The different standards for financial reporting

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This paper discusses in brief about the different standards for financial reporting, reasons to standardize, its advantages and disadvantage and the social, political and economic perspectives on financial reporting. We look at the various literatures and analyze whether government should mandate disclosure or whether firms, supported by their own reputation, gatekeepers, private lawsuits, and market discipline, have adequate incentives to disclose voluntarily information at socially optimal levels (Bushman & Landsman, 2010). Arguments in favor of regulation typically depend on the existence of market failure. The analysts seem to be more pessimistic that over the long run that a single global standard-setter likes the IASB can survive and succeed. We also discuss the recent decision of the European Union's (EU) to postpone acceptance of International Financial Reporting Standard 9 (IFRS 9) (Bushman & Landsman, 2010). The current economic crisis has made experts, governments and the Accounting Standards bodies focus on the regulation of corporate financial reporting more in the recent past and the developments made are discussed in this paper.

History attests to the influence of crisis and scandals as an impetus for regulatory intervention by politicians (Banner, 1997; Reinhart and Rogoff, 2008). After several such scandals in the UK, there were drastic changes made in the structure of financial regulation by the Financial Services Authority (Bushman & Landsman, 2010). Furthermore, there is no clear reason as to why the generally accepted accounting principles (GAAP) are regulated. Kothari et al. (2009) discuss the forces that have designed GAAP and provide a comprehensive report on the regulation of standards. Kothari (2009) outlines three theories for the regulation of accounting standards: public interest theory, capture theory and the ideology theory of regulation. After several arguments and issues, the International Accounting Standards Committee was succeeded by the International Accounting Standards Board (IASB). The IASB is proposing changes to the profession's International Standards for the Professional Practice of Internal Auditing Standards (Financial Reporting Council, 2010). According to the International Professional Practices Framework (IPPF), all the standards should be reviewed once in every three years so that it remains current and relevant. According to the existing standards, the internal auditor's opinions are permitted but not required. But under IASB, all internal auditors providing opinions is not appropriate. However, the IASB has proposed two new standards to in order to help stakeholders rely on the internal auditor's report.

"The standards are:

• Standard 2010.A2 addresses the need for internal auditing to establish the expectations of the board and senior management in its planning process.

• Standard 2450 sets out the requirements for the work internal auditors must do if they wish to provide an overall opinion", (Adrain & Shin, 2009).

In 2005, a significant change happened in the UK Financial Reporting as the transition to International Financial Reporting Standards (IFRS) was exercised mainly by the listed companies in the European Union (EU) and beyond (Lindberg & Seifert, 2010). The individual standards for reporting have had several controversies and there were discussions of the extent to which companies (e.g. PricewaterhouseCoopers, 2004) and analysts (e.g. KPMG, 2005) are prepared for the change. The biggest criticism of IFRS is that they are likely to make earnings more volatile (Aisbitt, 2006). For example, in 2003 Jacques Chirac, then French Prime Minister complained to the president of the European Commission that there would be an increase in volatility in the economy due to the excessive use off-market values. However, there is not much evidence to support this claim (Lindberg & Seifert, 2010).

Perhaps the effects of reporting on equity and balance sheet line items are a critical issue. According to a Regulation approved by the European Union in 2002 (EU, 2002), the listed companies had to present their consolidated financial statements in accordance with IFRS1 for accounting periods beginning on or after 1 January 2005 (Cairns, 1997). This Regulation was a part of a global action to provide a single framework of accounting standard while the International Organization of Securities Commissions (IOSCO) had been working on its 'global passport' for stock exchange listing (Cairns, 1997). The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) signed an agreement in 2002 called the Norwalk Agreement to further increase the momentum. From this point, the number of countries following IFRS increased to over hundred countries in 2005 (Sucher & Alexander, 2002). Several researches after this called for a clear document to explain the starting point of the change to IFRS so that it can have a long term future.

There is always a political aspect to the business and now we look at this aspect with regards to accounting standard setting. The fall of a huge number of financial institutions and the ongoing economic recession has generated a political thirst for regulatory change which can vastly alter the regulation of financial markets, including the regulation of accounting standard-setting (Burchell, Clubb, Hopwood, 1980). Fair value Accounting is in the centre of huge political interest.

The privacy issues in financial reporting should also be addressed. "Governing the use and protection of personal information across increasingly complex and distributed enterprises is the key challenge in managing risk and compliance regarding such Information", asserts an Ernst & Young (2010) report. The report is based on the experience of a few top firms and their experience in assisting clients with privacy risk management and compliance. It explains that recently privacy has been linked with the potential for abuse such as exposed information leading to fraud and theft whereas previously focus was more on customer preferences. "So to counter these issues the report presents a three-layer frame work:

• Risk management and compliance defines the people, processes, and technology used to protect and govern the use of personal information throughout the organization.

• Business-level performance describes the organization's understanding or determination of where and how it processes personal information, including its accounting of processes, systems, databases, and third parties.

• Governance defines the roles and responsibilities necessary for managing the use and protection of personal information at the corporate and business unit levels" (Ernst & Young, 2010).

Banks are one of the most important entities when it comes to Reporting and so let us look at the standards governing them. The Basel Committee was formed from representatives from central banks from around the world to regulate the reporting standards in 1988. They set a set of minimal capital requirement regulation for banks (Woods & Marginson, 2004). They then met again in 2002 and where Basel II was adopted. Basel II is an International standard that banking regulators use to negotiate the effects of financial and operational bank risks on the stability of the world-wide banking system. "Basel II rests on three 'pillars': (1) maintenance of minimum capital requirements; (2) supervisory review; and (3) market discipline" (Woods & Marginson, 2004).

Despite its wide usage, "Financial Reporting Transparency" lacks a universally agreed-upon definition. For example, in the conceptual framework of IASB or FASB, it does not appear as a qualitative. "It is believed that the idea of transparency has been imported into discussions of financial reporting from several contexts, each of which ascribes a distinct connotation to the term, and that a consideration of these other contexts may be useful in understanding what is implied by transparency in financial reporting" (Holthousen, 2009).

Looking at the future of Financial Reporting, the Accounting Standards Board (ASB) has published a Financial Reporting Exposure Draft outlining a proposed future for financial reporting in the UK (Rutherford, 2010). There have been several arguments in the past about the reporting standards depending on the size of the industry. This has been noted in the ASB draft proposing a tier system as follows,

"• In the highest tier, entities that have 'public accountability' (guidance is given on what is meant by public accountability) are subject to the EU adopted International Financial Reporting Standards;

• In the middle tier, entities that do not have public accountability and small publicly accountable entities that are prudentially regulated are subject to the Financial Reporting Standard for Medium-sized Entities; and

• In the bottom tier, small entities without public accountability are subject to the Financial Reporting Standard for Smaller Entities" (Financial Reporting Council, 2010).

An entity can voluntarily choose procedures from a higher tier. The success of this standard is hard to predict but it could be decisive to future of Financial Reporting. Thus, this paper has looked at the past, present and proposed future standards and also need for a regulatory framework.