Review questions
1. Why does accounting have regular reporting periods?
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Aids comparability and analysis
Conventional
Check on arithmetical accuracy
Report to absentee owners
Legal requirement
2. Consider the arguments for and against standardised reporting periods. Do you
agree that accounting periods should be more flexible? Give reasons for your
answer.
There are several arguments given to support a more flexible approach to
reportingperiods. For example, any standardised period cuts across many uncompleted
transactions.Standardisation may result in accountants apportioning unfinished
operationsand allocating assets to an arbitrary accounting period of 12 months.
Chambers (cited by Luther) argued that the appropriate accounting period is determined
by the nature of the entity, so that it should reflect the earnings cycle of thereporting
entity.This view was supported by the American Institute of Certified PublicAccountants
in 1973 but has not been adopted.
Johnson & Kaplanargue that standardisation puts pressure on managersto produce profits
over short-term periods. Luther quotes several authors whoargue that to overcome the
problems created by standardisation, annual accounts shouldhave a cumulative
component because they are tentative and conjectural statements, thetruth of which
cannot be verified until the reporting entity has run its entire course.
3.
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4.
What are the perceived purposes of an annual report?
Accountability of managers to absentee owners
Provides information for decision making by non-management stakeholders
Means of reporting corporate achievements
Means of impression management, especially of positive images
Why are financial statements ‘highly valued’?
They are ‘highly valued’ because financial statements have been attested to by a third
party (auditor) who is supposedly independent of management.
5.
What do you understand by the term ‘fair presentation’? Give an example to
support your answer.
To understand the term ‘fair presentation’ see chapter 2. The term means that the
representation should be free from bias. In this light it can be equated with “faithful
representation” where the financial statements correspond to the actual events and
transaction that are being reported.
6.
Financial reports have been criticised for their lack of completeness. In what
ways
do financial reports fail the completeness test?
 Financial reports report on only those activities sanctioned by GAAP (including
IASs).
 Reporting entities engage in activities that are not captured in the reporting process.
For example, social and environmental activities largely go unreported in financial
reports.
 Reporting of Intangibles is restricted by accounting standards so that many intangibles
are not included in financial statements.
7.
Defend the stand taken by accounting authorities in AASB138/IAS38 Intangible
Assetsin relationto the treatment of intangible assets.
The stand by accounting authorities is based on three grounds:
 probability of the future benefits flowing to the reporting entity is too low
 lack of reliable measurement for intangibles
 the inability to separate many intangibles from their controlling entity.
8.
Define ‘earnings management’. Do you consider it to be good or bad? Why?
Earnings management is defined as a ‘manager’s use of accounting discretion through
accounting policy choices to portray a desired level of earnings in a particular reporting
period’.
Whether it is considered good or bad will depend on the acceptance of the arguments of
Macintosh et al. 2000 or those of Parfet, 2000.
Because the measure of corporate success has become whether a corporation hasreached
its earnings predictions, the temptation for management is to ‘manage’ earningsto match
analysts’ forecasts. In this process, as outlined by Macintosh et al., accountingearnings do
not reflect the outcomes of an enterprise’s strategic decisions. Instead,analysts’ predicted
earnings determine the strategy of an enterprise to satisfy the prediction.This means
management may take predictions about earnings as targets andselect investments that
are likely to produce reported income equal to or exceeding theanalysts’ forecasts.
Meanwhile, the market incorporates analysts’ earnings forecasts into share prices. In this
way, share prices, analysts’ forecasts and reported income all relate toeach other but not
to ‘true’ or underlying income.
Parfet, a representative of preparers of financial reports, defends earnings management
by differentiating ‘bad’ from ‘good’ earnings management. The bad involvesintervening
to hide true operating performance by creating artificial accounting entriesor by
stretching the estimates required in preparing financial statements beyond
reasonableness.This, he points out, is the realm of hidden reserves, improper revenue
(income)recognition and overly aggressive or conservative accounting judgements.
Good earnings management, on the other hand, involves management taking actions to
try to create stable financial performance by acceptable, voluntary business decisions in
the
context of competition and market developments. The market tends to reward
corporations
that achieve stable trends of growing income. Good earnings management involves
spotting
the most beneficial use for the corporation’s resources and quickly reacting to unforeseen
circumstances. Parfet declares earnings management not to be a bad thing but a reflection
of expectations and demands, both inside and outside a business, on the part of all
stakeholdersin the capital market.
9.
Why are annual reports so well regarded?
 Chief means of communication between management and non-management
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stakeholders
Contain the audited financial statements
The audited statements give credibility to the annual report.
Annual reports also contain information not recognised in the financial statements,
information which is often complementary to the financials.
Annual reports are the main source of voluntary disclosures by management.
10. Researchers speculate that management is motivated to disclose information
voluntarily either because it feels accountable or because it wishes to legitimise
its
activities. Which do you think is the more likely reason and why?
“Accountable” invokes a responsibility or liability to be called to account whereas
legitimacy implies being in accordance with the values of society. The argument should
be based on who or what can call management to account and whether they would so. In
relation to legitimacy, scholars argue that an organisation’s survival will be threatened if
society perceives that it has breached its social contract in which societal values are
embedded. Management will be “called to account"societal concerns.
11. Debate whether management should solely pursue profits.
The pursuit of profit is normally the concern of shareholders to whom management is
accountable in a broad sense. However, the sole pursuit of profits may cause harm such
as in the case of James Hardie. In that situation, the changes by management to their
liability to those harmed by asbestos potentially created great harm. Profits were being
pursued to the detriment of those harmed by the company’s product. A notable case was
the Ford Pinto (USA) where even minor accidents ignited the car causing serious injury
to those travelling in the car. Ford has pursued profits rather than acknowledging a duty
of care to those who bought the vehicle.
12. What factors appear to instigate voluntary disclosure by management in
annualreports?
 Accounting standards prevent the recognition of many assets that contribute to the
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market value of the reporting entity — voluntary disclosures make this information
available.
To improve corporate reputations
Concern for stakeholders — a concern wider than that for shareholders
The philosophy that an entity has responsibilities beyond its legal responsibilities.
Accountability
To legitimise various aspects of a reporting entity
To comply with community expectations, legal requirements and industry
requirements
Borrowing requirements require such disclosures
To forestall regulations or actions by pressure groups
To win reporting awards and/or to secure endorsements
13. Why should management explain poor performance in technical
accountingterms?
Investors and other information users are assumed to be non-sophisticated users who are
unlikely to understand technical accounting terms and so, can be mislead in relation to
the so-called factors leading to a poor performance. The aim is to assign responsibility for
the poor performance to factors other than those in the control of management. In
contrast, good performances are reported in clear non-accounting terms, with
responsibility for the performance given to management.
14. Why do you think environmental disclosures are more researched than
othersocial disclosures?
Answers can be based on the reasons for disclosures:
Deegan lists ten reasons management might voluntarily disclose information in
annual reports:
1. to comply with legal requirements
2. because of economic rationality arguments
3. because of management’s feeling that it is accountable to stakeholders
4. because of borrowing requirements
5. to comply with community expectations
6. to ward off threats to organisational legitimacy
7. to manage powerful stakeholders
8. to forestall regulations
9. to comply with industry requirements
10. to win reporting awards.
O’Donovan’s research suggests that management discloses environmental information
in annual reports to:
1. align management’s values with social values
2. pre-empt attacks from pressure groups
3. improve corporate reputations
4. provide opportunities to lead debates
5. secure endorsements
6. demonstrate strong management principles
7. demonstrate social responsibilities
15. Why is XBRL a ‘language’?
Language can be thought of as the communication of data, ideas, thoughts and feelings
through a system of arbitrary signals, such as voice sounds, gestures, or written symbols.
As a language, XBRL creates data is created by ‘tagging’ financial information. The
XBRL tagging process converts the financial information contained within a document
such as an excel spreadsheet into a ‘document’ or computer file with XBRL codes.
16. Debate whether XBRL is the likely future of financial reporting.
XBRL fulfils many of the desired conditions of financial reporting such as timeliness and
comparability as well as satisfying the reliance on electronics as a means of
communication.