Accounting Regulations - Assignment Example

Accounting Theory 2 Student’s Name Institution of Affiliation Question 1 The New York Times news article, Fair Game by Gretchen Morgenso published on April 22, 2016, http://mobile.nytimes.com/2016/04/24/business/fantasy-math-is-helping-companies-spin-losses-into-profits.html?ref=topics&referer, relates how fantasy maths helps companies to spin their incurred losses into profits. This has been observed even in major public companies where the company’s financial reports are not founded on generally accepted accounting principles (GAAP). According to Morgenso, if companies are granted the leeway, they will without fail show their financial reports in their best feasible option. The companies will also try to convince the investors by using the calculations the investors prefer, where specific costs are omitted in order to present their operations reality. Morgenso refers to this practice as emphasizing the positive accounting-style. The surprising thing is how accounting regulatory bodies allows the increase of fraudulent financial reports and the way investors embrace these reports. Due to these, the cases of fraudulent financial reports in major companies have increased gradually. According to a recent study carried out by Analysts Accounting Observer, in the Standard and Poor’s 500-stock index, ninety percent of companies financial reports were non-GAAP in 2015, compared to the year 2009 where the non-GAAP financial reports were 72 percent. Corporations are still required by regulations to report financial results which are calculated using accounting rules. However, companies manipulate investors using massaged calculations that generate a preferable outcome. According to Morgenso, the abyss between make-believe and reality in the operations of these companies wide to an extent where critical questions are raised on whether the investors really understand the businesses they have invested in. In the year 2009 and 2015, the study indicated that the non-GAAP net income in 2015 was up by 6.6 percent in comparison with the previous years among the 380 companies in existence during that time. However, when calculations were done using GAAP, the net income among the 380 companies back in 2015, the results indicated that there was a decline of about 11 percent in net income from the year 2014. Also, 30 companies that were studied experienced losses in 2015 after calculations were done using accounting rules, however when the companies did the calculations themselves they magically generated profits. Many of these companies dealt with the energy sector which at that time was been affected by increasing oil prices though other companies were in this group. The companies turned the losses into profits through excluding some business incurred costs such as acquisition and restructuring costs, and write-downs of assets that are impaired. The study also found that in the S. & P. 500, nearly10 percent of the companies using exaggerated figures removed expenses that were categorised as other. The New York Times news article, Fair Game by Gretchen Morgenso can be linked to various accounting topics such as Ethics, Accounting regulations and the positive accounting Theory. Ethics In general, ethics refers a system of moral or code that gives a criteria for determining right or wrong. Understanding and maintaining ethics is crucial in the field of accounting. Many businesses and investors continuously depend on the financial information ethical collection and delivery, this places the investors and businesses at risk in case the accounting ethics are not adhered to. Learning accounting ethics basics is a starting point for investors, managers and companies to stay out of financial and legal troubles (Duska, Duska & Ragatz, 2011). Companies depend largely on accounting ethics, regardless of whether they are aware or not. Investors, managers and creditors are often reluctant to trust the accuracy of accounting records unless they are beyond doubt that their accounting professionals practises of financial recordkeeping are straightforward, honest and consistent with the standards set by the industry. Creditors and investors can also be exposed to fraud risks and risky investment decisions if the accounting integrity standards and ethics are not maintained, this can also sabotage the larger markets trust in the company (Sarlak, 2008). Every professional accounting organization in each state or country establishes ethics codes and integrity standards that the members of the particular accounting organizations must adhere to. Accounting boards in every state also outlines membership ethical standards with the state law requiring every accountant to be certified by the state board in order to be allowed to practice. The Financial Accounting Standards Board, lays out basic rules of accounting known as Generally Accepted Accounting Principles (GAAP) which are found at the accounting ethics core and strict adherence is required to these rules (Parker, 1994). This rules ensures the comparability, integrity and reliability of financial statements. Ethics and integrity standards in accounting are founded on a commitment to objectivity, honest and impartiality. Ethical standards requires accountants to present accounting information in the most possible accurate and clearest way, expecting that the information contains a business’s financial situations independent report. This entails not only adhering to professional rules but also realizing the probability for harm, applying judgement and reasoning to provide solutions to ethical conflicts (Canning & O'Dwyer, 2001). Accounting Regulations Many games today have a set of agreed rules and regulations. This rules and regulations provide a definition for the game and a structure that every player must follow. For example, in football, players are expected to follow rules that pertain to football, otherwise the football game would just be an uncoordinated chaotic kick-about. In accounting, there was no rules that were devised. Accounting rules and regulation grew over the years as businesses entities adopted the same transaction recording procedures and the way their entities had performed over a period of time. These procedures eventually with time became generally accepted as rules that were later adopted virtually by everyone. Accounting and accountants nowadays have been subjected to a wide variety of regulation forms. Accounting professional bodies have developed generally accepted accounting principles (GAAP) and a conceptual framework to serve as the foundation of accounting theory. This are principles that govern the company’s ways of disclosing financial information (Atiase, Bamber & Freeman, 1988). Every Accounting profession bodies constitutes of disciplinary committees whose main purpose is to enforce accounting regulations. However as seen in the case above, this is not an effective process since there exists political issues and power. Some major companies and corporations have so much power and political influence that they became immune to disciplinary actions by regulatory bodies, this is the reason as to why there are few corporate scandals (Mitchell & Sikka, 1993). In order to enforce this regulations the regulatory bodies uses two approaches namely: compliance and deterrence approaches. Regulatory bodies should be strict in enforcing the accounting regulations and take actions against companies that do not adhere to these regulations. It is the failure of regulatory bodies to enforce regulations that have led to an increase of phoney financial reports by major companies that are not founded on GAAP (Gregoriou & Gaber, 2006). Positive Accounting Theory Positive accounting theory (PAT) tries to explain the accounting practice through the prediction of a particular phenomenon. It predicts the firms which will adopt and the firms that will not adopt a particular method, even though it does not indicate the method that a firm should adopt. Through this, it concentrates on the relationships between accounting and various individuals, in terms of how accounting is employed to help in the operation of these relationships. Some of these relationships include: owners and managers, and managers and the firms creditors. This theory makes an assumption that all the actions of an individual are driven by self-interest and therefore people opt to act in a manner that is opportunistic for their own benefits. The theory does not include opinions of morality or loyalty. From the article above, it is evident that managers manipulate financial reports for their own self benefits of attracting investors to invest in their companies. Once the managers realize what the investors want to see. They manipulate their financial records by excluding certain costs to fit the needs of the investors. By misleading investors to make risky investment decisions, the investors provide the managers with a free pass on the manager’s effectiveness in managing all of the shareholder resources (Milne, 2002). Question 2 Answer A Last year (2015) on 28th May, the International Accounting Standards Board (IASB), issued an Exposure Draft for public comment that was suggesting a revised financial accounting conceptual framework. The proposals main aim was improving financial reporting through providing a clearer, updated and a more complete set of notions that could be applied by the IASB during its development of International Financial Reporting Standards (IFRS) and others to assist them in understanding and applying those standards. The published exposure draft when compared to the existing conceptual framework is more complete because it addresses the areas not covered and not covered in detail in the existing framework. This areas addressed by the exposure draft include: measurement; the reporting entity; presentation and disclosure, de-recognition and financial performance. The exposure draft also confirms various aspects of the current conceptual framework in the following ways: through explaining the substance over form and prudence roles in financial reporting; clarifying that the required information for meeting financial reporting objectives involves information that can be applied to assist in the assessment of the managements stewardship of the enterprise resources; providing a clearer liabilities and assets definitions and a wider guidance of supporting those definitions; clarifying that measurement uncertainty of high levels can cause the financial information to be less significant and clarifying that decisions that are important are driven through the consideration of the nature of the arising information regarding financial position and performance. Lastly, the exposure draft updates the sections of the existing conceptual framework. For example, the above exposure draft by IASB confirms the probability role in the determination of liabilities and assets. The selected four comment letters belongs to: The Australian Accounting Standards Board (AASB); Eumedion Corporate Governance Forum; American Gas Association (AGA) and Australian Council of Auditors-General (ACAG). The comment letters of this exposure draft deals with responses from the various respondents on whether they agree or disagree with the above stated proposed functions and roles of the exposure draft where they provide reasons for their agreements or disagreements and their views on what should be changed or added to the exposure draft. Answer B The above selected comment letters from the four groups agree on some proposals presented in the Exposure draft by IASB. The first issue that the groups agree on is regarding the exposure draft clarifying that the required information for meeting financial reporting objectives involves information that can be applied to assist in the assessment of the management’s stewardship of the enterprise resources. For example, according to ACAG, it agrees with the proposal. In its view, an evaluation of the management’s stewardship and prospects of future cash flow are crucial for making decisions regarding resource allocation. It views stewardship as an important concept that underlies general purpose financial reports. It recognizes the fiduciary responsibility of the management to those dependant on their decisions for their diligent, efficient, honest, effective, prudent and profitable management of the enterprises resources reporting. The fiduciary duties outlined in the 2001 Corporations Act needs directors to act in good faith, apply diligence and care, restrain from using their positions improperly and restrain from using information improperly. The second issue that the various groups agree on is introducing a direct notion of prudence reference (explained as a warning when identifying judgements in uncertain conditions) and to declare that discretion is crucial in achieving neutrality. For example, Eumedion Corporate Governance Forum supports this proposal and according to them, they understand that the explained prudence definition benefits the conceptual framework. The group is pleased to know that the IASB proposal is in line on the prudence topic with their comment letter. According to Eumedion, neutrality should be the starting standard setting even with many existing standards examples demonstrating asymmetry in the recognition of assets versus liabilities. The third issue is on the proposed change of stating directly that a faithful representation represents an economic phenomenon substance in lieu of representing its legal form. In the modern world, there is an increase in complex transactions, the capability to see through a transactions legal form to its economic substance keeps away from the inconsistent and perverse outcomes with a probability of occurring if only a transactions legal form is considered. For example, the AASB concurs with the proposal. According to the AASB, substance over form stays as a key basis through which important information is constituted in the general purpose financial reports. The fourth issue that the groups agrees on concerns clarifying that measurement uncertainty of high levels can cause the financial information to be less significant and clarifying that decisions that are important are driven through the consideration of the nature of the arising information regarding financial position and performance. For example, the ACAG concurs with the proposal where it states that dealing with uncertain measurements in public sector is common, where measurements for fair value have a high possibility of lacking points of reference in markets, to avoid this an enterprise can involve uncertain measurements of high degree and employ significant unobservable inputs (fair value hierarchy level 3). For example, in a case where the uncertain measurements of some cultural assets and heritage fair value is very high, the assets cannot be identified in the financial statements even though the can still be important at the Standards-level for disclosure. The issue of proposed change that the four groups don’t agree on concerns the continuation in identifying faithful representation and relevance of important financial information as the two essential qualitative characteristics. For example, the American Gas Association (AGA) concurs that the conceptual framework should continue its identification of the two stated essential qualitative characteristics but it does not believe that the changes proposed will represent any significant variations from the existing conceptual framework of the FASB. Answer C The capture theory best explains the various groups comment letters. This is because the International Accounting Standards Board (IASB) acts in the best interest of the public at heart (public interest theory) (Hantke-Domas, 2003). After the publication of the IASB exposure draft for public comments the various groups mentioned above wrote comment letters that were based on the capture theory where the firms tried to capture the process of regulation because each body had a lot at stake (Levine & Forrence, 1990). References Atiase, R. K., Bamber, L. S., & Freeman, R. N. (1988). Accounting Disclosures Based On Company Size: Regulations A. Accounting Horizons, 2(1), 18. Canning, M., & O'Dwyer, B. (2001). Professional accounting bodies' disciplinary procedures: accountable, transparent and in the public interest?. European Accounting Review , 10(4), 725-749. Duska, R., Duska, B. S., & Ragatz, J. A. (2011). Accounting ethics. John Wiley & Sons. Gregoriou, G. N., & Gaber, M. (Eds.). (2006). International accounting: standards, regulations, and financial reporting. Butterworth-Heinemann. Hantke-Domas, M. (2003). The public interest theory of regulation: non-existence or misinterpretation?. European Journal of Law and Economics, 15(2), 165-194. Levine, M. E., & Forrence, J. L. (1990). Regulatory capture, public interest, and the public agenda: Toward a synthesis. Journal of Law, Economics, & Organization, 6 , 167-198 Milne, M. J. (2002). Positive accounting theory, political costs and social disclosure analyses: A critical look. Critical perspectives on accounting, 13(3), 369-395 Mitchell, A., & Sikka, P. (1993). Accounting for change: The institutions of accountancy. Critical Perspectives on Accounting, 4(1), 29-52. Parker, L. D. (1994). Professional accounting body ethics: In search of the private interest. Accounting, Organizations and Society, 19(6), 507-525. Sarlak, N. (2008). Ethics in accounting. Read More