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Corporate reporting is a set of report that companies are required to present to the shareholders to ensure effective communication with the shareholders about its performance externally. There is a need to regulate corporate reporting as capital market investors need information in order to decide whether or not they should invest in a particular company. Regulation is able to set a standard as to how accounts are prepared and presented which improves comparability and this also helps to decrease the risk of fraud. Shareholders may have more confidence in the financial reports, knowing that the reports are regulated. This might attract more European companies and investors to Chavboro.
How financial reporting should be regulated in Chavboro
The government should set up a separate independent third party which could be named the Chavboro Financial Reporting Council(CFRC). The Council would have the responsibility to oversee the Chavboro Accounting Standards Board (CASB)'s performance, financial and funding arrangements and initial source of views for the CASB on proposed standards and pronouncements. The structure is a simplified version of the Financial Reporting Committee in order to reduce the cost of setting up the council and boards.
This new board would be able to operate independently of those activities they regulate with the support of the government. As Chavboro is a newly set up government, investors may not have full confidence in the government yet. Moreover, if the government was the one who governs the regulation of corporate reporting, investors may have doubts regarding the financial statements of the government. An example is Canada. Between the 1970s and 1980s, the credibility of the governments' financial statements was questioned because there was no independent accounting standard to refer to.
Other than that, an independent third party would be able to have more expertise in regulating the financial reports as the members would consist of people with financial knowledge. The newly set up government would probably lack of resources and knowledge as people with the expertise could be focused at other areas needing their attention such as the economy of the country. An independent third party is also more flexible and responsive to the companies. They are open to suggestions by industry members, consumers and consumer groups, academic institutions like universities or other scientific organizations, and even government agencies. In order to preserve their expert status, they would closely follow changes and technological advancement. This would benefit the government and also companies that are in Chavboro.
A few things that the CASB would be responsible for would be to issue accounting standards as approved accounting standards and to review, revise or adopt existing accounting standards, i.e. IFRS as approved accounting standards. Other than that, it would also be in charge of issuing statement of principles for financial reporting and conduct public consultations when necessary.
As Chavboro is thinking on joining the European Union, the International Financial Reporting Standard (IFRS) should be adopted by Chavboro. The IFRS is a set of accounting standards that has an international consultative approach to standard-setting, therefore it is able to get input from people with diverse expertise and diverse jurisdiction. The IFRS that is accepted globally would be a better choice rather than writing a new set of standards from scratch through trials and error.
The IFRS is used by more than a hundred countries in the world and since the government is hoping to attract large European companies, adopting the IFRS would make it easier for companies who are planning to relocate to Chavboro. Other lenders and investors would also be attracted to Chavboro as they would be able to facilitate comparability and increase transparency. They also would not have to pay for any processing and adjusting of financial statements. The IFRS is also more flexible compared to others as it uses a principles based approach. This gives companies freedom to adapt the IFRS to their situation.
However, the disadvantage of the IFRS would be that companies would manipulate the financial statements to paint an overly favorable picture as it is principle-based. They could pick to comply or explain if they do not agree with certain IFRS. This could lead to profit manipulation and even fraud. Stricter enforcement needs to be implemented in order to reduce the risk of this problem.
How financial reporting should be enforced in Chavboro
The financial statements should be audited if they are a public company according to the Companies Act. This is in order to ensure that investors are confident with and is satisfied with the financial statements. The auditors would follow the International Standards of Auditing and would be governed by the statute law, the auditing regulator which is the CFRC, and professional practice. The auditors would only have a duty of care only to the shareholders and to state in their opinion whether the presentation of the financial statements have been true or fair. Auditors should be members of professional accountancy bodies who have already completed their training period.
As for enforcements, a two-step enforcement system can be implemented, such as in Germany where they combined the elements of the UK model of a private agency, Financial Reporting Review Panel (FRRP) and of the US model of government agency, Securities and Exchange Commision(SEC). The FRRP would examine individual and group financial statements of listed corporations to ensure they comply with the Companies Act. The costs of the review body and enforcement would be financed by a charge to all listed corporations. The FRRP would motivate auditors to improve accounting compliance by increasing the possibility of errors being exposed. If there are errors identified by the FRRP, the audit firm may face reputational damage.
If the corporation is not cooperative and does not provide sufficient information in the course of a review, the Federal government would take over the case. The government should be involved in the enforcement financial reporting as they have the power to enforce. The government can enforce financial reporting through sanctions such as the statute law and common law. Legislations such as the Companies Act and Company Law requiring the financial statements (which consists of the Statement of Cash Flow, Statement of Profit and Loss and Other Comprehensive Income, Statement of Financial Position and Statement of Changes in Equity) prepared, listing the Directors Remuneration in the annual reports could be enforced through the sanctions.
Specific views on the development of regulation in Chavboro
As Chavboro is a country with substantial oil and other mineral resources, accounting for oil and gas activities may present many difficulties in ways of significant upfront investments, uncertainty over prospects and long project lives. IFRS 6: Exploration and evaluation of assets may be adopted. As the oil and resources are recently discovered, they can use IFRS 6 to determine how to account for the resources which would enable the oil and gas companies to present their financial reports to a wider capital community, which would in turn offer an easier access to foreign capital market and investments. The CASB can further develop this IFRS to fit the situation at Chavboro.
Adoption of the IFRS should be done according to IFRS 1: First-time Adoption of International Financial Reporting Standards. The IFRS 1 provides guidance for entities in order for them to have a smooth transition from the local GAAP to the IFRS.
As a conclusion, Chavboro should set up a separate independent council in order to mitigate any problems that the government might face. Once the country is stable and has established the Board, further regulation could be done for corporate governance. Chavboro should also to be adopted because it could bring a lot of benefit to Chavboro, especially since Chavboro is planning to join the European Union.
Other than that, the regulatory regime could be enforced by a few regulators such as the independent third party, the FRRP and government.
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