Benefits That Financial Reports Provide to the Reporting Companies and to the Society - Term Paper Example

Introduction Financial reports are important outputs in any business entity’s accounting cycle. These reports are meant to cater a wide variety of users who are external to the entities. The main objective of financial reports is to show vital financial information that will aid the users to come up with “informed decisions” based on the presented information (p. 55, Porter and Norton, 2010). On the other hand, the draft Conceptual Framework for Financial Reporting issued by the International Accounting Standards Board or IASB in 2010 not only stated the same objective but also added that general purpose financial reports aid the users in making an assessment whether or not the entity’s management and its board “have made efficient and effective use of the resources provided” (IASB, 2010). In general, financial reports are perceived to provide a net benefit not only to the reporting company but also to the society. However, questions about the actual benefits provided by these financial reports and whether or not these benefits far outweigh their costs are still present among accounting experts, the users and the public. These questions are the same, regardless of the country or the reporting framework used by such country. This paper focuses on Australia and discusses whether there is really a net benefit to the business community and the society of the financial reports as they are now and whether such is true in the Australian context. Financial Reports in Australia Like any other business entities around the world, the generation and issuance of financial reports are integral processes and regulatory requirements for any Australian business entity. This fact is highlighted in Australia’s Corporation Act 2001 or the Act. Section 1111AO of this Act specifically requires the entities that were incorporated in Australia to prepare financial reports. The entire Chapter 2M of the same Act lays out the requirements for such reports. These requirements include who are actually responsible for such reports and the timing of their preparation. The financial statements in Australia are prepared in accordance with the country’s accounting standards issued by the Australian Accounting Standards Board or AASB. Currently, the accounting standards issued by AASB are locally adopted from the International Financial Reporting Standards or IFRS, which became effective in January 2005 (AASB FAQs). Australia, however, uses a “different disclosure regime” wherein the requirements for financial reporting are “set according to the type of entity” (Treasury, n.d.). Do Financial Reports Lead to a Net Benefit in Australia’s Society? The following are discussions about specific areas in the financial reporting environment of Australia. Each one is described and its impact explained based on the Australian context. Concise vs. Full Financial Report One of the peculiarities in Australia’s financial reporting system is that entities are given an option to send to their stakeholders either a full financial report or a “concise report” (Sect. 314, Corporations Act 2001). This option was made available because of the belief that the needs of some of the entity’s members would still be met even though this type of report has fewer disclosures and information than a full financial report (AASB 1039, 2008). The notion here is that concise reports can actually benefit the intended users by “highlighting the information that is of greatest interest to them” while not burdening them with very detailed accounting disclosures (O’Sullivan and Percy, 2004). However, based on the study conducted by M. O’Sullivan and M. Percy (2004), it would seem that concise reports now have more contents than the ‘full’ financial reports. Thus, the originally conceived benefit of providing this option may not have been realised due to the reversal in terms of the contents of each report. Financial Reports and the Capital Markets In discussing the net benefits of financial reports in the Australian context, it is inevitable that the impact of these financial reports to the capital markets of this country will be discussed. Capital markets, the investors and other concerned parties rely (sometimes heavily) on the financial information presented in the financial reports, particularly those related to the earnings of the entities. But do these reports about the public companies’ income really have a big impact or benefit on the stock market? In a stock market, the financial reporting environment includes not only the financial statements, annual reports, etc. It also includes announcements on earnings and dividends. Both of these announcements are perceived to have key financial information needed for solid investor decisions and have effects on the way the number of shares traded and their prices move across the board. A study conducted by How, Huang and Verhoeven (n.d.) showed that announcements of negative or positive earnings and dividends have direct effects on the trading volume and the stock prices. What does this imply for Australia’s financial reporting and its capital market? Australia’s business and regulatory environment is “high investor protection” or one where the rights of the investors are highly protected through strict “financial reporting environment” (DeFond, Hung and Trezevant, 2005). DeFond, Hung and Trezevant’s (2005) study showed that there is a direct correlation between the quality and content of “annual earnings announcement” and the degree of protection afforded to the investors. This means that, in Australia, its financial reporting requirements and environment are actually working for the benefit of the investors through more informative “annual earnings announcement” (DeFond, Hung and Trezevant’s. 2005). Combining this with the findings of How, Huang and Verhoeven (n.d.), it would seem that financial reports issued by publicly – listed companies in Australia do have a positive effect on its stock market due to the general investor environment and the amount of information contained in the disclosures and announcements. Financial Reporting and Its Objectives Financial reporting is actually a means by investors and other external users to monitor the financial performance of the entity and to compare it with what they expect the performance should be. All of these revolve around how well the interests of the board and management, who were tasked to run the entity, align with those of the investors and stakeholders (Kiel and Nicholson, 2003). The government, in turn, who is actually one of the external users, seeks to ensure that such objective is met at all times by implementing rules and regulations related to financial reporting and its related requirements. This relationship between the investors, the board and management has caused various changes in the regulations in Australia, from the accounting standards, to the auditing standards, to corporate governance and to the way government monitors the entity’s compliance to its various regulations. The importance of financial reports and the desire of Australia’s government to ensure properly stated financial reports had led it to tighten the rules in corporate governance. A study conducted by He, Wright and Evans (2007) showed that the improvements in the corporate governance rules in Australia had decreased the likelihood that earnings are managed and had increased the credibility of financial reports issued by Australian entities. More credible financial reports mean better investor and business community confidence on such reports. The above is a plus point to the financial reporting form as required in Australia. However, there is a downside to such corporate governance regulations. In a survey conducted by Grant Thornton in 2008, the tight reporting deadlines (which is a part of corporate governance) given to business entities for the submission of their financial reports actually has negative effects on the financial reporting procedures and the quality of the financial reports. According to the survey (Grant Thornton, 2008), with these tight deadlines, the quality of financial information may be sacrificed due to the “limited technical accounting resources”; the reporting may be “less robust’ due to the limited time available to analyse the technical issues and to check the accuracy of the reports and the preparers as well as the reviewers (i.e., the independent directors) may be more stressed due to the shorter time afforded to them. Such results actually point out the possibility that the quality of the financial reports may actually decline, resulting to these financial reports being useless and non-beneficial to their intended users. Conclusion In summary, the financial reporting form and environment in Australia seem to result to both positive and negative effects to Australia’s society. The option to issue either a concise report or a full financial report was given to provide some ease to the investors and the preparers by allowing them to view and to prepare (respectively) shorter but more useful reports. However, this option seemed to have backfired as the concise reports seem to contain more information (and more pages) than the financial reports. On the other hand, the outlook is positive in terms of Australia’s financial reporting and disclosure requirements and its capital market. With Australia’s stricter regulations designed to provide higher protection to investors, the financial reports (including the earnings and dividends disclosures) are viewed to have sufficient information that can affect the stock market. These financial reports are thus more valued (and are thus more useful) for their contents and information as far as the stock market and the investors in Australia are concerned. Lastly, specific changes in the regulations (particularly in corporate governance) in Australia may have caused the credibility of the financial reports to rise, as well as the investor confidence. However, the tight reporting deadlines attributed to these financial reports are also hindering the degree of usefulness the financial reports can give to its users as shown by the survey from Grant Thornton. Although this report touches only on corporate governance as one of the improvements to ensure the credibility and to increase the usefulness of financial reports in Australia, there are still several of these improvements being implemented. One is the changes in the financial reporting of unlisted companies (Treasury, 2007). Others include the adoption of the IFRS, new auditing standards and the tightening of monitoring activities done by the Australian government on the entities’ financial reports. Over-all, the financial reports (as they are right now) issued by Australian entities seem to have a net benefit on the users of such reports. However, it cannot be denied that their costs are somewhat serious and, sometimes, can even offset the benefits derived from them. The current thrust to improve financial reporting requirements and to tighten the policies towards the preparation and monitoring of these financial reports may tip the balance towards better benefits but this remains to be seen. All the studies quoted in this paper actually admitted this and advocated for more studies to be conducted in the years to come. References AASB 1039 (2008). [Online] Available at: http://www.aasb.com.au/admin/ file/content105/c9/AASB1039_08-08.pdf (Accessed: April 24, 2010). AASB. Frequently Asked Questions. [Online] Available at: http://www.aasb.gov.au/About-the-AASB/Frequently-asked-questions.aspx#qa1067 (Accesssed: April 15, 2010). Commonwealth Treasury (no date). Chapter 5: Financial Reporting Requirements and Accounting Standards. [Online] Available at: http://www.treasury.gov.au/ documents/178/PDF/ch5.pdf (Accessed: April 16, 2010). Commonwealth Treasury (2007). Discussion Paper: Financial Reporting by Unlisted Public Companies. [Online] Available at: http://www.treasury.gov.au/documents/1269/PDF/ Discussion_paper_Financial_Reporting_by_Unlisted_Public_Companies.pdf (Accessed: April 22, 2010). DeFond, M., Hung, M. and Trezevant, R. (2005). Investor Protection and the Information Content of Annual Earnings Announcements: International Evidence. [Online] Available at: http://www.baf.cuhk.edu.hk/research/cig/pdf_download/Investor%20protection%20 and%20the%20information%20content%20of%20annual%20earnings%20announcements.pdf (Accessed: April 18, 2010). Grant Thornton (2008). Survey of Australia’s Financial Reporting Deadlines. [Online] Available at: http://www.grantthornton.com.au/files/financial%20reporting%20deadlines%20 survey%20v8%20-%20final.pdf (Accessed: April 23, 2010). He, L., Wright, S. and Evans, E. (2007). Does Better Corporate Governance Result in Lower Earnings Management. Keeping Good Companies. [Online] Available at: http://www.allbusiness.com/management-companies-enterprises/4501896-1.html (Accessed: April 24, 2010). How, J., Huang, C. and Verhoeven, P. (no date). Information Asymmetry Surrounding Earnings and Dividend Announcements: An Intra-Day Analysis. [Online] Available at: http://www.mssanz.org.au/MODSIM03/Volume_03/B17/04_How.pdf (Accessed: April 22, 2010). International Accounting Standards Board (2010). Exposure Draft - Conceptual Framework for Financial Reporting: The Reporting Entity. [Online] Available at: http://www.iasb.org/NR/rdonlyres/363A9F3B-D41C-41E7-9715-79715E815BB1/0/ EDConceptualFrameworkMar10.pdf. (Accessed: April 22, 2010). Kiel, G. and Nicholson, G. (2003). Board Composition and Corporate Performance: How the Australian Experience Informs Contrasting Theories of Corporate Governance. [Online] Available at: http://www.effectivegovernance.com.au/media/content/docs/board.pdf (Accessed: April 24, 2010). O’Sullivan, M. and Percy, M. (2004). Concise Reporting in Australia: Has the Concise Report Replaced the Traditional Report for Adopting Companies? Australian Accounting Review. Nov. 2004 14 (3), pp. 40 – 47. Available at: http://eprints.qut.edu.au/813/1/Percy_concise.pdf (Accessed: April 23, 2010). Porter, G. and Norton, C. (2010). Financial Accounting: The Impact on Decision Makers. Ohio: South-Western Cengage Learning. Available at: http://books.google.com.ph/books?id= WH95z-MY5LEC&pg=PA55&lpg=PA55&dq=objective+of+financial+reporting& source=bl&ots=OBE6ibpaNM&sig=aOg3zBXO6K04xUbZgFdJudvz4rk&hl=tl&ei=OtLSS4qgJZS5rAekrriHDg&sa=X&oi=book_result&ct=result&resnum=4&ved=0CBcQ6AEwAzge#v=onepage&q=objective%20of%20financial%20reporting&f=false (Accessed: April 19, 2010). The Corporations Act 2001. [Online] Available at: http://www.austlii.edu.au/au/ legis/cth/consol_act/ca2001172/ (Accessed: April 15, 2010). Read More