Financial reporting can be defined as a disclosure of financial and operational information of a business. This is done by preparing accounts for different periods (quarterly or annual), sharing risk management strategies and the level of risk to which the company is exposed, describing corporate governance, providing auditors' report and others. The information is summarised in annual reports of companies. The purpose of financial reporting is therefore to provide an access to financial information of the company for creditors, regulators, investors and other parties that are stakeholders of the company (Benston, 2006; Higson, 2003).
Key elements of regulatory framework in the UK for public companies
If financial reporting was not mandatory, companies would not be always interested in disclosing their internal information to other parties. Moreover, there would be more attempts to present fraudulent accounts in order to appear well performing and easily attract additional capital. Such actions would put investors and creditors to risk. Therefore, listed or public companies that raise capital from creditors and investors are subject to strict regulation from the standard setters and UK government (Rutherford, 2007).
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Regulatory framework prevailing in the UK can be divided into several elements. These elements are distinguished by particular bodies that govern financial reporting and create rules. The first regulatory body that plays a key role in the UK accounting and financial reporting standards is Financial Reporting Council (FRC). FRC is an independent body that has been preparing accounting rules since 1990. Its major role is to enforce financial reporting rules and oversee that they are kept and maintained properly (Elliott and Elliott, 2006). The role of FRC substantially increased after 2002 following the period of corporate scandals in the US (e.g. Enron scandal) (Fearnley et al., 2002; Lee, 2007). The UK government extended the power of FRC in the area of promoting transparent accounts, corporate governance and increasing confidence in financial reporting among the public.
FRC is a large regulatory body that is comprised of seven departments. These are Accounting Standards Board (ASB), Auditing Practices Board, Professional Oversight Board, Board for Actuarial Standards, Financial Reporting Review Panel (FRRP), Accountancy and Actuarial Discipline Board and Urgent Issues Task Force (FRC, 2009). From these departments, ASB can be singled out as the key player in setting mandatory accounting standards such as Financial Reporting Standards (FRS) and Statements of Standard Accounting Practices (SSAP) (Elliott and Elliott, 2006).
The next key body of the UK regulatory framework for listed companies is Financial Services Authority (FSA). Although this is a non-governmental independent corporation, it is still responsible before the UK Parliament. Current functions of the regulator were set in 2000 by Financial Services and Markets Act. FSA is in charge of controlling financial system of the UK and ensuring that economic agents have confidence in it. The objects of regulations are investing operations of institutions, deposits, mortgages, activities of commercial banks and investment banks etc. (Elliott and Elliott, 2006).
Regulation of financial reporting in listed companies in the UK is also provided by Company Law. Basic rules of financial reporting (that are further enhanced by Accounting standards) are set in the Companies Act 1985 and Companies Act 2006. Listed companies have to comply with them. Finally, public companies are listed on stock exchanges. So, they are also regulated by the rules set by each stock exchange (e.g. London Stock Exchange). In the UK, ASB and London Stock Exchange are the most important regulators that provide basic guidance and principles by which listed companies should prepare their financial reports. The cooperation of ASB and London Stock Exchange was recommended by Cadbury Committee (Elliott and Elliott, 2006). All these key elements (Accounting standards set by ASB, which is a part of FRC; FSA regulation and stock exchange rules and Company Law) represent regulatory framework in the UK for public companies (Elliott and Elliott, 2006; Rutherford, 2007).
Advantages and Disadvantages of IFRS to prepares, users, and standard setters
Over the past recent years UK regulators have been working on convergence of national accounting standards represented by UK GAAP and accounting practices of other countries, e.g. US GAAP and Japan GAAP (Weetman, 2006; Roberts et al., 2008). Acceptance of International Financial Reporting Standards (IFRS) gave an opportunity to reach unity of accounting rules within the European Union. Although not all developed companies are currently using IFRS, national accounting standards continue to be changing in order to be comparative to standards in other countries (Nobes and Parker, 2006). This need is raised by the increased rates of globalisation and integration of world economies. Companies become multination corporations with presence on several continents and different countries and regions. International investors and financial institutions have to work with financial reports completed by different accounting rules prevailing in the particular country. This raises difficulties in comparison (Taylor, 2009; Elliott and Elliott, 2006). Moreover, multinational corporations that have overseas activities have to translate financial reports to common accounting standards when consolidating subsidiaries. This results in different statements of earnings and value of assets since different methodologies and aspects of reporting are provided by accounting standards in other countries (Taylor, 2009).
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Acceptance of IFRS definitely has a number of advantages for preparers, users and standard setters. Preparers of the financial reports, i.e. corporations, will be able to cut accounting costs connecting with translating accounts from one type of standards to another if there are foreign operations. Uniform accounting standard accepted by countries will allow companies to exercise better control of their financial resources and simplify consolidation process when preparing annual reports (Nobes and Parker, 2006; Taylor, 2009). However, there are also disadvantages that will be faced by corporations that will have to report under new IFRS. Firstly, transition from previous accounting standards to IFRS will require additional costs in accounting departments and new qualified specialists and consultants. Secondly, the new rules of IFRS may affect the value of reported earnings and taxable income of the company since the principles of depreciation and revaluation are different for fixed assets. Inventory also has to be valued with different methodology (Taylor, 2009). Nonetheless, in spite of the disadvantages IFRS is quite flexible set of standards that are not based on rules but rather principles. Companies may use flexibility in interpretation to their own benefit (Nobes and Parker, 2006; Elliott and Elliott, 2006).
What is advantage to one party may be a disadvantage to another. This flexibility in IFRS and different interpretations of principles may increase the number of accounting fraud and creating accounting. This will hurt users of financial statements since they will receive misleading information (Taylor, 2009). This is a disadvantage for users such as investors and creditors. However, they also have advantages in switching to IFRS. It will become much easier to compare financial reports of several companies based in different countries. Better investment decisions will be made when the problem of information asymmetry is eliminated or reduced. Widespread use of IFRS will further stimulate international investing and increase international capital flows (Nobes and Parker, 2006). Financial lending institutions provide loans to corporations in different countries. Uniform standard for preparing financial reports will allow lenders to assess credibility of borrowers more easily and faster. Acceptance of IFRS will stimulate and increase mobility of accountants who will be able to work (or will be qualified) to work in other countries. Their skills can be used in more places. Increased mobility of accountants and competition among them will stimulate higher quality of accounting work and also allow corporations to have a wider choice of qualified specialists (Taylor, 2009).
Introduction of IFRS also has its advantages and disadvantages for standard setters and auditors. Launching new rules is costly. The costs will be spread between the companies, government and independent regulating bodies. This is an obvious disadvantage. Another disadvantage is that new IFRS rules may be interpreted differently in different countries (and even within one country by different companies). However, the bright side is that regulators of the UK and other countries in the European Union can work more efficiently when there is a common set of accounting rules by which financial reporting is guided. This will also increase efficiency of auditors' job (Roberts et al., 2008).
It should also be noted that national accounting standards (GAAP) developed in each country under influence of different factors such as the system of law, taxation and others. Accounting standards also bear cultural elements of each country (Nobes and Parker, 2006). Introducing a uniform IFRS prototype will cause many countries to abandon their historical cultural heritage and assimilate. This may also lead to inevitability of changing other laws such as principles of taxation if national standards differed greatly form IFRS (Taylor, 2009). While these disadvantages are important to account for, it should be argued that in the UK transition to IFRS is more smooth because the country has common elements of culture and historical heritage with other nations in Europe, North America and Australia. Moreover, there have been numerous steps undertaken towards convergence of UK GAAP and US GAAP, for example, so transition to IFRS cannot be viewed as a revolution in accounting (Roberts et al., 2008).
In conclusion, financial reporting in the UK has undergone a number of changes. The level of regulation increased. Different independent organisations (e.g. FRC and FSA) were formed to guide accounting practices. Public companies are also regulated by Company Law and stock exchange rules relating to financial reporting. There was also a shift towards acceptance of international accounting standards (IFRS). This tendency was shown to have both pros and cons for businesses that prepare financial reports, regulators and users of financial reports.
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