PART 1: THE AUSTRALIAN ACCOUNTING ENVIRONMENT

Solutions Manual t/a Financial Accounting 8e by Craig Deegan Copyright © 2016 McGraw-Hill Education (Australia) Pty Ltd 1–1

PART 1: THE AUSTRALIAN ACCOUNTING ENVIRONMENT

Chapter 1 An overview of the Australian external reporting environment Review questions 1.1 The main bodies responsible for regulating accounting disclosure in Australia are: (i)Australian Securities and Investments Commission (ASIC)

On its website, ASIC describes some of its responsibilities as follows:

We are an independent Commonwealth Government body. We are set up under and administer the Australian Securities and Investments Commission Act 2001 (ASIC Act), and we carry out most of our work under the Corporations Act.

The Australian Securities and Investments Commission Act 2001 requires us to:

•maintain, facilitate and improve the performance of the financial system and entities in it •promote confident and informed participation by investors and consumers in the financial system •administer the law effectively and with minimal procedural requirements •enforce and give effect to the law •receive, process and store, efficiently and quickly, information that is given to us •make information about companies and other bodies available to the public as soon as practicable.The Corporations Act, which is administered by ASIC, requires corporations to comply with accounting standards (as per s. 296 of the Corporations Act). Hence, the law administered by ASIC requires companies and other disclosing entities to comply with the accounting standards issued by the AASB.(ii) Australian Accounting Standards Board (AASB) The role of the AASB is to develop a conceptual framework. It is also responsible for ‘making’ accounting standards that have the force of law under the corporations legislation, as well as formulating accounting standards that are to be used by reporting entities that are not governed by corporations legislation, inclusive of entities operating in the not-for-profit sector and public sector entities. The AASB is also responsible for Interpretations Advisory Panels, focus groups (user focus groups and not-for-profit focus groups) and project advisory panels.As indicated in Chapter 1, however, a great deal of the responsibility for developing accounting standards released by the AASB is in the hands of the IASB, as is the development of the conceptual framework. It is to be anticipated that only minor changes would be made to standards being released by the IASB before they are subsequently released within Australia as AASB standards (for example, the changes might involve adding more explanatory material to the Australian standard, or to add additional requirements in relation to not-for-profit or public sector entities). The AASB does release accounting standards that are unique to Australia where there is believed to be a need for accounting guidance and the issue has not been addressed by the IASB. The AASB reports Financial Accounting, 8e (Australian Edition) By Craig Deegan (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) 1 / 4

Solutions Manual t/a Financial Accounting 8e by Craig Deegan Copyright © 2016 McGraw-Hill Education (Australia) Pty Ltd 1–2 to the Financial Reporting Council (FRC). Once an AASB-released accounting standard is in place, corporate directors are required to ensure that the company’s financial statements comply with the requirements of the standard (where applicable).(iii) Australian Securities Exchange (ASX) The ASX provides numerous disclosure requirements for entities listed on the Australian Securities Exchange. The principal aim is to help ensure that information is disseminated in an efficient and timely manner. Failure to comply with the ASX Listing Rules may lead to delisting from the exchange. The ASX disclosure requirements help to ensure that information about listed entities is disseminated in an efficient and timely manner. The disclosure requirements also reduce the likelihood of individuals prospering through access to privileged information.The ASX Listing Rules are divided into 20 chapters (details of the listing rules are available on the ASX website at www.asx.com.au). Of particular relevance are Chapters 3 and 4 of the Listing Rules, which relate to continuous disclosure and periodic disclosure, respectively. Listing Rule 3.1 (relating to continuous disclosure) provides the general

principle that:

Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information.The ASX also established the ASX Corporate Governance Council. The Principles released by the Council, which are now referred to as Corporate Governance Principles and Recommendations, were most recently amended and re-released in March 2014 and can be accessed on the ASX website. Companies are required to provide a statement in their annual report disclosing the extent to which they have followed the Corporate Governance Principles and Recommendations in the reporting period. Where companies have not followed all of the recommendations, they must identify the recommendations that have not been followed, and give reasons for not following them. This is often referred to as an ‘if not, why not?’ approach to disclosure.(iv) Financial Reporting Council (FRC) The FRC oversees the operations of the AASB. It also appoints the members of the AASB (other than the chairperson). The FRC, however, is not to direct the development of accounting standards by the AASB, or to veto accounting standards that are released by the AASB.

1.2 The International Accounting Standards Board (IASB) releases International Financial Reporting Standards (IFRSs). IFRSs are adopted directly by some countries, while others (such as Australia) release standards under the name of their domestic accounting standard setter but based upon the standards issued by the IASB. For a detailed overview of the workings of the IASB, students should review the IASB’s website. For countries that have decided to adopt IFRSs, such as Australia, a great deal of ‘power’ for developing accounting standards has been ‘surrendered’ to the IASB, although the IASB does tend to communicate with national standard-setters when developing accounting standards.While IFRSs are used in many countries throughout the world, the IASB does not have any direct enforcement powers. Rather, enforcement is the duty of national governments (for 2 / 4

Solutions Manual t/a Financial Accounting 8e by Craig Deegan Copyright © 2016 McGraw-Hill Education (Australia) Pty Ltd 1–3 example, within Australia, ASIC is primarily responsible for the enforcement of accounting standards).The IASB also has a committee known as the IFRS Interpretations Committee, which reviews accounting issues that are likely to receive divergent or unacceptable treatment in the absence of authoritative guidance, with a view to reaching consensus on the appropriate accounting treatment. Its recommended treatment is included within ‘Interpretations’.

1.3 The IASB does not have any direct enforcement powers. For example, in Australia we use IFRS developed by the IASB, but the IASB has no power within Australia to enforce its accounting standards. That power in Australia resides with ASIC. Therefore, although many countries throughout the world claim to be using IFRSs, whether they are actually being applied properly is really dependent upon the enforcement and compliance policies in place within the respective countries. Because some countries have very weak enforcement strategies, the claim that their national organisations are complying with IFRSs is often open to challenge.

1.4 The auditor acts as an independent reviewer of the financial statements presented by a reporting entity. Being independent, the auditor is expected to provide an objective assessment as to whether, in the auditor’s opinion, the financial statements have been prepared in conformity with the various accounting and other reporting rules applicable to the reporting entity. The auditor, in a sense, provides greater credibility to the financial statements and allows financial statement users to rely upon the statements with greater confidence. With greater confidence, the financial statement users may attribute lower risk to a reporting entity, and this in turn may translate to the reporting entity being able to attract funds at a lower cost than may otherwise be possible. Hence, although the reporting organisation will have to pay for the audit, the benefits of attracting greater funds at a lower cost (because of a perception that the information about the organisation is more reliable or credible) might more than offset the costs associated with the audit. In this regard it should be noted that prior to the introduction of legislation which required certain forms of organisations to have their financial statements audited, many organisations chose to have their financial statements audited because of the perceived benefits. Where there are perceived conflicts of interest between different parties within the organisation (for example, between owners and managers) the auditor can act to arbitrate on the reasonableness of the accounting rules and assumptions adopted by the managers.With this said, it should also be emphasised that an unqualified auditor’s report (that is, a report that does not indicate any departure from accepted or mandated accounting procedures) does not give assurance that all transactions have been correctly accounted for, or that the entity is assured of being viable in the future. Also, it is conceivable that the credibility of all audit firms will not be deemed to be the same, such that if financial statement users consider that an auditor is of low ‘quality’ then an audit report produced by such an auditor may be of limited value. Lastly, it should be stressed that the preparation of the financial statements is the responsibility of management and the auditor will not make any changes to those reports: the auditor’s role is to give an opinion on the statements (for example, that they are true and fair and comply with applicable accounting standards).

1.5 This question may be answered in terms of a ‘free-market’ versus a ‘pro-regulation’ perspective about the provision of accounting information. 3 / 4

Solutions Manual t/a Financial Accounting 8e by Craig Deegan Copyright © 2016 McGraw-Hill Education (Australia) Pty Ltd 1–4 Many academics argue in favour of a free-market approach. By this, we mean that there is a belief the market forces of supply and demand should be allowed to freely operate to determine the equilibrium amount of accounting information to be provided. It is considered in this argument that if the users of accounting reports demand information but it is not being supplied, then this will be priced in to the amount they will charge the firm for the factors of production they supply to the firm (for example, equity capital). If an individual is able to obtain the demanded information then this may lead them to reduce the risk they attribute to the investment, which may translate to a lower required return on their investment. In a sense, the price they pay for the information is the reduction in required return they demand as a result of being provided with the information (which reduced their risk). The firm is predicted to supply information to the point where the benefits of providing the information (perhaps in terms of lower cost of capital) equals the costs of providing the information (which of course assumes that the managers of an organisation have quite a sophisticated grasp of market economics). It has also been argued by proponents of the free-market argument that because there will often be conflict between the various parties associated with an organisation (for example, owners and managers) then accounting reports will be produced which are designed to minimise the conflict and the associated costs of the conflict. It has also been argued that managers are best placed to select accounting methods that best reflect the financial performance and position of their particular organisation, and hence it is inappropriate and inefficient to impose regulation upon them which restricts the accounting methods they might choose to use.There is also an argument that in the absence of regulation, organisations would still be inclined to disclose information in case various external parties construe that the entity has something to hide (the ‘market for lemons’ argument).Advocates of a regulated approach would, by contrast, argue that a free market approach is flawed for a number of reasons. Firstly, the producers of the information cannot typically control its dissemination. Parties, such as competitors, analysts and the like, will obtain the information, but will not directly pay for it (they are deemed to be ‘free-riders’). The free- rider problem may, in an unregulated environment, lead to a reduction in the supply of information due to an understatement of demand. Further, although in the long run market forces may operate, it may be that organisations have created significant social costs in the meantime. For example, the disclosure of environmental information within annual reports—that is, pollution emissions, clean-up costs, etc.—is not currently required in Australia. Research evidence, however, suggests that there are many financial statement users who may be interested in such information (for example, to assess the appropriate risk rates). It may be that sooner or later the market will punish those firms that do not provide information (in the absence of information the market may assume that there is bad news to report); however, significant costs may have been imposed on society by this time.The ‘free-market’ approach to financial reporting also ignores issues associated with stakeholders’ ‘right-to-know’ about certain aspects of an entity’s operations. Stakeholders without financial resources (and perhaps the ‘power’ to demand financial information) may simply be ignored in the information dissemination process, yet they may nevertheless be affected by the operations of the organisation. Introducing regulation might also have the effect of increasing confidence in the capital markets, which might be construed as being in the ‘public interest’.

1.6 The existence of this differential reporting requirement for small and large proprietary companies is based on the assumption that the limited number of parties with a material

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