information in order to make informed economic decisions. This information should be relevant and faithfully represents the transactions. Accounting that faithfully represents the transactions of irrelevant information or unfaithful representation of information that is relevant does not assist users of accounting information to make good decisions (Wahlen, Jones, & Pagach 2015, p. 2-15). Moreover, accounting information should have higher levels of enhancing characteristics in order to increase their usefulness in making decisions. They should be comparable, verifiable, and understandable. Additionally, they should be provided in a timely manner. It is a normative imperative that accounting should naturally serve the interest of the public when talking about accounting and society (Neu & Graham 2005, p. 585). Traditional claims that accounting ought to protect public interest reinforces this predisposition. Furthermore, neoclassical microeconomic theories underpinning significant amount of accounting research consider accounting as a tool that assist in maximization of social welfare (Neu & Graham 2005, p. 585). This objective is achieved through provision of transparent and reliable information to users of accounting information especially investors. This therefore illustrates to some extent that public interest and accounting information use to make useful decisions is mutually constitutive. Information provided by organizational accountants is useful in making various decisions in the society hence it can be understood as helping society with socially integrative function (Baker 2005, p. 701). In fact, public interest is deeply ingrained in the development of policies for purposes of ensuring that high quality accounting information is provided. In most cases, reforms in accounting are undertaken under the context that it will lead to enhancement of society’s well-being (Dellaportas & Davenport 2008, p. 1080). The development of accounting standards in the public interest is to some extent consistent with the importance that is attached to accounting information regarding decision-making. The interest of the public is served well when there is presence of ‘neutral’ accounting standards informing policy and not promoting it are developed (Dellaportas & Davenport 2008, p. 1082). In other words, openness and truth in accounting profession is always a good policy as it ensures that interest of the public is protected all the time through provision of accurate accounting information. In accounting profession, there is an increase legitimate substantial public interest that is tailored towards ensuring that their activities are carried out in manner that reflects effectiveness and integrity (Canning & O’Dwyer 2000, p. 725-726). Often, the public are not in the best position to assess in a direct manner the quality of professional services being offered. Likewise, members of a professional body such as accounting possess strong long-term self-interest relating to maintenance of their reputation for the entire profession (Canning & O’Dwyer 2000, p. 725). Hence, there exist close association between interests of the public and private in maintenance and development of thorough professional standards. Indeed, development of accounting standards in the public interest is strongly associated with the usefulness that the public will derive from accounting profession. On the other hand, preparer of accounting information secondary role is considered to be defending the public interest. In fact, this ‘function’ is derived directly from the accomplishment of the main or basic functions of accountants and accounting profession as a whole. In modern societies, the public is expected to have accession over the authority possessed by various professions because its members have exclusive and specific characteristics. Many professional organizations such as accounting have increasingly obtained enormous power and privilege (Puxty, Sikka, & Willmot 1997, p. 326). This is evident from increased self-regulation and laws and policies that protect these professions from competition by unqualified practitioners. The process of setting accounting standards and development of legislations are considered in the contexts to which accounting profession serve the public interest (Kaidos 2008, p. 01). From these two contexts, accounting information for making decisions is consistent with the notion of public interest. Accounting profession is thus expected to be practical and intellectual as well as have regard for the public interest in carrying out its activities. However, studies have shown profession of accounting by way of legislative instruments is tailored towards prioritizing the interests of companies rather than public interests (Kaidos 2008, p. 01). Nonetheless, accounting profession continue to carry out a crucial role in setting accounting standards in collaboration with industry stakeholders and the government regardless of whether the interest of the public is served, undermined, or reduced. The elements that constitute ‘public interest’ are both debatable and negotiable (Puxty et al., 1997. P. 328). Indeed, there is no global agreement regarding the meaning of ‘public interest’ or the manner in which it can be measured (Willmot 1990, p. 318). It is therefore not surprising to come along many pronouncements by professional bodies that emphasize their concern for public interest. Specifically, accounting profession plays a significant role in any economy. It is also expected to tailor its function towards serving the interest of the public. Question B: International Accounting Standards Over time, accounting standards have often been evolving to meet the changes in the economies, businesses and regulatory environments of the countries that utilize these standards. There have been consistent efforts to adopt uniform accounting standards throughout the world. In United States, a great milestone has been achieved in converging international financial reporting standards (IFRS) with the US Generally Accepted Accounting Standards (US GAAP). However, full transition to IFRS has not yet been achieved (Horton & Serafeim 2013, p. 390). The move towards utilization of similar accounting standards is an attempt to decrease the abilities of managers to record similar economic transactions in ways that are not same. It is therefore the mission of international accounting standards (IAS) to create an accounting language that is uniform all over the world. This makes financial statements to be more credible as the ability of a firm to distort them is reduced. The use of IAS compared to national or domestic accounting standards, however, has reduced the cost of capital of publicly listed companies. Many countries are increasingly requiring companies listed in their national stock exchanges to utilize IFRS in carrying out preparation of annual financial statements. In turn, the flexibility of managers to reflect the true business differences regarding their company’s accounting decisions is reduced. Research has shown that internationally harmonized financial reporting standards are highly capable of reducing the cost of capital especially countries that have strong economic freedom, innovation and legal system as well as entry regulation (Lee, Walker, & Christensen 2008, p. 05). Additionally, it was taunted by proponents of mandatory IAS adoption that it will lead to improved investments to business organizations. There are at least two reasons that can be cited to explain the reduced cost of capital by using IAS (Li 2010, p. 608). First, it has been found that IAS requires greater financial disclosure in comparison with majority of accounting standards that are used domestically. Due to increased disclosure, the company’s cost of capital is reduced (Lambert, Leuz, & Verrecchia 2007, p. 392). Second, there are plenty of arguments in the prior literature suggesting that a single uniform accounting standards that are used all over the world is highly capable of improving comparison of information between one company and another. As a result, the cost of capital is expected to go down (Armstrong et al., 2010, p. 38). According to advocates of IAS, publicly traded firms should use the same set of accounting standards in preparing their financial statements so they play a role in enhancing the functioning of capital markets (Horton & Serafeim 2013, p. 389). Indeed, IAS is capable of increasing reporting transparency, decreasing information costs and reduction of information asymmetry. However, these potential benefits rely on the assumption that compulsory adopting of IAS increased accounting comparability in comparison with the previous accounting systems. Since the move towards mandatory adoption of IAS was started, some studies have produced solid evidence about its effect on firms’ cost of capital. There is significant evidence that have concluded that adoption of IAS reduces the cost of capital of a firm and increase their value of equity (Daske et al., 2008, p. 1089). After immediately adopting IAS, the cost of capital of companies has been found to reduce. Since implementing the use of IAS results in greater disclosure, the firm’s cost of capital is reduced through lower transaction costs. This is also achieved through strong demand for company securities (Li 2010, p. 611). Investors are likely to invest and demand the securities of companies that have increased financial disclosures in their financial statements. Generally, empirical studies have shown that reduction of cost of capital is directly related to higher levels of disclosure. Although there is still skepticism concerning mandatory adoption of IAS, it seems that the firm’s cost of capital is reduced when companies are forced to adopt these standards or voluntarily implement them. This is achieved through two mechanisms; greater financial disclosure and improved comparability of information between companies. Therefore, adoption and use of IAS in comparison with domestic or national accounting standards reduces the cost of capital of publicly listed companies. Question C: Quality of Disclosure by Fortescue Metal Group Several scandals have rocked the accounting sector since the start of the 21st century. It ranges from fraud and manipulation of accounting information (Fathi 2013, p. 319). From Enron to WorldCom scandal, company top executives have been found guilty of overestimating the value of assets and diverting the shareholders funds. It has been argued that these malpractices are as a result of lack of risk of disclosure and failed contemporary models of corporate governance. Enron, WorldCom and other scandals led to development of numerous regulations aimed at promoting corporate responsibility (Myring & Shortridge 2010, p. 103). Enhancement of validity of information reported to shareholders was among the primary objectives of these regulations. Indeed, a company is required to provide annual financial information report of high quality to its shareholders, industry regulators, investors, government and all those who need this information. However, the quality of financial disclosure may vary from one company to another although all companies from a particular country are required to use same accounting standards. Fortescue Metals Group (FMG) is an Australian company that was formed in 2003. Its operations are mainly located in Western Australia. Fortescue Limited is listed in the Australian Stock Exchange (ASX). It is therefore required to prepare and disclose its financial statements on an annual basis as per the prescribed accounting standards and regulations in Australia. Profitability, audit firm, market structure, corporate governance are some of the characteristics that have the abilities of influencing the quality of financial statements. The latest disclosure of financial statements of FMG is of high quality as it covers several important areas. The financial performance is given in detailed form with supporting charts and graphs. A common user of accounting information will easily identify and understand each element in the financial statements. Additionally, notes to financial statements are very detailed and specific. All the accounting policies and standards that have been used in preparing the financial statements have been provided separately with explanations on how they are applicable. As regard to corporate governance and corporate social responsibility (CSR), FMG financial statements clearly shows the company’s structure, operations and performance including detailed information about remuneration of its directors. FMG has clearly shown various CSR activities that it has been conducting in the recent years. In general, the quality of financial disclosure of FMG in reference to corporate governance standards is high and they are sufficiently clear to a common user. In fact, there is a whole table detailing how the company have complied with various corporate governance standards. A common user can easily understand the extent of company’s compliance. Companies are required to prepare financial statements on an annual basis. These financial disclosures are aimed at helping various users of financial information to make informed choices about the company. It is therefore important that the quality of financial disclosure is high, detailed and easily understandable. FMG financial disclosure is high and it is clear enough to be understood by a common user. References Armstrong, C., M. Barth, A. Jagolinzer, and E. Riedl. 2010. Market reaction to the adoption of IFRS in Europe. The Accounting Review 85 (1): 31–61. Baker, C. R. (2005). What is the meaning of “the public interest”? 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Willmott, H. (1990) ‘Serving the public interest? A critical analysis of a professional claim’, in Cooper, D. J. and Hopper, T. M. (eds) Critical Accounts. London: Macmillan. Read More