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In the UK, there are two sources of regulation: the Companies Act and accounting standards. Non-listed companies follow national accounting standards. However, listed companies must follow International Financial Reporting Standards (IFRS).
The International Accounting Standards Committee (IASC) was formed in 1973 by professional accounting bodies from various countries. Accounting standards were set by a part-time, volunteer IASC board. However, a change in structure was needed to bring about the convergence of national and international standards and to produce high quality global standards. In 2001, the International Accounting Standards Committee Foundation (IASC Foundation) was formed as a non-profit organisation.
The IASC Foundation aims "to develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards." (IFRS, 2010, accessed 02/12/10) It has two main bodies: the Trustees and International Accounting Standards Board (IASB) but also has Standards Advisory Council (SAC) and International Financial Reporting Interpretations Committee (IFRIC).
The Trustees have responsibility for governance and fundraising. They approve the annual budget and publish an annual report. The Trustees review the strategy and effectiveness of the IASC Foundation and the IASB, but do not determine their agenda. They promote the use of IFRS.
The IASB is an independent standard setting board and is responsible for issuing IFRS. The Board adopted International Accounting Standards (IAS), which were issued by the IASC. The IASB work closely with IFRIC, SAC and national standard setters to determine their agenda.
The International Organisation of Securities Commissions (IOSCO) agreed with the IASB a set of standards to work on and if acceptable they would promote adoption to their members. IASB and IOSCO work to resolve outstanding issues.
The SAC provide a forum for participation were individuals and organisations who are interested in international financial reporting can interact. The main objectives are to advise the IASB on their agenda and priorities and inform the IASB of views which arise during the standard setting process.
IFRIC provide guidance on financial reporting issues and interpret the application of IFRSs. IFRIC review current standards and assist in developing and improving financial reporting standards. Their aim is to achieve convergence in the development of global standards.
The development of a standard entails a thorough and systematic process shown in the diagram. The IASB develop standards in the most effective and cost efficient way. The IASB works with other national setters to identify future agendas, but the SAC must be consulted before proposing agenda priorities.
The IASB may publish a discussion document, which provides an overview of issues proposed and identify possible solutions. This is available for public comment and comments are reviewed. Once resolved an exposure draft is published. Comments are reviewed and the IASB may decide further discussion is needed and publish another exposure draft. However, once all issues are resolved and the standard is approved by a majority, the IFRS are issued.
IFRS are enforced at national level. Auditors check financial statements to determine compliance with accounting standards and the company's Act. The Auditor's Practice Board establish high standards and a faithful representation of company affairs must be shown. In the UK, accounting standards are enforced by the FRRP, which is part of the Financial Reporting Council (FRC). The FRC develops, monitors and enforces accounting standards in the UK. They work closely with the IASB in developing international standards to try and achieve convergence of accounting standards. The FRRP ensures accounting standards and requirements of the Company's Act are followed.
Financial statements are prepared by individuals, which rely on their personal judgement and interpretation. Financial statements are required by a wide range of users, who make informed economic decisions from them. Therefore, rules and regulations are needed to provide the basis for preparing financial statements. Accounting standards are put in place to promote compliance and responsible business behaviour.
The regulatory framework is the set of rules and regulations which governs accounting. Financial statements are prepared by adopting the rules and regulations. Regulation is needed as a guide, so the rules are interpreted correctly. The regulatory framework aims to ensure responsible business behaviour and to provide a faithful representation of financial statements.
The regulatory framework consists of local laws, accounting standards, stock exchange requirements, international accounting standards and conceptual framework. The regulatory framework is needed to provide accepted, understandable and high quality rules and regulations to underpin accounting and provide clarity on the correct treatment of certain aspects of accounting. It provides a basis of reference to encourage professional behaviour when preparing financial statements. The framework promotes compliance with accounting standards and principles when preparing a faithful representation of financial statements, which will encourage individuals to act in a professional and responsible manner.
Accounting standards are provided were clarification is needed on how to deal with a particular aspect of accounting. For example, IAS 38 was developed to stop uncertainty surrounding goodwill. There can be purchased and internally generated goodwill. Internally generated goodwill is where firms took advantage. But IAS 38 states internally generated goodwill should not be recognised because the cost of the item cannot be measured reliably. Accounting standards define how to treat particular characteristics when preparing financial statements, promoting compliance and professional behaviour. Accounting standards must be adhered to when preparing financial statements.
The conceptual framework underpins accounting practice. It creates a set of fundamental accounting principles, which helps preparers of financial statements and auditors making an opinion on compliance with accounting standards. The conceptual framework gives guidance on broad principles such as recognition, measurement and presentation and provides a reference point where standards are less prescriptive.
The conceptual framework's main objective is to provide useful information about the financial position, performance and changes in financial position. Accounts are prepared to meet the needs of its users such as: investors, customers, lenders and the government. Financial statements cannot meet all of the user's needs, however financial statements that meet investor's needs normally covers the other user's needs too.
"FRS 18 then turns its attention to specifying four such characteristics, namely relevance, reliability, comparability and understandability. (Britton, A and Waterston, C, 2003, p.53)
The conceptual framework highlights four principal characteristics that make accounting information useful to users. Financial information needs to set out so it is understandable by users. However, users are expected to have a reasonable knowledge of accounting. The information provided needs to be relevant to users when making decisions. Users can use accounting information to analyse the position and to assess the future performance of the company. Financial statements must be produced using similar accounting policies or show where different policies are used. This is to help users compare accounting information from previous years to help make decisions. Financial statements need to be reliable for users to make good decisions. Information needs to be free from material error and individual bias, which shows a faithful representation of a business's performance and position. The conceptual framework promotes responsible business behaviour when constructing financial statements for users.
However, each country is different, as standardisation is unlikely and harmonisation is proving difficult. Different countries follow different accounting rules and regulations. For example the UK follow a more principle based system and the US a more rules based system. A rules based approach lists a detailed set of rules and regulations that must be followed, which limits the flexibility and judgement involved in preparing financial statements. Rule based standards are easier to audit, as they tell the preparer exactly what to do. A principle based approach such Generally Accepted Accounting Principles (GAAP) is used as a conceptual basis for preparing financial statements. This highlights a key set of principles that ensure good financial reporting. A principle based approach relies on the interpretation and judgement of the preparer.
"If you destroy a free market you create a black market. If you have ten thousand regulations, you destroy all respect for the law." (Jones, M, 2006, pg.267)
This quote from Winston Churchill shows that there is a need not to overregulate, as by creating too many standards and regulations individuals may lose respect for them. ACCA (2010, pg.21, accessed: 3/12/10) believes that failings in the banking sector occurred despite extensive and prescriptive regulatory controls. Failings occurred not because there were too little regulatory controls but despite them. This coincides with Churchill's statement, as the rules and regulations in place did not prevent irresponsible behaviour.
ACCA (2010, pg.21, accessed: 3/12/10) argues that scandals will continue to occur despite an expansion of regulatory controls. These have failed to prevent irresponsible behaviour. A rules based approach are easier to take advantage of, as businesses can search for loopholes that meet the standard's description but violate the intent of the standard. A principle based approach can be too vague in its meaning. Principles do not show the user precisely what to do, which creates fuzziness. They rely upon the judgement of individuals to implement the standards and there is a danger they can be used to manipulate results, as they are more difficult to audit.
Enforcement and supervision of regulatory rules and principles is a problem. A rules based system is easier to enforce than a principle based system, as it is more precise in its terms. To promote the use and compliance with rules and principles in place, there needs to be an effective way to supervise a company's conduct and needs to be strong enforcement of accounting standards to punish those who do not comply with them. Standardisation of accounting rules and regulations would make enforcement easier, as there would be one set of rules and principles for everyone to follow. This is unlikely due to the differences between nations such as: different political systems and cultural differences. Due to the variation of accounting standards between countries, businesses fail to commit fully to applying accounting standards and regulations because it might not be in the best interests of the company.
Arnold, G (2008, pg.7) argues the firm's main objective is to maximise long term shareholder wealth and the maximisation of profit. In the recent financial crisis a firm's objective might even be survival. These objectives might have an impact on a firm's business decisions, as business in capital society is about material gain. To achieve their objectives an individual might not follow accounting rules and principles and look for loopholes, which would benefit the firm.
"At heart, ethics are the fundamental principles of fairness, trust and good governance that underpin all effective businesses behaviour." (Steward, C, 2009, accessed: 23rd November 2010)
Organisations have various ethical schemes in place. Ethics are key to encourage responsible business behaviour. Professional Bodies all have a code of ethics. Elliott and Elliott (2011, pg.165) highlights the IFAC code of ethics for professional accountants consists of five important principles which are: integrity, objectivity, professional competence and due care, confidentiality and professional behaviour.
An ethical consideration of integrity is highly important, as honesty and truthfulness in business relationships is essential. Objectivity is also important, as individuals should be impartial and free from bias. Individuals should act in a professional manner by following professional standards and regulations and respect confidentiality of business relationships.
A compliance based approach to ethics can be used to encourage individuals to act in line with regulations and codes of ethics. This approach maintains professional competence, as violations are prevented, detected and punished. Individuals are monitored and precautions such as: whistle blowing, audit and discipline are in place to deter dishonest performance.
Despite professional codes of ethics and precautions carried out by companies scandals continue to occur. Moxey, P (2010, accessed: 05/12/10) claims the financial crisis has highlighted serious ethical failings. This is despite an increase in monitoring of businesses and their behaviour. Individuals have exploited openings in the rules and regulations, which highlights individual ethical failings.
"The effectiveness of any set of rules or codes of practice will be dependent on the competence and integrity of individuals who have the authority to make decisions." (Moxey, P, 2010, accessed: 05/12/10)
Rules and regulations promote responsible business behaviour, but eventually it is down to individual members of a business who make important decisions. Individual ethics will determine the success of accounting standards in place. The quote highlights that for rules and regulations to be successful, individuals who have the power to make decisions must act in an honest and competent manner. Individuals must behave responsibly when making business decisions.
Accounting standards promote responsible business behaviour. The regulatory framework consists of accounting rules and legal systems in place. They promote the use and compliance with accounting rules to give a faithful representation of a company's affairs. The conceptual framework consists of accounting principles to provide useful financial information to the users. However, a rule based or principle based frameworks cannot assure responsible business behaviour. The disadvantages of both the regulatory and conceptual frameworks allow individuals to exploit them. Rules and regulations can create fuzziness for individuals looking to benefit and principles can be too vague, which creates a possibility for individuals to take advantage. Both the regulatory and conceptual framework promotes responsible business behaviour but cannot guarantee that individuals will act responsibly and abide by the standards and principles.