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CRAIG DEEGAN
NANCIAL
ACCOUNNG
9TH EDITION
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CRAIG DEEGAN
NANCIAL
ACCOUNNG
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To my beautiful daughter Cassie for being the
best daughter a dad could ever have
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CRAIG DEEGAN
NANCIAL
ACCOUNNG
9TH EDITION
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Copyright © 2020 McGraw-Hill Education (Australia) Pty Ltd
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be made to the publisher via www.mheducation.com.au or marked for the attention of the permissions editor at the address below.
National Library of Australia
Author:
Deegan, Craig Michael
Title:
Financial accounting
Edition:
9th edition.
ISBN:
9781743767382
Copyright © Commonwealth of Australia 2019 All legislation herein is reproduced by permission but does not purport to be the official
or authorised version. It is subject to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction and
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ABOUT THE AUTHOR
Craig Deegan
BCom (UNSW), MCom (Hons) (UNSW), PhD (UQ), FCA
Craig Deegan is Professor of Accounting in the
School of Accounting at RMIT University in Melbourne.
He has been teaching at undergraduate and
postgraduate levels for nearly thirty years, and
before embarking on his distinguished academic
career, practised as a chartered accountant. Craig
is a Fellow of Chartered Accountants Australia and
New Zealand, and was, for approximately a decade,
a member of the judging panel of the Australasian
Sustainability Reporting Awards. He is currently on
the editorial boards of several academic accounting
journals and is a former Chairperson of the Triple
Bottom Line Issues Group of Chartered Accountants
Australia and New Zealand. For many years he
assisted in the development of the CPA Program,
Australia, with a notable contribution to the Ethics
and Governance Module.
An internationally renowned expert in the field
of financial accounting, Craig’s work is regularly
published in peer-reviewed accounting journals
including: Accounting, Organizations and Society;
Accounting and Business Research; Accounting,
Auditing and Accountability Journal; Accounting
and Finance; British Accounting Review; Critical
Perspectives on Accounting; Journal of Business
Ethics; Australian Accounting Review; Australian
Journal of Management; and The International
Journal of Accounting. According to Google Scholar,
his work has attracted over 22 000 citations, making
him one of the most highly cited researchers within
the accounting and/or finance literature in the world.
On 28 September 2018, and reflective of the extent
to which his research has been relied upon by
researchers and practitioners, the leading national
newspaper The Australian (in its annual feature
on Australian research leaders), identified Craig as
Australia’s Research Field Leader in the Field of
Accountability and Taxation
Craig’s expertise is frequently sought by
corporations, government and industry bodies on
issues pertaining to financial accounting, corporate
social and environmental accountability, and
ethics. The depth of his knowledge with respect
to social and environmental accountability is
reflected in the impressive Chapter 32, which has
been comprehensively updated for this edition.
A key tenet of his work, and reflected in his own
high standard of professional ethics, is that business
organisations have responsibilities to a broader
group of stakeholders, beyond their shareholders,
for their social and environmental performance, as
well as their financial performance.
Craig is the recipient of various teaching
and research awards, including teaching prizes
sponsored by KPMG and Chartered Accountants
Australia and New Zealand. He was the inaugural
recipient of the Peter Brownell Manuscript Award, an
annual research award presented by the Accounting
and Finance Association of Australia and New
Zealand. He was also awarded the University of
Southern Queensland Individual Award for Research
Excellence.
Craig is now working on the fifth edition of
his leading financial accounting theory textbook,
Financial Accounting Theory. His introductory
accounting textbook, An Introduction to Accounting:
Accountability in Organisations and Society, was
published by Cengage Learning in late 2019.
v
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CONTENTS IN BRIEF
PART 1
THE AUSTRALIAN ACCOUNTING ENVIRONMENT 1
Chapter 1
Chapter 2
An overview of the Australian external reporting environment . . . . . . . . . . . . . . . . . . . . . . . . 2
The Conceptual Framework for Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
PART 2
THEORIES OF ACCOUNTING Chapter 3
Theories of financial accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
PART 3
ACCOUNTING FOR ASSETS Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
An overview of accounting for assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation of property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Revaluations and impairment testing of non-current assets . . . . . . . . . . . . . . . . . . . . . . . . .
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for heritage assets and biological assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART 4
ACCOUNTING FOR LIABILITIES AND OWNERS’ EQUITY Chapter 10
Chapter 11
Chapter 12
Chapter 13
Chapter 14
Chapter 15
Chapter 16
Chapter 17
Chapter 18
An overview of accounting for liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share capital and reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for financial instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Revenue recognition issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The statement of profit or loss and other comprehensive income,
and the statement of changes in equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for share-based payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART 5
ACCOUNTING FOR THE DISCLOSURE OF CASH FLOWS Chapter 19
The statement of cash flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770
99
159
160
201
223
257
283
327
373
374
409
463
495
527
599
641
687
723
769
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PART 6
INDUSTRY-SPECIFIC ACCOUNTING ISSUES 813
Chapter 20
Accounting for the extractive industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 814
PART 7
OTHER DISCLOSURE ISSUES Chapter 21
Chapter 22
Chapter 23
Chapter 24
Events occurring after the end of the reporting period . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Segment reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Related party disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART 8
ACCOUNTING FOR EQUITY INTERESTS IN OTHER ENTITIES Chapter 25
Chapter 26
Chapter 27
Chapter 28
Chapter 29
Accounting for group structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 948
Further consolidation issues I: accounting for intragroup transactions . . . . . . . . . . . . . . 1005
Further consolidation issues II: accounting for non-controlling interests . . . . . . . . . . . . . 1055
Further consolidation issues III: accounting for indirect ownership interests . . . . . . . . . 1103
Accounting for investments in associates and joint ventures . . . . . . . . . . . . . . . . . . . . . . . 1155
PART 9
FOREIGN CURRENCY Chapter 30
Chapter 31
Accounting for foreign currency transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1206
Translating the financial statements of foreign operations . . . . . . . . . . . . . . . . . . . . . . . . . 1227
PART 10
CORPORATE SOCIAL-RESPONSIBILITY REPORTING Chapter 32
Accounting for corporate social responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1250
853
854
869
899
917
947
1205
1249
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CONTENTS
About the author ����������������������������������������������������������v
Contents in brief ���������������������������������������������������������vi
Preface �����������������������������������������������������������������������xix
Acknowledgments ����������������������������������������������������xx
AACSB statement�������������������������������������������������������xxi
How to use this book ����������������������������������������������xxii
Digital resources �����������������������������������������������������xxiv
PART 1
THE AUSTRALIAN ACCOUNTING ENVIRONMENT. . . . . . . . . . . . . . . . . . . 1
CHAPTER 1 An overview of the Australian external reporting environment. . . . . . 2
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
1.11
Accounting, accountability and the role of financial accounting
Users’ demand for general purpose financial statements
Australian Securities and Investments Commission
Australian Accounting standards Board
Financial Reporting Council
Australian Securities Exchange
International Accounting Standards Board
Accounting standards change across time
Differential reporting
The use and role of audit reports
What benefits can we expect from all of this international
standardisation?
1.12 International cultural differences and the harmonisation of
accounting standards
1.13 All of this regulation—is it really necessary?
1.14 The reporting of alternative measures of ‘profits’
3
6
7
18
31
32
34
38
38
41
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
2
3
53
53
53
54
55
57
42
44
45
48
CHAPTER 2 The Conceptual Framework for Financial Reporting. . . . . . . . . 59
2.1
2.2
2.3
2.4
An introduction to the IASB Conceptual Framework
Benefits of a conceptual framework
An overview of the recently revised Conceptual Framework
An overview of the building blocks of the
Conceptual Framework
2.5 Definition of general purpose financial reporting and a
reporting entity
2.6 Users of general purpose financial statements
2.7 Objective of general purpose financial reporting
2.8 Qualitative characteristics of useful financial information
2.9 Definition and recognition of the elements
of financial statements
2.10 Measurement principles
2.11 A critical review of conceptual frameworks
2.12 The conceptual framework as a normative theory of accounting
60
61
61
63
64
65
67
68
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
59
60
93
94
94
95
95
97
74
87
90
93
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PART 2
THEORIES OF ACCOUNTING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
CHAPTER 3 Theories of financial accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
3.10
3.11
3.12
3.13
3.14
Introduction to theories applicable to financial accounting
Positive accounting theory
Efficiency and opportunistic perspectives of PAT
Owner–manager contracting
Debt contracting
Political costs
Accounting policy choice and ‘creative accounting’
Some criticisms of Positive Accounting Theory
Normative accounting theories
Systems-oriented theories to explain accounting practice
Stakeholder Theory
Legitimacy Theory
Institutional Theory
Theories that seek to explain why regulation is introduced
101
104
105
106
110
114
120
122
124
128
129
133
137
144
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
Further reading
References
100
101
148
149
149
150
151
155
155
PART 3
59
ACCOUNTING FOR ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
CHAPTER 4 An overview of accounting for assets. . . . . . . . . . . . . . . . . . . . . . . . 160
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
Introduction to accounting for assets
Recognition criteria
Measurement of assets
Further consideration of ‘fair value’
Definition of current assets
How to present a statement of financial position
Accounting for property, plant and equipment—an introduction
Property, plant and equipment acquired with non-cash
consideration
4.9 Deferred payments made to acquire an asset
4.10 Accounting for borrowing costs incurred when constructing
an item of property, plant and equipment
4.11 Assets acquired at no cost
161
162
165
171
178
179
182
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
160
160
195
195
195
196
197
200
188
189
190
193
CHAPTER 5 Depreciation of property, plant and equipment. . . . . . . . . . . . . . . 201
5.1
Introduction to accounting for the depreciation of property,
plant and equipment
5.2 Key factors to consider when determining depreciation
5.3 Applying different methods of depreciation
5.4 Depreciation of separate components
5.5 When to start depreciating an asset
5.6 Revision of depreciation rate and depreciation method
5.7 Land and buildings
5.8 Modifying existing non-current assets
5.9 Disposition of a depreciable asset
5.10 Depreciation as a process of allocating the cost of an
asset over its useful life: some related concerns
5.11 Disclosure requirements
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202
204
205
208
209
210
210
212
212
214
215
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
Questions
Review questions
Challenging questions
References
201
202
216
216
216
217
218
221
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CONTENTS
CHAPTER 6 Revaluations and impairment testing of non-current assets. . . . . 223
6.1
6.2
6.3
6.4
6.5
6.6
6.7
6.8
6.9
6.10
6.11
6.12
6.13
Introduction to revaluations and impairment testing of
non-current assets
Measuring property, plant and equipment at cost or at fair
value—there’s a choice
The use of fair values
Revaluation increments
Treatment of balances of accumulated depreciation
upon revaluation
Revaluation decrements
Reversal of revaluation decrements and increments
Accounting for the gain or loss on the disposal or
derecognition of a revalued non-current asset
Recognition of impairment losses
Further consideration of present values
Investment properties
Economic consequences of asset revaluations
and impairments
Disclosure requirements
224
224
226
226
228
231
232
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
223
224
250
250
251
251
253
256
234
239
244
246
247
250
CHAPTER 7 Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257
7.1
7.2
7.3
7.4
7.5
Introduction to inventory
The general basis of inventory measurement
Inventory cost-flow assumptions
Reversal of previous inventory write-downs
Disclosure requirements
258
259
267
275
275
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
257
257
276
277
277
277
279
282
CHAPTER 8 Accounting for intangibles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283
8.1
8.2
8.3
8.4
8.5
8.6
8.7
8.8
8.9
Introduction to accounting for intangible assets
Which intangible assets can be recognised and included in the
statement of financial position?
What is the initial basis of measurement of intangible assets?
General amortisation requirements for intangible assets
Revaluation of intangible assets
Required disclosures in relation to intangible assets
Research and development
Accounting for goodwill
Does the way we account for intangible assets provide
useful financial accounting information?
284
287
288
290
292
294
295
303
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
283
283
314
315
315
316
319
325
313
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CONTENTS
CHAPTER 9 Accounting for heritage assets and biological assets. . . . . . . . . . 327
9.1
9.2
9.3
9.4
9.5
9.6
9.7
9.8
9.9
9.10
9.11
9.12
9.13
9.14
Introduction to accounting for heritage assets and
biological assets
Some arguments for and against recognising heritage
assets in financial terms
Do heritage assets provide future economic benefits?
Who controls heritage assets?
Faithful representation: are the benefits measurable
with reasonable accuracy?
Is the information ‘relevant’? The actual demand for
financial information about heritage assets
Measuring heritage assets in financial terms
An introduction to accounting for biological assets:
what is a biological asset?
The unique nature of biological assets
How should biological assets be classified, presented and
measured in financial statements?
When and how should revenue associated with biological
assets be recognised?
Accounting for agricultural produce
Non-financial disclosures
Opposition to AASB 1037 and AASB 141
328
330
335
337
338
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
327
328
365
365
365
366
367
370
339
341
349
352
352
358
360
360
364
PART 4
ACCOUNTING FOR LIABILITIES AND OWNERS’ EQUITY. . . . . . . . . . 373
CHAPTER 10 An overview of accounting for liabilities. . . . . . . . . . . . . . . . . . . . 374
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
The definition of liabilities
The recognition criteria for liabilities
Classification of liabilities as ‘current’ or ‘non-current’
Liability provisions
Onerous contracts
Accounting for bonds (debentures)
Contingent liabilities
Contingent assets
Some implications of reporting liabilities
Debt equity debate
Hybrid securities
375
377
379
380
383
385
390
394
395
397
399
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
374
375
400
400
400
401
404
407
CHAPTER 11 Accounting for leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409
11.1 An overview of recent developments in the accounting
requirements pertaining to accounting for leases
11.2 The core principle and scope of AASB 16
11.3 What is a lease pursuant to AASB 16?
11.4 When to recognise a lease
11.5 Accounting for the service component of a contract
that includes a lease
11.6 The meaning of ‘lease term’
11.7 Accounting for leases by lessees
11.8 Accounting for leases by lessors
11.9 Implications for accounting-based contracts
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410
415
417
420
420
421
422
436
451
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
409
410
453
455
455
456
458
462
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CONTENTS
CHAPTER 12 Accounting for employee benefits. . . . . . . . . . . . . . . . . . . . . . . . . 463
12.1 Overview of employee benefits
12.2 Categories of employee benefits
12.3 Accounting for employee benefits in the form of salaries
and wages
12.4 Annual leave
12.5 Sick leave
12.6 Long-service leave
12.7 Superannuation contributions
12.8 Employees’ accrued employee benefits and
corporate collapses
464
466
468
469
470
471
476
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
Reference
463
464
489
489
489
490
491
494
488
CHAPTER 13 Share capital and reserves. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495
13.1
13.2
13.3
13.4
13.5
13.6
13.7
13.8
13.9
Introduction to accounting for share capital and reserves
Creating reserves
Different classes of shares
Accounting for the issue of share capital
Forfeited shares
Rights issues and share options
Share splits and bonus issues
Accounting for distributions
‘Buyback’ of ordinary shares, and redemption of
preference shares
13.10 Required disclosures for share capital and reserves
496
498
499
500
507
511
513
514
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
Reference
495
496
521
522
522
523
524
525
518
520
CHAPTER 14 Accounting for financial instruments. . . . . . . . . . . . . . . . . . . . . . . . 527
14.1
14.2
14.3
14.4
14.5
14.6
14.7
14.8
14.9
14.10
14.11
14.12
14.13
14.14
14.15
Introduction to accounting for financial instruments
The definitions of financial assets, financial liabilities and
equity instruments, and the difference between primary
financial instruments and derivative financial instruments
Debt versus equity components of financial instruments
Set-off of financial assets and financial liabilities
Recognition and measurement of financial instruments on
acquisition
Measurement of financial assets following initial recognition
Initial recognition of financial liabilities
Subsequent measurements of financial liabilities
Derivative financial instruments and their use as
hedging instruments
Accounting for derivatives used within a hedging
arrangement
Futures contracts
Options
Swaps
Compound financial instruments
Disclosure requirements pertaining to financial instruments
528
530
536
540
542
543
558
559
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
527
528
590
590
591
591
594
598
560
561
572
578
579
585
588
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CONTENTS
CHAPTER 15 Revenue recognition issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 599
15.1
15.2
15.3
15.4
15.5
15.6
15.7
15.8
15.9
15.10
15.11
15.12
15.13
15.14
15.15
The definition and recognition of income
Income as ‘revenues’ and ‘gains’
Background to the release of the accounting standard
on revenue recognition (AASB 15)
Scope of AASB 15
An overview of the five-step model for determining the
recognition of revenue from contracts with customers
Step 1—identify the contract(s) with customers
Step 2—identify the performance obligation(s) in the contract
Step 3—determine the transaction price of the contract
Step 4—allocate a transaction price to each
performance obligation
Step 5—recognise revenue as each performance
obligation is satisfied
Unearned revenue
Accounting for sales with associated conditions–further
considerations
Construction contracts–further consideration
Interest and dividends
Allowance for doubtful debts
600
603
603
604
605
605
606
608
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
599
600
634
635
635
636
637
640
613
615
617
617
622
631
631
CHAPTER 16 The statement of profit or loss and other comprehensive
income, and the statement of changes in equity. . . . . . . . . . . . . 641
16.1
16.2
16.3
16.4
16.5
16.6
16.7
16.8
16.9
16.10
16.11
16.12
16.13
16.14
Introduction to the statement of profit or loss and other
comprehensive income
Information about significant judgements made when
compiling financial statements
The meaning of ‘total comprehensive income’
Components of other comprehensive income
Format of the statement of profit or loss and other
comprehensive income
Reclassification adjustments
Separate disclosure of ‘material items’
Changes in accounting estimates can impact profit
or loss and other comprehensive income
Other disclosures specifically required with respect
to particular items of income and expense
Accounting for prior period errors
Changes in accounting policy
Statement of changes in equity
The reporting of alternative (non-complying) measures
of ‘profits’
Profit as a guide to an organisation’s success
642
643
645
646
647
653
656
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
641
642
678
678
679
680
681
685
658
661
662
665
672
674
675
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CONTENTS
CHAPTER 17 Accounting for share-based payments. . . . . . . . . . . . . . . . . . . . . 687
17.1
17.2
17.3
17.4
17.5
17.6
17.7
Introduction to accounting for share-based payments
Background to the release of AASB 2
Equity-settled share-based payment transactions
Cash-settled share-based payment transactions
Share-based payment transactions with cash alternatives
Possible economic implications of AASB 2
Disclosure requirements
688
689
692
706
711
714
715
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening questions
Review questions
Challenging questions
Reference
687
688
719
719
720
720
721
722
CHAPTER 18 Accounting for income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723
18.1
18.2
18.3
Introduction to accounting for income taxes
The balance sheet approach to accounting for taxation
Temporary differences lead to ‘deferred tax assets’ and/or
‘deferred tax liabilities’ and directly influence ‘income
tax expense’
18.4 Calculating the tax base of assets and liabilities
18.5 Unused tax losses
18.6 Revaluation of non-current assets
18.7 Offsetting deferred tax liabilities and deferred tax assets
18.8 Change of tax rates
18.9 Disclosures pertaining to tax expense and related assets
and liabilities
18.10 Evaluation of the assets and liabilities created by AASB 112
724
725
727
733
740
743
753
753
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
723
724
761
761
761
762
764
767
755
760
PART 5
ACCOUNTING FOR THE DISCLOSURE OF CASH FLOWS. . . . . . . . . 769
CHAPTER 19 The statement of cash flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770
19.1
19.2
19.3
19.4
19.5
19.6
19.7
19.8
Comparison with other financial statements
The difference between cash flows and profits
Defining ‘cash’ and ‘cash equivalents’
Classification of cash flows
Format of statement of cash flows
Notes to accompany the statement of cash flows
Calculating cash inflows and outflows
The use of cash flow data by different stakeholders and
within various contractual arrangements
771
772
774
775
777
780
781
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
770
770
801
802
802
803
805
811
799
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CONTENTS
PART 6
INDUSTRY-SPECIFIC ACCOUNTING ISSUES. . . . . . . . . . . . . . . . . . . . . 813
CHAPTER 20 Accounting for the extractive industries. . . . . . . . . . . . . . . . . . . . . 814
20.1
Overview of the extractive industries, and introductory comments
about accounting for exploration and evaluation expenditures 815
20.2 Alternative methods to account for exploration and evaluation
expenditure
818
20.3 Basis for measurement of exploration and
evaluation expenditures
822
20.4 Subsequent impairment and amortisation of costs
carried forward
823
20.5 Accounting for restoration costs
825
20.6 Determining sales revenue
828
20.7 Determining the measurement of inventory
829
20.8 Disclosure requirements
829
20.9 Does the area-of-interest method provide a realistic value
for an entity’s reserves?
839
20.10 Research on accounting regulation pertaining to
exploration and evaluation expenditure
839
20.11 Consideration of the social and environmental performance
of organisations within the extractive industries
842
20.12 The development of a new accounting standard for
extractive activities
843
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
814
815
846
847
847
848
849
851
PART 7
OTHER DISCLOSURE ISSUES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853
CHAPTER 21 Events occurring after the end of the reporting period. . . . . . . 854
21.1 What is an ‘event after the reporting period’?
21.2 Why disclose information about events that have occurred
after the end of the reporting period?
21.3 Types of events after the reporting period
21.4 Events that necessitate adjustments to the financial
statements (adjusting events after the reporting period)
21.5 Events that necessitate disclosure but no adjustment
(non-adjusting events)
21.6 Disclosure requirements
855
856
857
858
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
854
854
863
864
864
865
866
860
862
CHAPTER 22 Segment reporting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 869
22.1
22.2
22.3
22.4
22.5
22.6
22.7
Advantages and disadvantages of segment reporting
An introduction to AASB 8
Defining an operating segment
Defining a reportable segment
Measurement of segment items
Required disclosures
Is there a case for competitive harm?
870
874
876
878
882
883
886
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
869
869
890
891
891
892
894
897
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CONTENTS
CHAPTER 23 Related party disclosures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 899
23.1
23.2
23.3
23.4
23.5
Introduction to related party disclosures
Implications of related party transactions
The rationale for requiring related party disclosures
Categories of related party
Disclosure requirements for related parties
900
901
902
904
907
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
899
899
913
913
913
914
914
915
CHAPTER 24 Earnings per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 917
24.1
24.2
24.3
24.4
Introduction to earnings per share
Computation of basic earnings per share
Diluted earnings per share
Linking earnings per share to other indicators
918
919
930
936
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
References
917
917
940
941
941
941
944
946
PART 8
ACCOUNTING FOR EQUITY INTERESTS IN OTHER ENTITIES. . . . . 947
CHAPTER 25 Accounting for group structures. . . . . . . . . . . . . . . . . . . . . . . . . . . 948
25.1
25.2
25.3
25.4
25.5
25.6
25.7
25.8
25.9
25.10
25.11
25.12
25.13
The meaning of ‘consolidated financial statements’, and
the rationale for consolidating the financial statements
of different legal entities
History of Australian accounting standards that govern
the preparation of consolidated financial statements
‘Investment entities’: exception to consolidation
Alternative consolidation concepts
The concept of control
Direct and indirect control
Accounting for business combinations
Gain on bargain purchase
Subsidiary’s assets not recorded at fair values
Previously unrecognised identifiable intangible assets
Consolidation after date of acquisition
Disclosure requirements
Control, joint control and significant influence
949
951
955
956
957
962
964
973
975
981
984
991
992
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
Reference
948
949
993
994
994
995
1000
1004
CHAPTER 26 Further consolidation issues I: accounting for
intragroup transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1005
26.1
26.2
26.3
26.4
Introduction to accounting for intragroup transactions
Dividend payments from pre- and post-acquisition earnings
Intragroup sale of inventory
Sale of non-current assets within the group
1006
1006
1014
1026
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
1005
1005
1044
1045
1045
1046
1049
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CONTENTS
CHAPTER 27 Further consolidation issues II: accounting for
non-controlling interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1055
27.1 Introduction to accounting for non-controlling interests
27.2 Non-controlling interests to be disclosed in the consolidated
financial statements
27.3 Calculating non-controlling interests
27.4 Adjustments for intragroup transactions
1056
1057
1060
1067
Learning objectives (LO)
Opening questions
Summary
Key term
Answers to Opening
questions
Review questions
Challenging questions
1055
1055
1095
1095
1095
1096
1099
CHAPTER 28 Further consolidation issues III: accounting for indirect
ownership interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1103
28.1 Introduction to accounting for indirect ownership interests
28.2 Calculating the parent entity interest, and the non-controlling
interest, in the presence of indirect interests
28.3 Sequential and non-sequential acquisitions
1104
1107
1134
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
1103
1103
1148
1148
1148
1149
1151
CHAPTER 29 Accounting for investments in associates
and joint ventures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1155
29.1
29.2
29.3
29.4
29.5
29.6
29.7
29.8
29.9
Introduction to the equity method of accounting
Significant influence
Application of the equity method of accounting
The equity method of accounting in the presence of
inter-entity transactions
Application of the equity method of accounting when losses
have been incurred by an associate
Disclosure requirements
Introduction to accounting for interests in joint arrangements
Joint ventures
Joint operations
1156
1158
1160
1172
1179
1181
1182
1183
1184
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
Questions
Review questions
Challenging questions
References
1155
1156
1195
1195
1195
1196
1197
1203
PART 9
FOREIGN CURRENCY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1205
CHAPTER 30 Accounting for foreign currency transactions. . . . . . . . . . . . . . 1206
30.1
30.2
30.3
30.4
30.5
Introduction to accounting for foreign currency transactions
Accounting entry at the date of the original transaction
Adjustments at the end of the reporting period
Determination of the presentation currency
The translation of longer-term receivables, payables
and cash deposits
30.6 Qualifying assets
30.7 Hedging transactions
30.8 Foreign currency swaps
1207
1209
1211
1212
1214
1216
1218
1220
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
questions
Review questions
Challenging questions
1206
1206
1221
1221
1221
1222
1224
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CONTENTS
CHAPTER 31 Translating the financial statements of foreign operations. . . . . . 1227
31.1 Introduction to translating the financial statements of foreign
operations
31.2 Reporting foreign currency transactions in the
functional currency
31.3 Translating the accounts of foreign operations
into the presentation currency
31.4 Consolidation subsequent to translation
1228
1228
1235
1242
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
Questions
Review questions
Challenging questions
1227
1227
1245
1245
1245
1246
1246
PART 10
CORPORATE SOCIAL-RESPONSIBILITY REPORTING. . . . . . . . . . . . 1249
CHAPTER 32 Accounting for corporate social responsibility. . . . . . . . . . . . . . 1250
32.1
32.2
32.3
Introduction to social-responsibility reporting
Sustainability
What are the responsibilities of business (to whom and
for what)?
32.4 Evidence of public social and environmental reporting
32.5 The application of an ‘accountability model’
32.6 Why report?
32.7 To whom will the organisation report?
32.8 What information shall be reported?
32.9 How (and where) will the information be presented?
32.10 United Nations’ Sustainable Development Goals
32.11 Accounting for externalities and ‘full cost accounting’
32.12 Counter (shadow) accounts
32.13 The critical problem of climate change
32.14 Personal social responsibility
Concluding remarks
Appendix A Present value of $1 in n periods = 1/(1 + k)n,
where k is the discount rate��������������������� 1334
Appendix B Present value of an annuity of $1
per period for n periods ���������������������������� 1336
1251
1254
1255
1260
1261
1262
1275
1276
1278
1301
1306
1311
1313
1322
1323
Learning objectives (LO)
Opening questions
Summary
Key terms
Answers to Opening
Questions
Review questions
Challenging questions
References
1250
1251
1323
1324
1324
1325
1327
1329
Appendix C Calculating present values����������������������� 1338
Glossary ��������������������������������������������������������������������������������� 1341
Index ��������������������������������������������������������������������������������������� 1353
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PREFACE
This is the ninth edition of a book that was originally
published in 1995. Since the first edition was
published we have seen extensive changes in
relation to the practice and regulation of general
purpose financial reporting. These changes continue
to occur and this book has always attempted to
carefully explain the nature of the changes as well
as the potential economic and social consequences
that might result from such changes.
In the period of time between when the eighth
edition of this book was published, and the writing of
this ninth edition was completed (in October 2019)
there have been some rather significant changes
in regulation and guidance pertaining to external
reporting. These changes have been incorporated
within this ninth edition. For example, there were some
significant changes to the Conceptual Framework for
Financial Reporting and a number of new accounting
standards have come into effect (such as AASB
15 Revenue from Contracts with Customers and
AASB 16 Leases). There have also been a number
of significant developments in the area of social and
environmental (and sustainability) reporting, and these
are addressed in Chapter 32.
Each chapter of this ninth edition contains clear
learning objectives, as well as a number of opening
questions, which students are encouraged to answer
before reading the chapter. Solutions to each
opening question are provided at the end of the
chapter and students are asked to consider how their
answers changed as a result of reading the chapter.
Throughout the chapters there are also numerous
boxes identifying why students need to know
particular material. The book provides material that
will enable the reader to gain a thorough grasp of the
contents and of the practical application of the majority
of financial accounting requirements currently in place
in Australia. In the discussion of these requirements,
numerous worked examples, with detailed solutions,
are provided throughout the text. A glossary of key
terms is provided towards the back of the book.
As well as addressing how to apply the various
accounting requirements, this text also encourages
readers to critically evaluate the various rules and
guidelines. The aim is to develop accountants who
are able to apply particular accounting requirements,
as well as being able to contribute to the ongoing
improvement of accounting requirements. The view
taken is that it is important for students not only to
understand the rules of financial accounting, but also
to understand the limitations inherent in many of the
existing accounting requirements. For this reason,
reference is made to research studies that consider the
merit, implications, and costs and benefits of the various
accounting requirements. Furthermore, newspaper
articles discussing different aspects of the accounting
requirements are included for consideration and
discussion. This all adds up to give this book a ‘realworld’ perspective. The permission of copyright holders
to reproduce this material is gratefully acknowledged.
Social-responsibility reporting continues to be an
important area of accounting, and one that is rapidly
developing. Its importance is further highlighted by the
growing evidence of climate change, species extinction
and large-scale poverty, hunger and social inequities in
many countries. While this book predominantly considers
financial accounting and reporting, Chapter 32 focuses
on social-responsibility reporting and provides the most
up-to-date and comprehensive material available on this
important topic, with additional material on the important
topic of climate change—from both an accounting and
a scientific perspective—as well as commentaries on
various alternative reporting frameworks.
Writing a text like this is an extremely timeconsuming exercise and it has been very gratifying
that the effort involved has been rewarded by so many
institutions across Australia (and also some outside
Australia) electing to prescribe previous editions of this
book as part of their accounting programs. Given the
success of all previous editions, every effort has been
made to ensure that this
ninth edition is equally
valuable to students and
teachers, and that it has
been substantially and
thoroughly revised.
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ACKNOWLEDGMENTS
There are many people who must be thanked for
their contribution to the ninth edition of this book.
First, thanks must go to the following reviewers of
the current edition:
Jahangir Ali, La Trobe University; Peter Baxter,
University of the Sunshine Coast; Collette
Chesters, University of Western Australia; Scott
Copeland, University of South Australia; Omar
Faroque, University of New England; Chelsea Liu,
University of Adelaide; Meiting Lu, Macquarie
University; Wei Lu, Monash University; Lara
Meng, Curtin University; Balachandran Muniandy,
La Trobe University; YH Tham, Curtin University.
This book has also been improved during the
course of the first eight editions by the feedback
received from many people and I would like to
acknowledge the contribution that they have
previously made. These people include:
Maria Balatbat, University of New South Wales;
Peter Baxter, University of the Sunshine Coast;
Poonam Bir, Monash University; Phil Cobbin,
University of Melbourne; Lome Cummings,
Macquarie University; Matt Dyki, Charles Sturt
University, Wagga Wagga campus; Natalie
Gallery, Queensland University of Technology;
John Goodwin, RMIT University; Deborah Janke,
University of Southern Queensland; Maurice
Jenner, University of Southern Queensland;
Graham Jones, Flinders University; Peter
Keet, RMIT University; Janet Lee, Australian
National University; Steven Lesser, Charles Sturt
University, Wagga Wagga campus; Stephen Lim,
University of Technology Sydney; Janice Loftus,
University of Sydney; Wei Lu, Monash University;
Diane Mayorga, University of New South Wales;
Kellie McCombie, University of Wollongong;
Malcolm Miller, University of New South Wales;
Lee Moermon, University of Wollongong; Gary
Monroe, Australian National University; Richard
Morris, University of New South Wales; Anja
Morton, Southern Cross University, Lismore
campus; Karen Ness, James Cook University;
Cameron Nichol, RMIT University; Gary Plugarth,
University of New South Wales; Lisa Powell,
University of South Australia; Jim Psaros,
University of Newcastle; Michaela Rankin,
Monash University; Andrew Read, University of
Canberra; Dan Scheiwe, Queensland University
of Technology; Mark Silvester, University of
Southern Queensland; Stella Sofocleous,
Victoria University of Technology; Jenny Stewart,
Griffith University; Seng The, Australian National
University; Len Therry, Edith Cowan University;
Matthew Tilling, University of Western Australia;
Irene Tutticci, University of Queensland; Mark
Vallely, University of Southern Queensland;
Trevor Wilmshurst, University of Tasmania;
Victoria Wise, University of Tasmania; Ann-Marie
Wyatt, University of Technology Sydney.
Thanks also go to many of my colleagues
at RMIT University for their friendship and
encouragement. The McGraw-Hill (Australia) team,
including Simone Bella, Caroline Hunter, Claire
Linsdell, Alison Moore, Paul Leslie, Bethany Ng,
Genevieve MacDermott, Debbie Gallagher,
Gurdish Gill, Rosemary Gervasi and Katie Miller,
also deserve a great deal of thanks for helping in
the preparation of this book.
And last, but certainly not least, thanks again go
to my 20-year-old daughter Cassandra for all the
love and support she gives me in whatever I seem
to be doing and for continually helping me to put
everything into perspective. As I have said before,
she is indeed my finest work (and my most valuable
‘asset’) and represents that aspect of my life of which
I am most proud. She is now ‘seven editions’ old.
xx
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AACSB STATEMENT
McGraw-Hill is a proud corporate member of AACSB International. Understanding the importance
and value of AACSB accreditation, Financial Accounting recognises the curricula guidelines detailed
in the AACSB standards for business accreditation by connecting selected questions in the resource
and the testbank to the six general knowledge and skill guidelines found in the AACSB standards.
The statements contained in Financial Accounting are provided only as a guide for the users
of this textbook. The AACSB leaves content coverage and assessment within the purview of
individual school, the mission of the school, and the faculty. While Financial Accounting and the
teaching package make no claim of any specific AACSB qualification or evaluation, within Financial
Accounting we have identified chapters as containing content and labelled selected activities
according to the six general knowledge and skills areas.
xxi
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HOW TO USE THIS BOOK
CHAPTER 1: An overview of the Australian external reporting environment
3
OPENING QUESTIONS
Learning objectives
41
Each chapter starts with a list of the chapter’s learning
objectives.
These flag what you should know when
C HAP TER
you have worked through the chapter. Make these the
C HAP TER
foundation
for your examof
revision
by using them to test
An overview
accounting
yourself. The end-of-chapter assignments also link back to
An
overview
of the
for
assets
these
learning
objectives.
Australian external reporting
environment
LEARNING OBJECTIVES (LO)
4.1 Understand and be able to apply the definition of an asset.
4.2 Understand and be able to apply asset recognition criteria.
4.3 Understand how assets are measured, and that different measurement bases can be applicable to
different classes of assets.
4.4 Know the meaning of ‘fair value’ and the reason that a ‘fair-value hierarchy’ has been introduced into the
1.1 Understand the meaning of ‘financial accounting’ and its relationship to the broader areas of ‘accounting’ and
accounting
standards. Also, be aware of some concerns that are attributed to the use of fair values.
‘accountability’.
4.5 Know how to differentiate between current and non-current assets.
1.2 Be able to explain who is likely to be a user of general purpose financial statements.
4.6 Be aware of how a balance sheet shall be presented.
1.3 Understand the role of the Australian Securities and Investments Commission with respect to general purpose financial
4.7 Have knowledge about how to account for property, plant and equipment, including how to account for
reporting within Australia, and be aware of the requirements within the Corporations Act that require the preparation of
related
safety and
environmental
expenditures,
and by
maintenance,
and how
to allocate
to Officer.
a Directors’
Declaration,
Directors’
Report, and arepairs
Declaration
the Chief Executive
Officer
and Chiefcosts
Financial
individual
items of
property,
plant
and equipment.
1.4 Understand
the
role of the
Australian
Accounting Standards Board with respect to general purpose financial
4.8 Be aware
of accounting
issues that arise when property, plant and equipment is acquired with assets
reporting
within Australia.
other
than cash. the role of the Financial Reporting Council with respect to general purpose financial reporting within Australia.
1.5 Understand
4.9 Understand
how the
to determine
the cost of
an assetExchange
when the
payments
for
the asset
are financial
deferred.reporting within
1.6 Understand
role of the Australian
Securities
with
respect to
general
purpose
4.10 Know Australia.
how to account for interest costs associated with the acquisition, or construction, of an item of
1.7 Be able
to and
explain
the general functions of the International Accounting Standards Board and its relevance to
property,
plant
equipment.
Australian
general
purpose
4.11 Be able
to account
for an
assetfinancial
that hasreporting.
been acquired at no direct cost.
LEARNING OBJECTIVES (LO)
1.8 Understand that accounting standards change across time, meaning that profits calculated in past years may not be
directly comparable with current profit calculations.
1.9 Be able to explain the idea of ‘differential reporting’.
Understand
the watch
role of the
the auditor,
and the video
auditor’s
report,Deegan
with respect
to general
financial
reporting.
Before 1.10
reading
this chapter,
accompanying
of Craig
explaining
whypurpose
this topic
is important
Be aware of some of the perceived benefits pertaining to the international standardisation of financial reporting as
for your1.11
studies.
espoused by the International Accounting Standards Board.
1.12 Be aware of some research which suggests that the pursuit of international standardisation in general purpose financial
reporting ignores many important impediments, such as international differences in ‘culture’.
1.13 Understand that the practice of general purpose financial reporting is quite heavily regulated within Australia, and
OPENINGbe
QUESTIONS
aware of some of the arguments for and against the regulation of financial accounting.
1.14
Understand
that organisations
will often
and answer
highlightthe
measures
of financial
performance
within their annual
Before
reading
this chapter,
please consider
how include
you would
following
four questions.
We will
reports
that do at
notthe
comply
with
standards.
return to these
questions
end of
theaccounting
chapter, where
we suggest some answers.
NEW!
Videos
A short video by Craig Deegan explains why topics are
being discussed and why you need to know particular
information.
1.
2.
3.
4.
Is there a requirement that all assets shall be measured on the same basis (for example, at fair value)? LO 4.3
What is the meaning of ‘fair value’? LO 4.4
What is the ‘fair-value hierarchy’ as it relates to the application of fair value to measuring assets? LO 4.4
Before reading this chapter, watch the accompanying video of Craig Deegan explaining why this topic is important
If an asset is constructed with the use of borrowed funds, how are the related interest costs to be treated? LO 4.10
for your studies.
160
NEW!
2
Opening questions
dee67382_ch04_159-200.indd
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At the start of each chapter there are several questions
that you should consider before reading the chapter,
with solutions provided at the end of the chapter. You
can use these questions to assess whether your views
have changed, and therefore your knowledge has been
advanced, as a result of reading the material provided
within
the
chapter.
60
PART 1: The
Australian
accounting environment
dee67382_ch01_001-058.indd
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2
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PART 1: The Australian accounting environment
A number of qualitative characteristics were identified as being important in terms of financial information. Two
fundamental qualitative characteristics were explained as being relevance and representational faithfulness. A further
four ‘enhancing’ qualitative characteristics were identified, and these are comparability, verifiability, timeliness and
OPENING
QUESTIONS
understandability.
The concept of materiality was also introduced and we learned that materiality is a threshold
concept, which in turn assists a reporting entity to decide whether particular information needs to be separately
Before
reading this chapter, please consider how you would answer the following seven questions. We will
disclosed.
return to these questions at the end of the chapter, where we suggest some answers.
The chapter discussed the five elements of accounting: assets, liabilities, income, expenses and equity. We learned
1. What
is definitions
the difference
in role
betweenrelied
a conceptual
forgiven
financial
reporting
and accounting
that the
of income
and expenses
directly uponframework
the definitions
to assets
and liabilities.
We also
learned thatLO
the2.1,
recognition
standards?
2.2 criteria of the respective elements of accounting rely upon professional judgements about
relevance
and representational
2. What
benefits
are generatedfaithfulness.
as a result of having a conceptual framework for financial reporting? LO 2.2
concludedcharacteristics
the chapter withwill
a critical
analysis
of conceptual
frameworks.
3. WhatWe
qualitative
useful
financial
accounting
information be expected to possess? LO 2.8
4.
5.
6.
7.
What are the five different ‘elements’ of financial accounting? LO 2.9
What are the three main components of the definition of assets? LO 2.9
KEY
TERMS
Are
all assets
required to be measured using the same basis of measurement? LO 2.10
What role does ‘materiality’ have with respect to deciding whether particular financial information should be
income 86
equity 87
asset 75
disclosed?
LO 2.8
Conceptual Framework
control (assets) 76
60
expenses 85
future economic benefits
76
liability 81
reporting entity 64
AASB STANDARDS REFERRED TO IN THIS CHAPTER AND IFRS/IAS EQUIVALENTS
AASB no.
Title
ANSWERS
TO OPENING
QUESTIONS
Accounting
Policies, Changes
in Accounting Estimates and Errors
108
IFRS/IAS equivalent
IAS 8
138
Intangible Assets
IAS 38
At the beginning of the chapter we asked the following seven questions. As a result of reading this chapter we should now
1053
Application
of Tiers of
Accounting Standards
—
be able to provide
informed answers
to Australian
these questions.
1. What is the difference in role between a conceptual framework for financial reporting and accounting standards?
LO 2.1, 2.2
2.1A An
introduction
to the
IASB
Conceptual
Framework
conceptual
framework provides
a general
framework
for general purpose
financial reporting and does not deal
with individual, or specific types of, transactions or events. Accounting standards, by contrast, deal with specific
LO 2.1
noted
in Chapter
1, in 2005,
Australia
startedstandards
using the
issued by the
types of As
assets
or liabilities
or transactions
or events.
Accounting
takeaccounting
precedencestandards
over the conceptual
framework.
When there is
no specifically
relevant accounting
standard,
should
be also
madeatorelated
the conceptual
International
Accounting
Standards
Board (IASB).
Asreference
such, there
was
requirement
Conceptual Framework
framework.
that we use the Conceptual Framework developed by the IASB. That is, because International
A framework that
Financial
Reporting
(IFRSs)
have been
developed
in accordance
with
2. What benefits
are generated
as aStandards
result of having
a conceptual
framework
for financial
reporting? LO
2.2 the IASB
describes the objective
of, and the concepts for,Section 2.2
Conceptual
Framework
Financial Reporting, and as Australia adopted IFRSs, then Australia
of this chapter
identified for
the benefits.
general purpose financial
must
also
adopt
the
IASB
Conceptual
Framework.
This
meant
we
had
to
move
away
from
using the
3. What qualitative characteristics will useful financial accounting information be expected to possess? LO 2.8
reporting.
xxii
developed
framework
that and
we faithfully
had developed
Australia.
Other or
countries
have adopted
First, theconceptual
information should
be relevant
representwithin
the underlying
transaction
event thatthat
it purports
to
IFRSs
have similarly
adopted
the IASB Conceptual
Framework
and should
abandoned
domestically
represent.
To enhance
the relevance
and representational
faithfulness,
the information
also betheir
comparable,
frameworks.
The
of the Conceptual Framework can be summarised as follows:
verifiable, timely
andpurpose
understandable.
(a) assist
IASB
to develop
accounting
standards
thataccounting?
are based on
concepts
4. the
What
are the
five different
‘elements’
of financial
LO consistent
2.9
are assets,
liabilities, income,
expenses
and equity.
(b) assist They
preparers
of financial
statements
to develop
consistent accounting policies when no accounting
standard
applies
to
a
particular
transaction
or
other
event,
or
when
an
accounting
standard allows a choice of
5. What are the three main components of the definition of assets? LO 2.9
accounting
policy entity controls the resource; the control exists as a result of a past transaction or event; and the
The reporting
(c) assist all
partieshas
tothe
understand
interpret
accounting
resource
potential toand
produce
economic
benefitsstandards.
for the reporting entity.
It is6.generally
accepted
that ittoisbeunwise,
andusing
perhaps
illogical,
accounting
standards unless there is first
Are all assets
required
measured
the same
basisto
of develop
measurement?
LO 2.10
some agreement
on key,
such as:measurement
the objectives
of general
purpose financial
reporting;
the
qualitative
No, assets
canfundamental
be measured issues,
using different
bases.
The measurement
basis used
should be
chosen
according
to whether
it bestinformation
enables relevant
representationally
faithful
financialand
information
to be presented
to
characteristics
that useful
financial
shalland
possess
(for example,
relevance
representational
faithfulness);
dee67382_fm_i-xxvi.indd
xxii
the users
of the financial
statements.
how and when
transactions
should
be recognised; what constitutes an element of financial reporting; and who is the
audience7. ofWhat
general
purpose
financialhave
statements.
Unless
the accounting
profession
and accounting
role does
‘materiality’
with respect
to deciding
whether particular
financial
informationstandard-setters
should be
have agreement
on such
central issues, it is difficult to understand how logically consistent accounting standards could
disclosed?
LO 2.8
Below are a number of questions that we want you to consider before reading the material in this chapter. We
will ask the same questions again at the end of the chapter and provide respective solutions. The solutions will
appear just before the end of chapter review questions but please do not look at the answers until you have
read the chapter. Each chapter of this book will have ‘Opening questions’ so that you can assess, or consider,
whether your views have changed, and therefore, your knowledge has been advanced, as a result of reading
the material provided within the chapter.
AASB standards referred to in this chapter
and
IFRS/IAS
equivalents
1. What
is ‘general purpose
financial reporting’? LO 1.1, 1.2
NEW!
2. What is the role of the Australian Accounting Standards Board (AASB) with respect to general purpose financial
reporting within Australia? LO 1.4
3. Does the AASB have legal power to enforce accounting standards within Australia? LO 1.4
4. What is the relevance of the International Accounting Standards Board (IASB) to general purpose financial
reporting within Australia? LO 1.7
5. What power does the IASB have to enforce the accounting standards that it develops, and which are in use
internationally? LO 1.7
In each chapter you will find a mini table highlighting the
AASB standards referred to in the chapter with the IFRS/
IAS equivalents, to give you a broader understanding of
how Australian standards link to the international scene.
AASB STANDARDS REFERRED TO IN THIS CHAPTER AND IFRS/IAS EQUIVALENTS
AASB no.
Title
IFRS/IAS equivalent
101
Presentation of Financial Statements
IAS 1
108
Accounting Policies, Changes in Accounting Estimates and Errors
IAS 8
1048
Interpretation of Standards
—
1049
Whole of Government and General Government Sector Financial Reporting
—
1053
Application of Tiers of Australian Accounting Standards
—
Chapter
introduction
1.1 Accounting, accountability and the role of financial accounting
Each
chapter
begins
with
excellent
overview
oflarger-sized
the LO 1.1
In this book
we focus on financial
accounting,
and an
particularly
financial accounting
undertaken by
organisations (which we will generally refer to as ‘reporting entities’) that are required to apply accounting standards.
material
to be
covered
that
places
it toinbriefly
the
broader
But before we launch
into doing
some ‘financial
accounting’,
it is useful
consider
how financial accounting
relates to the broader area of ‘accounting’, and how accounting in turn relates to the notion of ‘accountability’.
context
of how
topics
in ofvarious
chapters
interrelate.
Financial accounting
represents
only a part
the broader area
of ‘accounting’. So
what is ‘accounting’? Simply
stated, accounting can be defined as the provisionCHAPTER
of information
about aspects of the performance of an entity to a
2: The Conceptual Framework for Financial Reporting 77
particular group of people with an interest, or stake, in the organisation—we can call these parties stakeholders. But
what ‘aspects of performance’ should ‘accounting’ address and what ‘accounts’ are stakeholders entitled to? This
really depends upon judgements we make about the organisation’s responsibilities and accountabilities. For example,
Assets acquired at no cost
if we were to accept that an entity has a responsibility (and an accountability) for its social and environmental impacts,
To
satisfy
theaccountants,
definition ofshould
an ‘asset’,
it isa duty
not a to
prerequisite
the asset
acquired
a cost to theinreporting
then
we, as
accept
provide ‘anthat
account’
(orbe
a report)
to atstakeholders
respect ofentity.
the
As
the Conceptual
Framework
notes (paragraph
4.18), although there
is typically:
organisation’s
social
and environmental
performance—perhaps
by way
of releasing a publicly available corporate
social
responsibility
report.
If,
by
contrast,
we
consider
that
the
only
responsibility
an
organisation
has
is
to maximise
a close association between incurring expenditure and acquiring assets, the two do not necessarily coincide.
When
its financial
returnsexpenditure,
(profits), then
might
believe
that the
account
need tofuture
provide
is a financial
account.
an entity incurs
thiswe
may
provide
evidence
thatonly
the entity
haswe
acquired
economic
benefits,
but it
need toevidence
considerthat
thethe
breadth
of stakeholders
who should
an ‘account’—for
example,
isWe
notalso
conclusive
entity has
obtained an asset.
Further,betheprovided
absence with
of related
expenditure does
not
should
it be restricted
to shareholders
and/or creditors,
or doAssets
employees,
local communities
and other
preclude
an item from
meeting the definition
of an asset.
can include,
for example, rights
thatstakeholders
a governmentalso
have
a right
to be
provided
withofparticular
has
granted
to the
entity free
charge orinformation
that anotherabout
party an
hasorganisation?
donated to the entity. Therefore, the key point here
Gray,
Adams
and
Owen
(2014)
developed
an
accountability
model
that
explains
how
organisations
should
deal
is that the presence or absence of expenditure is not a defining factor in determining the existence of an ‘asset’.
with stakeholders and proposes that since a firm’s activities affect the wellbeing of a wide range of stakeholders, the
Worked
Example
2.3 provides
insights into
how to apply
the definition
of assets.
firm
is morally
responsible,
and therefore
accountable,
to these
stakeholders.
In more practical terms, Gray et al.
(1997, p. 334) provide a broader notion of accountability:
Worked examples
A wide range of detailed scenarios and solutions, some
fairly straightforward and some more complex, are
provided throughout the text and are a great learning aid,
helping to reinforce how the theory is applied in practice
and its relevance to actual situations.
WORKED EXAMPLE 2.3: Applying the definition of assets
CHAPTER 2: The Conceptual Framework for Financial Reporting
A reporting entity has been involved with the following transactions and events:
75
(a) The entity acquired some land at a cost of $1 million. However, after acquiring the land it became known
Different
can
be applied
to determining
profits
(income
lesstoexpenses)
andor
this
direct
implications
dee67382_ch01_001-058.indd
3approaches
that the
land was
highly
contaminated
and was
very
unlikely
be usable,
behas
able
to be
sold. 10/17/19 07:49 AM
for (b)
how we
define the
elementscustomer
of financial
accounting.
Two
approaches
are commonly
referred
to asorganisation
the asset/
A satisfied
long-term
decided
to give
thesuch
organisation
a delivery
truck for
free. The
liability approach and the revenue/expense approach. The asset/liability approach links profit to changes that have
expects to use the truck within the business.
occurred in the assets and liabilities of the reporting entity, whereas the revenue/expense approach tends to rely on
(c) The organisation has been given the right by the local government to use a nearby river to transport
concepts such as the matching principle, which is very much focused on actual transactions and which gives limited
some of its products to nearby markets.
consideration to changes in the values of assets and liabilities. The Conceptual Framework adopts the asset/liability
approach.
Conceptual
Framework,
the task
of defining
the elements
of financial
statements
must
REQUIREDTherefore,
Whichwithin
of the the
above
transactions
and events
would
generate
a resource
that satisfies
the definition
definitions of assets and liabilities, as the definitions of all the other elements flow from these definitions.
ofstart
an with
asset?
This should become apparent as we consider each of the elements of financial accounting in what follows. In relation
SOLUTION
Asliability
we know,
theofdefinition
of an asset the
hasFASB
three and
keyIASB
components.
to the land described
to the ‘asset and
view’
profit determination,
(2005, pp.In7relation
and 8) state:
above, while the organisation might control the land as a result of a past transaction or event, it appears that
In both
[FASB
and IASB]
frameworks,
definitions
of the elements
areTherefore,
consistent with
an ‘asset
and liability
the land
does
not have
the potential
to the
generate
economic
benefits.
it does
not seem
to satisfy the
view’, in which income is a measure of the increase in the net resources of the enterprise during a period, defined
definition of an asset.
primarily in terms of increases in assets and decreases in liabilities. That definition of income is grounded in
The delivery truck does appear to satisfy the definition of an asset. It is controlled as a result of a past event
a theory prevalent in economics: that an entity’s income can be objectively determined from the change in its
and itwealth
does plus
havewhat
theitpotential
to generate economic benefits for the organisation. It does not directly matter that
consumed during a period (Hicks, pp. 178–9, 1946). That view is carried out in definitions of
the truck
was not
acquired
at a cost
to the
organisation.
liabilities,
equity,
and income
that are
based
on the definition of assets, that is, that give ‘conceptual primacy’ to
The
right
to
use
the
nearby
not an asset
of the view’,
organisation
the organisation
does
not have
‘control’
assets. That view is contrasted river
with ais‘revenue
and expense
in which as
income
is the difference
between
outputs
over from
the river—it
justtohas
to it. earning
The river
would during
not appear
in the
financial
statements
of of
therevenues
organisation.
and inputs
theaccess
enterprise’s
activities
a period,
defined
primarily
in terms
(appropriately recognized) and expenses (either appropriately matched to them or systematically and rationally
allocated to reporting periods in a way that avoids distortion of income). (© Financial Accounting Foundation, 401
Recognition
of an asset
Merritt 7, Norwalk,
CT 06856, USA, used with permission.)
As we As
have
addition that
to defining
an asset,
also need
to consider
should
recognise the
wealready
should learned,
know, theinelements
appear within
the we
balance
sheet—and
whichwhen
relatewe
to an
organisation’s
Figures
existence
of an
asset and therefore
include itand
within
theThe
financial
statements.
‘financial
position’—are
assets, liabilities
equity.
elements
that appear within the income statement—and
The Conceptual Framework provides general recognition criteria for all of the five elements of financial accounting
which relate to an organisation’s ‘financial performance’—are income and expenses. These elements, and their role,
Figures
provide
a graphical
representation
that shows
(assets,
liabilities,
expenses
and equity). Paragraph
5.6 states:
are represented
inincome,
Figure 2.3.
We will consider each of the five elements in turn, but notice, once again, as the discussion proceeds, how the
Only items
meet and
the definition
of andirectly
asset,are
aonliability
or equity
are to
recognised
the statement of financial
how
events
actions
definitions
of that
expenses
and
income
depend
thelinked.
definitions
given
assets andinliabilities.
position. Similarly, only items that meet the definition of income and expenses are recognised in the statement of
financial performance. However, not all items that meet the definition of one of those elements are recognised.
Figure 2.3
Therefore, the first step in the recognition of a particular item in the financial statements (and therefore
in our
The elements
financial accounting Assets
system) is determining that the item meets the definition of an element of accounting—which
financial the
balance sheet
is what we have just discussed. However, as the above The
paragraph
indicates, further criteria (other thanof meeting
which provides information about
accounting
definition of an element
of financial accounting)
are required to be satisfied before an item shall be recognised for
Liabilities
the financial position of an organisation
financial accounting purposes.
at a point in time
When the Conceptual
Equity Framework was revised and re-released in 2018, it specifically required that accountants
must consider the fundamental qualitative characteristics of relevance and faithful representation (which were
discussed earlier) when deciding if an item should be recognised within the financial statements. This was a change
from the previous recognition criteria, which focused on assessing the probability of future economic benefits, as well
The income
Incomebe measured reliably. Specifically,
as whether the item could
thestatement
Conceptual Framework now requires that an asset
Expenses
which provides information about
the financial performance of an organisation
for a period of time
dee67382_ch02_059-098.indd 77
Definition and recognition of assets
According to the Conceptual Framework, an asset is defined as:
a present economic resource controlled by the entity as a result of past events.
The above definition of an asset refers to an economic resource. An ‘economic resource’ is
defined in the Conceptual Framework as:
10/18/19 07:05 AM
asset
Defined in the Conceptual
Framework as ‘a present
economic resource
controlled by the entity as
a result of past events’.
a right that has the potential to produce economic benefits.
10/24/19 04:13 PM
dee67382_ch02_059-098.indd
75
10/18/19 07:05 AM
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CHAPTER 2: The Conceptual Framework for Financial Reporting
93
2.12 The conceptual framework as a normative theory of accounting
LO 2.12
As the following chapter explains, theories can be classified in a number of ways. One way of classifying theories
is to label them either ‘positive’ or ‘normative’ theories. While the next chapter covers this issue in some depth,
we can briefly point out here that a positive theory of accounting is a theory that seeks to explain and predict particular
accounting practices. That is, a positive theory of accounting will provide explanations of some of the outcomes that
might follow the release of a particular accounting requirement (such as an accounting standard), or perhaps predictions
about which entities are likely to favour particular accounting methods or adopt particular accounting methods when
there are alternatives. By contrast, a normative theory of accounting provides prescription about what accounting
methods an organisation should adopt. Hence, the difference can be summarised by saying that a positive theory of
accounting attempts to explain or predict accounting practice, whereas a normative theory of accounting prescribes a
particular accounting practice. Conceptual frameworks can be classified as normative theories of accounting as they
provide guidance (prescription) to people involved in preparing general purpose financial statements.
Chapter 3 provides an overview of various theories of accounting. A number of the theories to be described are
positive theories that provide insight into the possible implications of the release of particular accounting regulations.
For example, theories are discussed that provide insight into questions such as:
∙ What motivates individuals to support and perhaps lobby regulators for certain accounting methods in preference
to others?
∙ What are the implications for particular types of organisations and their stakeholders if one method of accounting
is chosen or mandated in preference to other methods?
∙ How will particular stakeholder groups react to particular accounting information?
The next chapter also considers factors that motivate organisations to make voluntary accounting disclosures
(and all organisations make many voluntary disclosures in their annual report). Further, Chapter 3 reviews various
normative theories on how various elements of accounting should be measured and provides insight into the question
of whether there is a ‘true measure’ of income.
The majority of financial accounting textbooks provide little or no discussion of various theories of accounting.
While we acknowledge that the balance of this text could be studied without reading Chapter 3, we believe that a review
of that chapter will equip readers to place the impacts of financial accounting in perspective as opposed to merely learning
how to apply the respective accounting standards. Accounting plays a very important—pervasive even—role within
society and Chapter 3 provides important insight into this role. Ideally, readers should not only understand how to apply
the rules embodied in various accounting standards, they should have some understanding of the possible consequences
76 PART 1: The
Australian
accounting
environment
of standard-setters
mandating
particular
requirements.
Chapter 3 provides the basis for such an understanding.
Tables
Chapter summary
Tables provide useful checklists.
166
Key points of the chapter are summarised in this section.
Check through it carefully to make sure you have
understood the topics covered before moving on.
PART 3: Accounting for assets
Table 4.1
Some classes
of assets and
their associated
measurement rules
Asset
Measurement rule
Cash
Face value
Accounts receivable
Rights can take many forms, including rights to receive cash, rights to receive goods or services, or rights over
physical objects, such as property, plant and equipment or inventories (where the right to use the property, plant,
Face value less an allowance for doubtful debts. Amounts to be received
CHAPTER
2: The
Conceptual
Financial
Reporting 87
in more than
12 months
shall beFramework
discounted for
to present
value
Inventories
Lower of cost and net realisable value
Goodwill
At cost of acquisition—internally generated goodwill is not to be
equipment or inventories might have been established as a result of buying or leasing the item).
SUMMARY
Components of the definition of an asset
Therefore, transactions such as the purchase of assets,
or the issuance of debt, are not considered ‘income’ because
recognised
they do not result in anProperty,
increaseplant
in equity.
Looking atAtthe
above
formula,
the acquisition
ofamount
an asset
is not
income.
and equipment
cost,
recoverable
amount
(if recoverable
is less
than
cost) or For
revalued
amount. one
If revaluations
undertaken,
the requirement
that
example, purchasing assets with cash simply involves
substituting
asset forare
another
and does
not impactis equity.
the valuations
be based
on ‘fair value’
Similarly, borrowing cash leads to an increase in assets
(cash), and
an increase
in liabilities, with no direct effect on
Marketable securities
Fair value
equity.
Leased assets
At the present
valueas
of one
the expected
future lease
The Conceptual Framework
does not include ‘profit’
(or ‘loss’)
of the elements
ofpayments
financial accounting.
As we know, the fiveBiological
elementsassets
are assets, liabilities,
income,
expenses
and
equity. Profit
At fair
value less
estimated
point-of-sale
costs is simply the difference
between income and expenses,
of which are defined,
hence
there is no
need
recognition criteria
Explorationboth
and evaluation
Initially and
at cost
and thereafter
at cost
or for
fair separate
value
assets of mining organisation
for ‘profits’.
Investment properties
Definition of equity
Non-current assets held for sale
At cost initially and then at either fair value or cost
equity
Defined by the Conceptual
At the lower of carrying amount and fair value less costs to sell
Framework as ‘the residual
Paragraph 4.63 of the Conceptual Framework defines equity as ‘the residual interest in the assets
interest in the assets of
of the entity
deductingfor
allreporting
its liabilities’.
is:
the entity afterwas
deducting
that itafter
is appropriate
entitiesThat
to measure
different classes of assets in different ways. This judgement
made on the basis that:
Equity = Assets − Liabilities
Why do I need to know . . .?
all its liabilities’.
NEW!
Key terms
∙ a single measurement basis for all assets and liabilities may not provide the most relevant information for users of
The residual
interest
is a claim or right to the net assets of the reporting entity held by the owners of an organisation.
financial
statements
As a residual
interest,
ranksmeasurements
after liabilities
inshould
terms be
of the
a claim
against
the necessary
assets of atoreporting
entity.information.
Consistent
∙ the
numberequity
of different
used
smallest
number
provide relevant
with the definitions
of income
and expenses,
the definition
of and
equity
is directly
a function
of theshould
definitions
of assets
Unnecessary
measurement
changes should
be avoided
necessary
measurement
changes
be explained
and liabilities.
that
equityofrepresents
a residual
inmeasurement
the assets of approach
an entity,need
the amount
disclosed
as equity
∙ the Given
benefits
to users
financial reports
of a interest
particular
to be sufficient
to justify
the
cost associated
with compiling
the the
information.
will correspond
with the difference
between
amounts assigned to assets and liabilities. As such, the criteria for the
There are many resources that generate benefits for an entity but which are not recognised due
Key terms areto thebolded
in the text the first time they are
absence of control. For example, the use of the road system generates economic benefits for an
However, because the entity does not control the roads, they do not constitute assets of the entity. Similarly, particular
used,entity.
defined
in
the
margin
atbutthat
point,
atwaterways,
the
waterways might provide economic benefits to entities,
to the extent
that such and
entities dolisted
not control the
are not assets of those entities despite the fact that the organisation has a right to use them.
end they
of
each
chapter.
They
also
appear
in
the
glossary
at
Past events
In relation
‘control’,book.
it therefore follows from the requirement that the relevant transaction must already have
the end
ofto the
dee67382_ch02_059-098.indd
the Group of 100, an association of senior accounting and finance executives representing major companies and
government-owned enterprises in Australia. They found that 80 per cent of the respondents were satisfied with
historical cost. The respondents’ views were that historical cost is objective and verifiable; easily understood and
widely known; and allows for consistency and comparability. Of the 20 per cent of respondents who did not favour
WHY
DO I NEED TO KNOW ABOUT THE DEFINITIONS AND RECOGNITION CRITERIA
historical cost, at least half thought that historical cost was either meaningless or misleading and lacked relevance.
FOR THE
ELEMENTS
OF FINANCIAL
ACCOUNTING?
Perhaps
the above findings
are not surprising.
If a firm adopts some form of fair-value-based accounting, this will
typically introduce some degree of volatility into the financial statements, given that market values tend to fluctuate.
If we This
do not
understand
the be
definitions
recognition particularly
criteria, then
we will
really understand
the in
volatility
might not
favoured and
by management,
if they
havenot
accounting-based
debt what
contracts
reported
financial
performance
and
financial
position
of profits.
an organisation
actually
For example, is,
place or are themselves rewarded in terms of accounting
For example,
generalrepresents.
insurers in Australia—that
as a result
of knowing
theindefinitions
of the elements
financialwith
accounting,
weasknow
certain
organisations
involved
providing insurance
for lossesofassociated
events such
theft, that
storm,
vehicleaspects
accidents,
of organisational
performance
nottheir
be investments
reflected within
instance,
impacts
fire and flood—are
required towill
value
on the reported
basis of theprofits—for
assets’ fair values,
withcertain
any changes
in fair
values
being treated
a financial
period’s
profit
or loss. because
Many managers
of general
insurance
companies
on the
environment
will as
notpart
beofreflected
within
profits,
perhaps
the negative
impacts
caused
by
were particularly
opposed
to the requirement
to use
fair‘controlled’
value when by
it was
some and
yearswhich
ago. Intherefore
their view, it
the organisation
related
to resources
that were
not
theintroduced
organisation,
introduces
unwanted
and unnecessary
volatility
the accounts,We
given
that market
values
of investments
can is
change
had not
ever been
recognised
as assets
of theinto
organisation.
would
therefore
know
that ‘profits’
a
quite drastically
in either
direction
duringorganisational
an accounting period.
somewhat
incomplete
measure
of overall
performance. As another example, through having
Houghton
and Tan alsoand
found
that the level
of support
for historical
cost
or present
and fairthat
value
knowledge
of the definitions
recognition
criteria,
we will
also know
that
certain value
resources
areseemed
used to
on the industry
which the respondent
belonged.
Individuals
financial
institutions had
statistically
by andepend
organisation
will nottonecessarily
appear in
the balance
sheetworking
if theyinare
not ‘controlled’,
or ifa there
is
significant preference for fair-value measures as opposed to historical cost, while non-financial-institution representatives
some significant doubt about the relevance, or faithful representation, of the information pertaining to the
had a significantly stronger preference for historical cost. To explain this difference, the authors note (p. 36):
underlying item.
93
10/18/19 07:05 AM
occurred that future economic benefits which are not currently controlled are not to be recognised by a reporting entity.
Potential to produce economic benefits
The expected future economic benefits can be distinguished from the source of the benefit—a
particular object or right. The definition refers to the economic benefit and not the source. Thus,
whether an object or right is disclosed as an asset will be dependent upon the potential it has to
The scarce capacity to
generate economic benefits for the entity. In the absence of potential to generate economic benefits,
provide benefits to the
entities
that use
them—
theaccounting
object or right
should not be considered to be an asset. Rather, any related expenditure would
54
PART
1: The
Australian
environment
common to all assets
constitute an expense.
irrespective of their
Therefore, cash is an asset owing to the economic benefits that can flow as a result of the
physical or other form.
purchasing
power
it generates.
A machine
is an asset
to Australia?
the extent LO
that1.4
economic benefits are
3. Does the AASB have
legal power
to enforce
accounting
standards
within
anticipated
to flow
from
it. That is,powers.
the assetWithin
is effectively
the itfuture
economic
benefits that
No. The AASB does
not directly
have
anyusing
enforcement
Australia,
is ASIC
that enforces
the
will be generated,
the source ofAct,
theand
economic
benefits
(such as the machine).
economic
benefitsfor
could
come
requirements
of thenot
Corporations
it is within
the Corporations
Act that These
there is
a requirement
particular
from
two
broad
sources—either
from
the
asset’s
use,
or
from
its
sale.
If
the
economic
benefits
are
greater from its use
forms of organisations to comply with accounting standards.
by the reporting entity, then the asset would be expected to be retained, otherwise it would likely be sold. That is, the
4. What
is the relevance
thenot
International
Accounting
Board before
(IASB)ittocan
general
purpose
Conceptual
Frameworkofdoes
require an item
to have a Standards
value in exchange
be recognised
asfinancial
an asset.
The economic
mayLO
result
reporting
withinbenefits
Australia?
1.7from its ongoing use (often referred to as value in use) within the organisation.
As already
noted,
the previous
definition
of an
asset and
liability
had required
expected
future
flows of
The IASB
is of great
relevance
to general
purpose
financial
reporting
within
Australia.that
Thethe
AASB
releases
accounting
economicthat
benefits
probable,
which
meant
more
likely than Act,
less and
likely.
This
is no longer
theaccounting
requirement.
Recognition
standards
have be
legal
force by
virtue
of the
Corporations
the
majority
of these
standards
are
is now based
uponofthere
beingby
a ‘potential’
developed
outside
Australia
the IASB. for economic benefits to flow to the reporting entity. For that potential to
exist, it does not need to be certain, or even likely, that the right will produce economic benefits. It is necessary only that
5. What
power
doesexists
the IASB
haveoftoa enforce
the accounting
standards
develops,
and which
areproduce
in use
the right
already
as a result
past transaction
or event and
that, in atthat
leastitone
circumstance,
it would
internationally?
LO for
1.7the reporting entity. However, while there is no longer a requirement that the future economic
economic benefits
The
IASB has
no power
enforce itsthe
accounting
standards. will
It is nevertheless
a standard­setter,
not the
a standard­enforcer.
When
benefits
are judged
to beto‘probable’,
assessed probability
influence
measurement ultimately
to an asset
with
a higher
likelihood
of generating
economic
benefits
wouldcompliance
be expectedwith
to have
a attributed
country claims
that it(aisresource
adopting
IFRSs,
it is the
responsibility
of local
regulators
to ensure
the
a higher value
in the ‘market’
to a similar
withenforcement
lower likelihood).
accounting
standards.
Becausecompared
some countries
haveasset
minimal
mechanisms in place, together with poor
standards of financial statement auditing, any claims that the financial statements being generated in such countries
comply with accounting standards are often questionable, and should be met with scepticism.
future economic
benefits
Review questions
By their nature, a significant part of the activities of financial institutions involves dealing with assets (investments
and other financial instruments) for which there are active markets. Accordingly, information based on Present
Values might be seen by these users as being more appropriate in evaluating financial performance and position.
Although the Houghton and Tan study looked only at the perceptions of financial statement preparers and not
financial statement users, the results do imply that perhaps it is not appropriate to expect all industries to favour the
Exhibits
2.10 Measurement principles
LO 2.10
As we have features
already indicated,contain
once we have decided
that a liability
or asset
should becompany
recognised, we then
These
extracts
from
actual
need to determine how to measure it. For financial reporting purposes, measurement refers to the process of
determining the
to be included in the
statements.aApplying
a measurementused
basis to an asset or a
reports
oramounts
documents,
orfinancial
provide
commonly
liability also creates a basis for measuring any related income or expense.
Conceptual
have tended to provide
very limited
prescriptionthe
in relation
to measurement issues.
Assets
format
forframeworks
accounting.
They
highlight
relevance
of the
and liabilities are often measured in a variety of ways depending upon the class of assets or liabilities being considered.
Given the way content
income and expenses
are defined—which
reliesof
upon
measures attributed to provide
assets and liabilities—
chapter
to the
practice
accounting,
this has direct implications for reported profits. For example, liabilities are frequently recorded at present value, face
another element to the topics covered and help to
reinforce
learning.
168
PART 3: Accounting
for assets
166
position). Frequently, controlled assets are owned, but this is not always the case. For example, many
organisations include leased assets (and the associated lease liabilities) in their balance sheets.
the pursuit of the entity’s
objectives and to deny
or regulate the access of
others to that benefit.
These boxes enhance real-world relevance; they help
make the content relevant to your working life after
recognition Research
of assets has
andindicated
liabilities,
turn, directly
govern
the recognition
of equity.
there isby
nothe
need
for a
thatinmanagers’
support
for particular
measurement
rulesTherefore,
will be influenced
industry
separatetorecognition
for example,
equity. Houghton and Tan (1995) undertook a survey of the chief financial officers of
university.
which they criterion
belong. For
dee67382_ch04_159-200.indd
In this chapter we considered the history of conceptual frameworks, and we learned that from 2005 Australia has adopted
There are three separate components to the above definition of an ‘asset’ that we need to consider. All three related
the conceptual framework that has been developed and released by the IASB. Initially, in 2005, we adopted the IASB
requirements must exist if we are to consider that a particular transaction satisfies the definition of an asset. The
Framework for the Preparation and Presentation of Financial Statements (which was initially released by the International
components are:
Accounting Standards Committee in 1989). In 2010 and 2018 the IASB released revised frameworks, referred to as the
1. an asset Framework
is an economic
resource (right)
controlled
by the entity
IASB Conceptual
for Financial
Reporting,
and Australia
thereafter adopted this framework in place of the
2. IASB
an asset
exists as a result of past events
previous
framework.
3.learned
the right
to produce
economic
benefits.
We
thathas
thethe
rolepotential
of a conceptual
framework
includes
identifying the scope and objectives of financial reporting;
identifyingLet
the us
qualitative
characteristics
that financial
information
should possess; and defining the elements of accounting
now consider
each of these
components
separately.
and their respective recognition criteria. A number of benefits of conceptual frameworks were identified, including
Control
accounting standards being
more consistent and logical; more efficient development of accounting standards; accounting
As indicated
thecontent
above ofdefinition
of standards;
an asset, aand
resource
must frameworks
be controlled
before it
can be
standard-setters being accountable
forinthe
accounting
conceptual
providing
useful
control (assets)
to be an
‘asset’.that
Control
relates
to the transaction
capacity of ora event.
reporting entity to benefit from
guidance in the absenceconsidered
of an accounting
standard
deals with
a specific
If an asset is to be
an asset
and to deny
or regulate
access
of noted
others that
to the
benefit.
The capacity
to control
The control
chapter
discussed
the concept
of the
‘reportingthe
entity’
and
if an
organisation
is deemed
to bewould
a
recognised,
rather
normally
stem from legal
rights. people
However,
legal
enforceability
is not apurpose
prerequisite
for establishing
than
legal ownership
reporting
entity must
(which would
be determined
by whether
exist
who
rely upon general
financial
statements the
be established. Control is
existence
of control.
Hence it isofimportant
to then
realise
that
not legal
ownership,
required
for the purposes of decisions
relating
to the allocation
resources),
it is
to control,
release and
financial
statements
that is
comply
the capacity of an entity
before an asset can be shown within the body of an entity’s balance sheet (statement of financial
accounting
towith
benefit
from an assetstandards.
in
These questions ask you to reflect on key topics within
the chapter, and help cement your learning. For this
edition they have been graded by difficulty level as Easy,
Medium or Hard.
10/17/19 08:09 AM
REVIEW QUESTIONS
dee67382_ch02_059-098.indd
76
(KEY: Easy • Medium ••
Hard •••)
10/18/19 07:05 AM
1. Describe the roles of ASIC, the AASB, the ASX and the FRC, and the relationships between these regulatory bodies.
LO 1.3, 1.4, 1.5, 1.6 ••
2. What is the IASB and how does it affect financial reporting regulation in Australia? LO 1.4 ••
3. What enforcement powers does the IASB have? LO 1.7 •
dee67382_ch02_059-098.indd
87
Exhibit 4.1 The balance sheet of BHP Billiton Ltd as at 30 June 2019
10/18/19 07:05 AM
4. What is the role of the independent auditor, and why would the manager or the users of financial statements be
prepared to pay for the auditor’s services? LO 1.10 •
CHAPTER 1: An overview of the Australian external reporting environment
55
5. With all the regulations that companies must follow, fulfilling the requirement for corporate reporting is an additional
expensive activity. What are some possible arguments for and against disclosure regulation? LO 1.13 ••
18.
permitted,asoutline
some
possible
theoretical
and disadvantages
associated
with
permitting
6. Although
Provide anot
justification
to why
large
companies
shouldadvantages
have to produce
financial statements
that
comply
with
directors
to standards
deviate from
standards
in situations
compliance
with 1.13
particular
accounting
butaccounting
small companies
should
not have where
to do this.
LO 1.3, 1.9,
•• accounting standards
is perceived by the directors as likely to generate financial statements that are not true and fair. LO 1.3, 1.4 ••
7. Provide a brief description of the differential reporting requirements in Australia as addressed by AASB 1053.
19. What
are
LO 1.9
• some of the possible cultural impediments to the international standardisation of accounting standards?
LO 1.12 ••
8. Define ‘generally accepted accounting procedures’. LO 1.2 •
20. Why did the FRC decide that Australian Accounting Standards needed to be consistent with those being issued by
9. the
WhoInternational
are perceived
to be theStandards
‘primary users’
of general
purpose
Accounting
Board?
LO 1.5, 1.12
• financial reports? LO 1.2 •
Challenging questions
These questions require detailed problem analysis and
10. Explain
What
of financial
areFinancial
the usersReporting
ofand
financialStandards
statements
to
possess?
LO
•
help
toknowledge
build
problem-solving
critical
thinking
21.
why
the adoption
ofaccounting
International
in expected
Australia
might
haveskills.
led 1.2
to material
to reported
LO 1.11
11. changes
If the auditor
providesprofits.
an opinion
that••
the financial statements comply with accounting standards, does this indicate
that there are no errors in the financial statements? LO 1.10 •
12. What is included in a Directors’
Declaration, and what are the implications if a director signs the declaration and the
CHALLENGING
QUESTIONS
organisation subsequently fails, owing millions of dollars that it cannot repay? LO 1.3 ••
22.
directors
thethat
application
of a particular
accounting
inappropriate
to the circumstances
of
13. IfWhat
does believe
it mean that
to say
some financial
statements
are ‘true standard
and fair’?isHow
would a director
try to ensure that
their
organisation,
what options
to them
compiling
their financial
statements?
the financial
statements
are trueare
andavailable
fair before
he or when
she signs
a Directors’
Declaration?
LO 1.3 LO
•• 1.3
23.
standards change
time. Standards
Why? LO 1.8
14. Accounting
How are International
Financialacross
Reporting
developed and revised? Explain the role of the AASB in that
LO 1.4,
1.7 ••
24. Ifprocess.
a company
adopted
a particular accounting policy that ASIC considered to be questionable, in principle ASIC might
taking
legal action
against
company’s directors
failing
produce trueCommittee?
and fair financial
statements.
15. consider
What is the
relevance
to Australia
ofthe
Interpretations
issued byfor
the
IFRS to
Interpretations
LO 1.7
••
However, from a practical perspective, why would it be difficult for ASIC to prove in court that the company’s financial
16. statements
What authority
donot
Interpretations
were
true and fair?issued
LO 1.3by the IASB and AASB have in the Australian financial reporting context? If
they do have authority, from where does this authority emanate? LO 1.4, 1.7 ••
25. Visit the website of a company listed on the ASX. (Hint: some corporate website addresses are provided in this
17. chapter.)
What are Review
the functions
of the IASB?
LO 1.7 governance
•
the company’s
corporate
disclosures and determine whether the company complies
with the ‘Eight Essential Principles of Corporate Governance’ identified by the ASX. If the company discloses non­
compliance, evaluate the reasons provided for this non­compliance. LO 1.6
xxiii
26. Considered together, does the set of existing accounting standards provide guidance for all transactions and events
that might arise within an organisation? If not, what guidance is available to the organisation? LO 1.3, 1.4
dee67382_ch01_001-058.indd
54
27. The decision
10/17/19 07:49 AM
that Australia would adopt IFRSs was in large part based on the view that Australian reporting entities,
and the Australian economy, would benefit from adopting accounting methods that are the same as those adopted
internationally. Do you think that all Australian reporting entities have benefitted from international standardisation?
LO 1.11
dee67382_fm_i-xxvi.indd
xxiii
28. Globally, there are variations in business laws, criminal laws and so forth. Such international variations in laws will be a
10/24/19
result of differences in history, cultures, religions and so on. While we are apparently prepared to accept international
differences in various laws, groups such as the IASB expect there to be global uniformity in regulations relating to
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PART
1
The Australian
accounting environment
CHAPTER 1
An overview of the Australian external reporting
environment
CHAPTER 2
The Conceptual Framework for Financial Reporting
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C HAP TER
1
An overview of the
Australian external reporting
environment
LEARNING OBJECTIVES (LO)
1.1 Understand the meaning of ‘financial accounting’ and its relationship to the broader areas of ‘accounting’ and
‘accountability’.
1.2 Be able to explain who is likely to be a user of general purpose financial statements.
1.3 Understand the role of the Australian Securities and Investments Commission with respect to general purpose financial
reporting within Australia, and be aware of the requirements within the Corporations Act that require the preparation of
a Directors’ Declaration, Directors’ Report, and a Declaration by the Chief Executive Officer and Chief Financial Officer.
1.4 Understand the role of the Australian Accounting Standards Board with respect to general purpose financial
reporting within Australia.
1.5 Understand the role of the Financial Reporting Council with respect to general purpose financial reporting within Australia.
1.6 Understand the role of the Australian Securities Exchange with respect to general purpose financial reporting within
Australia.
1.7 Be able to explain the general functions of the International Accounting Standards Board and its relevance to
Australian general purpose financial reporting.
1.8 Understand that accounting standards change across time, meaning that profits calculated in past years may not be
directly comparable with current profit calculations.
1.9 Be able to explain the idea of ‘differential reporting’.
1.10 Understand the role of the auditor, and the auditor’s report, with respect to general purpose financial reporting.
1.11 Be aware of some of the perceived benefits pertaining to the international standardisation of financial reporting as
espoused by the International Accounting Standards Board.
1.12 Be aware of some research which suggests that the pursuit of international standardisation in general purpose financial
reporting ignores many important impediments, such as international differences in ‘culture’.
1.13 Understand that the practice of general purpose financial reporting is quite heavily regulated within Australia, and
be aware of some of the arguments for and against the regulation of financial accounting.
1.14 Understand that organisations will often include and highlight measures of financial performance within their annual
reports that do not comply with accounting standards.
Before reading this chapter, watch the accompanying video of Craig Deegan explaining why this topic is important
for your studies.
2
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CHAPTER 1: An overview of the Australian external reporting environment
3
OPENING QUESTIONS
Below are a number of questions that we want you to consider before reading the material in this chapter. We
will ask the same questions again at the end of the chapter and provide respective solutions. The solutions will
appear just before the end of chapter review questions but please do not look at the answers until you have
read the chapter. Each chapter of this book will have ‘Opening questions’ so that you can assess, or consider,
whether your views have changed, and therefore, your knowledge has been advanced, as a result of reading
the material provided within the chapter.
1. What is ‘general purpose financial reporting’? LO 1.1, 1.2
2. What is the role of the Australian Accounting Standards Board (AASB) with respect to general purpose financial
reporting within Australia? LO 1.4
3. Does the AASB have legal power to enforce accounting standards within Australia? LO 1.4
4. What is the relevance of the International Accounting Standards Board (IASB) to general purpose financial
reporting within Australia? LO 1.7
5. What power does the IASB have to enforce the accounting standards that it develops, and which are in use
internationally? LO 1.7
AASB STANDARDS REFERRED TO IN THIS CHAPTER AND IFRS/IAS EQUIVALENTS
AASB no.
Title
IFRS/IAS equivalent
101
Presentation of Financial Statements
IAS 1
108
Accounting Policies, Changes in Accounting Estimates and Errors
IAS 8
1048
Interpretation of Standards
—
1049
Whole of Government and General Government Sector Financial Reporting
—
1053
Application of Tiers of Australian Accounting Standards
—
1.1 Accounting, accountability and the role of financial accounting
LO 1.1
In this book we focus on financial accounting, and particularly financial accounting undertaken by larger-sized
organisations (which we will generally refer to as ‘reporting entities’) that are required to apply accounting standards.
But before we launch into doing some ‘financial accounting’, it is useful to briefly consider how financial accounting
relates to the broader area of ‘accounting’, and how accounting in turn relates to the notion of ‘accountability’.
Financial accounting represents only a part of the broader area of ‘accounting’. So what is ‘accounting’? Simply
stated, accounting can be defined as the provision of information about aspects of the performance of an entity to a
particular group of people with an interest, or stake, in the organisation—we can call these parties stakeholders. But
what ‘aspects of performance’ should ‘accounting’ address and what ‘accounts’ are stakeholders entitled to? This
really depends upon judgements we make about the organisation’s responsibilities and accountabilities. For example,
if we were to accept that an entity has a responsibility (and an accountability) for its social and environmental impacts,
then we, as accountants, should accept a duty to provide ‘an account’ (or a report) to stakeholders in respect of the
organisation’s social and environmental performance—perhaps by way of releasing a publicly available corporate
social responsibility report. If, by contrast, we consider that the only responsibility an organisation has is to maximise
its financial returns (profits), then we might believe that the only account we need to provide is a financial account.
We also need to consider the breadth of stakeholders who should be provided with an ‘account’—for example,
should it be restricted to shareholders and/or creditors, or do employees, local communities and other stakeholders also
have a right to be provided with particular information about an organisation?
Gray, Adams and Owen (2014) developed an accountability model that explains how organisations should deal
with stakeholders and proposes that since a firm’s activities affect the wellbeing of a wide range of stakeholders, the
firm is morally responsible, and therefore accountable, to these stakeholders. In more practical terms, Gray et al.
(1997, p. 334) provide a broader notion of accountability:
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4
PART 1: The Australian accounting environment
Accountability is concerned with the relationships between groups, individuals, organisations and the rights to
information that such relationships entail. Simply stated, accountability is the duty to provide an account of the
actions for which one is held responsible. The nature of the relationships—and the attendant rights to information—
are contextually determined by the society in which the relationship occurs.
From this definition, we can see that accountability involves two responsibilities or duties, namely:
1. to undertake certain actions (or to refrain from taking actions) in accordance with the expectations of a group of
stakeholders, and
2. to provide a reckoning or account of those actions to the stakeholders.
Therefore, the broad role of ‘accounting’, and of a corporate report (and corporate reporting) is to inform relevant
stakeholders about the extent to which the actions for which an organisation is deemed to be responsible (which in itself
is a controversial issue as people can have very different views about the responsibilities of organisations) have actually
been fulfilled. Reporting provides a vehicle for an organisation to fulfil its requirement to be accountable. Such accounts,
or reports, do not all have to be prepared in financial terms. For example, if an organisation is considered to be accountable
for its water consumption (perhaps it is operating in an area with limited rainfall and water reserves) or its greenhouse
gas emissions (perhaps it is operating in an industry with relatively high carbon emissions), then such ‘accounts’ may
be presented in physical terms (and there are available frameworks for measuring and reporting water consumption and
greenhouse gas emissions, which are discussed in Chapter 32). If a company is considered to be responsible for the
health and safety of people who are making its products in developing countries, then it might produce ‘accounts’ of how
the organisation is ensuring the safety of its employees in factory workplaces in those countries.
Of course, different people will have different views about the responsibilities of organisations, and therefore will
hold different views about what ‘accounts’ should be produced by an organisation. That is, they will have different
views about the extent of ‘accounting’ that should be applied.
Organisations will have many different responsibilities. These differing responsibilities will lead to many
different accountabilities. If we accept a very restricted view that organisations are accountable only for their financial
performance, then we would believe that organisations need only provide financial accounts. But if we accept that
organisations are responsible for their social and their environmental performance, then we would also expect the
organisation to produce social and environmental accounts. The social and the environmental accounts would be of
interest to a much broader group of stakeholders than would financial accounts. Financial accounts would primarily
be of interest to existing and potential investors, lenders and other creditors. However, we also acknowledge that there
will be other stakeholders with an interest in financial accounts.
This book focuses on financial accounting and, in particular, on the rules and principles used to generate general
purpose financial statements. However, it needs to be acknowledged that not all ‘accounts’ prepared by an organisation
will be, or should be, of a financial nature. Therefore, the purpose of this brief section is merely to emphasise that
financial accounting is just one form of ‘accounting’, and it is a form of accounting that provides information primarily
about only one aspect of performance—financial performance—and the information is generally of major interest to
those stakeholders with a financial interest in the organisation. If we are also seeking to find out information about an
organisation’s social and environmental performance—and such information would be of interest to a broader group
of stakeholders—then we will also have to look at other ‘accounts’ or reports released by the entity using broader
methods of ‘accounting’. Chapter 32 of this book specifically addresses these other forms of accounts. Specifically,
it looks at frameworks used to compile social reports, environmental reports and what are commonly referred to as
sustainability reports. That chapter also explores the idea of accountability in greater depth. While Chapter 32—which
addresses accounting for corporate social and environmental responsibility—is the last chapter of this book, this
should not be interpreted to mean that social and environmental reporting is not as important as financial reporting.
Indeed, many people would argue that such reporting is more important. Nevertheless, this book was written to explain
financial reporting, hence financial accounting and reporting is the primary focus of the material within it.
At this point you, the reader, should take a little time out to consider what responsibilities you think organisations
should embrace and what sort of ‘accounts’ they should produce. Indeed, you can reflect on what the term ‘accounting’
means to you.
From the above discussion we can see that ‘accounting’ is actually a very broad activity, or discipline, which is
tied to the concept of accountability and to perceptions of organisational responsibilities. We therefore caution against
narrow definitions of ‘accounting’, as they appear in many textbooks, which define accounting in terms of it simply
being a process of identifying, measuring and communicating/reporting economic information to permit informed
decisions to be made. Accounting is a much richer process than this.
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CHAPTER 1: An overview of the Australian external reporting environment
5
Financial accounting defined
As we have noted earlier, in this book our focus is on one aspect of accounting known as financial accounting, which
can be considered to be a process involving the collection and processing of financial information to meet the decisionmaking needs of parties external to an organisation and who have an interest in the financial performance of the entity.
Financial accounting information will also be used by managers within an organisation.
Financial accounting can be contrasted with management accounting. Management accounting focuses on
providing information for decision making—with such information also often being provided in financial terms—by
parties within the organisation (that is, for internal as opposed to external users) and it is largely unregulated. Financial
accounting, by contrast, is subject to many regulations. Because management accounting relates to the provision of
information for parties within an organisation—such as preparing budgets for managers that focus on the likely future
costs and revenues associated with particular products or services—the view is taken that there is no need generally
to protect the information needs or rights of these parties as, being ‘insiders’, they can access the information they
require relatively easily.
By contrast, it is generally accepted that the information rights of outsiders, who are not involved in the dayto-day operations of an organisation (such as the shareholders of a listed company), must be protected. Because
financial statements prepared for external parties are often used as a source of information for parties contemplating
transferring resources to an organisation, it is arguably important that certain rules be put in place to govern how
the information shall be compiled and presented. That is, the adoption of a ‘pro-regulation’ perspective to protect
the interests of parties external to a firm requires some regulation relating to the accounting information that such
firms should disclose. (We will consider pro-regulation and ‘free-market’ perspectives in more detail towards the
end of this chapter.)
WHY DO I NEED TO KNOW ABOUT THE RELATIONSHIP BETWEEN
ORGANISATIONAL RESPONSIBILITY, ACCOUNTABILITY AND ACCOUNTING?
Organisations will be perceived by various stakeholders to have particular responsibilities. These stakeholders
will expect the organisation to comply with these expectations held with regard to particular perceived
responsibilities. This creates an ‘accountability’ for the managers of the organisation to act in accordance with
these perceived responsibilities and to thereafter provide an account of the organisation’s performance with
respect to these responsibilities.
Therefore, when it comes to what accounts ‘should’ be prepared, it really is a matter of judgement for
managers and often there is no one absolutely right answer. Legislation will require certain reports to be
prepared and presented to particular stakeholders (such as
shareholders), but an organisation can go beyond this and
Views about organisational
present further reports voluntarily. Nevertheless, there is a
direct relationship between the responsibilities (or duties)
responsibilities
the managers of an organisation believe the organisation
has, and the accepted accountabilities. Therefore, by
knowing this, we can interpret an absence of disclosures
about particular aspects of performance as potentially
indicating that the managers do not believe they have a
Views about organisational
responsibility, or accountability, in relation to such aspects
accountabilities
of performance.
The argument is that if the managers of an organisation
accept a responsibility to particular stakeholders for cer­
tain aspects of performance, then the managers accept
that these stakeholders have a right to information about
Decisions about what
those aspects of the organisation’s performance. This is
accounts to prepare
represented in the diagram.
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6
LO 1.2
PART 1: The Australian accounting environment
1.2 Users’ demand for general purpose financial statements
General purpose financial statements may be used by an array of user groups, and for many purposes. However,
pursuant to the Conceptual Framework for Financial Reporting issued by the International Accounting Standards
Board (which we address in detail in Chapter 2) and used within Australia (a conceptual framework of accounting seeks
to satisfy a number of objectives, including identifying the objectives of general purpose financial reporting as well as
the qualitative characteristics that useful financial information should possess), general purpose financial statements
are primarily directed towards the information needs of ‘existing and potential investors, lenders and other creditors’.
Specifically, paragraph 1.2 of the Conceptual Framework for Financial Reporting (hereafter, simply referred to as the
Conceptual Framework) states that:
The objective of general purpose financial reporting is to provide financial information about the reporting entity
that is useful to existing and potential investors, lenders and other creditors in making decisions about providing
resources to the entity. Those decisions involve decisions about:
(a) buying, selling or holding equity and debt instruments;
(b) providing or settling loans and other forms of credit; or
(c) exercising rights to vote on, or otherwise influence, management’s actions that affect the use of the entity’s
economic resources.
In identifying the ‘primary users’ of general purpose financial reports, paragraph 1.5 of the Conceptual Frame­
work states:
Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide
information directly to them and must rely on general purpose financial reports for much of the financial information
they need. Consequently, they are the primary users to whom general purpose financial reports are directed.
The Conceptual Framework also acknowledges that there are other potential users of financial reports (for
example, management, regulators and other members of the public), but they are not deemed to be the ‘primary’
users of general purpose financial reports and hence these ‘secondary’ users are not the focus of
the prescriptions provided within the Conceptual Framework. As paragraphs 1.9 and 1.10 of the
special purpose
Conceptual Framework state:
financial statement
1.9 The management of a reporting entity is also interested in financial information about the
entity. However, management need not rely on general purpose financial reports because
it is able to obtain the financial information it needs internally.
1.10 Other parties, such as regulators and members of the public other than investors, lenders
and other creditors, may also find general purpose financial reports useful. However,
those reports are not primarily directed to these other groups.
A financial statement
designed to meet the
needs of a specific
group or to satisfy a
specific purpose. Can
be contrasted with a
general purpose financial
statement, which is
intended to meet the
information needs
common to users who are
unable to command the
preparation of reports.
Some parties with an interest in the financial affairs of an entity might be in a position to
successfully demand financial statements that satisfy their specific information needs. For example,
a bank might have the necessary power to demand, as part of a loan agreement, that a borrowing
organisation provide information about its projected cash flows. Such a financial statement would
be considered a special purpose financial statement—in this case, a financial statement prepared
specifically to satisfy the needs of the bank.
Other parties with interests in the affairs of an organisation might not have the necessary power
to demand financial statements that specifically address their own information requirements, having
to rely instead on financial statements of a general nature released by the reporting entity to meet the
general information needs of a broad cross-section of users, such as investors, potential investors,
employees, employee groups, creditors, customers, consumer groups, analysts, media, government
bodies and lobby groups. These financial statements are referred to as general purpose financial
statements, as opposed to special purpose financial statements. As noted above, general purpose
financial statements are produced primarily to meet the needs of existing and potential investors,
lenders and other creditors; however, the statements will often also satisfy the information needs
of a broader cross-section of users, which might include employees, government, news media,
researchers, interest groups and ‘the public’.
general purpose
financial statement
Financial statements that
comply with Conceptual
Framework requirements
and accounting standards
and meet the information
needs common to
users who are unable to
command the preparation
of financial statements
tailored specifically
to satisfy all of their
information needs.
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CHAPTER 1: An overview of the Australian external reporting environment
7
In this book, we are concerned primarily with general purpose financial reporting. Our explanation of general
purpose financial statements is consistent with the definition used in accounting standards. For example, paragraph 7
of the accounting standard AASB 101 (equivalent to IAS 1, as we will explain later and show in Table 1.1) Presentation
of Financial Statements defines general purpose financial statements in the following way:
General purpose financial statements (referred to as ‘financial statements’) are those intended to meet the needs
of users who are not in a position to require an entity to prepare reports tailored to their particular information
needs. (AASB 101)
Examples of general purpose financial statements are the financial statements and supporting notes included
within an annual report presented to shareholders at a company’s annual general meeting (and thereafter typically
made available to shareholders and other interested parties on the organisation’s website). Our focus in this book
will be on general purpose financial reporting practices that would typically be used by private-sector profit-seeking
entities. However, governments and government departments often adopt the kind of accounting procedures that
are used by business entities in the private sector. Therefore, much of our discussion can be applied to government,
particularly government trading enterprises that compete directly with private-sector firms (for example, governmentcontrolled organisations involved in telecommunications, public transport and shipping). Nevertheless, there continue
to be some differences between the reporting practices of some government departments and those of private-sector
entities, and there are some accounting standards that are dedicated to government bodies (such as AASB 1049 Whole
of Government and General Government Sector Financial Reporting).
As should be clear by now, financial accountants cannot just decide to use any accounting method they would like
when preparing financial statements that are provided to shareholders and other interested stakeholders. Rather, they
are bound by legislation, accounting standards and accounting concepts. In this regard, there are four principal bodies
involved in formulating, interpreting and/or enforcing accounting regulations within Australia, these being the:
∙
∙
∙
∙
Australian Securities and Investments Commission
Australian Accounting Standards Board
Financial Reporting Council
Australian Securities Exchange.
We will now give further consideration to each of the four main bodies involved in formulating and/or enforcing
accounting regulations within Australia.
1.3 Australian Securities and Investments Commission
LO 1.3
The Australian Securities and Investments Commission (ASIC) evolved from the Australian Securities
Commission (ASC). The ASC was established in 1989 by the Australian Securities Commission Act 1989
(Cwlth), and it replaced the National Companies and Securities Commission (NCSC).
The name of the ASC was changed to ASIC in July 1998 to reflect the increased responsibility
Australian Securities
assigned to the ASC in relation to monitoring and regulating various investment products, including
and Investments
superannuation, approved deposit accounts and retirement savings accounts. The ASIC website
Commission (ASIC)
(www.asic.gov.au) provides an overview of its role. The information provided on the website about
Body responsible for
ASIC’s role (as accessed in September 2019) is reproduced in Exhibit 1.1.
administering corporations
legislation in Australia.
As indicated in Exhibit 1.1, ASIC is solely responsible for administering corporations
It is independent of
legislation in Australia. It is independent of state ministers or state parliaments, and reports
state ministers or
directly to an appointed Minister of the Commonwealth Parliament. Among other things, the
state parliaments and
reports directly to an
Corporations Act, which is administered by ASIC, outlines the responsibilities of company
appointed Minister of
directors in relation to the nature of their conduct, financial statement preparation, lodgement and
the Commonwealth
distribution. Since the Corporations Act enacts the majority of legislative requirements pertaining
Parliament.
to financial accounting, this discussion of ASIC will include a look at a number of the Act’s
requirements. For readers interested in reviewing the content of the Corporations Act (as well
as other Acts), free access to electronic versions is available at the Federal Register of Legislation (the Legislation
Register: www.legislation.gov.au), which, according to the website, is the authorised whole-of-government website
for Commonwealth legislation and related documents.
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8
PART 1: The Australian accounting environment
Exhibit 1.1 The role of ASIC
WHAT WE DO
ASIC is Australia’s integrated corporate, markets, financial services and consumer credit regulator.
We are an independent Commonwealth Government body. We are set up under and administer the
Australian Securities and Investments Commission Act 2001 (ASIC Act), and we carry out most of our work under
the Corporations Act 2001 (Corporations Act).
The ASIC Act requires us to:
•
•
•
•
•
•
•
maintain, facilitate and improve the performance of the financial system and entities in it
promote confident and informed participation by investors and consumers in the financial system
administer the law effectively and with minimal procedural requirements
enforce and give effect to the law
receive, process and store, efficiently and quickly, information that is given to us
make information about companies and other bodies available to the public as soon as practicable
take whatever action we can, and which is necessary, to enforce and give effect to the law.
OUR VISION AND MISSION
Our vision: A fair, strong and efficient financial system for all Australians.
OUR REGULATORY MISSION
To realise our vision we will use all our regulatory tools to:
•
•
•
•
change behaviours to drive good consumer and investor outcomes
act against misconduct to maintain trust and integrity in the financial system
promote strong and innovative development of the financial system
help Australians to be in control of their financial lives.
OUR REGISTRY MISSION
To realise our vision we will:
• provide efficient and accessible business registers that make it easier to do business.
OUR STRATEGIC PRIORITIES
ASIC’s strategic priorities are outlined in our Corporate Plan, updated each year.
WHO WE REGULATE
We regulate Australian companies, financial markets, financial services organisations and professionals who deal
and advise in investments, superannuation, insurance, deposit taking and credit.
As the consumer credit regulator, we license and regulate people and businesses engaging in consumer
credit activities (including banks, credit unions, finance companies, and mortgage and finance brokers).
We ensure that licensees meet the standards—including their responsibilities to consumers—that are set out in
the National Consumer Credit Protection Act 2009.
As the markets regulator, we assess how effectively authorised financial markets are complying with their
legal obligations to operate fair, orderly and transparent markets. We also advise the Minister about authorising
new markets.
On 1 August 2010, we assumed responsibility for the supervision of trading on Australia’s domestic licensed
equity, derivatives and futures markets.
As the financial services regulator, we license and monitor financial services businesses to ensure that
they operate efficiently, honestly and fairly. These businesses typically deal in superannuation, managed funds,
shares and company securities, derivatives and insurance.
OUR POWERS
The laws we administer give us the facilitative, regulatory and enforcement powers necessary for us to perform
our role. These include the power to:
• register companies and managed investment schemes
• grant Australian financial services licences and Australian credit licences
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CHAPTER 1: An overview of the Australian external reporting environment
9
• register auditors and liquidators
• grant relief from various provisions of the legislation which we administer
• maintain publicly accessible registers of information about companies, financial services licensees and credit
licensees
• make rules aimed at ensuring the integrity of financial markets
• stop the issue of financial products under defective disclosure documents
• investigate suspected breaches of the law and in so doing require people to produce books or answer
questions at an examination
• issue infringement notices in relation to alleged breaches of some laws
• ban people from engaging in credit activities or providing financial services
• seek civil penalties from the courts
• commence prosecutions—these are generally conducted by the Commonwealth Director of Public
Prosecutions, although there are some categories of matters which we prosecute ourselves.
PROTECTING CONSUMERS AND INVESTORS
We have powers to protect consumers against misleading or deceptive and unconscionable conduct affecting
all financial products and services, including credit.
SOURCE: © Australian Securities & Investments Commission. Reproduced with permission.
An important requirement of the Corporations Act is for directors of public companies, large proprietary companies,
organisations with securities listed on the Australian Securities Exchange and some small proprietary companies to
present shareholders with true and fair financial statements for a given financial year. (This and other requirements
of the Corporations Act do not apply to organisations outside the ambit of the Act, for example, partnerships or sole
traders.) ‘Financial statements for the year’ is defined at s. 295(2) of the Corporations Act. Specifically, s. 295(2) states:
The financial statements for the year are:
(a) unless paragraph (b) applies—the financial statements in relation to the company, registered scheme or
disclosing entity required by the accounting standards; or
(b) if the accounting standards require the company, registered scheme or disclosing entity to prepare financial
statements in relation to a consolidated entity—the financial statements in relation to the consolidated entity
required by the accounting standards.
Therefore, the above requirements rely directly upon accounting standards, which are released by the Australian
Accounting Standards Board (AASB), and which are generally developed at an international level by the International
Accounting Standards Board (IASB), which is based in London. To determine which ‘financial statements’ would be
included in a financial report we can refer to accounting standard AASB 101. Paragraph 10 of this standard states that
a complete set of financial statements comprises:
(a) a statement of financial position as at the end of the period;
(b) a statement of profit or loss and other comprehensive income for the period;
(c) a statement of changes in equity for the period;
(d)
(e)
(ea)
(f)
a statement of cash flows for the period;
notes, comprising significant accounting policies and other explanatory information;
comparative information in respect of the preceding period as specified in paragraphs 38 and 38A; and
a statement of financial position as at the beginning of the preceding period when an entity applies an
accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or
when it reclassifies items in its financial statements in accordance with paragraphs 40A–40D.
An entity may use titles for the statements other than those used in this standard. For example, an entity may use the
title ‘statement of comprehensive income’ instead of ‘statement of profit or loss and other comprehensive income’.
(AASB 101)
Across time, the terminology used in relation to financial statements has changed. For example, within
AASB 101, reference is made to the ‘statement of financial position’. This is equivalent to what many people
traditionally call a balance sheet.
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PART 1: The Australian accounting environment
There are also requirements as to when different forms of organisations must report the required information
to their members (for instance, shareholders). For example, for public companies, there are requirements within the
Corporations Act (Section 315 (1) (a) and (b)) that the company must report to shareholders by the earlier of:
∙ 21 days before the next Annual General Meeting after the end of the financial year, or
∙ four months after the end of the financial year.
As we have noted above, the Corporations Act requires financial statements, as defined above, to be ‘true and fair’.
The requirement to produce true and fair financial statements is set out in s. 297 of the Corporations Act. Specifically,
s. 297 requires that:
The financial statements and notes for a financial year must give a true and fair view of:
(a) the financial position and performance of the company, registered scheme or disclosing entity; and
(b) if consolidated financial statements are required, the financial position and performance of the con­
solidated entity.
But why do we need a ‘true and fair’ requirement? The answer to this is that it is generally accepted that it would
be unrealistic to assume that specific disclosure rules, or accounting standards, could be developed to cover every
possible transaction or event. For situations not governed by particular rules or standards, the ‘true and fair view’
requirement is the general criterion to assist directors and auditors to determine what disclosures should be made and
to consider alternative recognition and measurement approaches. Although there is no definition of ‘true and fair’
in the Corporations Act—which is perhaps somewhat surprising—it would appear that for financial statements to
be considered true and fair, all information of a ‘material’ nature should be disclosed so that readers of the financial
statements are not misled. However, ‘materiality’ is an assessment calling for a high degree of professional judgement.
The meaning of ‘materiality’
It is not possible to give a definition of ‘material’ that covers all circumstances. Paragraph 5 of Accounting Standard
AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors provides that:
omissions or misstatements of items are material if they could, individually or collectively, influence the economic
decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the
omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination
of both, could be the determining factor. (AASB 108)
The definition of materiality in AASB 108 is consistent with how the concept of materiality is utilised in the
Conceptual Framework (paragraph 2.11) and also consistent with the definition of materiality provided in other
accounting standards.
As noted above, determining ‘materiality’ relies upon a great deal of professional judgement. In this regard, in
late 2017 the IASB issued Practice Statement 2 on Making Materiality Judgments. Within this document, paragraph
33 identifies four steps that need to be taken when determining whether information is material, and therefore should
be disclosed:
The steps identified as a possible approach to the assessment of materiality in the preparation of the financial
statements are, in summary:
(a) Step 1—identify. Identify information that has the potential to be material.
(b) Step 2—assess. Assess whether the information identified in Step 1 is, in fact, material.
(c) Step 3—organise. Organise the information within the draft financial statements in a way that communicates
the information clearly and concisely to primary users.
(d) Step 4—review. Review the draft financial statements to determine whether all material information has been
identified and materiality considered from a wide perspective and in aggregate, on the basis of the complete
set of financial statements.
The above definition of materiality makes reference to ‘users’. Of particular importance would be the accounting
knowledge or expertise in accounting that the users of general purpose financial statements are expected to possess. In
this regard, paragraph 2.36 of the Conceptual Framework states:
Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and
who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek
the aid of an adviser to understand information about complex economic phenomena.
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CHAPTER 1: An overview of the Australian external reporting environment
11
Other reporting obligations within the Corporations Act
Moving on to other requirements of the Corporations Act, we note that directors of large and listed companies, as well
as some other entities, are required by the Act to attach to the company’s financial statements a Directors’ Declaration
and a Directors’ Report. The Corporations Act also requires a declaration to be made by the chief executive officer and
the chief financial officer. We will consider each of these requirements in the material that follows.
As part of its responsibilities, ASIC also undertakes regular surveillance of the reporting practices of Australian
entities in terms of whether financial statements comply with the reporting requirements of the Corporations Act, and
therefore also with applicable accounting standards. If ASIC has concerns, it invites the reporting entity to explain
the reasoning behind its accounting treatment, after which time ASIC might take action against the officers of the
organisation. ASIC publishes the results of its ongoing surveillance program, which can be found on its website.
Exhibit 1.2 provides details from the results of ASIC’s review of 30 June 2018 financial reports. Specifically, Exhibit 1.2
identifies the issues that caused ASIC the greatest concern, and which resulted in ASIC seeking an explanation and/or
taking further action against particular organisations.
Exhibit 1.2 Findings from the ASIC review of financial reporting, 2018
MAIN ISSUES OF CONCERN:
1. ASSET VALUES AND IMPAIRMENT TESTING
ASIC continues to identify concerns regarding assessments of the recoverability of the carrying values of assets,
including goodwill, exploration and evaluation expenditure, and property, plant and equipment.
2. REVENUE RECOGNITION
ASIC is following up 17 matters concerning the recognition of revenue on contracts that involve the provision of
goods or services in the future, or multiple deliverables (i.e. both goods and services).
3. TAX ACCOUNTING
ASIC is making inquiries of 10 entities concerning their accounting for income tax, including the adequacy of
tax expense and whether it is probable that future taxable income will be sufficient to enable the recovery of
deferred tax assets relating to tax losses.
4. CONSOLIDATION ACCOUNTING
We have made inquiries of several entities on the non-consolidation of other entities, including an entity that has
treated an apparent loan securitisation arrangement as off-balance sheet.
5. BUSINESS COMBINATIONS
We have made inquiries of three entities in relation to business combinations. In one instance, the transactions
have been treated as under common control which may not be appropriate.
6. EXPENSE DEFERRAL
We have made inquiries of three entities to ascertain whether amounts deferred as assets should have been
charged to the income statement as expenses. In one instance, costs incurred have been capitalised in
anticipation of recovery under an insurance claim.
7. ESTIMATES AND ACCOUNTING POLICY JUDGEMENTS
We observed instances where entities needed to improve the quality and completeness of disclosures in
relation to estimation uncertainties, and significant judgements in applying accounting policies. The disclosure
requirements are principle-based and should include all information necessary for investors and others to
understand the judgements made and their effect. This may include key assumptions, reasons for judgements,
alternative treatments, and appropriate quantification.
The ongoing surveillance program of ASIC helps to ensure that the standard of financial reporting within
Australia is maintained at a high level.
SOURCE: © Australian Securities & Investments Commission. Reproduced with permission.
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PART 1: The Australian accounting environment
Directors’ Declaration
Within the Directors’ Declaration, required pursuant to s. 295(4) of the Corporations Act, directors must state whether,
in their opinion, the financial statements comply with accounting standards, and that the financial statements give
a true and fair view of the financial position and performance of the entity. Importantly, directors must also state
whether, or not, in their opinion there were, when the declaration was made out, reasonable grounds to believe that the
company would be able to pay its debts as and when they fall due. Specifically, s. 295(4) states:
The directors’ declaration is a declaration by the directors:
(c) whether, in the directors’ opinion, there are reasonable grounds to believe that the company, registered scheme
or disclosing entity will be able to pay its debts as and when they become due and payable; and
(ca) if the company, registered scheme or disclosing entity has included in the notes to the financial statements,
in compliance with the accounting standards, an explicit and unreserved statement of compliance with
international financial reporting standards—that this statement has been included in the notes to the financial
statements; and
(d) whether, in the directors’ opinion, the financial statement and notes are in accordance with this Act, including:
(i)
section 296 (compliance with accounting standards); and
(ii)
section 297 (true and fair view); and
(e) if the company, disclosing entity or registered scheme is listed—that the directors have been given the
declarations required by section 295A.
Should directors make such a declaration fraudulently, carelessly or recklessly, it is possible that they might
become personally liable for any outstanding debts of the company.
That is, if directors allow the organisation to keep trading when they knew, or ought reasonably to have known,
that the company could not pay its debts as and when they fall due (meaning that the organisation is ‘insolvent’), then
they can be personally prosecuted and their private funds used to pay the outstanding debts of the company. As some
recent examples of this, consider the following:
∙ In a newspaper report of 21 March 2019 entitled ‘Board directors exposed as RCR may have traded while insolvent’
(by Jenny Wiggins, The Australian Financial Review, p. 19), it was noted that the company known as RCR
Tomlinson may have been trading while insolvent for at least a month before it went into administration, meaning
its Board directors are thereafter potentially personally liable for debts incurred during this time. According to the
liquidators, the company filed for administration on 21 November 2018 but had potentially become insolvent at
the end of October 2018 or earlier. As the newspaper article emphasises, Board directors have a responsibility to
ensure that a company does not trade while it is insolvent; if a company goes into liquidation, and insolvent trading
is found to have occurred, the company’s directors are personally liable for the debts incurred during that time.
One role of the liquidator is to investigate the exact date that RCR became insolvent, and to report any offences by
directors to ASIC.
∙ In a newspaper report of 7 March 2019 entitled ‘Acquire eyed success before fall’ (by Sarah Danckert, The Sydney
Morning Herald, p. 5), it was reported that the directors of the education company known as Acquire (which was
linked to the former head of the Australian Football League, Andrew Demetriou) had received warnings about the
solvency of the company from the organisation’s then chief financial officer (CFO), as well as a suggestion from
the CFO that an administrator be appointed to run the company and hopefully enable it to keep trading. However,
the company was not placed into administration until several months later, thereby raising the possibility that the
directors may have personal liability for debts occurred after they were warned of the potential cash flow problems.
∙ In a newspaper article of 11 February 2019 entitled ‘KPMG gives Rosewalls a serve’ (by Joyce Moullakis, The
Australian, p. 19), it was reported that the directors of an organisation linked to former tennis champion Ken
Rosewall, which collapsed in 2015, were being pursued for funds lost when the organisation was apparently trading
while insolvent. The article reported that this insolvent trading might have been going on for a number of years.
As an example of a ‘real-life’ Directors’ Declaration, Exhibit 1.3 reproduces the Directors’ Declaration that was
disclosed within the 2019 Annual Report of BHP Group Ltd.
At this stage you, the reader, should try to obtain some recent corporate annual reports. Find the Directors’
Declaration in each report. You will see that, in most cases, the declaration will be similar in form to the example
shown here. As we discuss other accounting requirements throughout this book, please make a point of referring to
your collection of recent annual reports to see how the companies in your sample are complying with the various
requirements that we are discussing. Referring to corporate annual reports as you progress through this book will
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CHAPTER 1: An overview of the Australian external reporting environment
13
Exhibit 1.3 Directors’ declaration of BHP Group Ltd (from the 2019 Annual Report)
SOURCE: © BHP Group Ltd
serve to give the material you read a more ‘real-world’ feel. Large, listed Australian companies provide copies of their
annual reports on their websites. For example, see the websites of:
∙ BHP (www.bhpbilliton.com)
∙ Westpac Banking Corporation (www.westpac.com.au)
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∙
∙
∙
∙
∙
PART 1: The Australian accounting environment
AMP (www.amp.com.au)
Australia and New Zealand Banking Group Limited (ANZ: www.anz.com.au/personal)
National Australia Bank (NAB: www.nab.com.au)
Commonwealth Bank (CommBank: www.commbank.com.au)
Qantas (www.qantas.com).
The annual reports of corporations will typically be available by clicking on an ‘investors’ or ‘shareholders’ option
(or something similar) that is commonly shown on the home page of a company’s website.
Directors’ Report
Another required disclosure within the annual report is the Directors’ Report. In the Directors’ Report, required
pursuant to ss. 298–300A of the Corporations Act, directors must disclose items of information, such as the names
of the directors, details of directors’ emoluments, the principal activities of the company, review of operations during
the year, significant changes in the state of affairs of the company, likely future developments and results, significant
post-reporting-date events and details about compliance with environmental laws.
The Directors’ Report often includes a great deal of information that is disclosed by corporations on a voluntary basis.
That is, while the Corporations Act stipulates the minimum level of disclosure that must be made in a Directors’ Report,
many organisations voluntarily produce additional information (which raises a number of interesting issues about why
they elect to disclose additional information when not required to—we will consider this issue in Chapter 3). For example,
it is common to find companies voluntarily providing information about community-based projects in which they are
participating, as well as employee-training schemes and safety initiatives, and company-promoted environmental initiatives.
Review the Directors’ Reports of a number of companies to see the variety of topics that are addressed in these reports.
The Directors’ Report is also to include an operating and financial review. The review should include information
that shareholders of the company would reasonably require in order to make informed assessments of the operations,
financial position and future strategies of the organisation. Specifically, s. 299A(1) of the Corporations Act states:
The directors’ report for a financial year for a company, registered scheme or disclosing entity that is listed must also
contain information that members of the listed entity would reasonably require to make an informed assessment of:
(a) the operations of the entity reported on;
(b) the financial position of the entity reported on; and
(c) the business strategies, and prospects for future financial years, of the entity reported on.
Declaration by the chief executive officer and chief financial officer
The chief executive and chief financial officers of entities with securities listed on the Australian Securities Exchange
are required to provide a written declaration to the board of directors that the annual financial statements are in
accordance with the Corporations Act and accounting standards and that the financial statements present a true and
fair view of the entity’s financial position and performance. Specifically, s. 295A(2) of the Corporations Act states
that a declaration is to be made that:
(a)
the financial records of the company, disclosing entity or registered scheme for the financial year have
been properly maintained in accordance with section 286;
(b)
the financial statements, and the notes referred to in paragraph 295(3)(b), for the financial year comply
with the accounting standards;
(c)
the financial statements and notes for the financial year give a true and fair view (see section 297); and
(d)
any other matters that are prescribed by the regulations for the purposes of this paragraph in relation to
the financial statements and the notes for the financial year are satisfied.
As we can see from the Directors’ Declaration provided in Exhibit 1.3, towards the end, the Directors’ Declaration
of BHP specifically notes that the directors received the declaration from the chief executive officer and the chief
financial officer.
Lastly, from time to time ASIC also releases regulatory guides (previously referred to as policy statements) that
relate to various issues, including financial reporting. For example, ASIC has released statements in relation to pension
accounting, related party transactions and valuing share options. To see current ASIC regulatory guides, go to ASIC’s
website at www.asic.gov.au.
The true and fair view: further considerations
As we have already noted, the Corporations Act requires directors to ensure that financial reports are ‘true and fair’.
Before the early 1990s, the directors of a company could elect not to comply with an accounting standard on the
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CHAPTER 1: An overview of the Australian external reporting environment
15
grounds that applying the particular standard would cause the accounts not to present a true and fair view. The ‘old’
s. 298(2) provided that:
where a company’s financial statements for a financial year would not, if made out in accordance with a particular
applicable accounting standard, give a true and fair view of the matters with which this division requires the
financial statements to deal, the directors need not ensure that the financial statements are made out in accordance
with that accounting standard.
The above requirement, which allowed directors to elect not to comply with an accounting standard if noncompliance was deemed necessary to create true and fair accounts, was referred to as the ‘true and fair override’. The
perspective taken was that in some isolated cases, certain accounting standards might not be appropriate for a particular
entity, and application of the standards might actually make the financial statements misleading. However, this view
was abandoned some years later, with the corporations law being amended, and the override being withdrawn such that
s. 296 of the Corporations Act requires that ‘[t]he financial report for a financial year must comply with accounting
standards’ (although there is a ‘let-out’ for small proprietary companies). Following the amendment, directors were
therefore required to comply with applicable accounting standards. If, in their view, compliance did not generate a true
and fair view, additional information had to be presented in the notes to the financial statements.
So, directors must comply with the applicable accounting standards. Nevertheless, if directors believe that particular
accounting standards are not appropriate, they have the option of highlighting this fact and explaining why. Specifically,
paragraph 23 of AASB 101 (the reference to ‘the Framework’ below relates to the Conceptual Framework) states:
In the extremely rare circumstances in which management concludes that compliance with a requirement in an
Australian Accounting Standard would be so misleading that it would conflict with the objective of financial
statements set out in the Framework, but the relevant regulatory framework prohibits departure from the requirement,
the entity shall, to the maximum extent possible, reduce the perceived misleading aspects of compliance by disclosing:
(a) the title of the Australian Accounting Standard in question, the nature of the requirement, and the reason why
management has concluded that complying with that requirement is so misleading in the circumstances that it
conflicts with the objective of financial statements set out in the Framework; and
(b) for each period presented, the adjustments to each item in the financial statements that management has
concluded would be necessary to achieve a fair presentation. (AASB 101)
A current problem is that our qualitative requirement of true and fair is very unclear. There is no legal definition of
‘true and fair’. Even though the Corporations Act requires directors to make sufficient disclosures to ensure that financial
statements present a ‘true and fair’ view, it provides no definition of the concept. Nor has the Australian accounting
profession provided definitive guidelines relating to truth and fairness. The Directors’ Declaration of BHP, reproduced
in Exhibit 1.3, shows how directors are required to state that the financial statements are true and fair. The auditors of
a company are also required to give an opinion on whether, in their opinion, the financial statements are true and fair.
Exhibit 1.4 shows the opinion section of the auditor’s report from the Commonwealth Bank of Australia 2019
Annual Report. The whole independent auditor’s report was actually 11 pages in length; apart from the audit opinion
section that we have reproduced, the audit report also included sections about the scope of the audit, materiality
thresholds and key audit matters (those matters that in the auditor’s judgement were of significance to the audit of the
financial statements).
In December 1993, the Legislation Review Board (now disbanded) released a discussion paper entitled ‘A
Qualitative Standard for General Purpose Financial Reports: A Review’. In the discussion paper (p. 7), qualitative
standards (such as the true and fair view requirement) are defined as:
the basis for establishing a benchmark to regulate the overall quality of financial reports prepared under the relevant
financial reporting regime . . . the qualitative standard is concerned with prescribing a certain total or overall quality
for the information contained in the financial reports that will enhance their usefulness to users of those reports.
Within the discussion paper, three alternative qualitative standards were proposed:
1. The first alternative was to retain the true and fair view requirement, but to provide a technical meaning by way of
a definition, thus providing a way to remove existing ambiguities relating to the meaning of the concept.
2. The second alternative was to amend the Corporations Act by replacing the true and fair view requirement with a
requirement that general purpose financial statements of companies comply with the explicit financial reporting
framework comprising statements of accounting concepts and accounting standards. This would allow a qualitative
standard to be incorporated within this framework.
3. The third alternative was to require that general purpose financial statements be prepared in accordance with
generally accepted accounting procedures (GAAP).
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PART 1: The Australian accounting environment
Exhibit 1.4 Independent auditor’s report to the members of Commonwealth
Bank of Australia
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CHAPTER 1: An overview of the Australian external reporting environment
17
SOURCE: © CBA Commonwealth Bank of Australia
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PART 1: The Australian accounting environment
The discussion paper did not support one alternative in preference to another and at present the true and fair view
requirement is a very important part of Australian corporate reporting. Nevertheless, as there has been such debate on
the issue, it is possible that the true and fair view requirement will be amended or removed in the future.
As we have noted a number of times, there is a requirement within the Corporations Act that directors must ensure
compliance with accounting standards issued by the Australian Accounting Standards Board (AASB). We will now
further consider the functioning of the AASB.
WHY DO I NEED TO KNOW ABOUT THE ROLE OF ASIC WITH RESPECT TO
FINANCIAL REPORTING WITHIN AUSTRALIA?
ASIC plays a central role in regulating corporate reporting within Australia, and in enforcing reporting
requirements included within the Corporations Act. Therefore, to understand the context of corporate reporting
within Australia, it’s important to understand the role that ASIC plays. The more active we believe ASIC to be in
monitoring and enforcing corporate reporting requirements, the more we’re inclined to believe that Australian
reports are of higher quality (relative to other overseas jurisdictions with less active corporate regulators).
LO 1.4
1.4 Australian Accounting Standards Board
While the Corporations Act, which as we know is administered by ASIC, requires corporations to comply with
accounting standards (as per s. 296 of the Corporations Act), ASIC does not actually develop
accounting standards. Within Australia, this responsibility is borne by the Australian Accounting
Australian Accounting
Standards Board
Standards Board (AASB).
(AASB)
The AASB began operations on 1 January 1991 and replaced the Accounting Standards
Body charged with
Review
Board. While its functions, membership and structure were changed in 2000 as a result
developing a conceptual
of
amendments
included in the Corporate Law Economic Reform Program Act 1999 (Cwlth), the
framework for accounting
practices, making and
body charged with formulating accounting standards has retained the name ‘Australian Accounting
formulating accounting
Standards Board’. The functions of the AASB are listed in s. 227 of the ASIC Act and include to:
standards, and participating
∙ develop a conceptual framework, not having the force of an accounting standard, for the
purpose of evaluating accounting standards and international standards;
∙ make accounting standards under section 334 of the Corporations Act for the purpose
of the national scheme laws;
∙ formulate accounting standards for other purposes; and
∙ participate in and contribute to the development of a single set of accounting standards
for world-wide use.
The AASB is responsible for ‘making’ accounting standards that have the force of law pursuant to s. 334 of
the Corporations Act, and also for ‘formulating’ accounting standards that are to be used in the public and nonprofit sectors (that is, by entities that are not governed by the Corporations Act). The difference in terminology
between ‘making’ and ‘formulating’ accounting standards can be explained as follows. When the AASB develops
accounting standards that have the force of the Corporations Act, it is said to be making standards. When it develops
accounting standards that are to be applied by entities other than those governed by the Corporations Act, it is said to
be formulating accounting standards.
For many years within Australia we had two sets of accounting standards: those that applied to corporations and
other entities that are governed by the Corporations Act (which had the prefix AASB); and another set that applied
to entities not governed by the Corporations Act (bearing the prefix AAS, which referred to Australian Accounting
Standards). Having two sets of accounting standards was a source of confusion for many people. To remove some
of this confusion it became the practice of the AASB to issue only one set of accounting standards (with the prefix
AASB), which have general applicability to the private, public and not-for-profit sectors. That is, the AASB adopted
a ‘sector-neutral’ approach to the development of accounting standards.
We will consider the full list of AASB accounting standards later in this chapter. It is worth emphasising here that
the majority of AASB standards underwent changes in 2003 or 2004 as Australia moved towards adopting accounting
standards released by the IASB from 2005.
in and contributing to
the development of a
single set of accounting
standards for worldwide
use.
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CHAPTER 1: An overview of the Australian external reporting environment
19
The AASB reports to the Financial Reporting Council (FRC). The FRC assumes an oversight function in regard
to the AASB, and appoints the 12 part-time AASB members. The part-time members of the AASB come from a
variety of backgrounds, including the private sector, government, academia, Big 4 accounting firms and independent
consultancy. Section 236B of the ASIC Act requires that a person may not be appointed a member of the AASB unless
their ‘knowledge of, or experience in, business, accounting, law or government qualifies them for appointment’. The
full-time chairperson of the AASB is appointed by the delegated Minister within the Federal Government. (By now it
should be becoming clear how much control the government is attempting to exert over accounting standard-setting.)
The structure of Australian accounting standard-setting can be summarised diagrammatically, as in Figure 1.1.
Referring to Figure 1.1, the Federal Minister appoints the Chair of the Australian Accounting Standards Board
(AASB). The Chair of the AASB is accountable to the Minister in respect of the operations of the AASB and the
Office of the AASB. The Office of the AASB provides technical and administrative services, information and advice
to the AASB and is responsible to the Minister for financial management of the Office of the AASB. The Chairperson
of the AASB is also the chief executive officer of the Office.
Figure 1.1 also identifies ‘focus groups’ as part of the AASB structure. These focus groups are further divided
into the:
∙ User Focus Group, and
∙ Not-for-Profit (Private Sector) Focus Group.
According to the AASB website, the ‘User Focus Group’ was established to increase participation by investors,
investment professionals and equity and credit analysts in the accounting standard-setting process in order to enhance
feedback from the perspective of a significant group of users of financial statements. The purpose of the User Focus
Group is to assist the AASB in raising awareness about how investors and investment professionals, equity and credit
analysts, credit grantors and rating agencies use financial statements, and their information needs.
The AASB’s ‘Not-for-Profit (Private Sector) Focus Group’ is designed to increase participation by those involved
with these entities in the accounting standard-setting process, and to enhance feedback from the perspective of a
significant group of preparers and users of financial statements. The Not-for-Profit Focus Group comprises members
who have expertise in, and are involved in, charitable and related organisations; these members are a key source of
information in this area and provide feedback to the AASB on selected projects.
As we can see from Figure 1.1, the AASB also has ‘project advisory panels’. Experts in a particular field or topic
area are invited to join an advisory panel to provide advice that will assist the AASB in progressing specific standardsetting projects. Panels work with AASB staff to develop agenda materials for consideration by the Board.
Figure 1.1
Organisational structure
Diagrammatic
representation
of the structure
of Australian
accounting
standard-setting
The Minister
Financial
Reporting
Council
Australian
Accounting
Standards Board
Office of the Australian
Accounting
Standards Board
Focus groups
Project
advisory panels
Interpretation
advisory panels
SOURCE: Adapted from © Australian Accounting Standards Board (AASB), www.aasb.gov.au
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PART 1: The Australian accounting environment
Interpretations advisory panels are another important component of the AASB structure. Panel membership
normally includes preparers, users, auditors and regulators in order to represent a wide range of perspectives.
Interpretations are required from time to time in respect of how particular accounting requirements are to be applied
in the Australian context. As stated on the AASB website: ‘Interpretations are issued by the AASB to provide
requirements concerning urgent financial reporting issues.’ At the international level there is the IFRS Interpretations
Committee—functioning under the auspices of the IASB—which was specifically established to provide official
Interpretations of the standards being released by the IASB and, therefore, being used within Australia. We discuss
the IFRS Interpretations Committee in greater depth later in this chapter.
According to the AASB website, one of the features of the ‘Interpretations model’ is that the AASB decides on a
topic-by-topic basis whether to appoint an advisory panel, which would be constituted as a committee of the AASB.
The role of advisory panels is limited to preparing alternative views on an issue and, where appropriate, presenting
recommendations for consideration by the AASB.
Each Interpretations Advisory Panel normally includes between four and eight members, including the AASB
Chair and at least one other AASB member. Panel members are appointed on the basis of their professional competence
and practical experience in the topic area. The AASB seeks to ensure that the perspectives represented include those
of preparers, users, auditors and regulators.
Where an Interpretations Advisory Panel makes a recommendation, the process would generally be as follows:
(a) If an issue proposal relates to an Australian equivalent to the IFRS, the Panel will either:
∙ recommend that the AASB take no action and give reasons, or
∙ recommend to the AASB that the issue be referred to the IFRS Interpretations Committee for consideration for
inclusion in its work program.
Decisions by the AASB in respect of all rejected issue proposals relating to Australian equivalents to IFRSs
will be sent to the IFRS Interpretations Committee for information and be published on the AASB website. Where
the AASB refers an issue proposal to the IFRS Interpretations Committee:
(i)
(ii)
if the IFRS Interpretations Committee adds the issue to its work program, the AASB will adopt the
IFRS Interpretations Committee decisions, and
if the IFRS Interpretations Committee does not add the issue to its work program, the AASB will
assess the reasons for its rejection and, depending on the significance of the issue in Australia and
before publishing an agenda rejection statement on the AASB website, decide whether further action,
if any, should be taken by the AASB. The AASB may decide to add the issue to its work program and
establish an advisory panel. However, the AASB considers that a unique domestic interpretation of an
Australian equivalent to IASB requirements will be needed only in rare and exceptional circumstances.
(b) If the issue proposal relates to domestic requirements that relate only to not-for-profit entities in the public and/or
private sectors, the Panel will either:
∙ recommend that the AASB take no action and give reasons, or
∙ recommend that the issue be added to the work program and, if required, a panel be established to prepare
recommendations for consideration by the AASB.
The AASB website also provides a diagram to summarise how it develops pronouncements. It is reproduced as
Figure 1.2.
In explaining Figure 1.2, the website of the AASB provides the following information about the various steps
undertaken within the process of developing accounting standards.
1. International organisation identifies a technical issue
∙ A technical issue may be identified by the International Accounting Standards Board (IASB) or the IFRS
Interpretations Committee (IFRIC).
∙ A technical issue may also be identified by the International Public Sector Accounting Standards Board (IPSASB).
The AASB closely monitors the IPSASB work program and undertakes work on selected topics, based on their
significance to public sector financial reporting in Australia.
2.
∙
∙
∙
AASB identifies a technical issue
AASB Board members and staff can identify technical issues requiring consideration.
Issues identified in relation to for-profit entities are normally referred to the IASB or the IFRIC for consideration.
Issues affecting not-for-profit entities in the public and private sectors may be addressed domestically or referred
to the IPSASB.
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CHAPTER 1: An overview of the Australian external reporting environment
21
Figure 1.2
Diagrammatic
representation of
how accounting
standards are
developed by the
AASB
SOURCE: © Australian Accounting Standards Board, 2016. www.aasb.gov.au/About-the-AASB/The-standard-setting-process.aspx
3. Australian organisation/individual identifies a technical issue
∙ Australian stakeholders can advise the AASB of issues that in their view should be considered by the AASB or an
international standard-setter. For example, issues may be raised in the context of improving the relevance and
reliability of financial information or reducing the costs of financial reporting.
4. Add issue to the agenda
∙ Once a technical issue has been identified, the AASB will develop a project proposal.
∙ A project proposal contains an assessment of the potential benefits of undertaking the project, the costs of not
undertaking it, the resources available and the likely timing.
∙ The AASB will then review the project proposal and make a decision as to whether the project is worthwhile and
should be placed on its agenda (work program).
∙ If the Board decides not to add a topic to the agenda, the Board may decide to formally report the decision as a
Board Agenda Decision, sometimes called ‘items not taken onto the agenda’ or ‘agenda rejection statements’. The
minutes of meetings record the decisions made and whether or not a formal Board Agenda Decision is issued.
5. Research and consider issue
∙ When an issue has been added to the agenda, the AASB will discuss agenda papers developed and presented
by AASB staff. The agenda papers address the scope of issues, alternative approaches, and timing of outputs.
They may draw upon relevant material from other standard-setters, including the IASB, the IPSASB and the New
Zealand Accounting Standards Board, or from other organisations.
∙ Some issues may be considered jointly with the New Zealand Accounting Standards Board where they are of
significance in each country, in order to develop comparable requirements.
6. Consult with stakeholders
Once the research has been completed, the AASB makes related documents available for public comment and
discussion with stakeholders via one of the following document types.
∙ Exposure Drafts (EDs)
An exposure draft typically is a draft of a proposed standard (or other pronouncement) or draft amendment to a
standard. An ED is likely to include more refined proposals in comparison with invitations to comment, discussion
papers and consultation papers.
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PART 1: The Australian accounting environment
∙ Invitations to Comment (ITCs)
Invitations to comment generally seek feedback on broad proposals. An ITC may contain a discussion paper or a
consultation paper.
∙ Draft Interpretations
A draft interpretation is a draft of a proposed interpretation of a standard.
∙ Discussion Papers (DPs)
These usually outline a wide range of possible accounting policies on a particular topic. Discussion papers,
consultation papers and similar documents may be issued by the AASB, the IASB, the IPSASB or other standardsetters. The AASB may choose to issue international documents in Australia for comment, perhaps with an
Australian preface added to explain the context.
The methods the AASB uses to consult with stakeholders may also include the following:
∙ Roundtable discussions
The AASB may hold formal discussions with a range of stakeholders in connection with proposals issued for comment.
∙ Consultation through the vehicle of the Focus Groups, Project Advisory Panels, or Interpretation Advisory
Panels (we discussed these groups previously).
7. Issue standard or other pronouncement
The outcome of the AASB’s consideration of an issue may be the issuance of a pronouncement, such as a standard,
an interpretation, or a conceptual framework document. Alternatively, the AASB might decide to address an issue
by giving its view on the issue in the minutes of a meeting or in a formal Board Agenda Decision.
Pronouncements applicable to for-profit entities will be consistent with International Financial Reporting
Standards (IFRSs) issued by the International Accounting Standards Board. This is to ensure that general purpose
financial statements prepared by for-profit entities in accordance with AASB standards will also be in accordance
with IFRSs.
The AASB has a transaction neutrality policy under which similar transactions and events should be accounted
for in a similar manner by all types of entities, whether in the for-profit sector, the not-for-profit private sector, or
the public sector—unless there is a sound reason to be different in particular circumstances. The AASB considers
the specific needs of not-for-profit entities in the private and public sectors when preparing new and revised IFRSs
for adoption in Australia.
8. Submissions to international organisations
The AASB takes input received from Australian organisations and individuals into account when preparing its
submissions to international organisations. The AASB makes formal submissions on documents issued for comment
by the IASB and the IPSASB, to contribute to the setting of high-quality international accounting standards.
9. Comments from stakeholders in Australia
The AASB requests formal comment letters (submissions) and other input from stakeholders on the AASB’s own
proposals and in relation to various consultative documents issued by the IASB and the IPSASB. The AASB
considers this input in making submissions to the IASB and the IPSASB and in developing its own pronouncements.
10. Implementation and compliance
The AASB monitors implementation of accounting standards and interpretations in Australia. This may lead
to revisions to domestic AASB standards or to submissions to the IASB or the IPSASB to propose changes to
international standards.
Compliance with Australian accounting standards and interpretations is also monitored by other
organisations, including ASIC, the Australian Prudential Regulation Authority, other Federal, State and Territory
Government regulators, CPA Australia, Chartered Accountants Australia and New Zealand, and the Institute of
Public Accountants. The AASB receives feedback from the above organisations that assists in assessing whether
amendments to standards are required.
As part of the process of developing accounting standards, Section 231 of the ASIC Act also requires the AASB
to carry out a cost–benefit analysis of the impact of a proposed accounting standard before making or formulating that
standard (to the extent ‘to which it is reasonably practicable to do so in the circumstances’). Of course, working out
the costs and benefits of an accounting standard can be a very difficult, and sometimes political, exercise. Section 231
of the ASIC Act states that:
(1)
The AASB must carry out a cost–benefit analysis of the impact of a proposed accounting standard before
making or formulating the standard. This does not apply where the standard is being made or formulated by
issuing the text of an international standard (whether or not modified to take account of the Australian legal
or institutional environment).
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CHAPTER 1: An overview of the Australian external reporting environment
23
(2)
The AASB must carry out a cost–benefit analysis of the impact of a proposed international accounting
standard before:
(a)
(b)
providing comments on a draft of the standard; or
proposing the standard for adoption as an international standard.
(3)
The AASB has to comply with subsections (1) and (2) only to the extent to which it is reasonably
practicable to do so in the circumstances.
(4)
The Minister may direct the AASB to give the Minister details of a cost–benefit analysis carried out under
this section. The AASB must comply with the direction.
Once the AASB makes an accounting standard, which as we know is generally the equivalent of a standard issued
by the IASB, it is the responsibility of the Commonwealth Parliament to either allow or disallow the standard. Before
being approved by parliament, standards released by the AASB are referred to as ‘pending’ accounting standards.
The accounting standards themselves will generally provide guidance on how a classification of items (for example,
inventory) should be identified, measured, presented and disclosed.
Once a pending accounting standard is approved by parliament, directors are required to ensure that a company’s
financial statements comply with the standard (when standards are issued there is usually a transitional period such
that entities might have at least one accounting period before they have to comply with the new requirements). This is
in terms of s. 296 of the Corporations Act, which as we now know requires a company’s directors to ensure that the
company’s financial statements for a financial year are made out in accordance with accounting standards.
As already noted, there is also a requirement within the Corporations Act for the chief executive officer and chief
financial officer of listed companies to provide a written declaration to the board of directors to the effect that the
financial statements comply with accounting standards.
Reporting exemption allowed for ‘small proprietary companies’
Most ‘small’ proprietary companies are exempted from complying with accounting standards released by the AASB.
While the thresholds do change from time to time, new thresholds commenced from 1 July 2019 and, pursuant to the
Corporations Act, s. 45A, a proprietary company is considered to be ‘small’ if it satisfies two of the following three tests:
1. Its gross operating revenue is less than $50 million (as determined by applying accounting standards).
2. Its gross assets are less than $25 million (as determined by applying accounting standards).
3. It has fewer than 100 equivalent full-time employees.
Section 296(1A) of the Corporations Act provides that:
the financial report of a small proprietary company does not have to comply with particular accounting standards if:
(a) the report is prepared in response to a shareholder direction under section 293; and
(b) the direction specifies that the report does not have to comply with those standards.
The above requirement therefore needs to be read in conjunction with s. 293. Section 293 states:
(1) Shareholders with at least 5% of the votes in a small proprietary company may give the company a direction to:
(a)
prepare a financial report and directors’ report for a financial year; and
(b)
send them to all shareholders.
(2) The direction must be:
(a)
signed by the shareholders giving the direction; and
(b)
made no later than 12 months after the end of the financial year concerned.
(3) The direction may specify all or any of the following:
(a)
that the financial report does not have to comply with some or all of the accounting standards;
(b)
that a directors’ report or a part of that report need not be prepared;
(c)
that the financial report is to be audited.
Effectively, therefore, a small proprietary company does not have to apply accounting standards or have its
financial statements audited unless ASIC requests the company to do so, or if shareholders holding at least 5 per
cent of the voting shares request the company to do so. As noted above, where shareholders make directions for the
preparation of financial reports, they can specify that those reports do not have to comply with accounting standards.
If a proprietary company is not considered small, it is classified as large, and large proprietary companies are subject
to more stringent disclosure requirements.
Public companies and large proprietary companies will typically have to prepare financial statements that comply
with accounting standards, have their financial statements audited and send them to the members (shareholders) of the
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24
PART 1: The Australian accounting environment
company (or make them available on the corporation’s website if the shareholder has not made a specific request to
receive a hard copy). The existence of this differential reporting requirement for small and large proprietary companies
is based on the assumption that the limited number of parties with a material interest in ‘small’ companies would
conceivably be able to request information to satisfy their specific needs. However, it is assumed that the majority of
shareholders in ‘large’ companies do not have this ability. As organisations become larger there tends to be greater
separation between ownership and management (or, as this is often termed, between ownership and control) and
owners tend to become more reliant on external reports in order to monitor the progress of their investment. Further,
as an entity increases in size, its economic and political importance increases, and in general this increases the demand
for financial information about the entity.
The process of Australia adopting accounting standards issued by the International
Accounting Standards Board
In 2002 the Financial Reporting Council (FRC), which we now know oversees the AASB, decided to commit Australia
to adopting accounting standards issued by the International Accounting Standards Board (IASB). Such standards
are referred to as International Financial Reporting Standards (IFRSs). When they were previously released by the
International Accounting Standards Committee (the IASB’s predecessor), they were referred to as International
Accounting Standards (IASs). It would appear that the catalyst for the FRC’s directive was a decision by the European
Union that all listed companies within the European Union should adopt IASB standards by 1 January 2005 for the
purposes of preparing consolidated financial statements. This was to support the ‘single market objective’ that has
been embraced within the European Union. The intention was for the European Union to adopt IFRSs directly without
modification. This can be contrasted with the Australian situation, where IFRSs are being turned into Australian
(AASB) Accounting Standards, each bearing the prefix AASB.
In relation to the adoption of IASB standards within Australia, former deputy chairperson of the AASB Ruth
Picker made the following comments (Picker 2003):
The announcement in July 2002 by the Financial Reporting Council (FRC) that all entities reporting under the
Corporations Act would be required to comply with IASs, now referred to as International Financial Reporting
Standards (IFRSs), with effect from 1 January 2005, has turned the corporate accounting world on its head.
The ambit of the requirement for reporting under IASs is extremely wide as it applies to all reporting entities
under the Corporations Act, both listed and unlisted, private and public. This is in contrast to the situation in
Europe where compliance with IASs by 1 January 2005 will only be mandatory for listed entities.
Furthermore, because the Australian Accounting Standards Board only produces one set of accounting standards
for reporting entities, the IASs will effectively apply also to reporting entities that are not Corporations Act entities.
Within Australia, and even though we have adopted the accounting standards issued by the IASB, our accounting
standards are still referred to as Australian Accounting Standards (with the AASB prefix, as previously indicated), and
they might have some minor differences from the equivalent International Accounting Standards (for example, they
might include more explanatory material and make reference, where necessary, to the Corporations Act 2001)—but
essentially they will be the same as the International Accounting Standards (which, as we have already indicated, are
referred to as IFRSs). IFRSs are developed for the ‘for-profit’ sector (for example, for profit-seeking companies). Within
Australia, however, AASB standards have general applicability to the not-for-profit and local government sectors too (that
is, they are sector-neutral). Hence, material will need to be added by the AASB that describes the scope and applicability
of the standards in the Australian context. Table 1.1 shows the accounting standards in place within Australia as at
September 2019 with reference also to the equivalent IASs/IFRSs (not all AASB standards have an IAS/IFRS equivalent).
Remember that the standards issued by the IASB (and its predecessor, the IASC) were formerly referred to as International
Accounting Standards. It is only recently that IASB-released accounting standards have been referred to as IFRSs.
At this stage you should review Table 1.1 to gain an understanding of the many and varied issues addressed by our
accounting standards. Appreciate, however, that even all of these accounting standards do not cover every conceivable
transaction or event, which is why Australia retains the overriding qualitative reporting requirement that corporations
must prepare ‘true and fair’ financial statements. Many of the accounting standards listed below will be covered in
depth in other chapters of this text. While Table 1.1 provides a list of the standards in place as at mid-2019, it should be
appreciated that new standards will be added, and particular accounting standards might be withdrawn, over time. This
means that such lists of accounting standards do not remain current for long. Further, and as indicated earlier, the wording
and requirements incorporated within particular accounting standards will often change, so interested parties (such as
practitioners, students and researchers) should always check the websites of standard-setters for the very latest versions
of accounting standards.
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CHAPTER 1: An overview of the Australian external reporting environment
AASB No.
Title
Equivalent IFRS/IAS
1
First-time Adoption of Australian Equivalents to International
Financial Reporting Standards
IFRS 1
2
Share-based Payments
IFRS 2
3
Business Combinations
IFRS 3
4
Insurance Contracts
IFRS 4
5
Non-current Assets Held for Sale and Discontinued Operations
IFRS 5
6
Exploration for and Evaluation of Mineral Resources
IFRS 6
7
Financial Instruments: Disclosures
IFRS 7
8
Operating Segments
IFRS 8
9
Financial Instruments
IFRS 9
10
Consolidated Financial Statements
IFRS 10
11
Joint Arrangements
IFRS 11
12
Disclosure of Interests in Other Entities
IFRS 12
13
Fair Value Measurement
IFRS 13
14
Regulatory Deferral Accounts
IFRS 14
15
Revenue from Contracts with Customers
IFRS 15
16
Leases
IFRS 16
17
Insurance Contracts
IFRS 17
101
Presentation of Financial Statements
IAS 1
102
Inventories
IAS 2
107
Statement of Cash Flows
IAS 7
108
Accounting Policies, Changes in Accounting Estimates and Errors
IAS 8
110
Events after the Reporting Period
IAS 10
111
Construction Contracts
IAS 11
112
Income Taxes
IAS 12
116
Property, Plant and Equipment
IAS 16
117
Leases
IAS 17
118
Revenue
IAS 18
119
Employee Benefits
IAS 19
120
Accounting for Government Grants and Disclosure of Government
Assistance
IAS 20
121
The Effects of Changes in Foreign Exchange Rates
IAS 21
123
Borrowing Costs
IAS 23
124
Related Party Disclosures
IAS 24
127
Separate Financial Statements
IAS 27
128
Investments in Associates and Joint Ventures
IAS 28
129
Financial Reporting in Hyperinflationary Economies
IAS 29
132
Financial Instruments: Presentation
IAS 32
133
Earnings per Share
IAS 33
134
Interim Financial Reporting
IAS 34
136
Impairment of Assets
IAS 36
137
Provisions, Contingent Liabilities and Contingent Assets
IAS 37
138
Intangible Assets
IAS 38
25
Table 1.1
AASB accounting
standards, with
details of equivalent
IFRSs/IASs
continued
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PART 1: The Australian accounting environment
AASB No.
Title
Equivalent IFRS/IAS
139
Financial Instruments: Recognition and Measurement
IAS 39
140
Investment Property
IAS 40
141
Agriculture
IAS 41
1004
Contributions
–
1023
General Insurance Contracts
–
1038
Life Insurance Contracts
–
1039
Concise Financial Reports
–
1048
Interpretation of Standards
–
1049
Whole of Government and General Government Sector Financial
Reporting
–
1050
Administered Items
–
1051
Land Under Roads
–
1052
Disaggregated Items
–
1053
Application of Tiers of Australian Accounting Standards
–
1054
Australian Additional Disclosures
–
1055
Budgetary Reporting
–
1056
Superannuation Entities
–
1057
Application of Australian Accounting Standards
–
1058
Income of Not-for-profit Entities
–
1059
Service Concession Arrangements: Grantors
–
Table 1.1
continued
SOURCE: © Commonwealth of Australia. Reproduced by permission.
Compliance with the AASB standard would still mean compliance with the IASB standard. The AASB standards
might also require additional disclosures. Any difference from the equivalent IFRS will be readily identified within
the AASB standard (relevant amended paragraphs will have the prefix ‘Aus’). The AASB will issue future standards
in Australia at about the same time that the standards concerned are issued by the IASB.
Numbering of Australian Accounting Standards
Because we will be referring to accounting standards in this and subsequent chapters, it is worth looking at the
numbering system applied to Australian Accounting Standards.
Accounting standards issued by the International Accounting Standards Board and its predecessor, the International
Accounting Standards Committee, were, until 2003, referred to as International Accounting Standards and given the
prefix ‘IAS’. For example, the accounting standard relating to intangible assets as issued in 1998 is IAS 38 Intangible
Assets. Accounting standards issued by the IASB from late 2003 onwards are to be referred to as International
Financial Reporting Standards and will have the prefix ‘IFRS’. For example, the accounting standard issued in late
2003 that relates to first-time adoption of International Financial Reporting Standards is IFRS 1 First-time Adoption
of International Financial Reporting Standards. Where the IASB has issued a standard as an IAS, whether or not
it has been the subject of subsequent ‘improvement’, to the extent it was referred to as an IAS it will continue to be
referred to as one. Therefore, the IASB will have standards with different prefixes—the ‘older’ standards (which might
nevertheless have had recent updates or amendments) will have the prefix ‘IAS’ and the ‘newer’ standards will have
the prefix ‘IFRS’. Look at the right-hand column of Table 1.1 for yourself and you will see the use of both ‘IFRS’ and
‘IAS’ as prefixes.
By contrast, when the Australian Accounting Standards Board releases accounting standards they will all have
the prefix ‘AASB’. However, the numbering system applied to a particular AASB standard will depend upon whether
the ‘adopted’ standard relates to an ‘old’ or ‘new’ international standard. As we can see from the left-hand column of
Table 1.1, there are three different numbering systems being applied by the AASB. The AASB has devised a policy
for numbering according to which the numbering system will be:
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CHAPTER 1: An overview of the Australian external reporting environment
27
AASB Standards 1–99 Series Where an Australian standard relates to a standard with the IFRS prefix (one of
the more recent standards issued by the IASB), the Australian standard will be numbered from AASB 1 to 99. For
example, our Australian standard AASB 15 Revenue from Contracts with Customers equates to IFRS 15 Revenue from
Contracts with Customers, which was released by the IASB in 2014.
AASB Standards 100–199 Series Where the adopted AASB standard relates to an international standard that has
the IAS prefix, the Australian standard will be numbered from AASB 101 to AASB 199. For example, our standard
on intangible assets will be AASB 138 Intangible Assets (the related international standard being IAS 38 Intangible
Assets).
Standards 1000 + Series In situations where Australia releases an accounting standard that does not have an
international equivalent (the AASB might release standards relating to particular issues of domestic importance that
are not covered by the IASB), the numbering system will be from AASB 1001 to AASB 1099. For example, we
had an accounting standard issued in 2014 by the AASB that does not have an equivalent, this being AASB 1056
Superannuation Entities.
Therefore, we have three different numbering systems for our accounting standards. We hope that this explanation
of the numbering system will prevent confusion in this, and the following chapters.
From time to time, the IASB will amend existing IFRSs. This is done by way of what is referred to as ‘omnibus’
standards that explain the changes to particular accounting standards. Following this process, the AASB incorporates
the changes into what are now referred to as ‘compiled’ standards. That is, ‘compiled standards’ represent the original
standard, with the subsequent amendments.
While the AASB will be issuing standards (with slight changes, as noted above) to match those being issued by
the IASB, from time to time the AASB might issue standards to cover areas not addressed by the IASB. That is, the
AASB will develop additional standards to cater for issues of a domestic nature, and will also issue standards that are
specific to the not-for-profit sector and public sector. The AASB will also advise the IASB of issues that it believes
should be covered within IASB standards (earlier in this chapter we covered the processes involved when the AASB
develops an accounting standard).
The decision by the FRC (the body that oversees the AASB) that Australia would adopt IFRSs from 2005
produced a sweep of changes in Australian accounting standards that has been unparalleled in Australian financial
reporting history. The decision required reporting entities to prepare financial statements in accordance with IFRSs
for accounting periods beginning on or after 1 January 2005. Given the historical significance of the FRC’s decision,
we have reproduced in Exhibit 1.5 the bulletin that was released by the FRC in July 2002 outlining the FRC’s
strategic direction.
Prior to the formalisation of the FRC’s strategic direction supporting adoption of IFRSs, Australia had, since
1995, been involved in a process that would harmonise Australian Accounting Standards with their international
equivalents. The ‘harmonisation process’ required Australian Accounting Standards to be as compatible as possible
with International Accounting Standards, but still allowed some divergence where the Australian treatment was
construed to be more appropriate. The majority of Australian Accounting Standards were changed as a result of
the harmonisation process. Once the harmonisation process was almost complete it was decided that harmonisation
was not sufficient and that Australia should adopt the standards being issued by the IASB. This meant that many
of the standards that went through the harmonisation process were changed yet again to converge them with their
international equivalents (that is, to remove any of the minor differences that survived the harmonisation process).
This ‘second round’ of changes within such a short time was a source of frustration for both readers and preparers of
financial statements (not to mention authors of textbooks!).
The AASB was one of the first major accounting standard-setters to embark on a program that sought to harmonise
its accounting standards with those of the IASB (or, as it was then known, the IASC). The harmonisation of Australian
Accounting Standards with their international equivalents was justified on the basis that if Australia elected to retain
accounting standards that were unique, this would restrict the flow of foreign investment into Australia. (Do you,
the reader, think this is a realistic perspective?) This view was promoted within the federal government’s Corporate
Law Economic Reform Program (CLERP). CLERP’s 1997 document Accounting Standards: Building International
Opportunities for Australian Business states (p. 15):
There is no benefit in Australia having unique domestic Accounting Standards which, because of their unfamiliarity,
would not be understood by the rest of the world. Even if these standards were considered to represent best practice,
Australia would not necessarily be able to attract capital because foreign corporations and investors would not be
able to make sensible assessments, especially on a comparative basis, of the value of Australian enterprises. The
need for common accounting language to facilitate investor evaluation of domestic and foreign corporations and
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PART 1: The Australian accounting environment
Exhibit 1.5 Financial Reporting Council’s bulletin on the council’s strategic direction
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CHAPTER 1: An overview of the Australian external reporting environment
29
continued
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PART 1: The Australian accounting environment
Exhibit 1.5 continued
SOURCE: Bulletin of the Financial Reporting Council 2002/4—3 July 2002
to avoid potentially costly accounting conversions by foreign listed companies are powerful arguments against the
retention of purely domestic financial reporting regimes.
The above view is consistent with that provided in Policy Statement 4, ‘International Convergence and
Harmonisation Policy’ (issued in April 2002 by the AASB), which emphasised the need for international comparability
of financial statements. As the policy statement notes in paragraph 2:
There is considerable divergence between standards issued by national and international standard-setting bodies. The
globalisation of economic activity has resulted in an increased demand for high quality, internationally comparable
financial information. The AASB believes that it should facilitate the provision of this information by pursuing a policy
of international convergence and international harmonisation of Australian accounting standards. In this context,
‘international convergence’ means working with other standard-setting bodies to develop new or revised standards that
will contribute to the development of a single set of accounting standards for world-wide use. ‘International harmonisation’
of Australian accounting standards refers to a process which leads to these standards being made compatible with the
standards of international standard-setting bodies to the extent that this would result in high quality standards. Both
processes are intended to assist in the development of a single set of accounting standards for world-wide use.
While the FRC’s 2002 directive was for Australia to adopt IFRSs, because of the requirements of the Corporations
Act, the standards had to be released by the AASB (which can be contrasted with the situation within the European
Union where IFRSs are generally being used without any changes). Specifically, the Corporations Act requires,
pursuant to s. 296, that financial reports must comply with ‘accounting standards’. Section 334 further states that
‘the AASB may make accounting standards for the purposes of this Act. The standards must be in writing and must
not be inconsistent with this Act or the regulations.’ Hence, rather than simply embracing IFRSs without change, the
standards needed to be issued by the AASB and to be ‘re-badged’ as AASB standards.
For some reporting entities, the impact of adopting IFRSs in place of the previous accounting standards was quite
significant. Some organisations had their reported profits severely reduced and their reported assets greatly reduced
as a result of applying IFRSs. This, in turn, impacted on such things as gearing ratios (which might be utilised within
borrowing agreements with banks) and profit-based bonuses that might be paid to employees. Earnings per share and
other indicators of performance were also affected.
While many countries throughout the world now use IFRSs, there are still differences between the United States’
generally accepted accounting principles (US GAAP) and IFRSs, and these differences are expected to continue
for some time. For a number of years there was a joint project between the IASB and the US Financial Accounting
Standards Board (FASB) aimed at converging IFRSs and FASB standards. There was an expectation for some years
that the US would ultimately adopt IFRSs, and the aim of the convergence project was to work towards the time when
a ‘true’ international standardisation of accounting becomes a reality. The wisdom of this was subsequently questioned
within the US by the Securities and Exchange Commission (SEC) and hence it is not at all certain that the US will
ultimately adopt IFRSs as the basis of its corporate reporting.
So, while there appears to be a long-term aim that ultimately there will be one set of standards used internationally,
including within the US, the timing as to when the US will adopt IFRSs (and some people still question if it will) is far
from certain. Obviously, for the IASB to achieve its aim of developing ‘a single set of high-quality, understandable and
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CHAPTER 1: An overview of the Australian external reporting environment
31
international financial reporting standards (IFRSs) for general purpose financial statements’ (as stated on the IASB
website), it will need to encourage the US to adopt its standards.
We will now further consider the organisation that oversees the activities of the AASB, this being the Financial
Reporting Council.
WHY DO I NEED TO KNOW ABOUT THE ROLE OF THE AUSTRALIAN
ACCOUNTING STANDARDS BOARD?
The AASB is the accounting standard-setter within Australia. In order to understand the practice of financial
reporting within Australia, it is important to understand the role of the AASB, and the various pronouncements
it releases. If you are a preparer of financial statements, or a company director, you need to ensure that the
financial reports you are releasing are in compliance with the standards released by the AASB (these are
available on the AASB’s website). You also need to understand that although the AASB does not directly
have the power to enforce accounting standards, the accounting standards released by the AASB (whether
developed within Australia, or based upon standards developed by the IASB) do have the force of law by
virtue of the Corporations Act, as enforced by ASIC. The website of the AASB is also relevant as it provides
information about the various activities and projects being pursued by the AASB, and which might be expected
to impact future financial reporting within Australia
1.5 Financial Reporting Council
LO 1.5
As noted previously, the Financial Reporting Council (FRC) oversees the activities of the AASB and was
instrumental in the decision that Australia adopt the accounting standards issued by the IASB. The website of the
FRC (at www.frc.gov.au) provides the names and occupations of those making up the membership
Financial Reporting
of the FRC. Section 235A(1) of the Australian Securities and Investments Commission Act 2001
Council (FRC)
(ASIC Act)—also available at www.legislation.gov.au—provides that members of the FRC are
Body that oversees the
either appointed directly by the relevant Minister or, alternatively, the Minister may specify an
activities of the AASB and
organisation or body to choose someone to represent that organisation.
the AUASB.
According to the website of the FRC (accessed September 2019), the membership of the FRC
was made up of a retired partner from PriceWaterhouse Coopers; a chief financial officer; a deputy
secretary of the Department of Finance; the Chief Compliance Officer of ASX; the Under Treasurer of the Treasury
and Economic Development Directorate of the ACT Government; the AASB Chairperson; the Australian Auditing
Standards Chairperson; and a partner of KPMG. (There is a notable absence of representation from groups that
are not concerned primarily in the financial performance of reporting entities but might nevertheless be interested
in other aspects of the entities’ performance. For example, social, environmental or employee lobby groups are
not represented, despite the fact that they would also have a legitimate interest in the financial performance and
position of various reporting entities. Do you, the reader, consider that the FRC is appropriately representative of
the information needs of the broader community, or is it appropriate that only people with a financial interest in
organisations are represented?)
While we are concerned primarily here with financial accounting and not the auditing of financial reports, the
responsibilities of the FRC include overseeing the activities of the Auditing and Assurance Standards Board (AUASB),
which is responsible for developing auditing standards within Australia. Auditing standards have the force of law. The
overall objective of the AUASB is to improve the quality of auditing in Australia. In meeting this objective, the Board
develops and promulgates auditing standards and audit guidance releases. In carrying out its functions, the Board seeks
to ensure that professional auditing guidance reflects appropriate theory, practice and international developments, and
meets reasonable community expectations. The AUASB has full regard to developments occurring within the ambit
of the International Auditing and Assurance Standards Board.
Section 225 of the ASIC Act details the functions and powers of the FRC. These include:
(a)
(b)
(d)
(e)
to provide broad oversight of the processes for setting accounting standards in Australia; and
to provide broad oversight of the processes for setting auditing standards in Australia; and
to give the Minister reports and advice about the matters referred to in paragraphs (a) and (b); and
the functions specified in subsections (2) (specific accounting standards functions), (2A) (specific auditing
standards functions) and (2B) (specific auditor quality functions); and
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PART 1: The Australian accounting environment
(f) to establish appropriate consultative mechanisms; and
(g) to advance and promote the main objects of this Part; and
(h) any other functions that the Minister confers on the FRC by written notice to the FRC Chair.
With regard to what the FRC may not do, s. 225(5), (6), (7) and (8) explicitly state that:
∙ The FRC does not have power to direct the AASB in relation to the development, or making, of a particular
standard.
∙ The FRC does not have power to veto a standard formulated and recommended by the AASB (only Parliament can
do this).
∙ The FRC does not have power to direct the AUASB in relation to the development, or making, of a particular
auditing standard.
∙ The FRC does not have power to veto a standard made, formulated or recommended by the AUASB.
The above provisions were introduced in an attempt to ensure the independence of both the AASB and the AUASB.
As we have noted previously, it was the decision of the FRC in 2002 that Australia would adopt IFRSs. What
was apparent at the time was that the FRC’s decision to adopt IFRSs was effectively presented to the AASB as an
accomplished fact. We would really have expected more debate on the issue, rather than what amounted to a unilateral
decision. Further, we can question whether the FRC went beyond what had been construed as its ‘proper role’ in
the standard-setting process. As we can also see above, s. 225 of the ASIC Act details the functions and powers
of the FRC. These include: providing broad oversight of the process for setting accounting standards in Australia;
appointing members of the AASB; approving and monitoring the AASB’s priorities, business plan, budget and
staffing arrangements; and giving the AASB directions, advice and feedback on matters of general policy. Section
225(5) and (6) explicitly state that the FRC does not have the power to direct the AASB in relation to the development,
or making, of a particular standard.
These appear to be solid grounds for contending that the FRC went beyond its purview. However, the reality is that
the FRC’s decision generated a great deal of work for accountants and users of financial statements within Australia as
they became familiar with a new set of accounting standards. It would be an interesting exercise to try to quantify the
costs (and benefits) associated with the FRC’s decision that Australia would adopt IFRSs. Indeed, Keith Alfredson,
the Chairperson of the AASB at the time of the FRC’s decision, openly questioned whether the FRC had adequately
considered the costs and benefits before committing Australia to adopting accounting standards issued by the IASB (as
reported in a newspaper article written by Tom Ravlic that appeared in The Age on 5 May 2003 entitled ‘Accountant
queries standards move’).
LO 1.6
1.6 Australian Securities Exchange
For those reporting entities that have securities listed on the Australian Securities Exchange (ASX), there are
further reporting requirements over and above those provided within accounting standards or in the Corporations
Act. As of 1 April 1987 there has been one nationally operated securities exchange in Australia. In
Australian Securities
November 1998 the ASX became a public company with shares listed on its own exchange. Therefore,
Exchange (ASX)
while the ASX was previously predominantly self-regulated, it now falls under the control of the
Body that sets uniform
Corporations Act, as well as its own listing rules. That is, although the ASX develops and imposes
trading rules, ethical
regulations on other companies that are listed on its exchange, it is ASIC that regulates the ASX.
standards and listing
requirements.
Failure to comply with the ASX Listing Rules may lead to removal from the Board. The
ASX disclosure requirements help to ensure that information about listed entities is disseminated
in an efficient and timely manner. They also reduce the likelihood of individuals prospering through access to
privileged information.
The ASX Listing Rules are divided into 20 chapters (details of the listing rules are available on the ASX website at
www.asx.com.au). Of particular relevance to us are Chapters 3 and 4 of the Listing Rules, which relate to continuous
disclosure and periodic disclosure, respectively. You would do well to take the time to review the Listing Rules.
Listing Rule 3.1 (relating to continuous disclosure) provides the general principle that:
Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have
a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information.
The ASX also established the ASX Corporate Governance Council. In 2003 the ASX Corporate Governance
Council released its Principles of Good Corporate Governance and Best Practice Recommendations. These Principles,
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CHAPTER 1: An overview of the Australian external reporting environment
33
which are now referred to as Corporate Governance Principles and Recommendations, were most recently amended
and re-released in February 2019 (the fourth edition) and can be accessed on the ASX website. As indicated in the
principles document (p. 1):
Corporate governance is the framework of rules, relationships, systems and processes within and by which authority
is exercised and controlled in corporations. It encompasses the mechanisms by which companies, and those in
control, are held to account.
The basis of the ASX corporate governance disclosure recommendations is that to assess the risk of an organisation
it is essential to know about the policies and procedures in place that govern how the organisation is run (that is, to
know about the organisation’s corporate governance policies). As stated in the recommendations (p. 5), pursuant to
ASX Listing Rule 4.10, companies are required to provide a statement in their annual report disclosing the extent to
which they have followed the Corporate Governance Principles and Recommendations in the reporting period. Where
companies have not followed all of the recommendations, they must identify the recommendations that have not been
followed, and provide reasons for not following them. This is often referred to as an ‘if not, why not?’ approach to
disclosure. Therefore, the ASX principles do not compel organisations to change their governance systems, but rather
rely upon ‘market forces’ to encourage adoption of best practice.
Within the Corporate Governance Principles and Recommendations the Corporate Governance Council has
proposed eight essential principles of corporate governance. They are summarised in Exhibit 1.6. Disclosure pertaining
to the eight essential principles must be made in the annual report in a dedicated corporate governance section.
Exhibit 1.6 The eight essential corporate governance principles identified by the ASX
continued
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PART 1: The Australian accounting environment
Exhibit 1.6 continued
SOURCE: © Copyright 2019 ASX Corporate Governance Council
LO 1.7
1.7 International Accounting Standards Board
Because the accounting standards being used within Australia emanate overwhelmingly from the IASB in
London it is useful to understand the structure of the IASB, and its predecessor, the IASC.
The International Accounting Standards Committee (IASC) was established in 1973 with the aim of bringing
together parties from throughout the world to develop accounting standards that apply internationally. In April 2001
the IASC was replaced by the IASB. The IASB is now responsible for releasing International Accounting Standards
or, as they have now become known, International Financial Reporting Standards (IFRSs).
Until the early 2000s, standards issued by the IASC, and subsequently by the IASB, were not of direct importance
to countries that had their own standard-setting processes in place. They would, however, typically be referred to
for an indication of possible best practice when accounting standards were being developed within these countries.
They were also deemed to provide useful guidance when no domestic standard related to a particular accounting
issue. Countries that did not have their own accounting standards in place were known to adopt directly the standards
developed by the IASC and later the IASB. This has been the case especially in developing countries. In more recent
times, however, most developed countries have adopted IFRSs. This was done because of the perceived benefits
associated with having globally consistent accounting standards. The IASB provided a diagram on its website relating
to the extent of the global adoption of IFRSs as of late 2018. It is reproduced in Figure 1.3.
As noted above, there has been a change in the parties responsible for developing International Accounting
Standards. In essence, with the establishment of the IASB, the standard-setting structure of the IASB became very
similar to the accounting standard-setting structure established in Australia. There is a group of trustees who comprise
the IFRS Foundation (similar to the FRC in Australia) made up of 22 individuals, and these trustees are responsible for
the appointment of IASB members as well as the members of the IFRS Interpretations Committee and the Standards
Advisory Council (SAC). The trustees also exercise oversight over the IASB and are involved in raising the funds
needed by the IASB. The trustees come from a number of different countries, and in 2019 six were from North
America, six from Europe, six from the Asia–Oceania region, and four others from any region.
Members of the IASB shall be appointed for a term of up to five years, renewable once. The website of the IASB
explains how accounting standards are developed and issued within the IASB:
∙ during the early stages of a project, the IASB may establish an Advisory Committee to give advice on the issues
arising in the project. Consultation with the Advisory Committee and the Standards Advisory Council (also part
of the IASB) occurs throughout the project;
∙ the IASB may then develop and publish Discussion Documents for public comment;
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CHAPTER 1: An overview of the Australian external reporting environment
35
Figure 1.3
The number of
jurisdictions using
IFRSs
SOURCE: www.ifrs.org/-/media/feature/about-us/who-we-are/who-we-are-english-2018-final.pdf
∙ following the receipt and review of comments, the IASB could then develop and publish an Exposure Draft for
public comment; and
∙ following the receipt and review of comments, the IASB would issue a final International Financial Reporting Standard.
Figure 1.4 provides a diagrammatic representation of how accounting standards are developed by the IASB.
Each IASB member has one vote on technical and other matters. In relation to how many votes are required for an IFRS
or exposure draft to be approved, paragraph 36 of the IFRS Foundation Constitution (as updated in December 2018) states:
The publication of an exposure draft, or an International Financial Reporting Standard (including an International
Accounting Standard or an Interpretation of the Interpretations Committee) shall require approval by eight members
of the IASB, if there are 13 members or fewer, or by nine members if there are 14 members. Other decisions of the IASB,
including the publication of a Discussion Paper, shall require a simple majority of the members of the IASB present
at a meeting that is attended by at least 60 per cent of the members of the IASB, in person or by telecommunications.
When the IASB publishes a standard, it also publishes a Basis for Conclusions to explain publicly how it reached
its conclusions and to give background information that might help users of standards to apply them in practice. These
Figure 1.4
How the IASB
develops
accounting
standards
SOURCE: IFRS Foundation, Who We Are and What We Do, International Accounting Standards Board (IASB), January 2018.
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PART 1: The Australian accounting environment
Basis for Conclusions documents are publicly available. The IASB would also publish dissenting opinions from
members of the Board who disagreed with the majority opinions.
The IASB website explains how the Board coordinates its activities with national standard-setters, such as the
AASB. The Board believes that close coordination between the IASB’s due process and the due process of national
standard-setters is important to the success of the IASB’s mission. Further, according to the IASB website, the IASB is
exploring ways to integrate its due process more closely with that of its members. Such integration might grow as the
relationship between the IASB and national standard-setters evolves. In particular, the IASB is exploring the following
procedure for projects that have international implications:
∙ IASB and national standard-setters (such as the AASB) would coordinate their work plans so that when the IASB
starts a project, national standard-setters would also add it to their own work plans so that they can play a full part
in developing international consensus. Similarly, where national standard-setters start projects, the IASB would
consider whether it needs to develop new standards or revise its existing standards. Over a reasonable period,
the IASB and national standard-setters should aim to review all standards where there are currently significant
differences, giving priority to areas where the differences are greatest.
∙ National standard-setters would publish their own exposure documents at approximately the same time as IASB
exposure drafts are published and would seek specific comments on any significant divergences between the two
exposure documents. In some instances, national standard-setters might include in their exposure documents
specific comments on issues of particular relevance to their country or include more detailed guidance than is
included in the corresponding IASB document.
∙ National standard-setters would follow fully their own due process, which they would, ideally, choose to integrate
with the IASB’s due process. Such integration would avoid unnecessary delays in completing standards and would
also minimise the likelihood of unnecessary differences between the standards that result.
In 2013 the IFRS Foundation established the Accounting Standards Advisory Forum (ASAF), which provides
technical advice to the IASB. The ASAF has 12 members who come from standard-setting bodies around the world,
one member of which (in 2019) came from Australia.
The IASB does not have power to enforce its standards
An important point to consider, and remember, is that the IASB is a standard-setting body. It does not have any
enforcement powers. For example, in Australia we use IFRSs developed by the IASB, but the IASB has no power
within Australia to enforce its accounting standards. That power in Australia resides with ASIC. Therefore, although
many countries throughout the world claim to be using IFRSs, whether they are actually being applied properly really
is dependent upon the enforcement and compliance policies in place within the respective countries. Because some
countries have very weak enforcement strategies, the claim that their organisations are complying with IFRSs is
logically open to challenge. Questioning the logic behind any belief that the efforts of the IASB will realistically lead
to international consistencies in accounting practice, Ball (2006, p. 16) states:
Does anyone seriously believe that implementation will be of an equal standard in all the nearly 100 countries that
have announced adoption of IFRS in one way or another? The list of adopters ranges from countries with developed
accounting and auditing professions and developed capital markets (such as Australia) to countries without a
similarly developed institutional background (such as Armenia, Costa Rica, Ecuador, Egypt, Kenya, Kuwait, Nepal,
Tobago and Ukraine). Even within the EU, will implementation of IFRS be at an equal standard in all countries?
The list includes Austria, Belgium, Cyprus, Czech Republic, Denmark, Germany, Estonia, Greece, Spain, France,
Ireland, Italy, Latvia, Lithuania, Luxembourg, Hungary, Malta, Netherlands, Poland, Portugal, Slovenia, Slovakia,
Finland, Sweden and the UK. It is well known that uniform EU economic rules in general are not implemented
evenly, with some countries being notorious standouts. What makes financial reporting rules different?
The above view was also reflected again a decade later in Ball (2016). Ball (2016, p. 554) notes:
Does anyone really believe that implementation will be of equal standard in all of the countries? Many of the countries
counted among the 116 adopters simply do not have the infrastructure to enforce actual implementation, even if they
wanted to. Many will not want to, due to political and economic factors. . . . The emerging consensus is that changes
in rules have little effect on reporting quality without incentives of preparers to actually implement them.
Therefore, we should not simply accept claims that the international adoption of IFRSs automatically leads to the
adoption of uniform accounting methods globally, and to ‘better’ financial reporting universally.
IFRS Interpretations Committee
The IASB has a committee known as the IFRS Interpretations Committee, which is the official ‘interpretative arm’
of the IASB. The IASB website states that the IFRS Interpretations Committee reviews, on a timely basis within
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CHAPTER 1: An overview of the Australian external reporting environment
37
the context of existing International Accounting Standards and the IASB Conceptual Framework, accounting issues
that are likely to receive divergent or unacceptable treatment in the absence of authoritative guidance, with a view
to reaching consensus on the appropriate accounting treatment. While the IFRS Interpretations Committee provides
guidance on issues not specifically addressed in IFRSs, it also provides Interpretations of requirements existing
within IFRSs. In developing Interpretations, the IFRS Interpretations Committee works closely with similar national
committees and meets about every six to eight weeks. All technical decisions are taken at sessions that are open to
public scrutiny. The IFRS Interpretations Committee addresses issues of reasonably widespread importance, and not
issues of concern only to a small set of enterprises. The Interpretations cover both:
∙ newly identified financial reporting issues not specifically addressed in IFRSs, and
∙ issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop, in the absence
of authoritative guidance, with a view to reaching consensus on the appropriate treatment.
Given that so many countries have now adopted IFRSs, a central objective of the IFRS Interpretations Committee
is to achieve consistent Interpretations of IFRSs by IFRS-adopters internationally. If IFRSs were interpreted differently
within each country, the purpose and benefits of promoting one set of global accounting standards would be diminished.
Indeed, the aim of global uniformity in interpreting financial reporting requirements has meant that many national
standard-setters have disbanded their own domestic Interpretations committees. For example, within Australia, the
AASB disbanded the Urgent Issues Group (which was formerly the Australian equivalent of the IFRS Interpretations
Committee) because the AASB considered that disbanding the UIG helped to ensure that IFRSs are being adopted
consistently on a worldwide basis.
According to its website, the primary responsibility for identifying issues to be considered by the IFRS
Interpretations Committee is that of its members and appointed observers. Preparers, auditors and others with an
interest in financial reporting are encouraged to refer issues to the IFRS Interpretations Committee when they believe
that divergent practices have emerged regarding the accounting for particular transactions or circumstances or when
there is doubt about the appropriate accounting treatment and it is important that a standard treatment is established.
An issue may be put forward by any individual or organisation.
The majority of issues raised with the IFRS Interpretations Committee are not placed on its agenda. Where issues
are not accepted for consideration, the IFRS Interpretations Committee issues a rejection notice, which is published
on the IASB website. The rejection notice sets out the reasons why the IFRS Interpretations Committee did not place
the issue on its agenda, the typical reason provided being that the answer to the issue raised is already available from
existing accounting standards and therefore there is no need to issue an Interpretation. The IFRS Interpretations
Committee Interpretations are subject to IASB approval and have the same authority as a standard issued by the IASB.
Within Australia, Interpretations issued by the IFRS Interpretations Committee and by the AASB are given the same
authoritative status as accounting standards by virtue of AASB 1048 Interpretation of Standards, issued by the AASB.
AASB 1048 clarifies that all Australian Interpretations have the same authoritative status. Australian Interpretations
comprise those issued by the IFRS Interpretations Committee as well as those issued by the AASB, together with
those that were issued by the Urgent Issues Group and that have been retained for use.
For Interpretations to be mandatory in the Australian context they need to be listed within tables included within
AASB 1048. AASB 1048 will be reissued as and when necessary to keep the tables up to date and to give force to
newly released Interpretations.
The Interpretations can be found on the websites of the IASB and AASB. More information about the IASB and
the IFRS Interpretations Committee can be found on the IASB website at www.ifrs.org.
At this point it should be noted that the IASB is also responsible for developing a conceptual framework—a
framework that is used in developing accounting standards. Chapter 2 provides an in-depth review of the IASB
Conceptual Framework for Financial Reporting.
WHY DO I NEED TO KNOW ABOUT THE ROLE OF THE INTERNATIONAL
ACCOUNTING STANDARDS BOARD?
While Australia does use some accounting standards that were developed within Australia and which do not
have an international counterpart, the vast majority of accounting standards being applied within Australia
were developed by the IASB. Therefore, because of the influence that the IASB exerts over Australian general
purpose financial reporting, it seems reasonable that you should know about how the IASB functions, and what
processes are in place to develop its pronouncements.
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LO 1.8
PART 1: The Australian accounting environment
1.8 Accounting standards change across time
One other thing we need to know, or remember, is that accounting standards frequently change across time.
Each year various existing accounting standards will be changed, and new ones addressing new topics might
be introduced. The accounting standards themselves might retain the same numbers (for example, AASB 101)
but undergo changes periodically. Sometimes these changes can be significant. For example, how we account for
intangible assets has shown great change across the years and this has had major implications for whether certain
expenditures should be treated as assets or expenses. Another major change is how we are to account for leases. Recent
changes have meant that many more leased assets, and lease liabilities, are to be recognised in the financial statements
and this has also had implications for expense recognition.
Many more examples could be given of major changes, but what should be appreciated at this point is that it is
a fairly silly (or ignorant) exercise to compare the profits or losses of one company for one year with its profits or
losses as calculated some years earlier. Effectively the profits or losses calculated in previous years were generated
when different accounting rules were in place, which perhaps allowed certain expenditures to be capitalised (that is,
treated as assets) when now they must be treated as expenses, or vice versa. Or perhaps certain obligations—such as
certain employee benefit-related obligations—were not previously recognised as accounting liabilities (with related
expenses), but now they must be. To use a sporting analogy, the ‘rules of the game’ have changed, so old scores
(profits) cannot really be meaningfully compared with current ‘scores’ unless a number of adjustments are made.
The above discussion should lead us to question some of the analysis that we often see published in newspapers
and other media. For example, some people often provide charts that show the trend in profits of a company over an
extended period of time, say five to ten years. But what such analysis often ignores is that the accounting rules in place
several years ago in relation to the recognition and measurement of income and expenses can be quite different from
the rules in place now, so that we are really comparing very different things.
The other point that should be made is that because accounting standards do change across time, some of what we
learn now (for example, some of what is included in this textbook) might not be terribly relevant in say five or more
years. Therefore, to stay up-to-date, financial accountants must continually keep abreast of ongoing changes and this
in itself is why professional accounting bodies typically require their members to undergo continuing professional
development/education as part of their membership requirements.
LO 1.9
1.9 Differential reporting
In relation to the issue of differential reporting, we know from discussion already provided within this chapter
that within Australia the Corporations Act does provide some reporting ‘let-outs’ for organisations such as ‘small
proprietary companies’. However, many other organisations are still required to produce financial statements that
comply with accounting standards. Because so many organisations were required to produce financial reports that
complied with accounting standards, this arguably created a reporting burden for some organisations in situations
where there were questionable benefits to report users. With this is mind, the AASB released AASB 1053 Application
of Tiers of Australian Accounting Standards. AASB 1053 introduced a two-tier reporting system for entities producing
general purpose financial statements. Tier 1 general purpose financial statements are financial statements that comply
with all relevant accounting standards. Tier 2 comprises the recognition, measurement and presentation requirements
of Tier 1 but substantially reduces the disclosure requirements.
Because the Tier 2 requirements do not change the recognition and measurement requirements being applied,
the differential reporting approach is consistent with the position that has been taken by the AASB for a number of
years—this being that the same transactions and other events should be subject to the same accounting requirements
to the extent feasible (that is, transaction neutrality), and this principle should apply to all entities preparing general
purpose financial statements (whether for-profit or not-for-profit).
Each Australian Accounting Standard will specify the entities to which it applies and, where necessary, set out
the disclosure requirements from which Tier 2 entities are exempt. Complying with Tier 1 requirements will mean
compliance with International Financial Reporting Standards (IFRSs) as issued by the IASB. Conversely, entities
applying Tier 2 reporting requirements would not be able to state that their reports are in compliance with IFRSs
(because of the reduced disclosure).
In identifying which entities shall apply Tier 1 reporting requirements, paragraph 11 of AASB 1053 states:
Tier 1 reporting requirements shall apply to the general purpose financial statements of the following types of
entities:
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CHAPTER 1: An overview of the Australian external reporting environment
39
(a) for-profit private sector entities that have public accountability; and
(b) the Australian Government and State, Territory and Local Governments. (AASB 1053)
In relation to ‘for-profit private-sector entities’ (which would include, for example, listed companies), we obviously
need to have some definition of ‘public accountability’ given its centrality to the above requirement. Appendix A of
AASB 1053 defines it as follows:
Public accountability means accountability to those existing and potential resource providers and others external
to the entity who make economic decisions but are not in a position to demand reports tailored to meet their
particular information needs. (AASB 1053)
The above definition links directly to the definition of ‘general purpose financial statements’, which has been
used widely within financial reporting, and which has already been discussed earlier in this chapter. General purpose
financial statements are defined in AASB 1053 (and elsewhere, as we have already seen) as statements:
intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their
particular information needs. (AASB 1053)
The definition of ‘public accountability’ reproduced above provides a general principle. Appendix A to AASB
1053 provides practical application guidance. It states:
A for-profit private sector entity has public accountability if:
(a) its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments
for trading in a public market (a domestic or foreign stock exchange or an over-the-counter market, including
local and regional markets); or
(b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. This is
typically the case for banks, credit unions, insurance companies, securities brokers/dealers, mutual funds and
investment banks. (AASB 1053)
Paragraph B2 of Appendix B to AASB 1053 further states:
The following for-profit entities are deemed to have public accountability:
(a) disclosing entities, even if their debt or equity instruments are not traded in a public market or are not in the
process of being issued for trading in a public market;
(b) co-operatives that issue debentures;
(c) registered managed investment schemes;
(d) superannuation plans regulated by the Australian Prudential Regulation Authority (APRA) other than Small
APRA Funds as defined by APRA Superannuation Circular No. III.E.1 Regulation of Small APRA Funds,
December 2000; and
(e) authorised deposit-taking institutions. (AASB 1053)
In relation to which entities are permitted to apply Tier 2 reporting requirements, paragraph 13 of AASB 1053 states:
Tier 2 reporting requirements shall, as a minimum, apply to the general purpose financial statements of the
following types of entities:
(a) for-profit private sector entities that do not have public accountability;
(b) not-for-profit private sector entities; and
(c) public sector entities, whether for-profit or not-for-profit, other than the Australian Government and State,
Territory and Local Governments.
These types of entities may elect to apply Tier 1 reporting requirements in preparing general purpose financial
statements. (AASB 1053)
Therefore, for example, if a proprietary company is not deemed to be small (thereby not satisfying the ‘let-out’
provisions included at Section 296(1A) of the Corporations Act)—as discussed earlier in this chapter—then it must,
at the least, prepare Tier 2 financial statements. Such financial statements would be referred to as complying with
Australian Accounting Standards—Reduced Disclosure Requirements. As paragraph 16 of AASB 1053 states:
Disclosures under Tier 2 reporting requirements are the minimum disclosures required to be included in general
purpose financial statements. Entities may include additional disclosures using Tier 1 reporting requirements as
a guide if, in their judgement, such additional disclosures are consistent with the objective of general purpose
financial statements. (AASB 1053)
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PART 1: The Australian accounting environment
The above requirements would also need to consider whether the organisation is a reporting entity and therefore
required to produce general purpose financial statements. Organisations producing financial statements that comply
with Tier 2 requirements are still considered to be producing general purpose financial statements. A reporting entity
is defined in AASB 1053 (and elsewhere) as:
An entity in respect of which it is reasonable to expect the existence of users who rely on the entity’s general purpose
financial statements for information that will be useful to them for making and evaluating decisions about the allocation
of resources. A reporting entity can be a single entity or a group comprising a parent and all its subsidiaries. (AASB 1053)
An organisation that is not a ‘reporting entity’ and does not have ‘public accountability’ would not be impacted by
the requirements of AASB 1053 to the extent that the organisation does not elect to produce general purpose financial
statements.
In relation to the disclosures from which Tier 2 entities are exempt, reference must be made to the ‘Application’ section
of each accounting standard (which typically follows the ‘Objective’ section within the accounting standard); within this
section there will be a sub-heading ‘Reduced Disclosure Requirements’. Under this sub-heading will be a statement:
The following do not apply to entities preparing general purpose financial statements under Australian Accounting
Standards—Reduced Disclosure Requirements:
A list of relevant paragraphs would then be provided. Some Australian Accounting Standards are equally applicable
to both Tier 1 and Tier 2 entities. Therefore, such standards do not provide reduced disclosures for Tier 2 entities.
Also, some standards apply only to Tier 1 entities, but Tier 2 entities may elect to use them. Examples are AASB 8
Operating Segments and AASB 133 Earnings per Share, which generally apply only to listed entities.
While Australian Accounting Standards are generally equivalent to standards issued by the IASB (IFRSs), AASB
1053 represents a departure from what is occurring at the international level. In 2009 the IASB issued its International
Financial Reporting Standard for Small and Medium-Sized Entities. The IASB standard allows small and medium
enterprises (SMEs) to depart from various recognition, measurement and presentation requirements incorporated
within IFRSs. By contrast, the view adopted by the AASB (as reported in the Basis for Conclusions that supports
AASB 1053) was that since Australia has adopted full IFRSs, it would be logical to use the public accountability
notion used by the IASB in determining which entities in the for-profit sector should apply Australian Accounting
Standards in full (the definition of ‘public accountability’ as used by the AASB is identical to that used by the IASB).
The Reduced Disclosure Requirements (RDR) reflected in AASB 1053 are fundamentally different from the approach
adopted in the IFRS for SMEs because the RDR involve applying the same recognition and measurement requirements
as Tier 1, whereas the IFRS for SMEs modifies the recognition and measurement requirements of full IFRSs. The
implications of the IASB approach to SMEs is that there will be disparities in the choice of accounting policies by
different entities because precedence will be given to the Conceptual Framework over full IFRSs as the source of
guidance in determining accounting policies in the absence of a specific requirement.
Other reasons identified by the AASB for why it elected not to adopt the IASB’s approach to differential reporting
included:
∙ the additional initial and ongoing costs of training and education for two sets of standards, both at the profession
and at the tertiary level
∙ the fact that some subsidiaries of publicly accountable entities would find it burdensome to apply the proposed
IFRS for SMEs in preparing their general purpose financial statements. They would need to prepare financial
information based on the recognition and measurement requirements of full IFRSs for the purposes of the parent
entity consolidation
∙ the fact that entities seeking to access international capital markets would generally apply full IFRSs
∙ a loss of comparability across all types of entities’ general purpose financial statements within Australia
∙ the fact that adoption of the IFRS for SMEs may be seen as a retrograde step in a country that has already adopted
full IFRS recognition and measurement accounting policy options
∙ the fact that in the event that an entity moves to, or from, full IFRSs, there would be costs involved in migrating
from the recognition and measurement requirements of one tier of reporting to another.
While AASB 1053 did represent a relatively major change for the Australian financial reporting environment, the
requirements embodied within AASB 1053 are likely to be amended in the not-too-distant future. As paragraph BC20
from the Basis for Conclusions to AASB 1053 states:
The Board regards AASB 1053 as a pragmatic and substantive response to the need to reduce the burden of disclosure
requirements on Australian reporting entities. However, the Board does not regard it as a complete or final answer
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CHAPTER 1: An overview of the Australian external reporting environment
41
to that need. The Board intends continuing its deliberations on revising the differential reporting framework with
a view to ongoing improvements (including having regard to decisions made by the IASB in relation to its IFRS for
SMEs). The Board concluded that the reforms in AASB 1053 should not be delayed while consideration of other
possible areas of reform continues. (AASB 1053)
Apart from the issue of differential reporting as addressed in AASB 1053, some AASB accounting standards are
applicable only to specific classes of companies (for example, companies listed on the Australian Securities Exchange).
Further, ASIC may, from time to time and pursuant to the Corporations Act, release a Class Order that grants relief
from certain Corporations Act provisions, such as the requirement to comply with all accounting standards. As we have
indicated in this chapter, from 2000 the AASB has also been responsible for issuing standards applicable to reporting
entities that are not governed by the Corporations Act (for example, large partnerships and government departments).
As noted above, and pursuant to s. 285(2) of the Corporations Act, AASB standards can apply to some entities
that are not of a corporate form—for example, to ‘disclosing entities’. This has had the effect of increasing the ambit
of accounting standards so that all disclosing entities need to comply with the majority of AASB accounting standards.
According to the Corporations Act, disclosing entities include:
(a) entities which have securities that are quoted on a stock market of a securities exchange;
(b) entities which have securities (except debentures) that have been issued pursuant to a prospectus;
(c) entities which have securities (except debentures) that have been issued as consideration for the acquisition of
shares pursuant to a takeover scheme;
(d) entities which have securities that have been issued pursuant to a Part 5.1 compromise or arrangement; and
(e) borrowing corporations.
Disclosing entities are required to comply with AASB accounting standards, with only a limited number of
exceptions. Hence, many forms of organisations other than companies are required by law to follow the majority
of AASB accounting standards. This is despite the specific wording of some AASB standards.
1.10 The use and role of audit reports
As we have discussed many of the reporting requirements for general purpose financial statements (GPFSs), it LO 1.10
would be useful also to consider briefly the use and role of another report that typically appears in corporate
annual reports, this being the audit report.
An audit is the independent examination of financial information of any entity—whether profit-oriented or not
and irrespective of its size or legal form—where such an examination is conducted with a view to expressing an
opinion on that financial information. The audit opinion is the output of the audit process and is provided in the audit
report. The auditor’s opinion helps to establish the credibility and reliability of the financial information. The user of
this information, however, should not assume that the auditor’s opinion is an assurance of the future viability of the
entity, or of the efficiency or effectiveness with which management has conducted the affairs of the entity—it is simply
an opinion about the financial statements. Also, it cannot be considered with absolute certainty that all transactions
have been correctly recorded, even when the auditor provides an unqualified opinion. The auditor does not test/check
all transactions; hence there is always the possibility that the financial statements might be materially misstated. It is
to be hoped, however, that the probability of material misstatement is kept to a low level. We provided an example of
part of an audit report earlier in this chapter.
In the private sector, decisions relating to the internal affairs of an organisation, as well as lending and investment
decisions of creditors and investors, must be made daily. In the public sector, interested parties must decide whether
managers are complying with the controls placed upon them and whether the entity is operating efficiently and effectively.
Therefore, managers must collect and report financial information about the entity that summarises and communicates
the results of their activities to interested groups. To do this, they must identify user needs for the purpose of establishing
the nature of the data to be communicated—that is, decisions must be made as to what is ‘material’.
It should be remembered that the auditor is not responsible for the preparation of the financial information; that
responsibility rests with management. The auditor’s responsibility is to form and express an opinion on the financial
information. Arguably, the auditor’s report is the first item a reader should review when looking at an annual report.
A review of the audit report might indicate that the financial statements have not been properly prepared and, perhaps,
that they should not be relied upon for making resource-allocation decisions.
Preparers of financial information include the financial managers of enterprises, each of whom might, at times, place
primary importance on maximising their own welfare. This frequently results in the goals of the persons preparing the
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42
PART 1: The Australian accounting environment
financial information being different from the goals of those using it. This conflict, which will be further considered in
Chapter 3, might cause the preparers of financial information to intentionally or unintentionally introduce misstatements
(or bias) into the financial data. Because of the potential bias of management in identifying and presenting such
information, there is a need for independent verification of the financial data to assure fairness of presentation.
The users of financial statements need their information to be unbiased in order to reduce the information risk they
face—that is, the risk of using materially misstated information—when making economic decisions. An independent
auditor’s task is to reduce the potential bias and error that the preparers of financial statements might introduce. The
reduction (or elimination) of bias makes it a ‘fairer game’ for investors and creditors. When using unbiased financial
information, users are given a fairer chance of earning reasonable returns on their investment. With biased information,
they might be forced into making inappropriate investment decisions.
To lessen this risk, users of financial statements are willing to incur an audit fee in return for some assurance that
financial statements are fairly presented. The managers of business entities are also generally prepared to subject their
financial operations to an audit. Potential investors are thus able to monitor past and future performance in a more confident
manner and this might motivate them to invest more funds at a lower required rate of return than would otherwise be
required. Of course, the value of the independent audit will be tied to the reputation of the firm performing the audit.
Audits are typically required for all public companies, large proprietary companies and a limited number of small
proprietary companies, as defined earlier in this chapter. Small proprietary companies will be required to have their
financial statements audited if they are controlled by a foreign company or if shareholders holding more than 5 per cent
of the voting shares request that the reports be audited. From time to time, ASIC may also request that a small proprietary
company has its financial statements audited. Commonwealth and state government departments, statutory authorities,
government companies and business undertakings and municipalities also typically have their financial statements audited.
WHY DO I NEED TO KNOW ABOUT THE ROLE OF EXTERNAL FINANCIAL
STATEMENT AUDITORS?
Audit reports are typically included within annual reports issued by reporting entities. They provide an insight
into the reliability of the information being presented by the managers of the organisation. However, just
because an auditor might provide an opinion that the financial statements appear to comply with accounting
standards and other generally accepted accounting principles, there is always a chance that the financial
statements have been prepared inappropriately. The audit opinion is simply that—an opinion. Sometimes they
are wrong, and we need to appreciate that. Nevertheless, if the opinion is provided by a reputable auditor, then
our confidence in the information should be enhanced.
LO 1.11
1.11 What benefits can we expect from all of this international
standardisation?
As indicated earlier in this chapter, the Australian government decided that Australia would adopt IFRSs
because of the perceived benefits. The benefits that were promoted by the FRC included an increased ability for
Australian entities to access capital from international sources and, somewhat relatedly, an increased ability of investors
to compare the results of Australian entities with those of overseas entities. There is also the expectation that it will be
more efficient for international companies operating in Australia to prepare financial statements internationally on the
basis of the same set of accounting standards. In the past, companies that are listed in more than one jurisdiction had
to bear the costs of preparing financial statements under more than one accounting system.
All convergence and standardisation benefits come at a cost. Such costs include the costs of educating accountants
to adopt a new set of accounting standards and the costs associated with changing data-collection and reporting
systems. Such costs are borne by large listed companies, as well as large proprietary companies, not-for-profit entities
and local governments. These last three categories of reporting entities are relatively unlikely to benefit from such
things as increased capital inflows. Yet they will still incur significant costs.
Some of the perceived benefits of harmonisation were discussed in paragraph 7 of Policy Statement 4 ‘International
Harmonisation and Convergence Policy’. The main benefits of international harmonisation identified in this
document included:
(a) increasing the comparability of financial reports prepared in different countries and providing participants in
international capital markets with better quality information on which to base investment and credit decisions.
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CHAPTER 1: An overview of the Australian external reporting environment
(b)
(c)
(d)
(e)
43
It will also reduce financial analysis costs through analysts not having to recast information on a common
basis and requiring knowledge of only one set of financial reporting standards rather than several;
removing barriers to international capital flows by reducing differences in financial reporting requirements
for participants in international capital markets and by increasing the understanding by foreign investors of
Australian financial reports;
reducing financial reporting costs for Australian multinational companies and foreign companies operating in
Australia and reporting elsewhere;
facilitating more meaningful comparisons of the financial performance and financial position of Australian
and foreign public sector reporting entities; and
improving the quality of financial reporting in Australia to best international practice.
In relation to the issue of being better able to compare the financial performance of entities from different countries
(point (a) above), it is argued that while there are variations in the accounting standards issued by different countries, the
difficulties in comparing the financial performance of reporting entities from different countries will persist. The variations
in accounting rules can have significant implications for profit comparisons. In this regard we can consider research by
Nobes and Parker (2004). They undertook a comparison of the results of a small number of European-based multinational
which reported their results in accordance with both their home nation’s accounting rules and US accounting rules. Their
comparative analysis shows, for example, that the underlying economic transactions and events of the Anglo-Swedish drug
company AstraZeneca in the year 2000 produced a profit of £9521 million when reported in conformity with UK accounting
rules, but the same set of transactions produced a reported profit of £29 707 million when prepared pursuant to US accounting
rules—a difference of 212 per cent in reported profits from an identical set of underlying transactions and events!
Extending this analysis to a more recent period, the 2006 Annual Report of AstraZeneca (the final year that
companies with a dual home country and US listing had been required to provide a reconciliation between their results
using IFRS and US accounting rules) shows that net income derived from applying IFRSs of $6043 million became
a net income of $4392 million when calculated in accordance with US accounting rules—this time a difference of
27 per cent compared to the IFRS rules. In its balance sheet (or as it is also known, its statement of financial position),
AstraZeneca’s shareholders’ equity at 31 December 2006 was $15 304 million when reported in accordance with
IFRSs, but this became $32 467 million when determined in accordance with US accounting rules, a difference of
112 per cent. Although percentage differences of this size might be unusual, examination of the financial reports of
almost any company that reported its results in accordance with more than one nation’s set of accounting regulations
will have shown differences between the profits reported under each set of regulations and between the financial
position reported under each set of regulations.
A further dramatic example of the existence of differences between the accounting rules of different countries is
provided by the US corporation Enron. As Unerman and O’Dwyer (2004) explain, in the aftermath of the collapse of
Enron, many accounting regulators, practitioners and politicians in European countries claimed that the accounting
practices that enabled Enron to ‘hide’ vast liabilities by keeping them off their US balance sheet would not have been
effective in Europe. In the United Kingdom, this explanation highlighted the differences between the UK and US
approaches to accounting regulation. It was argued that under UK accounting regulations these liabilities would not
have been treated as off balance sheet, thus potentially producing significant differences between Enron’s balance
sheet under UK and US accounting practices.
Having considered how different countries’ accounting rules can generate significantly different profits or losses,
as well as different assets and liabilities, we should perhaps consider whether such differences are a justification for
all of the activity undertaken to standardise accounting standards internationally. What do you think? Certainly, this
justification was used by Australian accounting standard-setters.
The view that the harmonisation and subsequent adoption of IFRSs would lead to cost reductions in Australia,
as well as capital inflows, is not a view that is necessarily supported (or refuted) by any empirical data, but the ASX
nevertheless took the view that general compliance with IASB standards would lead to significant additional inflows
of foreign investment. In this regard, in May 2000, the International Organization of Securities Commissions (IOSCO)
announced that it would recommend adoption of IASC/IASB standards as a permissible basis for the preparation of
financial statements to member exchanges throughout the world. The actions of IOSCO reinforced the position of the
IASB as a global accounting standard-setter. Such a move meant that an organisation whose reports already accord
with IASB standards and which was seeking listing in another country would not need to adjust its reports to comply
with particular national requirements. More details about IOSCO can be found on its website at www.iosco.org.
It should also be noted that from late 2007 the Securities and Exchange Commission (SEC) in the US adopted rules
that permitted foreign private issuers (but not US domestic companies) to lodge, with the SEC, their financial statements
prepared in accordance with IFRSs without the need to provide a reconciliation to generally accepted accounting
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PART 1: The Australian accounting environment
principles (GAAP) as used in the United States. That is, foreign companies that are listed across a number of securities
exchanges internationally, including within the US, can now lodge their reports in the US even though the reports have
not been prepared in accordance with US accounting standards and do not provide a reconciliation to US GAAP. The
ruling of the SEC requires that foreign private issuers which take advantage of this option must state explicitly and
unreservedly in the notes to their financial statements that such financial statements are in compliance with IFRSs
as issued by the IASB (without modifications), and they must also provide an auditor’s unqualified report explicitly
providing an opinion that the financial statements have been compiled in accordance with IFRSs as issued by the IASB.
Hence, effectively there are two types of financial statements being lodged within the US (as is the case in
many other countries). Foreign companies can lodge their reports within the US in accordance with IFRSs, whereas
domestic US companies must lodge their reports in accordance with US GAAP.
In reflecting upon whether the adoption of IFRSs in Australia actually led to benefits for Australia, the AASB
undertook a review in 2017 (reported in AASB 2017). The AASB reported that the general view from all stakeholders
was that adopting IFRSs was the right decision for Australia. Eighty people were interviewed for the research and they
came from various forms of organisations (including listed companies, charities and government departments). Such
results are also consistent with a report released in late 2016, also by the AASB.
From an extensive review of existing research, the AASB (2016) reports that available research generally supports
the view that IFRS adoption has benefitted the Australian economy and that there is no significant evidence to suggest
that any reconsideration of the decision to adopt IFRSs is warranted. While there is some evidence that the way
Australia now accounts for intangible assets under IFRSs (relative to how Australia formerly accounted for intangible
assets) has deficiencies, the evidence also suggests that the adoption of IFRSs has led to financial reports becoming
longer but easier to read. Another positive effect is that the evidence points to the comparability of Australian entities’
financial reporting practices, with their global peers, as being enhanced.
LO 1.12
1.12 International cultural differences and the harmonisation of
accounting standards
As we have emphasised in this chapter, globally countries have adopted, or are moving to adopt, International
Financial Reporting Standards rather than accounting standards developed domestically. We now consider some
factors that might impact negatively on the global harmonisation or convergence of accounting standards.
There are a number of potential barriers to global standardisation of accounting standards; these include the
influences of different business environments, legal systems, cultures and political environments.
One of these ‘barriers’, which we will consider briefly, is cultural differences. ‘Culture’ itself is described by Gray
(1988, p. 4) as a system of societal or collectively held values, where values are defined as a broad tendency to prefer
certain states of affairs over others. Perera (1989, p. 43) describes culture as an expression of norms, values and customs,
which reflect typical behavioural characteristics. There are many accounting researchers (for example, Gray 1988; Perera
1989; Fechner & Kilgore 1994; Eddie 1996; Chand & White 2007) who argue that the accounting policies and practices
adopted within particular countries are to some extent a direct reflection of the cultural and individual values and beliefs
in those countries. That is, the values in the accounting subculture are directly influenced by society-wide values. Perera
(1989, p. 43) argues that culture is a powerful environmental factor affecting the accounting system of a country and,
therefore, accounting cannot be considered to be ‘culture-free’. In the same vein, Gray (1988, p. 5) states:
the value systems of accountants may be expected to be related to and derived from societal values with special
reference to work related values. Accounting ‘values’ will, in turn, impact on accounting systems.
For example, if a country is deemed to be basically conservative, the argument is that the
accounting policies developed in that country will tend towards conservatism. Conservative
accounting policies would rely on traditional measurement practices (such as historical cost) and
Policies that tend to
understate the value of
would be more likely to be used in countries in which the society is generally classified as seeking
an entity’s net assets; a
to minimise uncertainty (Perera 1989). Gray (1988, p. 10) argues that the degree of conservatism
bias towards understating
varies by country, ranging from a strongly conservative approach in the continental European
the carrying amount of
assets and overstating
countries, such as France and Germany, to a much less conservative approach in the US and the UK.
the carrying amount of
Countries might have cultural attributes that suggest they tend more towards secrecy than
liabilities.
transparency, and their accounting disclosure requirements might reflect this cultural bias. As with
degrees of conservatism, Gray (1988, p. 11) argues that the extent of secrecy seems to vary between
countries, with lower levels of disclosure—implying greater secrecy—including instances of secret reserves, evident
in the continental European countries, for example, compared with higher levels of disclosure in the US and the UK.
conservative
accounting policies
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CHAPTER 1: An overview of the Australian external reporting environment
45
Eddie (1996) investigated the association of particular national cultural values (identified by Hofstede 1991) with
consolidation disclosures made by particular entities within a number of different countries. Consolidation practices
are covered in a later chapter of this text; however, at this stage consolidation can be defined simply as the practice
of combining the financial statements of various entities within a group to form one set of consolidated financial
statements. Eddie found that particular cultural values or attributes—which had been identified and measured in
previous research—are significantly associated with the extent of consolidation disclosure and the degree of variation
in the extent of consolidation disclosures.
If national culture has impacted on the approaches and decisions taken by accounting practitioners and accounting
standard-setters within their own particular countries, is it appropriate to expect different countries, with varying
cultural values, to adopt internationally uniform accounting practices? Perera (1989, p. 52) considers the potential
success of transferring accounting skills from Anglo-American countries to developing countries. He notes: ‘The skills
so transferred from Anglo-American countries may not work because they are culturally irrelevant or dysfunctional in
the receiving countries’ context.’
Consistent with the above, Brown (2011) notes that:
Accounting standards have differed from country to country, because of differences across countries in the economic
and social forces that have interacted in the past to determine those countries’ accounting standards today.
Much of the diversity in accounting standards across countries results from deeply entrenched differences
in legal systems, in relationships between firms and their financiers, in income tax systems, in inflation rates,
in historical ties (political and economic), in the extent of economic development and in the level of community
education.
Moreover, many of those differences are deep-seated and will not disappear quickly after a country commits
to adopting IFRS.
Following from the above discussion, the issue of ‘culture’ and international cultural differences together with
differences in political, social and economic systems might have some bearing on whether the harmonisation or
adoption of accounting standards on a worldwide basis is a realistic, achievable and sustainable goal. Gray (1988,
p. 2) states that ‘fundamentally different accounting patterns exist as a result of environmental differences and that
international classification differences may have significant implications for international harmonisation’.
Perera (1989) argues that International Accounting Standards themselves are strongly influenced by AngloAmerican accounting models and, as such, these standards tend to reflect the circumstances and patterns of thinking
in a particular group of countries. He argues therefore that International Accounting Standards are likely to encounter
problems of relevance in countries with different cultural environments from those found in Anglo-American countries.
Perhaps it could be argued that with the increasing globalisation of business, international cultural differences
will be reduced. Further consideration of this issue is really beyond the ambit of this book, but it is nevertheless an
interesting topic.
1.13 All of this regulation—is it really necessary?
As preceding sections of this chapter have discussed, financial accounting is fairly heavily regulated in Australia LO 1.13
and many other countries. Within Australia, there are numerous Corporations Act requirements, and there
are many accounting standards and interpretations, with additional standards and interpretations being issued fairly
frequently. The ASX also provides extensive regulation for listed entities. But is all this regulation really necessary?
What if we had no accounting standards, and reporting entities could report whatever information they wanted and in
whatever format they considered appropriate?
Opinions on the need for regulation vary, and range from the ‘free-market’ perspective to the ‘pro-regulation’
perspective. We will now briefly consider some arguments for and against regulation—for a more detailed discussion,
refer to a text dedicated to financial accounting theory.
The ‘free-market’ perspective
Proponents of a free-market perspective on accounting regulation often believe that accounting information should
be treated like other goods, with demand and supply forces being allowed to operate to generate an optimal supply of
information about an entity. In support of their claims, a number of arguments are provided. One argument, based on
the work of authors such as Jensen and Meckling (1976), Watts and Zimmerman (1978), Smith and Warner (1979)
and Smith and Watts (1982), is that even in the absence of regulation, there are private economics-based incentives
for the managers of an organisation to provide credible information about its operations and performance to certain
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PART 1: The Australian accounting environment
parties outside the organisation, otherwise the costs of the organisation’s operations would rise. This view is based on a
perspective that the provision of credible information allows other parties to monitor the activities of the organisation.
Being able to monitor the activities of an entity reduces the risk associated with investing in the entity, and this in turn
should lead to a reduction in the cost of attracting capital to the organisation.
It has also been argued that there will often be conflicts between various parties with an interest in an organisation,
and accounting information will be produced, even in the absence of regulation, to reduce the effects of this conflict.
For example, if an owner appoints a manager, the owner might be concerned that the manager will not best serve the
interests of the owner. To align the interests of both parties, the manager might be provided with a share of profits,
meaning that the manager will work hard to increase profits, with higher profitability also being in the interests of the
owners. To determine profits, accounting reports will be produced, and the owners will demand that these reports be
produced in an unbiased manner.
As will be discussed in Chapter 3, there is also an argument that accounting reports can be used to reduce the conflict
that might arise between managers and the providers of loans (debt holders). This is consistent with the usual notion of
‘stewardship’, according to which management is expected to provide an ‘account’ of how it has utilised the funds it has
been provided. If an entity that borrows funds also agrees to provide regular financial statements to the providers of the
debt capital (the debtholders), this ability to monitor the financial performance and position of the borrower will reduce
the risks of the lender. This should translate to lower costs of interest being charged and hence provide an incentive for
the borrower (the reporting entity) to provide financial statements even in the absence of regulation.
Further, depending on the parties involved and the types of assets in place, it has been argued that managers of
the organisation will be best placed to determine what information should be produced to increase the confidence
of external stakeholders (thereby decreasing the organisation’s cost of attracting capital). Regulation that restricts
the available set of accounting methods (for example, banning a particular method of amortisation that was used
previously by some organisations) will decrease the efficiency with which information will be provided. It has also
been argued that certain mandated disclosures will be costly to the organisation if they enable competitors to take
advantage of certain proprietary information. Hakansson (1977) used this argument to explain costs that would be
imposed as a result of mandating segment disclosures.
While this discussion is about providing financial statements, a related issue is that of external auditing of such
reports. It has been argued that even in the absence of regulation, external parties would demand that financial
statement audits be undertaken. If such audits are not undertaken, financial statements would not be deemed to have
the same credibility and, consequently, less reliance would be placed on them. If reliable information is not available,
the risk associated with investing in an organisation might be perceived to be higher, and this could lead to increases
in the cost of attracting funds to the organisation. It has therefore been argued that managers would have their reports
audited even in the absence of regulation (Watts 1977; Watts and Zimmerman 1983; Francis and Wilson 1988).
That is, financial statement audits can be expected to be undertaken even in the absence of regulation, and evidence
indicates that many organisations did have their financial statements audited prior to any legislative requirements to
do so (Morris 1984). However, as Cooper and Keim (1983, p. 199) indicate, for auditing to be an effective strategy
for reducing the costs of attracting funds, ‘the auditor must be perceived to be truly independent and the accounting
methods employed and the statements’ prescribed content must be sufficiently well-defined’.
There is also a perspective that even in the absence of regulation, organisations would still be motivated to disclose
both good and bad news about an entity’s financial position and performance. Such a perspective is often referred to as
the ‘market for lemons’ perspective (Akerlof 1970), the view being that in the absence of disclosure the capital market
will assume that the organisation is a ‘lemon’. (Something is a lemon if it initially appears or is assumed, perhaps
owing to insufficient information, to be of a quality comparable to other products, but later turns out to be inferior.
Acquiring the ‘lemon’ will be the result of information asymmetry in favour of the seller.) That is, no information is
viewed in the same light as bad information. Hence, even though the firm might be worried about disclosing bad news,
it is assumed that the market might make an assessment that silence implies that the organisation has very bad news to
disclose (otherwise, it would disclose it). This ‘market for lemons’ perspective provides an incentive for managers to
release information in the absence of regulation, as failure to do so will have its own implications for the organisation.
That is, ‘non-lemon owners have an incentive to communicate’ (Spence 1974, p. 93).
Drawing upon arguments such as the lemons argument above and applying them to preliminary profit
announcements, Skinner (1994, p. 39) states:
Managers may incur reputational costs if they fail to disclose bad news in a timely manner. Money managers,
stockholders, security analysts, and other investors dislike adverse earnings surprises, and may impose costs on
firms whose managers are less than candid about potential earnings problems. For example, money managers may
choose not to hold the stocks of firms whose managers have a reputation for withholding bad news and analysts
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CHAPTER 1: An overview of the Australian external reporting environment
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may choose not to follow these firms’ stocks . . . Articles in the financial press suggest that professional money
managers, security analysts, and other investors impose costs on firms when their managers appear to delay bad
news disclosures. These articles claim that firms whose managers acquire a reputation for failing to disclose bad
news are less likely to be followed by analysts and money managers, thus reducing the price and/or liquidity of
their firms’ stocks.
Reviewing previous studies, Skinner (1994, p. 44) notes that there is evidence that managers disclose both good
and bad news forecasts voluntarily. These findings are supported by his own empirical research, which shows that
when firms are performing well, managers make ‘good news disclosures’ to distinguish their firms from those doing
less well, and when firms are not doing well, managers make pre-emptive bad news disclosures consistent with
‘reputational effects’ arguments (p. 58).
Arguments that the market will penalise organisations for failure to disclose information (which might or might
not be bad) of course assume that the market knows that the manager has particular information to disclose. This
expectation might not always be that realistic, as the market will not always know that there is information available
to disclose. That is, in the presence of information asymmetry (which means that information is not equally available
to all—for example, a manager might have access to information that is not available to others), a manager might
know of some bad news, but the market might not expect any information disclosures at that time. However, if it does
subsequently come to light that news was available that was not disclosed, then we could perhaps expect the market
to react (and in the presence of regulation, we could expect regulators to react, as failure to disclose information
in a timely manner might be in contravention of particular laws). Also, at certain times, withholding information
(particularly of a proprietary nature) could be in the interests of the organisation. For example, the organisation might
not want to disclose information about certain market opportunities for fear of competitors utilising such information.
So, in summary of this point, there are various arguments or mechanisms in favour of reducing accounting
regulation, as even in the absence of regulation, firms have incentives to make disclosures. We will now give some
consideration to alternative arguments in favour of regulating the practice of financial accounting.
The ‘pro-regulation’ perspective
In the above discussion we considered a number of reasons that have been proffered in favour of reducing or eliminating
regulation. One of the simplest of arguments is that if somebody really desired information about an organisation,
they would be prepared to pay for it (perhaps in the form of reducing their required rate of return) and the forces of
supply and demand should operate to ensure an optimal amount of information is produced. Another perspective is
that if information is not produced, there will be greater uncertainty about the performance of the entity and this will
translate into increased costs for the organisation. With this in mind, organisations would, it is argued, elect to produce
information to reduce costs. However, arguments in favour of a ‘free market’ rely on users paying for the goods or
services that are being produced and consumed. Such arguments can break down when we consider the consumption
of ‘free’ or ‘public’ goods.
Accounting information is a public good: once it is available, people can use it without paying and can pass it on
to others. Parties that use goods or services without incurring some of the associated production costs are referred to as
‘free-riders’. In the presence of free-riders, true demand is understated because people know they can get the goods or
services without paying for them. Few will have any incentive to pay for the goods or services, as they can be relatively
confident of being able to act as free-riders. This dilemma, it is argued, is a disincentive for producers of the particular
good or service, which in turn leads to an underproduction of information. As Cooper and Keim (1983, p. 190) state:
Market failure occurs in the case of a public good because, since other individuals (without paying) can receive
the good, the price system cannot function. Public goods lack the exclusion attribute, i.e. the price system cannot
function properly if it is not possible to exclude non-purchasers (those who will not pay the asked price) from
consuming the good in question.
To alleviate this underproduction, regulation is argued to be necessary to reduce the impacts of market failure. In
relation to the production of information, Demski and Feltham (1976, p. 209) state:
Unlike pretzels and automobiles, [information] is not necessarily destroyed or even altered through private
consumption by one individual . . . This characteristic may induce market failure.
In particular, if those who do not pay for information cannot be excluded from using it and if the information
is valuable to these ‘free riders’, then information is a public good. That is, under these circumstances, production
of information by any single individual or firm will costlessly make that information available to all . . . Hence, a
more collective approach to production may be desirable.
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While proponents of a free-market approach argue that the market, on average, is efficient, it can also be argued
that such ‘on-average’ arguments tend to ignore the rights of individual investors, some of whom might lose their
savings as a result of relying upon unregulated disclosures.
In addition, whether an individual is able to obtain information about an entity might depend on the individual’s
control of scarce resources required by the entity. Although an individual might be affected by the activities of an
organisation, without regulation and without control of significant resources, the individual might be unable to obtain
the required information.
Regulators often use the ‘level playing field’ argument to justify putting legislation in place. From a financial
accounting perspective, everybody should (on the grounds of fairness) have access to the same information. This is
the basis of laws that prohibit insider trading and that rely upon an acceptance of the view that there will not be, or
perhaps should not be, transfers of wealth between parties that have access to information and those that do not. There
is also a view (Ronen 1977) that extensive insider trading will erode investor confidence to such an extent that market
efficiency will be impaired. Putting in place greater disclosure regulations will make external stakeholders more
confident that they are on a ‘level playing field’. If the community has confidence in the capital markets, regulation is
often deemed to be in ‘the public interest’. However, we will always be left with the question of what is the socially
right level of regulation. Such a question cannot be answered with any degree of certainty. Regulation might also lead
to uniform accounting methods being adopted by different entities, and this in itself will enhance comparability of
organisational performance.
While we have provided only a fairly brief overview of the free-market versus regulation arguments, it should
perhaps be stressed that this debate is ongoing with respect to many activities and industries, with various vested
interests putting forward many different and often conflicting arguments for or against regulation. The subject often
gives rise to heated debate within many economics and accounting departments throughout the world. What do you,
the reader, think? Should financial accounting be regulated and, if so, how much regulation should there be? If
regulation is introduced, will the regulation favour some parts of the community more than others? Will governments
always act in the ‘public interest’ and from whose perspective do we actually evaluate ‘public interest’ arguments.
There are many tricky issues when it comes to the issue of regulation.
While we can argue about the merits or otherwise of accounting regulation, the current extent of regulation can
reasonably be expected to be at least maintained and probably increased in the future.
1.14 The reporting of alternative measures of ‘profits’
LO 1.14
In this chapter we have stressed that financial statements, particularly those prepared for large proprietary
companies and public companies, are to comply with accounting standards. This means that the financial
statements shall present a measure of profits that has been determined by applying accounting standards. As we will
learn in this book, profit (as determined by applying accounting standards) shall include all items of ‘income’ and
‘expense’, unless they are specifically excluded from being included within profit or loss by virtue of a requirement
within a specific accounting standard.
While organisations are required to measure and report profit in accordance with accounting standards, it is also
becoming quite common to find that many organisations also disclose alternative (additional) measures of profits
which are derived in a way that is inconsistent with accounting standards, but which are argued by the managers of
the organisation to provide a measure of performance that they believe is more representative of the organisation’s
performance. The news media also often refer to these alternative measures of performance.
The motivations for providing these alternative measures of performance might come from a belief that the measure
of performance derived by not complying with accounting standards provides a relatively superior indicator of the
organisation’s underlying performance and that this measure is more useful to both the managers of the organisation,
in terms of effectively managing the organisation, and to the readers of the financial reports. Alternatively, such
disclosures might be made opportunistically by managers to generate a result managers think will provide some form
of benefits to the organisation, or to themselves. Perhaps it could also be a mixture of both incentives.
The evidence indicates that, when calculating these alternative measures of profits, the most commonly excluded
expenses are depreciation and amortisation, the costs assigned to share-based remuneration provided to managers,
research and development costs, and major impairments of assets. When referring to these alternative measures of
financial performance, organisations often refer to the alternative measure as ‘underlying profit’, ‘underlying earnings’,
‘cash earnings’ or ‘underlying profit after tax’ (CAANZ 2016).
Even though we might feel it is inappropriate to provide these alternative measures of profits in the same financial
reports in which accounting standards must be followed, it is permitted unless the disclosures are considered to be
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CHAPTER 1: An overview of the Australian external reporting environment
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misleading. If the alternative measures are reported in a way that is misleading, ASIC can take action against the
directors of the company.
In respect to this type of reporting, evidence provided by Chartered Accountants Australia and New Zealand (as
reported within CAANZ 2016) shows that:
∙ In 2014 (which was the latest year of data they used to do the study), 42 per cent of large Australian companies
listed on the ASX (ASX 500 Australian companies) disclosed within their annual report at least one measure of
earnings that was not calculated in accordance with accounting standards.
∙ The majority of organisations provided a reconciliation of the alternative earnings figure (see the exhibits below
for examples of this practice) with the result that would be calculated by applying accounting standards.
∙ In general, the measures of earnings reported and derived from not complying with all accounting standards were
not as ‘volatile’ as profit calculated using accounting standards.
∙ Evidence suggests that where other measures of profit are presented they tend to be higher than profit calculated
in accordance with accounting standards.
∙ The practice of providing disclosures within annual reports that referred to other measures of profits became more
common in Australia following the adoption of IFRSs in 2005.
Therefore, the point to be appreciated here is that although organisations are required to comply with accounting
standards, it is also becoming common to find that when they discuss their results they might tend to refer to alternative
measures of ‘profits’ other than the profits that would be derived from following accounting standards. As a result,
when we review financial reports we need to understand whether the financial results that are being emphasised and
discussed by the senior management of the organisation are the same as the results that have been reported within
their financial statements, and which have been subject to an independent financial audit—or whether the results
are based upon non-compliant methods of accounting. If they have been derived from an accounting approach that
does not comply with accounting standards, we perhaps need to determine whether we agree with the management’s
assertions about the need for an alternative (additional) measure. We also need to consider whether there might be
other motivations driving managers to report numbers that deviate from accounting standards. Also, we need to
appreciate that the ability to compare the results of different organisations is undermined if organisations use different
accounting methods.
As an example of this practice (and again, we emphasise that it is common practice for larger organisations), we
can consider the Commonwealth Bank of Australia. In its 2019 Annual Report it refers many times throughout the
report to ‘net profits after tax (cash basis)’. According to the Annual Report (page 81):
The Group manages its business performance using a “cash basis” profit measure. The key items that are excluded
from statutory profit for this purpose are non-recurring or not considered representative of the Group’s ongoing
financial performance.
Exhibit 1.7 reproduces one of the places in the Commonwealth Bank’s 2019 Annual Report where reference is
made to its preferred measure of profit (and there are many other references to this number used throughout the Annual
Report). Consistent with many other organisations, it also provides a reconciliation of this preferred measure of profit
with what profit would be pursuant to the application of accounting standards (which it refers to as profit determined
on a ‘statutory basis’). We reproduce this reconciliation in Exhibit 1.8. We stress again here that, regardless of whether
the organisation has an alternative measure of profit that it discusses, when it presents the financial statements itself
(such as the statement of profit or loss and other comprehensive income), the financial statement must be compiled in
accordance with the accounting standards.
As another example, in the 2018 Annual Report of BHP Group Ltd, the Consolidated Income Statement, which,
as we know, is to be compiled in accordance with accounting standards, reports a profit after tax (from continuing and
discontinued operations) of US$4823 million. However, at various points through the Annual Report, BHP’s managers
refer instead to ‘underlying attributable profit’ of US$8933 million. According to BHP’s 2018 Annual Report:
We consider Underlying attributable profit provides better insight into the amount of profit available to distribute
to shareholders. It is also the key KPI against which short-term incentive outcomes for our senior executives are
measured.
In the case of BHP, we can see (Exhibit 1.9) that the preferred measure of profit that managers elect to discuss
(which is US$8933 million) greatly exceeds the measure calculated by use of accounting standards (US$4823 million).
However, by contrast, the preferred measure reported by Commonwealth Bank is slightly less than the measure
calculated in accordance with accounting standards.
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PART 1: The Australian accounting environment
Exhibit 1.7 An example of the use of a measure of ‘profits’ that deviates from
accounting standards
SOURCE: © CBA Commonwealth Bank of Australia
Exhibit 1.8 An example of a reconciliation of a preferred measure of profit with profit
calculated applying accounting standards
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CHAPTER 1: An overview of the Australian external reporting environment
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SOURCE: © CBA Commonwealth Bank of Australia
Exhibit 1.9 A further example of the use of a measure of ‘profits’ that deviates from
accounting standards
continued
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PART 1: The Australian accounting environment
Exhibit 1.9 continued
SOURCE: © BHP Group Ltd
WHY DO I NEED TO KNOW THAT ORGANISATIONS OFTEN HIGHLIGHT
MEASURES OF FINANCIAL PERFORMANCE WHICH ARE CALCULATED IN A WAY
THAT FAILS TO COMPLY WITH ACCOUNTING STANDARDS?
One of the reasons why regulators require reporting entities to comply with accounting standards is that this
is perceived to increase the ‘comparability’ of the information being produced by different reporting entities.
Nevertheless, it is often questioned whether requiring all organisations to apply the same accounting standards
(that is, a ‘one-size-fits-all’ approach) allows managers to efficiently, and effectively, report information about the
performance of an organisation.
Because of perceptions that other measures of ‘profits’ are more efficient in terms of reflecting organisational
performance, managers might prefer to emphasise such non-conforming measures. Therefore, we need to
clearly understand that if managers do this, then they are using measures that are not in compliance with
accounting standards. While this might be done in good faith by the company, it might also be done because
managers have incentives to provide a more favourable view of their performance. We need to appreciate this.
Further, such non-complying measures might not have been subject to audit; also, they arguably should not be
used as a basis of comparison with other organisations.
The point, therefore, is that if managers are discussing their performance we first need to understand
whether they are using measures that comply with accounting standards or whether they are applying their
preferred approach to income and expense recognition and measurement. If they are using their preferred
approach, we need to assess their possible motivations for using the alternative measures before relying upon
such measures.
In concluding the final section of this chapter, we therefore stress that while it is a requirement for directors to
ensure that financial statements comply with accounting standards, it is quite common for us to find directors referring
to measures of profits derived in a way that is not consistent with accounting standards. We need to take care when
assessing such measures of profits.
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CHAPTER 1: An overview of the Australian external reporting environment
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SUMMARY
This chapter commenced with a discussion of accounting and its relationship to accountability. As we discussed, the term
‘accounting’ can be quite broadly interpreted and can relate to providing various types of ‘accounts’, not all of which will
necessarily be financial in nature. As we emphasised, perspectives that restrict definitions of accounting to matters that
are only financial seem to ignore the relationship between corporate responsibilities and corporate accountabilities. This
chapter also provides an overview of the sources of regulation and guidelines relating to financial reporting in Australia. In
Australia we have a system under which Australian Accounting Standards are predominantly the standards developed by
the International Accounting Standards Board.
There are numerous rules relating to external reporting. The body of rules is frequently amended (which also means
that care must be taken when comparing profits generated in different years), and therefore accountants in practice
(and academia) must continually update their knowledge of the rules. The Australian accounting profession, which is
dominated by three bodies—CPA Australia, Chartered Accountants Australia and New Zealand, and the Institute of
Public Accountants—requires its members to undertake continuing professional education throughout the period of their
professional membership.
The chapter also explored some of the perceived benefits that are attributable to the international standardisation of
general purpose financial reporting, together with some of the factors, such as differences in national cultures, that can
work against the ongoing application of IFRSs internationally. It was also stressed that the extent to which a country actually
applies IFRSs will be dependent upon the extent to which compliance is monitored and enforced within the country.
Arguments for and against regulation were also explored, as was the practice of organisations in respect of disclosing
measures of performance that deviate from the requirements of accounting standards.
KEY TERMS
Australian Accounting Standards
Board (AASB) 18
Australian Securities and
Investments Commission
(ASIC) 7
Australian Securities Exchange
(ASX) 32
conservative accounting
policies 44
Financial Reporting Council
(FRC) 31
general purpose financial
statement 6
special purpose financial
statement 6
ANSWERS TO OPENING QUESTIONS
At the beginning of this chapter we asked the following five questions. As a result of reading this chapter, you should now
be able to provide informed answers to these questions—ours are shown below.
1. What is ‘general purpose financial reporting’? LO 1.1, 1.2
General purpose financial reporting generates general purpose financial statements, which are those financial
statements that are intended to meet the information needs of users who are not in a position to require an entity to
prepare reports tailored to their particular information needs. General purpose financial statements are expected to
comply with accounting standards. They can be contrasted with ‘special purpose financial statements’, which will not
necessarily comply with accounting standards.
2. What is the role of the Australian Accounting Standards Board (AASB) with respect to general purpose financial
reporting within Australia? LO 1.4
The AASB releases the accounting standards that are to be applied within Australia by those reporting entities
generating general purpose financial statements. Some of the accounting standards released by the AASB are
developed within Australia by the AASB. However, the majority of accounting standards released by the AASB are
developed away from Australia by the IASB.
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PART 1: The Australian accounting environment
3. Does the AASB have legal power to enforce accounting standards within Australia? LO 1.4
No. The AASB does not directly have any enforcement powers. Within Australia, it is ASIC that enforces the
requirements of the Corporations Act, and it is within the Corporations Act that there is a requirement for particular
forms of organisations to comply with accounting standards.
4. What is the relevance of the International Accounting Standards Board (IASB) to general purpose financial
reporting within Australia? LO 1.7
The IASB is of great relevance to general purpose financial reporting within Australia. The AASB releases accounting
standards that have legal force by virtue of the Corporations Act, and the majority of these accounting standards are
developed outside of Australia by the IASB.
5. What power does the IASB have to enforce the accounting standards that it develops, and which are in use
internationally? LO 1.7
The IASB has no power to enforce its accounting standards. It is a standard-setter, not a standard-enforcer. When
a country claims that it is adopting IFRSs, it is the responsibility of local regulators to ensure compliance with the
accounting standards. Because some countries have minimal enforcement mechanisms in place, together with poor
standards of financial statement auditing, any claims that the financial statements being generated in such countries
comply with accounting standards are often questionable, and should be met with scepticism.
REVIEW QUESTIONS
(KEY: Easy •
Medium ••
Hard •••)
1. Describe the roles of ASIC, the AASB, the ASX and the FRC, and the relationships between these regulatory bodies.
LO 1.3, 1.4, 1.5, 1.6 ••
2. What is the IASB and how does it affect financial reporting regulation in Australia? LO 1.4 ••
3. What enforcement powers does the IASB have? LO 1.7 •
4. What is the role of the independent auditor, and why would the manager or the users of financial statements be
prepared to pay for the auditor’s services? LO 1.10 •
5. With all the regulations that companies must follow, fulfilling the requirement for corporate reporting is an additional
expensive activity. What are some possible arguments for and against disclosure regulation? LO 1.13 ••
6. Provide a justification as to why large companies should have to produce financial statements that comply with
accounting standards but small companies should not have to do this. LO 1.3, 1.9, 1.13 ••
7. Provide a brief description of the differential reporting requirements in Australia as addressed by AASB 1053.
LO 1.9 •
8. Define ‘generally accepted accounting procedures’. LO 1.2 •
9. Who are perceived to be the ‘primary users’ of general purpose financial reports? LO 1.2 •
10. What knowledge of financial accounting are the users of financial statements expected to possess? LO 1.2 •
11. If the auditor provides an opinion that the financial statements comply with accounting standards, does this indicate
that there are no errors in the financial statements? LO 1.10 •
12. What is included in a Directors’ Declaration, and what are the implications if a director signs the declaration and the
organisation subsequently fails, owing millions of dollars that it cannot repay? LO 1.3 ••
13. What does it mean to say that some financial statements are ‘true and fair’? How would a director try to ensure that
the financial statements are true and fair before he or she signs a Directors’ Declaration? LO 1.3 ••
14. How are International Financial Reporting Standards developed and revised? Explain the role of the AASB in that
process. LO 1.4, 1.7 ••
15. What is the relevance to Australia of Interpretations issued by the IFRS Interpretations Committee? LO 1.7 ••
16. What authority do Interpretations issued by the IASB and AASB have in the Australian financial reporting context? If
they do have authority, from where does this authority emanate? LO 1.4, 1.7 ••
17. What are the functions of the IASB? LO 1.7 •
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CHAPTER 1: An overview of the Australian external reporting environment
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18. Although not permitted, outline some possible theoretical advantages and disadvantages associated with permitting
directors to deviate from accounting standards in situations where compliance with particular accounting standards
is perceived by the directors as likely to generate financial statements that are not true and fair. LO 1.3, 1.4 ••
19. What are some of the possible cultural impediments to the international standardisation of accounting standards?
LO 1.12 ••
20. Why did the FRC decide that Australian Accounting Standards needed to be consistent with those being issued by
the International Accounting Standards Board? LO 1.5, 1.12 •
21. Explain why the adoption of International Financial Reporting Standards in Australia might have led to material
changes to reported profits. LO 1.11 ••
CHALLENGING QUESTIONS
22. If directors believe that the application of a particular accounting standard is inappropriate to the circumstances of
their organisation, what options are available to them when compiling their financial statements? LO 1.3
23. Accounting standards change across time. Why? LO 1.8
24. If a company adopted a particular accounting policy that ASIC considered to be questionable, in principle ASIC might
consider taking legal action against the company’s directors for failing to produce true and fair financial statements.
However, from a practical perspective, why would it be difficult for ASIC to prove in court that the company’s financial
statements were not true and fair? LO 1.3
25. Visit the website of a company listed on the ASX. (Hint: some corporate website addresses are provided in this
chapter.) Review the company’s corporate governance disclosures and determine whether the company complies
with the ‘Eight Essential Principles of Corporate Governance’ identified by the ASX. If the company discloses noncompliance, evaluate the reasons provided for this non-compliance. LO 1.6
26. Considered together, does the set of existing accounting standards provide guidance for all transactions and events
that might arise within an organisation? If not, what guidance is available to the organisation? LO 1.3, 1.4
27. The decision that Australia would adopt IFRSs was in large part based on the view that Australian reporting entities,
and the Australian economy, would benefit from adopting accounting methods that are the same as those adopted
internationally. Do you think that all Australian reporting entities have benefitted from international standardisation?
LO 1.11
28. Globally, there are variations in business laws, criminal laws and so forth. Such international variations in laws will be a
result of differences in history, cultures, religions and so on. While we are apparently prepared to accept international
differences in various laws, groups such as the IASB expect there to be global uniformity in regulations relating to
accounting disclosure—that is, uniformity in accounting standards. Does this make sense? LO 1.12
29. It is argued by some researchers that even in the absence of regulation, organisations will have an incentive to
provide credible information about their operations and performance to certain parties outside of the organisation;
otherwise, the costs of the organisation’s operations will rise. What is the basis of this belief? LO 1.13
30. Any efforts towards standardising accounting practices on an international basis imply a belief that a ‘one-size-fitsall’ approach is appropriate at the international level. That is, for example, it is assumed that it is just as relevant for a
Chinese steel manufacturer to apply AASB 102 Inventories as it would be for an Australian surfboard manufacturer.
Is this a naive perspective? Explain your answer. LO 1.11, 1.12
31. Provide some arguments for, and some arguments against, the international standardisation of financial reporting.
Which arguments do you consider to be more compelling? (In other words, are you more inclined to be ‘for’ or
‘against’ the international standardisation of financial reporting?) LO 1.11, 1.12, 1.13
32. Evaluate the claim that ‘accounting is the language of business’. LO 1.1
33. Review a number of accounting standards and then discuss how accounting standards are structured. LO 1.4, 1.7
34. You are a junior executive of a large mining company and had been asked to show how the performance
(as measured in terms of profitability) of the company has been improving over the past ten years. You subsequently
collected financial performance information from the previous ten years and placed it on a graph. A trend of ongoing
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56
PART 1: The Australian accounting environment
improvements in profits was apparent and everybody was very happy. The question is, should you have supplied
such a graph to your company without some adjustments? LO 1.8
35. Do financial reports provide a good representation of the ‘performance’ of an organisation? LO 1.1, 1.4
36. Identify some responsibilities that you think organisations have in relation to how they conduct their operations (they
could be social, environmental or financial responsibilities). Having done this, think of some ‘accounts’ that could
be produced by the organisation to indicate how it has performed in relation to those expected responsibilities.
LO 1.1
37. What is the relationship between corporate responsibilities, accountability and accounting? LO 1.1
38. Evaluate and explain the following claim: Unless there is consistency globally in the implementation of accounting
standards and subsequent enforcement mechanisms, we cannot expect accounting practices to be uniform
throughout the world, despite the initiatives of the IASB, which encourage different nations to adopt IFRSs.
LO 1.11, 1.12
39. As we know, there is a requirement within the Corporations Act that financial statements be ‘true and fair’. There
is also a requirement that company directors comply with accounting standards. In respect of one such standard,
AASB 102 Inventories, there is a requirement that inventory be valued at the lower of cost and net realisable value.
There is also another accounting standard, AASB 116 Property, Plant and Equipment, which permits property, plant
and equipment to be measured at either cost or fair value. Now assume that Angourie Ltd has assets with the
following costs and fair values (fair values can be thought of as the amounts that the company expects the assets
could be sold for in the normal course of business, and in a transaction between knowledgeable parties that are
not related):
Asset type
Cost
Fair value
Inventory
$ 11 000 000
$ 24 000 000
Machinery
$ 4 000 000
$ 6 000 000
Land
$ 16 000 000
$ 40 000 000
Total
$31 000 000
$70 000 000
In accordance with the options available in the accounting standards, Angourie Ltd decides to measure the
assets at cost and therefore discloses the assets in the statement of financial position (balance sheet) at an amount
of $31 million, despite the fact that it could receive $70 million for them at that point if it sold them. Although there is
compliance with accounting standards, would such financial statements be ‘true and fair’ if the assets were disclosed
at a total of $31 million when they could actually be sold for $70 million? LO 1.3, 1.4, 1.7
40. In a newspaper article dated 27 April 2019 entitled ‘Flight Centre turbulence as guidance cut, shares hit’ (by Sarah
Danckert, The Age, p. 1), it was noted that the travel company Flight Centre expects its ‘underlying profit before tax’
to fall below the range it had previously signalled to the share market (i.e. to fall to between $325 and $360 million,
which was below the $390 to $420 million it initially targeted). This ‘underlying profit’ measure was different from the
profit to be reported within the financial statements.
REQUIRED
Is the organisation allowed to use and disclose this alternative measure even if it fails to comply with accounting
standards? Why would the managers do this? LO 1.14
41. Lehman (1995) provides a definition of accounting, this being that it is ‘both the means for defending actions and the
means for identifying which actions one must defend’. He further states that accounting information should ‘form part
of a public account given by a firm to justify its behaviour’.
REQUIRED
Try to explain what Lehman is arguing in terms of the meaning of accounting, and the role it plays within society. Do
you agree with Lehman? LO 1.1
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CHAPTER 1: An overview of the Australian external reporting environment
57
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