Regulatory frameworks and the IFRS

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A. Critically evaluate how the regulatory Framework and International Financial Reporting Standards have ensured that annual Reports and Financial Statements meet Investor and Shareholder needs

Accountants all over the world have displayed an agreement for uniformity in accounting standards. Standardised accounting standards are desirable to make accounting a universal language of communication and to deny any scope for manipulation. Financial statements prepared using a common set of accounting standards help investors better understand investment opportunities of international businesses. Companies prepare financial statements in accordance with Companies Act (1985); these financial statements are accompanied with reports from significant members of the company, to form the company's annual report. This report gives a comprehensive understanding on a company's activities throughout the preceding year. The purposes of annual reports are to ensure shareholders and investor needs are met by providing information about the company's activities and financial performance.

Financial globalisation has brought substantial benefits to countries around the world (International Monetary Fund, 2010). The international globalisation of accounting standards brings international accounting standards into agreement, with the overall goal of achieving a common set of principles. This uniformity allows everyone involved in financial management to make comparisons and achieve a higher level of confidence in strategic decisions. Globalisation of accounting standards would bring about the benefit of comparability (Roberts, Weetman & Gordon, 2005) and would remove misinterpretations of foreign financial statements and certify reliability and understandbility. With standardised international standards, all the information presented in the financial statements will be relevant and without having to consolidate divergent financial information, time and money will be saved. Global accounting would be advantageous to those countries that still do not have adequate codification of accounting standards.

The standardisation of accounting rules and procedures is not one without its obstacles and disadvantages. The most fundamental difficulty to globalisation is the present differences between the accounting practices of different countries (Nobes & Parker, 2008), some countries lack strong professional accountancy bodies and this may make it difficult for those countries to adhere to a set of principles. Nobes and Parker (2008) suggest the differences in political and economic systems and nationalism may pose as a threat to globalisation as countries may see conforming to a standardised set of principles as relinquishing control of their accounting regulations to foreigners, especially if it is perceived as substituting their own accounting regulations with those of other countries. Globalisation of accounting standard could prove risky because of the lack an international regulatory agency; with countries still dependent on their local bodies (Rolfe, 2008), achieving convergence will not come without difficulty. Globalisation of accounting standards will change the quality and structure of financial information in some countries therefore it is vital that companies and stakeholders understand the extent of the impact.

Accounting standards are there to provide detailed rules regarding the accounting treatment of transactions and other items (Melville, 2008). However accounting standards and accounting standard setting bodies have been reviewed critically in recent years. The standards provide broad guidelines which can be practical for a variety of circumstances, but the lack of guidelines can produce unreliable and inconsistent information that makes it difficult to compare one organisation to another. The standards are there as guidelines however in order to achieve the ultimate goal of a true and fair view; compliance of certain standards may not be possible.

A true and fair view is the ultimate aim, at times a departure from the accounting standards is required to obtain a true and fair value. Already present in the current regulatory financial reporting framework, there are contradictory concepts embedded. IAS 16, Property Plant and Equipment states that all non-current assets within a business must be stated at their cost less cumulative depreciation, impairment or revaluation to fair value. IAS 20, Accounting for Government Grants and Disclosure of Government Assistance states that if a capital grant is received in support of the purchase of a non-current asset, this grant should not be netted off against the asset purchased but be treated as a deferred credit, held in the statement of financial position and transferred to the statement of comprehensive income each year, so offsetting the higher depreciation charge on the original cost of the asset. These two IAS standards contradict each other and can confuse users of IAS standards.

General accepted accounting principles (GAAP) is the term used to describe the basis on which financial reports are normally prepared (Heerkens, 2006). Companies however do not always comply with the GAAP. In the case of Severn Trent Water, in accordance with industry practice, grants and contributions relating to infrastructure assets have been deducted from the cost of fixed assets. This is not in accordance with the Act, which requires assets to be shown at their purchase price or production cost and hence grants and contributions to be presented as deferred income. The director stated that the departure from the requirements of the Act was necessary to give a true and fair view, while a provision is made for depreciation of infrastructure assets, finite lives have not been determined for these assets, and therefore no basis exists on which to recognise grants and contributions as deferred income. The effect of this departure is that the cost of fixed assets is £566.1 million lower than it would otherwise have been (Clewlow, T. 2010).

One of the main purposes of the regulatory framework is to assist in the development of international accounting standards. As a result the framework identifies the concepts that underpin financial statements which are prepared and presented at least annually and are intended to serve the need of a wide range of external users that include investors and shareholders (Melville, 2008). Investors use the information provided within these statements and reports to help in the decision making process of how investments are handled. The supplied information can also assist in the assessment of an entity's ability to pay dividends and the "stewardship of management" of that entity (International Accounting Standards Board, 2008).

International globalisation of accounting standards has been gaining momentum in recent years, and although there are criticisms and disadvantages to the process, the advantages and the benefits seem to prevail. The standardisation of these accounting rules and procedures and the regulatory framework provide a common set of principles that assist in the preparations of the financial statements and in turn the annual reports, it is these standards that prove vital and ensure annual reports and financial statements meet the needs of investors, shareholders and other interested parties.

B. Critically appraise the advantages and disadvantages of environmental accounting and of including environmental and social reports within the Annual Report and Financial Statements

The primary financial objective of any business or organisation has always been the maximisation of shareholder's wealth. However, with the rise in globalisation and social and environmental awareness, organisations have gravitated towards environmental accounting as an attempt to factor environmental costs into the financial results of operations. This is a method of acknowledgment and assumption of responsibility for environmental issues as well as ensuring sustainability for the future of the organisation. Environmental accounting is defined as "the collection, analysis and assessment of environmental and financial performance data obtained from business management information systems, environmental management and financial accounting systems" (Environment Agency 2010). Environmental accounting involves taking corrective management actions to lower environmental impacts as well as costs plus. It also involves the completion of external reporting in regard to environmental and financial benefits on confirmed environmental reports or published annual reports and accounts, aiming to improve the overall environmental performance.

Whilst there are no compulsory requirements relating to environmental performance in the international accounting standards (IAS's), companies can volunteer to publicise environmental information to ensure organisational transparency and sustainability. The triple bottom line accounting means "expanding the traditional reporting framework to take into account environmental and social performance in addition to financial performance" (Grünewälder, 2009). By adopting this method organisations can evolve traditional accounting to a means of communicating financial information as well as social and environmental issues. The Sustainability Reporting Guidelines are quickly becoming the widely accepted accounting framework for a more balanced and complete picture of the overall performance of organisations (Sustainability at Work, 2010). Sustainability accounting involves integrating environmental, social and the addition of economical performance (Hilary & Jolly, 2001) this can give stakeholders a view of the overall performance of the company.

There is steady growth in the rate at which environmental reports are being produced (Elliot &Elliot, 2005). There are many advantages and benefits that may attract organisations to adopt environmental accounting and producing environmental and social reports. This type of accounting can create reduction or elimination of environmental costs, which can result in more accurate costing or pricing of products and more environmentally desired processes (Environment Agency, 2010). There are also possible competitive advantages as customers are increasingly interested in the environmental and social impact of businesses. Producing an environmental report can bring a marketing advantage by demonstrating the business' awareness of its environmental responsibilities. It may also help improve the relationship with key stakeholders, such as investors, suppliers and the wider local community. Potential job applicants increasingly look at the environmental performance of a business they're thinking about working for. In addition, businesses may find it easier to retain existing staff if they produce a report that clearly demonstrates their environmental performance. Environmental accounting and reporting should focus the business' attention on environmental performance and can support the development and running of an overall environmental management system.

"Running any business effectively requires good decision-making, which is based on good management information" (ICEAW, 2010). In 2009 the Department for Environment Food and Rural Affairs (DEFRA) and the Department for Energy and Climate Change (DECC) published guidance for businesses and organisations. These guidelines included how to measure, report, identify and address their environmental and social impacts. (Defra, 20101). The guidelines outline how companies might begin to set targets i.e. Key performance indicators (KPI) to measure environmental performance against, these are necessary to understand the development, performance or position of the company. KPI's are often used to effectively achieve success in an area of the business (Business link, 20101). Marks and Spencer PLC have financial KPI for revenue and the profits, in which the performance are compared year on year and can be measured against the strategy, and an analysis can be made on significant positive areas and possible areas of improvement.

The process of measuring environmental and social impacts is not one without issues, the impacts can often be measured subjectively and although they do consist of truthful information, they may not provide the whole picture. The main issues include transparency, accountability and credibility (Business Link, 20102). Precise information needs to be given out, to include but not limited to, what aspect of the business the information is related to, when, where, how and what was collected as well as the frequency of the collection. Also environmental impacts may be negative, companies may not want to report on this and may withhold information, this could lead to information being misrepresented and misinterpreted.

It is increasingly rare that a major FTSE100 company omits a corporate social responsibility section from its annual report (Willsher, 2004). Although there is no compulsory requirements relating to environmental performance in the IAS's, The companies Act 2006 requires disclosure of the company's impact on environment and the social and community issues in the business review of the directors report (Chivers, 2010). There are many government legislative requirements that protect the environment that companies have to comply with. NetRegs is a partnership between the UK environmental regulators; they provide free environmental guidance for small and medium-sized businesses throughout the UK (NetRegs, 2010). NetRegs provide free environmental guidance on what companies need to do to comply with environmental law and to protect the environment. Legislation such as Environment Act 1995 and Environmental Protection Act 1990 affect all businesses in England, Scotland and Wales (NetRegs, 2010). These legislations ensure businesses' have a legal responsibility for the duty of care for waste, contaminated land, statutory nuisance and the environment as a whole.

Management and organisations need to consider environmental issues when planning and formulating decisions. Environmental impact assessment (EIA) was introduced in 1988 (Glasson, Therivel & Chadwick, 2005), which is a cyclical process that examines and measures the environmental consequences on development actions. The environmental impact statement that is produced can provide significant information to that could contribute to modifying or abandoning of the proposed development plan. There are other environmental auditing processes such as Environmental Surveys and Environmental Quality management (EQM) that can examine a business and its operations.

The development of Accounting Standards, the framework and reporting in regards to environmental accounting will possibly follow from the introduction of the UK Climate Change Act 2008 to have a legally binding long-term framework to cut carbon emissions (Defra, 2010). It also creates a framework for building the UK's ability to adapt to climate change and deliver against the target of an 80% cut in greenhouse emissions by 2050 through investment in energy efficiency and clean energy (Harvey, Dinmore & Parker, 2009).

Marks and Spencer PLC periodically report on their carbon efficiency, store energy efficiency and operational waste to landfill. It's reassuring to see that carbon efficiency has decreased by 20% and operational waste to landfill has decreased by 25% between 2006/07 to 2009/10, both with a target of 0 in 2012. Store energy efficiency has decreased by 19% between the two periods with a target of an overall 25% between 2006/07 and 2012. (Marks and Spencer, 2010).

Environmental accounting and reporting is no longer rare for companies to commit to but is now seen as an essential part of taking social responsibility as organisations. The reports are seen as necessary in communicating to shareholders about possible environmental concerns. Organisations are realising that it is their corporate responsibility to achieve sustainable development where possible. Although there are many benefits to environmental accounting there are still issues involved in the ability to measure the environmental and social impacts. Many companies have adopted environmental accounting and success for these companies is made possible as they realise the significance of how to enhance their processes, minimise their costs and improve the business in general. Overall environmental accounting is a vital tool to assist in the management of any organisation with many benefits to the organisation, the consumers and the environment.

C. Financial Instruments

A compound financial instrument is one which has both a liability and an equity instrument.

Convertible bonds are examples of compound financial instruments. The accounting standards relevant to compound financial instrument are IAS 32, IAS 39 and IFRS 7. IAS 32 states that where there is an obligation to transfer economic benefits there should be a liability recognised.  On the other hand, where there is not an obligation to transfer economic benefits, a financial instrument should be recognised as equity. IAS 32 also states the financial instrument should be presented according to their substance, and not merely their legal form. The value of the convertible bond consists of a liability component which is the bond and the right to convert in due course, is the equity part of the transaction.

The split between the liability and equity components of a compound financial instrument is done on issue and is not subsequently revised, even when exercise of the conversion option becomes more likely. The company must on initial recognition, measure the fair value of the compound instrument as a whole, measure the fair value of the liability component, and assign a value to the equity component by deducting from the fair value of the instrument as a whole the amount separately determined for the liability component. No gain or loss arises on initial recognition. Thereafter, the liability component is measured at amortised cost, with changes going through the statement of comprehensive income. On conversion of the convertible, the company derecognises the liability component and recognises it as equity. The original equity component remains as equity. There is no gain or loss on conversion at maturity.

The two elements must be separately recognised in the statement of financial position. Firstly the value of the cash flows at the agreed contractual rate needs to be determined and then the cash flows need to be discounted to determine the present value of the future cash flows using the market value, then the present value of the debt and the balancing figure will be the value of the equity needs to be calculated. The financial instrument should be recognised in the statement of financial position when, and only when, it becomes a party to the contractual provisions of the instrument and it should be valued at cost.

Preference shares are an example of a financial instrument according the IAS 32. The issuer must consider whether it has a contractual obligation to transfer cash or other financial assets to the holder of the share. If the preference share is non-redeemable and does not have conversion rights attached, but the company has a contractual obligation to pay a dividend, it will again be a financial liability. Where a preference share is classified as a financial liability, the preference dividend paid will be shown as interest in the company's income statement; nevertheless this does not affect the tax treatment of such dividends.

If however the preference shares have conversion rights attached, then it will be classed as a compound financial instrument because it contains both equity and liability components. Such preference shares are those where payment of a dividend is solely at the discretion of the directors, where there is no contractual obligation to make a payment and the preference share is classified as an equity instrument. In these cases the standard requires the liability and equity components of a compound instrument to be accounted for separately.

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