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The preparation of financial statements is becoming more and more complex. Public listed companies have to comply with Company Law regulation, Financial Reporting Standards and Stock Exchange requirements in the preparation of their annual reports. And for complying with these regulations, is there too much regulations?
The importance of financial statements
Accountants in companies summarize, evaluate, analyze all of activities of companies and prepare financial statements to provide managers and outside investors with financial information. Managers need financial information to control and manage problems in their company. Beside that, outside investors need financial information to analyze financial activities of companies and make decisions. The major users of company's financial statements are following
Investors: Need information to assess the stewardship of management and using them properly, efficiency and profitably for take decisions about their investment. For example, they use information to decide whether to hold, buy or sell shares and assessing the ability to pay dividends.
Suppliers: They use information to decide whether to supply, determine solvency of their customer and long term stability if the company where they supply is the major customer.
Lenders: They will determine whether their loans and interest will be paid on time and decide they should or shouldn't to lend.
Customers: They assess the stability and profitability of the company and assess the ability to provide remuneration, retirement's benefits, etcâ€¦
Government authorities (tax, auditingâ€¦): They need information to measure and analyze all of the commercial activities of the company (collect income tax, produce national statistics, etcâ€¦)
Public: Members of the public use to determine the effect on the local economy of the company's activities and assess development and changes of company
To prepare the reliable financial statements responding to the above needs of users, many regulations have been promulgated to help companies and monitor that process of making. Main regulations comprise of Company Law, Financial Reporting Standards and Stock Exchange requirements
Standards of Financial Reporting
History of Accounting was established in a long year ago since human know trade and exchange. In any generation of human, trade and exchange always based on rule and standards and suitable in these generations. For managing trade and exchanging more effective, accounting was created and become useful tool for operating trade and exchanges. In addition, most important function of accounting is help people control and solve their financial problems.
Over time, accounting regulations were developed and updated in during history of development of world's economy. In 1970s, with trend of international business of nations in the world, International Accounting Standards Committee (IASC) was established in June 1973. The purpose of IASC is to make accounting regulation of nationals in the world comply with basic rules and international standards. The IASC survived for 27 years, until 2001, this organization was renamed as International Accounting Standards Board (IASB).
Beside IASC standards, different countries and regions in the world based on different accounting standards like US GAAP (General Accepted Accounting Principles), UK GAAP etcâ€¦. Example, companies in UK and EU do their accounting and reporting relied on Company Law and EU Regulation on IAS/IFRS and the counterpart in US based on GAAP.
Why need different standards?
Although financial statements of companies based on standards on IAS but there are many other difference in economic and cultural conditions, at first they will based on standards of their national. In countries with a legal system based on common law include England and Wales, USA, Australia, Canada...if a company operates in another countries where accounting standards different with its standards, it should edit and comply with these standards. Example, the USA Company operates on the British market should comply with law and standards of British, beside that this company also comply with US GAAP and IFRS
Differences between US GAAP & IFRS
In today's global business environment, it is likely that U.S. businesses have customers, suppliers, or potential acquisition candidates that prepare their financial statements in accordance with IFRS. To evaluate the financial condition and net income of these companies appropriately, accountants familiar with U.S. GAAP need to understand where U.S. GAAP and IFRS differ and be able to estimate the potential impact of these differences. We will look at current differences between U.S. GAAP and IFRS
Some points differences:
Inventory: 2 key differences exist in the area of inventory evaluation. First, IFRS use the LIFO method for evaluate inventory allowed under GAAP. Second, IFRS requires reversal of inventory write-downs under certain conditions, whereas reversals are prohibited under GAAP.
Property, Plant, and Equipment: The most obvious and significant difference is that IFRS allows companies to revalue property, plant, and equipment to fair value while U.S. GAAP relies on historic cost.
Share-based Payments: Differences exist in the treatments of volatility, the measurement date, and the determination of expense when awards are modified.
Example about some differences between U.S GAAP & UK GAAP:
Under UK GAAP, pension, liabilities and retirement costs are determined in accordance with the UK Financial Reporting Standard
FRS 17: Retirement Benefits, whereas under US GAAP these costs and liabilities are determined primarily in accordance with the requirements of FAS No. 87, Employers' Accounting for Pension
FAS 88: Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits
And in FAS 106: Employers' Accounting for Post Retirement Benefits other than Pensions.
Under FRS 17, the expected costs of providing retirement benefits are charged to the profit and loss account over the period benefiting from the employee's service based upon actuarial methodologies that are similar to those applied under US GAAP. Variations from the expected costs are recognised as they occur in the statement of total recognised gains and losses, with pension plan assets and liabilities included in the Group balance sheet at fair value. Under UK GAAP pension assets in the balance sheet are recognised at their market value at the balance sheet date, whereas under US GAAP the valuation is based on a market-related value.
A significant difference between UK and US GAAP can result from the application of the 'corridor approach' under US GAAP, whereby variations from expected costs are recognised in the profit and loss account and balance sheet over the expected service lives of the employees.
Under US GAAP, interest incurred as part of the cost of constructing fixed assets is capitalised and amortised over the lives of the qualifying assets in accordance with FAS 34. In accordance with common UK practice, Gallaher does not capitalise such interest in its financial statements.
Goodwill and intangible asset amortization:
Both UK and US require purchase consideration to be allocated to net assets acquired at their fair value on the date of acquisition, although the criteria for allocating amounts to intangible assets differs. For US GAAP purposes, Gallaher allocated a portion of its consideration to amortising intangible assets as required by FAS 141, Business Combinations, whereas for UK GAAP, such amounts were included in goodwill, as they did not meet the criteria for separable allocation, etcâ€¦
Corporate Responsibility and Sarbanes Oxley Act (SOX Act):
Beside with financial statements standards like IASB, IFRS, US GAAP, UK GAAP, etcâ€¦ international finance companies almost on securities markets. All activities investing, information of them must update and clear fair for investors, shareholders, must comply with law and regulations of securities markets and The SEC (Securities and Exchange Commission) was established to enforce regulations and law for securities, these regulations and law require companies when joining securities market must comply. In addition, responsibility and ethics of corporate is most important and factors decide success or failure of corporate. Enron is an example of responsibility and ethics of corporate, scandals cheat on financial statements and after the death of Enron, SOX Act (Sarbanes Oxley Act) was passed in 2002 by U.S Government for tight responsibility of corporate in management and internal control, in section 802 of SOX Act: This section imposes penalties of 5 or up to 20 years imprisonment for altering, destroying, mutilating, concealing, falsifying records, documents or tangible objects with the intent to obstruct, impede or influence a legal investigation. This section also imposes penalties of fines and/or imprisonment up to 10 years on any accountant who knowingly and wilfully violates the requirements of maintenance of all audit or review papers for a period of 5 years (source: Sarbanes Oxley Act 2002)
But after SOX Act passed in 2002 was created arguments between group support and against group of this SOX Act, they argued about strength and weakness of this Act.
Supporters group think SOX Act is helpful and will improve and create benefits in auditing, internal control. An article in the Harvard Business Review, they researched and gave the following benefits:
Strengthened control environment
More reliable documentation
More standardized process for IT and other functions
More effective use of automated and manual controls
Increased audit committee involvement
But against group don't think so and they gave disadvantages and following negative effects of SOX:
40% executives say SOX Act created a cost burden that suppresses stock prices
Compliance cost were cited as the biggest complaint about SOX Act
IT costs and other functions involve internal control will increase for improve internal control system and audit techniques if the management of these systems based on IT, etcâ€¦
In fact, for using SOX effective is not easy and with conclusion of 1 IT auditor have been working with SOX section 404 and this IT auditor gave followings reasons
. Text book auditor vs. real life IT process auditor
There is a big gap between SOX auditor and IT auditor, its matter on what do you see day by day. The SOX auditor main job is work with detail documentation. SOX auditor need to examine a lot of document. Complete and detailed document make them happy. But, IT auditor has a very different view, IT main focus is maintain availability of the system, most of them did not care about whether all process should be written in paper, should be signed, approved and others SOX auditor jargon.
If SOX auditor pressure come from deadline and the IT auditor pressure is from IT board that need IT process run effectively, surely no one happy. We have found several auditor that become paranoid with all part of SOX auditor, whether their appearance or their style.
. Never ending control frequency
Frequency of this control is daily and should be review monthly. In SOX, every control that we created has a different control e.g. control for program changes it event based, so when you have a change request then you should follow that SOX rule you have been made. Control for incident monitoring is daily, so everyday you should record the incident that happened but someone think should record semi annual but other persons not agree and at the end, they think it's no longer suitable.
. Global problem local hell
SOX said that every company that listed to NYSE should follow the compliance; every subsidiary company that owned by the company also should follow. What that mean? This means that making the local or subsidiary company becoming hell. Everybody now that local subsidiary company has different way perform the businesses compare to the head quarter. Implementing SOX is just the same as moving a very big problem to each subsidiary.
. Costs for hire auditors and supervisors
For auditing by SOX, companies must prepare over 1000 pages/report and for complete the report, companies when auditing need hire a great number auditors from audit firms and beside that, they need made the supervision department for supervise these auditors for ensure the integrity.
Etcâ€¦ At the basic, SOX Act will make arguments of everyone for a long time and it's a story never ending process.
With these regulations, standards, law has applied of IASC, US GAAP; UK GAAPâ€¦ was raised researches and analysis about difference standards.
Advantages & Disadvantages of difference standards
Advantages: With existence of IFRS, US GAAP, UK GAAP and Company Law, etcâ€¦ the economic activities of a company is best reflected in its financial statements by complying with the standards of country in which it operates. The national standards are frequently updated and modified to suit with globalization environment. New recent standards will replace the disadvantages of old standards and add the new regulation. For example, IASC after change to IASB, they keep all suitable IASs of IASC and issue their own standards (IFRS) to reflect the dynamic environment.
Disadvantages: Multinational companies get confused in finding and applying standards and regulations in preparation their financial statements. For example, US companies operate on UK market, their financial statements comply with standards of UK GAAP but maybe their financial statements not comply with US GAAP, and they must modify financial statements. This process takes time and expense of those multinationals. Recently, FASB and IASB have worked together to ease the difference of US GAAP and IFRS using three steps:
1. The FASB and IASB identified short- and long-term convergence projects in their 2006 "Roadmap for Convergence."2 The accounting topics mentioned in these convergence projects are listed in two tables, and key differences between IFRS and U.S. GAAP are provided.
2. A few additional accounting topics not addressed by either convergence project are noted, and key differences are highlighted.
3. The actual impact of the key differences on net income is illustrated using Form 20-F reconciliations of IFRS-based net income compared to that computed using U.S. GAAP.
Although finance professionals were explained why need difference standards but is there too much regulation? In fact, these regulations and standards always created by scandals, problems, cheatsâ€¦of companies (example: Enron die - SOX Act created) and every nation should create specific regulations for them because they are different. If companies no scandals, problems and clear fair, federations accounting won't severe with them but in the modern business environment, these problems always exist and need specific regulation to prevent these critical problems. Especially, Viet Nam government should based on international experiences to modify regulations of VAS (Vietnamese Accounting Standards) for manage finance companies in Viet Nam.
Finally, almost regulations of finance statements are suitable and necessary in the modern finance environment.