THE REGULATORY FRAMEWORK

LECTURE 2

LEARNING OBJECTIVES
Identify and evaluate the functions of profit measurement
Appreciate and critically assess the need for and role of
accounting standards
Outline the historical development of accountancy bodies
and standards
Understand and evaluate the concepts and principles
upon which accounting is based

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Panagiotis Dontis Charitos

WBS, 2013-14

IN TODAYS LECTURE...
Topics

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Ways in which profit figures are useful

Reasons for, and role of accounting standards
Historical evolution of accounting bodies and standards
Accounting concepts and conventions

Panagiotis Dontis Charitos

WBS, 2013-14

WHY MEASURING PROFIT IS IMPORTANT...

Facilitates dividend decisions

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Dividends paid out of realised profit, not capital

Depreciation charge ensures capital maintenance
The Companies Act (limit on dividends)
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Accumulated profits + Realised profits Accumulated losses

Indicates amount of cash generated

Profits not necessarily cash

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The Companies Act

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Inventories, receivables, long-term debt...

Dividends paid from realised profit
Quiz...
Upward
p
(downward)
(
) revaluation of assets = profit
p
(loss)
(
) ??
Panagiotis Dontis Charitos

WBS, 2013-14

WHY MEASURING PROFIT IS IMPORTANT...

Indicates degree of management success

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Shareholder value maximisation

Moral hazard (principal-agent) issues?

F
Forms
bbasis
i ffor ttax purposes

HMRC rules for profit measurement differ from financial

reporting rules

Facilitates investment decisions

Current and p
prospective
p
owners

Monitoring by creditors
Indicates economic efficiencyy

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Maximisation of ratio of output to input

Can be used in many different contexts

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Panagiotis Dontis Charitos

WBS, 2013-14

NEED FOR ACCOUNTING STANDARDS

Users depend on financial information

Decision making

Information should represent true position of firms

Minimisation information asymmetries

Managers
g
prone
p
to overstatingg performance/profits
p
p
Interaction between regulation and directors

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Series of Companies Acts

Requirements for published information
Not
ot ttight
g t accou
accounting
t g rules
u es p
prone
o e to creative
c eat ve accounting
accou t g
Governments unable to respond to changes

Need for Accounting

g Standards

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Panagiotis Dontis Charitos

WBS, 2013-14

EVOLUTION OF ACCOUNTING STANDARDS

Accounting Standards Steering Committee (1969)

Intention

Guidance beyond requirements of Companies Acts

Additional definitions and rules for measurement and disclosure

Aim to reduce variations in accounting practice

Structure and problem areas

Creation of number of professional accountancy bodies

25 Statements of Standard Accounting Practice (SSAPs)

Effective in definitions

No consistency - room for alternative treatments

Absence of legal backing / enforcement mechanism

Discredited by scandals and creative accounting...

Panagiotis Dontis Charitos

WBS, 2013-14

EVOLUTION OF ACCOUNTING STANDARDS

Accounting Standards Board (1990)

Intention

To provide a tighter reporting framework

Structure and problem areas

Supervised by Financial Reporting Council (FRC) & Financial Reporting

Review Panel (FRRP)
Fi
Financial
i lR
Reporting
i EExposure D
Drafts
f (FRED
(FREDs))
Consultation Financial Reporting Standards (FRSs)

More effective than previous regime

More consistency - less room for alternative treatments
Audit of statements
More legal backing FRRP as enforcement mechanism

British origin different systems elsewhere

Globalisation need for international accounting standards

Panagiotis Dontis Charitos

WBS, 2013-14

EVOLUTION OF ACCOUNTING STANDARDS

Evolution of two main approaches by beginning of 21st century
` US Financial Accounting Standards Board (FASB)
` International Accounting Standards Board (IASB)

Formed in 1973 as International Accounting Standards Committee

41 International Accounting Standards (IASs)
Reconstituted
R
i
d as IASB iin 2001
Issues International Financial Reporting Standards (IFRSs)

Adopted existing IASs

Issued 8 IFRSs by 2009

Panagiotis Dontis Charitos

WBS, 2013-14

EVOLUTION OF ACCOUNTING STANDARDS

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Need for convergence

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Memorandum of Understanding (MOU, 2006)

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Companies following both approaches

Signed between FASB and IASB
Development of convergence programme
IFRSs increasingly converge with FASBs accounting standards

Increasingg effectiveness of accountingg standards

However...
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Still room
St
oo for
o truly
t u y international
te at o a standards
sta a s

Panagiotis Dontis Charitos

WBS, 2013-14

FUNDAMENTAL ACCOUNTING CONCEPTS

Definition:
Thee term
te accounting
accou t g concepts
co cepts refers
efe s to tthee
axioms or basic assumptions underlying the
fi
financial
i l accounts
t

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Panagiotis Dontis Charitos

WBS, 2013-14

FUNDAMENTAL ACCOUNTING CONCEPTS

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Going concern
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Assumes the company will continue to trade for the

foreseeable future and that the fixed assets and stock will be
used
d in
i the
th normall course off trade
t d
Used to justify showing assets at cost (- depreciation)

A
Accruals
l
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Revenues and costs recognised as earned or incurred and

matched with one another in the period to which they relate.
relate
Profit measurement based on accruals and matching, not when
cash is received or paid
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Cost of unsold inventories is treated as expense only when the latter

are sold
Panagiotis Dontis Charitos

WBS, 2013-14

FUNDAMENTAL ACCOUNTING CONCEPTS

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Consistency
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Consistency in accounting treatment of similar items within

each accounting period and from one period to the next
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All vehicles to be depreciated in similar fashion

Not acceptable to change depreciation method from one period to
the next

E bl comparability
Enables
bilit

Prudence
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Revenues and profits are only recognised when realised (sale is

made). Expenses and losses are recognised whether amount is
known with certainty, or is best estimate
Ensures that revenues profits and assets (losses and liabilities)
not overstated (understated)
Panagiotis Dontis Charitos

WBS, 2013-14

FUNDAMENTAL ACCOUNTING CONCEPTS

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Separate Valuation
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Value of each item on financial statements should be estimated

independently
O item should
One
h ld not be
b offset
ff against another
h
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Fleet of cars should not be valued as a whole, rather each car should
be valued separately and then added together

Panagiotis Dontis Charitos

WBS, 2013-14

QUALITATIVE CHARACTERISTICS
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British ASB Statement of Principles for Financial Reporting

(1999)
Identifies four objectives to be met by accounting practice
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Relevance
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Reliability
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Facilitates cross section comparison (disclosure, consistency)

Understandability
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Transactions are represented faithfully, information is neutral, free from

errors, complete, and estimates are made with caution
Conflict between relevance reliability...

Comparability
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Important to users in predicting future or confirming present/past

Users with reasonable knowledge in business, economics and accounting

should be able to understand content of financial statements
Panagiotis Dontis Charitos

WBS, 2013-14

QUALITATIVE CHARACTERISTICS
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Collaboration between FASB and IASB

New conceptual framework emerging
Likely to include four principal qualitative objectives
characteristics of accounting information
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Relevance
R
l
Faithful representation
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Replaces reliability
Measures and descriptions in financial statements should correspond to economic
phenomena they represent

Comparability
U d t d bilit
Understandability

Subject to constraints
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Materiality
Benefits that justify costs
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Trade-off between producing better information and respective cost

Panagiotis Dontis Charitos

WBS, 2013-14

READING LIST
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Core reading
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Perks and Leiwy

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Chapter 3 sections 3.2 to 3.4

Further reading
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Perks and Leiwy

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Atrill and McLaney

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Chapter 8
Ch t 1
Chapter

Panagiotis Dontis Charitos

WBS, 2013-14

UNTIL NEXT WEEK...

Three candidates are short listed
for a jjob. Duringg the interview
process the chairman asks each
the question "what is two and
two?"
The mathematician replies...
"Four"
The statistician replies...
Statistically anything between
3 999 and 4
3.999
4.0111
0111"
The accountant stands up, shuts
the curtains and then approaches
the chairman and whispers into his
ears....
" What do you want it to be Mr
Chairman??"
18

Panagiotis Dontis Charitos

WBS, 2013-14