1. The regulatory approach to the formulation of an accounting theory
Chapter 4
The regulatory approach to the formulation of an accounting theory

2. The nature of accounting standards
Accounting standards usually consist of three parts:
a description of the problem to be tackled
a reasoned discussion on ways of solving the problem, then,
in line with the decision or theory, the prescribed solution

3. Requirements under accounting standards
Edey divides accounting standards into four types:
Requires accountants to tell people what they are doing by disclosing the methods and assumptions adopted
Aims at achieving some uniformity of presentation of accounting statements
Calls for the disclosure of specific matters in which the user may be called to exercise his or her own judgement
Requires implicit or explicit decisions to be made about approved asset value and income determination

4. Reasons for establishing standards
To provide users with information about a firm’s financial position, performance and conduct
To provide public accountants with guidelines and rules of action
To provide the government with databases on variables that are deemed essential to the conduct of taxation, regulation of enterprises, planning and regulation of the economy, and enhancement of economic efficiency and other social goals
To generate interest in principles and theories among all those interested in the accounting disciplines

5. Approaches to accounting policy questions
A representational faithfulness approach:
favours neutral reporting and the pursuit of faithful representations through the standard-setting process
An economic consequences approach:
favours the adoption of standards with good economic consequences

6. Pre-1999 standard-setting arrangements
Australian Accounting Standards Board (AASB) was created in 1989
The AASB replaced the Accounting Standards Review Board (ASRB)
The AASB has similar standard-setting functions, but broader responsibilities than the ASRB

7. The ASRB
The ASRB was created in 1983 to improve the enforceability of Australian accounting standards
At this time, the rules governing compliance were outlined in APS1:
members of the accounting profession responsible for financial statement preparation were to attempt to ensure that any departures from accounting standards were adequately disclosed in the accounts

8. The ASRB (rules governing compliance cont’d)
members of the accounting profession who were auditors were required to issue qualified audit reports if a departure from an accounting standard undermined the presentation of a true and fair view
if APS1 was not observed by members of the profession, then the councils of the two accounting bodies could take disciplinary action

9. APS1 deficiencies APS1 only applied to members of the profession
APS1 only required mandatory disclosure of non-compliance rather than compliance

10. Legislative backing of the AASB
In contrast to other boards of the AARF, the AASB had a line of authority to the government and not to the accounting profession
The accounting standards of the AASB have legal backing
If publicly listed companies do not comply, they risk punitive action from the Australian Securities Commission
The Attorney-General and federal cabinet must approve all 11 members of the AASB and appoint the chairman

11. Functions of the AASB
To develop a conceptual framework, not having the force of an AASB standard, for the purpose of evaluating proposed AASB standards
To review proposed AASB standards
To sponsor or undertake the development of possible AASB standards
To engage in such public consultation as may be necessary to decide whether or not it should make a proposed AASB standard
To make such changes to the form and contents of a proposed AASB standard as it considers necessary

12. The Public Sector Accounting Standards Board (PSASB)
Created in the early 1980s by the ASCPA and the ICAA as a board of the AARF
It reviewed the standards for relevance and applicability to the public sector
It developed a conceptual framework and accounting standards that were compatible with private-sector standards

13. Responsibilities of the PSASB
To devise and implement a process for the formulation and maintenance of AASs, statements of accounting practice (SAPs) and SACs of relevance to public sector reporting entities
To prepare AASs, SAPs and SACs of relevance to public sector reporting entities
To prepare and issue accounting guideline releases and exposure drafts of AASs, SAPs and SACs
To keep under review existing AASs, SAPs, SACs and accounting guideline releases

14. Other boards of the AARF
The Auditing Standards Board (AuSB) is responsible for promulgating statements of auditing practice and a conceptual framework for auditing practice
The Legislative Review Board (LRB) reviews relevant companies’ legislation for consistency and applicability to existing accounting standards

15. The AARF Funded jointly by the ASCPA and the ICAA
Primary function is to act as secretariat to the AASB, PSASB and other AARF boards

16. Principal duties of the AARF
To provide the boards with relevant technical advice on accounting and policy matters
To develop and write technical discussion papers and accounting-theory monographs
To develop, write, expose and issue exposure drafts to provide whatever other technical assistance the boards require. and to release statements of accounting concepts, accounting standards and other releases on behalf of the boards

17. The Australian Securities and Investment Commission (ASIC)
Founded in 1991, the ASIC is the supreme corporate regulator in Australia, and is comparable to the Securities Exchange Commission in the USA
The ASIC oversees the administration and compliance of the Corporations Law and companies’ legislation generally
Members are appointed by the Governor-General on the nomination of the Commonwealth Attorney-General

18. Interpretation of accounting standards
The ASIC delegates responsibility for standard setting for the AASB, however company compliance with AASB standards is enforced by the ASIC
It is not always clear whether the AASB as opposed to the ASIC should be clarifying or interpreting accounting standards
It has been argued that if the AASB sets the standards then it should interpret their meaning and applicability

19. The Urgent Issues Group (UIG)
Formed by the AARF and its boards early in 1995
The UIG’s main function is to provide timely guidance releases on urgent accounting issues
Any decision of the UIG can be vetoed by the AASB and PSASB

20. Influence of the accounting profession on standards
Standards that do not have support from accountants and/or the business community could result in:
lobbying by particular interest groups
non-compliance
refusal of companies to contribute to or participate in the standard-setting process
threat of governmental regulatory intervention
It is in the AARF’s best interests to issue standards that are accepted by the business community and the accounting profession

21. Consultative groups
Each board consults with members of its consultative group to increase the involvement of interested groups in the standard-setting process
Consultative group members include representatives of the parties interested in and affected by accounting standards

22. Exposure drafts
Draft exposure drafts are prepared by the boards and refined through discussion
The draft is then issued as an exposure draft by the AARF, which invites comment from all interested parties, usually over a period of at least three months

23. Finalisation of accounting standards
Draft is forwarded to the National Councils of the Society and Institute and to the Federal Attorney-General’s Department and the Australian Securities Commission
After the exposure draft and consideration of comments are received, a draft statement of accounting concepts (or draft accounting standard) is prepared
A 30-day review period applies
Statements of accounting concepts are issued by the AARF and the AASB
The AARF issues AASs
The AASB makes and issues AASB standards

24. Comparability with International Accounting Standards
This is an important aspect of accounting standard setting in Australia
Australian Accounting Standards carry an endorsement indicating compatibility with International Accounting Standards
Where an Australian Accounting Standard differs from an International Accounting Standard, reasons for material differences are given (where appropriate)

25. Peirson Report 1990
Commissioned to recognise defects in standard setting by reviewing existing institutional arrangements for accounting standard setting in Australia
Reviewing comparable arrangements internationally
Recommending appropriate arrangements for Australia

26. Recommendations of the Peirson Report
The formation of two broadly constituted consultative groups, one for the private sector and one for the public sector
Replacement of the AARF with a reconstituted Australian Accounting Standards Foundation, which would be independent of the accounting profession, business and government
The merging of the AASB and the PSASB into a single national accounting standards-setting body of the AASF

27. Benefits of the reforms
Accounting standard setting will be independent of interest groups including the accounting profession, business and government
There will be a significant increase in the numbers involved in the standard-setting process
Merging the PSASB and the AASB will enable more efficient use of the scarce resources available for standard setting
There will be a coordinated national approach to setting accounting standards
Legislative backing for accounting standards will continue
The funding for the AASF will be broadly based, insuring its independence

28. Rejection of the Peirson Report
The Peirson report was largely rejected by the Attorney-General’s Department
Proposals may have been too far-reaching and ambitious
There may have been a perception that the status quo was working satisfactorily
It is most likely is that the government did not wish to relinquish its control over the standard-setting process

29. Changes effected by the Peirson Report
In 1994, broad-based consultative groups were established
Membership of the AASB was increased from nine to 11 members
The Attorney-General’s Department supported a merger of the AASB and PSASB

30. Post-1999 structure and the Corporate Law Economic Reform Program Act
The Corporate Law Economic Reform Program (CLERP) was announced in 1997
Under the new legislation, standard setting is now within the domain of the federal treasurer
Two questions addressed in CLERP Position Statement No. 1 were:
How should existing standard-setting arrangements and structures be reformed?
Should Australia continue to develop its own accounting standards or adopt international accounting standards?

31. Reforms to institutional arrangements
Perceived deficiencies of the present system according to CLERP
Existing arrangements for accounting standards setting are confusing and inefficient
There is duplication between the AASB and PSASB
Australian Accounting Standards are not well understood internationally
The standard-setting process is perceived to be dominated by the accounting profession and there is no real accountability to its users
Accounting standards do not reflect modern business practices

32. Changes proposed by CLERP and adopted by the 1999 Act
Creation of the Financial Reporting Council (FRC) to oversee the setting of accounting standards
Creation of a new AASB
The new AASB will follow the strategic direction determined by the FRC
Project advisory panels of experts on particular subjects are to be used in the development of standards
The FRC will appoint members of the AASB

33. International harmonisation
Major recommendations by CLERP
Australia should continue to harmonise its standards with the International Accounting Standards
The prime focus of the AASB should be to influence the development of high-quality and relevant IASC accounting standards
A key role of the FRC should be to ensure that the AASB is committed to and works towards the adoption of IASC standards

34. Benefits of adopting IASC standards
Many of Australia’s trading partners in Asia have now adopted IASC standards
Foreign-listed companies are permitted by the Australian Stock Exchange to register using IASC standards
The international profile of Australian companies needs to be lifted to facilitate access to foreign capital markets at a lower cost
Harmonisation will facilitate creation of a common language around the world

35. Public accounting firms
The most influential public accounting firms are:
Ernst & Young
Arthur Andersen
Coopers and Lybrand
KPMG Peat Marwick
Price Waterhouse
Deloitte Haskins & Sells
Touche Ross
Lavanthol & Horwath
The work of public accounting firms consists of auditing, accounting, tax and management-advisory services

36. Users of financial statements
Direct users include:
the owners of a corporation and its shareholders
creditors and suppliers
the firm’s management
the firm’s workers
taxing authorities
customers

37. Indirect users of financial reports
Indirect users include:
financial analysts and advisers
stock exchanges
lawyers
regulatory or registration authorities
the financial press and reporting agencies
trade associations
labour unions
competitors
the general public
other government departments

38. Different users’ needs
Direct and indirect users have different information needs
Three kinds of financial statements may be prepared:
general purpose financial statements that meet the common needs of the users
specific purpose financial statements that meet the needs of specific user groups
differential disclosures may present different figures for the user to select

39. Theories of regulation
Two major categories
Public interest theories:
maintain that regulation is supplied in response to a public demand for the correction of inefficient or inequitable market prices
Interest group or capture theories:
maintain that regulation is supplied in response to the demands of special-interest groups in order to maximise their members’ income

40. Arguments against regulating accounting
Arguments for an unregulated market use the agency theory to question the existence of incentives for reliable and voluntary reporting to owners
Firms have an incentive to report voluntarily to the capital market because they compete for scarce resources: failure to report might be interpreted as bad news

41. Arguments for a regulated market
Those arguing for a regulated market use a public interest argument
Either market failures or the need to achieve social goals dictates regulation of accounting
Causes of market failures include:
a firm’s reluctance to disclose information about itself
the occurrence of fraud
the underproduction of accounting information as a public good

42. The free-market approach
Assumes that accounting information is an economic good that:
is subject to the forces of demand and supply
results in an optimal amount of information disclosed at an optimal price
Advocates of a regulatory approach maintain that there are market failures in the private market for information

43. Market failures
Explicit: In explicit market failure, the quantity and quality of information differ from the social optimum
Implicit: Implicit market failures focus on the following defects:
monopoly control over information by management
naïve investors
functional fixation
misleading numbers
diversity of procedures
lack of objectivity

44. Private-sector regulation of accounting standards
Advantages
The AASB is responsive to various constituents
The AASB attracts as members people who possess the necessary technical knowledge to develop and implement alternative measurement and disclosure systems
The AASB is successful in generating a reasonable amount of response from its constituency base and in responding to this input

45. Private-sector regulation of accounting standards
Disadvantages
The AASB lacks statutory authority and faces the challenge of being overridden by government
The AASB has been accused of lacking independence from dominating interests, such as the accounting profession
The AASB has often been accused of responding too slowly to major issues that are of crucial importance to some of its constituents

46. Public-sector regulation of accounting standards
Arguments in favour
The ASIC acts as ‘creative irritant’ and as a catalyst for change, since the private sector and market forces do not provide the leadership necessary to effect such change
The structure of securities regulation established by the 1991 Corporations Law serves to protect investors against perceived abuses

47. Public-sector regulation of accounting standards (cont’d)
Arguments in favour (cont’d)
The ASIC is motivated by the desire to create a level of public disclosure deemed necessary and adequate for decision making
Unlike the AASB, the ASIC is secured greater legitimacy through its statutory authority
Private-sector objectives may sometimes contradict the public interest

48. Public-sector regulation of accounting standards (cont’d)
Arguments against
There is a high corporate cost for compliance with government regulation of information
Bureaucrats have a tendency to maximise the total budget of their bureau
There is the danger that standard setting may become increasingly politicised
Government regulation backed by police power may hinder the conduct of research and experimentation of accounting policy and is not essential to achieving standardisation of measurement

49. Accounting standards overload
Too many standards
Too detailed standards
No rigid standards, making selective application difficult
General-purpose standards fail to provide for differences in preparers’, users’ and CPA’s needs
General-purpose standards fail to provide for differences between:
public and non-public entities
annual and interim financial statements
large and small enterprises
credited and non-audited financial statements
Excessive disclosures and/or complex measurements

50. Effects of accounting standards overload
Accountants may lose sight of their real jobs because of the excessive data required to comply with standards
Audit failures may result because the accountant may forget to perform basic audit procedures
The proliferation of complex accounting regulations may lead to non-compliance

51. Solutions to the standards overload problem
The AICAP Special Committee on Accounting Standards evaluated the following possible approaches:
no change
a change from the present concept of a set of unitary GAAP for all businesses, to two sets of GAAP
change GAAP to simplify application to all business enterprises
establish differential disclosure and measurement alternatives

52. Solutions to the standards overload problem (cont’d)
a change in CPAs’ standards for reporting on financial statements
an alternative to the GAAP as an optional basis for presenting financial statements

53. The outcome
The AICAP Special Committee on Accounting Standards recommended either establishing disclosure and measurement alternatives or adopting an alternative to GAAP
The alternative to GAAP rests on three possibilities:
a new basis accounting method (BAM)
the cash or modified cash basis
the income tax basis

54. The outcome (cont’d)
A BAM is out of the question because it would create more costs than benefits
The committee suggested that the issuance of compiled, reviewed or audited other comprehensive-bases-of-accounting (OCBOA) financial statements would help alleviate the burden of accounting standards overload for small non-public entities