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Contemporary Issues in Accounting, Special Topics in Accounting, MBA, University of Jordan
  • 1. Solution Manual to accompany Contemporary Issues in Accounting Michaela Rankin, Patricia Stanton, Susan McGowan, Kimberly Ferlauto & Matt Tilling PREPARED BY: Patricia Stanton John Wiley & Sons Australia, Ltd 2012
  • 2. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.1 CHAPTER 3 STANDARD SETTING Contemporary issue 3.1 Rules-based versusprinciples-based standards 1. The two principles for the design of the village were shelter and safety. In what ways do accounting standards also provide ‘shelter and safety’? (K) Accounting standards shelter preparers by providing guidance in the preparation of financial statements. The standards can be used by preparers to defend their decisions when challenged by auditors. 2. Using the example in the above scenario, what are the advantages of principles over rules? (J) Principles should remain unchanged with changing economic conditions so that standards derived under a principles based system should not have to be changed when conditions change. Standards can be form of fuzzy based law under a principles system. Under rules based standards, any change in the underlying conditions requires a change to the standard. Ways to circumvent the black letter law of rules based standards are more easily found than under principles based standards. Contemporary issue 3.2 Treasury chiefs revolt over budgetrules 1. What reasons can you offer for the International Monetary Fund issuing requirements for government financial reporting? (K) The IMF is an organization of over 180 countries working to foster among other things global monetary cooperation, secure financial stability, and facilitate international trade. Its stated objectives are to promote international economic cooperation, international trade, employment, and exchange rate stability, including by making resources available to member countries to meet balance of payments needs. To this end, the IMF needs comparable and reliable reporting by governments of their financial situation.
  • 3. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.2 2. What do you think is the fundamental difference between company financial reporting and government reporting? (AS) Companies need to make a profit. Governments do not have a profit motive. Their results are measured in terms of surplus or deficit. 2. 3. What do the letters GFS and GAAP stand for? (K) GFS refers to Government Financial Statistics; GAAP to Generally Accepted Accounting Principles.
  • 4. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.3 Review questions 1. In what sense are accounting standards ‘standards’ in the general meaning of the word? Accounting standards are set by what can be referred to as ‘general consent’, which mirrors the dictionary definition of a ‘standard’. 2. How do principle-based standards differ from rules-based standards? A principle-based standard is based on a concept or concepts which are derived from conceptual framework. Standards based on principles derived from a common conceptual framework should be constituent both within and across standards. A rules-based standard contains specific rules designed to meet as many contingencies as possible. Rules based standards often conflict with other rules-based standards. A rules-based standard is prescriptive; the principles-based one is broader. 3. What are the functions of accounting standards? The main function of accounting standards is to guide preparers of financial reports so that information contained therein permits users to make useful decisions based on that information. Another function is to provide a defence for preparers of financial reports based on those standards if a reporting entity fails and misleading accounts are blamed for the failure. Additionally, standards raise the profile of the profession. 4. What do you think the standard-setting process should achieve? As this question is targeting the views of those using the text, a single answer cannot be provided for this question. Perhaps views should include the features of consistency, transparency and due process.
  • 5. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.4 5. Justify Australia’s approach of imposing its set of accounting standards on all reporting entities, irrespective of whether they are profit seeking. Under a principles based system, the definitions of the elements of financial reporting should apply universally. The recognition test arguably should also apply universally. A profit (loss) is derived from the difference between assets and liabilities over a period (itemised in the income statement). A surplus or deficit is also the difference between assets and liabilities, therefore, there is no need technically to have separate standards. 6. Define regulation. Mitnick’s (1980) definition is that regulation is a policing of some activity by an entity which is not party to, or involved in, the activity being regulated. 7. In what ways does accounting standard setting conform to your definition of regulation? This answer will depend on what answer was given to question 3.6. However, the profession’s historical intention to intervene in the production of financial information by reporting entities, and the restriction of choice that the intervention generated should be mentioned. The independence of the AASB also should be mentioned. 8. If the standard-setting process should achieve better information, what criteria would identify better information? 1. common concepts underlying the information 2. similar interpretations of guidance issued by the standards-setting authorities 3. relevance 4. reliability 5. comparability 6. understandability
  • 6. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.5 9. Is the setting of accounting standards desirable for society? If so, who should set standards? There are several facets to this question. Responses as to who should set standards will depend on the angle taken in answer to the first part. Students may respond in terms of: 1. social contract theory — in which case standards setters should reflect the composition of society affected by the standards and the organisations to which they apply 2. technical expertise — standards setters should have the expertise necessary to set appropriate standards 3. public interest 4. regulatory approaches, including the difficulty of monitoring and enforcement 10. How does good financial reporting add value to organisations? Information is important to the good working of financial markets. Financial reporting makes an important contribution to the information set used by financial market participants. Good financial reporting enhances the reputation of the disclosing entity. Signalling theory suggests a hierarchy of disclosure so that the best reporters are seen as having nothing to hide, thereby adding value. Good financial reporting also implies adherence to standards, which in turn implies that the information is relevant, reliable, understandable and comparable with other entities — qualities which should add value to the reporting entity. 11. Are interested parties behaving ethically when they try to influence the standard- setting process? The answer will depend on the ethical stance of the person advancing the argument, as well as on how and why interested parties try to influence the standard-setting process. For example, if an interested party is trying to capture all the benefits of a particular standard to
  • 7. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.6 the detriment of all other interested parties, then they could be argued to be not acting ethically. 12. Explain the statement that ‘information is the oil that lubricates markets’. How can this statement be used to justify the regulation of accounting information? A perfect market requires perfect information. Without accurate and useful information, the market cannot function. Regulation of accounting information ensures that accounting information, a public good, will not be under-produced. Some argue that without regulation, accounting information would not be produced at all and therefore, markets would not operate efficiently. 13. In your opinion, do the benefits from regulating accounting information outweigh the costs? Justify your answer. The benefits relate to: 1. increased efficiency in allocating capital 2. cheaper production of accounting information 3. checks on perquisites 4. public confidence 5. standardisation 6. public good argument. The costs relate to: 1. attempting to achieve efficiency and equity through regulation 2. determining the amount of optimal information 3. the difficulty of reversing regulation once it is in place 4. the restrictions placed on innovation of ways of presenting and communicating accounting information 5. the imposition of standard reporting systems on entities which are very different 6. regulation generates lobbying which advantages certain interest groups
  • 8. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.7 7. the displacement of contracts as a means of negotiating with management as to the types of information to be disclosed, as well as place and time of information disclosure. 14. How do you reconcile the ‘adoption’ of international accounting standards with the process of ‘harmonisation’? Answers will depend on the position taken by students. However, adoption implies that no changes will be made to the standards by the adopting country. Harmonisation implies that changes will be made to suit the requirements of the adopting country. Such changes reduce the comparability of the resulting financial statements. 15. With particular reference to the following opinion expressed by Watts and Zimmerman, discuss whether accounting standards setting is a ‘two-edged sword’: Regulation affects the nature of the audit. It expands the audit … [R]egulation provides the auditor with the opportunity to perform additional services and lobby on accounting standards on clients’ behalf. Regulation also provides the auditor with the opportunity to lobby for increasing accounting complexity because of its audit fee effect.45 A suggested solution to this question is inappropriate, although reference to accounting/auditing incidents such as Enron, WorldCom suggest that Watts and Zimmerman ‘were on the money’! 16. Drawing on your knowledge of the Conceptual Framework and of principles based standards, discuss the following statement: Ultimately, it is the underlying economic substance that must drive the development of the scope of standards, if . . . standards are to remain stable and meaningful.46 Again, a suggest solution is inappropriate, although students should define the key terms of ‘economic substance’ and ‘principles based’.
  • 9. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.8 17. What is ‘lobbying’? Who would be expected to lobby an accounting standard, and why? Lobbying is the attempt to influence decisions made by officials such as the members of the IASB when setting standards. Lobbying can be viewed as a mechanism by which regulators are informed about policy issues because lobbyists convey their specific knowledge about the issue being regulated. Management can afford to invest more than users in lobbying for their point of view. As a result, standards are more likely to reflect benefits for the reporters of financial information than for users of that information. Certain interest groups such as preparers and auditors seek and gain economic rents by investing resources in the pursuit of favourable regulations. 18. Sutton states that accounting standard setting is a political lobbying process, and as such offers several opportunities and means for interested parties to influence its outcomes.47 What are the opportunities that Sutton mentions? Various points in the due process procedures; meetings with individual standard setters. What methods do lobbyists employ to influence the outcomes? Lobbying methods are classified as either direct or indirect. Direct methods involve communicating with members of the standard setting board. Indirect methods mean communicating via an influential third party. How has Australia’s adoption of international standards affected lobbying activity by interested parties? The adoption alters opportunities for lobbying. Decisions must be made whether to lobby various members of the IASB directly or only the Australian member; or to lobby members of the Australian liaison board so that the board conveys their viewpoint to the IASB; to make submissions via the Australian body or the international one.
  • 10. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.9 19. Hoogendoorn suggests that there is tension between a principles-based interpretation of IFRSs and a rules-based interpretation.48 If IFRSs are principles- based standards, why should there be such tension? When the US adopts IFRSs, is this tension likely to increase? Why? The tension arises from principles-based standards relying on preparers’ judgement when preparing financial statements. Judgement is likely to result in a diversity of outcomes so that the resulting financial statements are probably less comparable than under a rules-based system. To avoid the diversity in outcomes, rules for application of the principles-based standard are a solution. If, and when, the US adopts IFRSs, the tension is likely to increase as the US has used rules-based standards for a very long time. 20. In relation to the governance of the IASB, who governs the governor? From the IASB’s website: “The IFRS Foundation is an independent, not-for-profit private sector organisation working in the public interest... The governance and oversight of the activities undertaken by the IFRS Foundation and its standard-setting body rests with its Trustees, who are also responsible for safeguarding the independence of the IASB and ensuring the financing of the organisation. The Trustees are publicly accountable to a Monitoring Board of public authorities.” “Trustees are appointed for a renewable term of three years. Each Trustee is expected to have an understanding of, and be sensitive to, international issues relevant to the success of an international organisation responsible for the development of high quality global accounting standards for use in the world’s capital markets and by other users. Six of the Trustees must be selected from the Asia/Oceania region, six from Europe, six from North America, one from Africa, one from South America and two from the rest of the world.”
  • 11. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.10 Application questions 3.1 Laughlin stated the following: Accounting standard setting may not fulfil the litmus test of being ‘regulative and amenable to substantive justification’ due to its active rejection of a wider stakeholder commitment and the preferential treatment of finance capitalists.49 (J, K, AS) (a) What is a ‘litmus test’? A litmus test in chemistry is a test for chemical acidity using litmus paper. The term has been used to signify a test that uses a single indicator to prompt a decision; in this case Laughlin is suggesting that standard setting would fail the test of substantive justification for standards (b) Why should accounting standards be ‘amenable to substantive justification’? Accounting standards can redistribute wealth and in so doing effect many stakeholders. Accounting needs significant social and political studies of accounting standard setting so that the effects of regulation can be assessed. The IASB appears to be largely indifferent to the information needs of any user other than finance capitalists. (c) Does the AASB’s User Focus Group provide evidence of ‘the preferential treatment of finance capitalists’ in the standard setting process? The User Focus Group generally comprises eight to ten investment and credit professionals.
  • 12. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.11 3.2 The Australian reported that one of Australia’s top accountancy firms said that company annual reports have become too long and it wants IFRSs trimmed. Representatives of the firm said that IFRSs had complicated accounting — for reporting financial instruments alone, there was now more than 300 pages of rules, and guidance that did not exist under ‘the old rules’. [J, K] (a) Are IFRSs rules-based or principles-based? They are principles-based. (b) If IFRSs are principles-based, why do you think the standard focusing on financial instruments is accompanied by 300 pages of rules and guidance? Financial instruments are complex commercial instruments (as the Global Financial Crisis revealed). Describing unambiguously the instruments to be accounted for (and those to be excluded) is an issue for standard setters. “Fair value” requires many rules to provide guidance such as which market price should be chosen when there are several market prices for an instrument. The complexity of both financial instruments and fair value has generated the 300 pages of guidance. (c) Do you think that the existence of such lengthy guidance notes is what Hoogendoorn was referring to when he commented on the tension between a principles-based interpretation of IFRSs and a rules-based interpretation? Under a principles-based approach, the test is whether an accounting treatment is appropriate in the circumstances. If the IASB wants to avoid diversity in practice, the only solution according to Hoogendoorn is to have more and more detailed rules (or official interpretations).
  • 13. Solution manual to accompany:Contemporary Issues in Accounting © John Wiley and Sons Australia, Ltd 2012 3.12 3.3 Coca-Cola Amatil conducted a campaign against Australia’s adoption of IFRSs in 2004. The company lobbied against requirements that meant Coca-Cola Amatil’s balance sheet values would have to be written down by as much as $1.9 billion. (J, K, AS) (a) What is meant by the term ‘lobbying’? Lobbying is the attempt to influence decisions made by officials such as the members of the IASB when setting standards. (b) Who would be likely targets of Coca-Cola Amatil’s lobbying activities? The FRC? AASB? Federal Government? (c) Why would adoption of international standards so heavily affect Coca- Cola Amatil? IAS 38 would prevent Coca-Cola Amatil from including valuable internally generated intangibles on their balance sheet. (d) Did harmonisation affect Coca-Cola Amatil’s balance sheet? The note from the 2004 financial statements: Intangible assets Impact on retained earningsof previousrevaluation at 1 January 2004 (reduce by approximately $1.9 billion) CCA’s investments in bottlers’ agreements are recognisable under IFRS. However, revaluation of CCA’s investments in bottlers’ agreements at fair value is not permitted underIFRS. This will result in the reversal of the previous revaluation (as was permitted under the previous version of AASB 1010 “Recoverable Amount of Non-Current Assets” and the current version of AASB 1041 “Revaluation of Non-Current Assets”),thereby impacting retained earnings and net assets on transition to IFRS.
  • 14. Chapter 3: Standard setting © John Wiley and Sons Australia, Ltd 2012 3.13 3.4 A New Zealand paper reported that the integrated nature of capital markets, the mobility of capital and the global nature of the financial crises highlighted the need for a single set of high quality globally accepted accounting standards. The report went on to state that banks particularly wanted to eliminate diff
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