HI6025 Accounting theory PAT

HI6025 Accounting theory and current issues

Please find attached file of requirements for Assignments.

  Some information from lecturer :-

1. And Please select two company (Listed in ASX S&P 300 index) from same industry.

2. Try to make table or diagram if possible.

3. Use the annual reports of the companies that will be helpful.

4. In Sec-3 write something about earning bonus. If policies changes then describes AASB

5. Sec- 4 Very important part 

     1) Quality of disclosure

      2) Every account should have enough information on disclosure.

 

6.   Sec 4, 5, 6 are mainly important, lecturer will consider these parts seriously. 

 Instructions :

  1. 1. This assignment is to be submitted in accordance with assessment policy stated in the

Subject Outline and Student Handbook.

  1. 2. It is the responsibility of the student who is submitting the work, to ensure that the work is in fact her/his own work. Incorporating another’s work or ideas into one’s own work without appropriate acknowledgement is an academic offenc Students can submit all assignments for plagiarism checking (self-check) on Blackboard before final submission in the subject. For further details, please refer to the Subject Outline and Student Handbook.
  2. 3. Maximum marks available: 20 marks.
  3. 4. Due date of submission: Week 11
  4. 5. Assignment should be of 3,000 words. Please use “word count” and include in report. Important Note: Please submit Assignment through SafeAssig

 Group Assignment theme:

Evaluate accounting quality, for a company of your choice, by assessing accounting policies and estimates and prepare an investigative report on Managers’ Accounting and Reporting

Strategy Choice

 Recommended  steps/navigation  to  complete  the  assignment  project:

  1. A)  Rea d y :
  2. Form a group (maximum of 4 members)
  3. b. If you have difficulties forming such groups, please contact your lecturer as soon as possible
  4. c. Select a company and get approval of the company (Any company listed with

ASX and not taken by other groups) from your lecturer, on which your group want to progressively analyze

  1. B)  Get  set
  2. a) Read and gain in-depth understanding of the various normative and positive theories of financial accounting from the text book and from other relevant & credible literature
  3. b) Be aware of some of the limitations of the various theories of accounting
  4. c) Appreciate that there is no single unified theory of accounting
  5. d) Understand the various pressures and motivations that might have an effect on the methods of accounting selected by an organisation
  6. e) Understand what is meant by ‘creative accounting ’ and why it might occur
  7. f) Understand Financial statement preparation process (from Business Activities to Financial Statements) and the various influencing factors from this document and from other credible sources.
  8. g) In-depth knowledge on Accounting Framework.
  9. C) G o:
  10. a.  Download  Annual  Reports  ( for  2  years  at  least)  and  explore
  11. b. Assess accounting policies and estimates of your  selected  AS X  listed

 company

  1. i. Which accounting policies and estimates used by the firm?
  2. ii. Are there any flexibilities of accounting policies and estimates used by the firm?

iii.   Are these accounting policies and estimates used by their competitors?

  1. iv. Show a comparison of accounting policies and estimates used by the

firm with one of its rival company.

  1. v. Do you agree with the policies and estimates?
  2. vi. Is accounting strategy hiding or revealing

vii.   Any Red Flags/questionable number in the accounting report?

viii.   Which accounting positions capture them? Why? Explain

  1. Critically evaluate accounting quality by assessing accounting policies and estimates
  2. i. consider the various pressures, many of which are political in nature, that influence the accounting standard-setting environment
  3. ii. consider the implications of organisations making particular accounting disclosures, whether voluntarily or as a result of a particular mandate

iii.   understand the possible implications of an organisation making

particular accounting choices and disclosures

  1. d. Prepare an investigative report on the Managers’ Accounting Strategy and Reporting Strategy choices on the basis of the above evaluation. The report should have following sections for minimum:

Section 1: Identify Key Accounting Policies

Key policies and estimates used to measure risks and critical factors for success must be identified.

Section 2: Assess Accounting Flexibility

Accounting information is more open to distortion if managers have a high degree of flexibility in choosing policies and estimates.

Section 3: Evaluate Accounting Strategy

Flexibility in accounting choices allows managers to strategically communicate economic information or distort performance.

Issues to consider include:

  • Norms for accounting policies with industry peers
  • Incentives for managers to manage earnings
  • Changes in  policies  and  estimates  and the  rationale  for doing so
  • Whether transactions  are  structured  to  achieve  certain accounting objectives.

Section 4: Evaluate the Quality of Disclosure

Issues to consider include:

  • Whether disclosures seem adequate
  • Adequacy of footnotes to the financial statements
  • Whether notes sufficiently explain and are consistent with current performance
  • Whether  GAAP   reflects   or   restricts   the   appropriate measurement of key measures of success
  • Adequacy of segment disclosure.

Section 5: Identify Potential Red Flags

Issues that warrant gathering more information include:

  • Unexplained  changes   in   accounting,   especially   when performance is poor
  • Unexplained transactions that boost profits
  • Unusual increases in inventory or receivables in relation to sales revenue
  • Increases in the gap between net income and cash flows or taxable income
  • Use of R&D partnerships, SPEs or the sale of receivables to finance operations
  • Unexpected large asset write-offs
  • Large fourth-quarter adjustments
  • Qualified audit opinions or auditor changes
  • Related-party transactions.

Section 6: Compliant with the Conceptual Framework

  1. D) Gone/ Done!!!

Submit the report in accordance with assessment policy stated in the Subject

Outline and Student Handbook.

Format of the Report and deliverables

  1. 1. You at least should have the following details:
  2. Assignment Cover page clearly stating your members name and student number s
  3. b. A table of contents, executive summary
  4. c. A brief introduction or overview of what the report is about.
  5. d. Body of the report with sections to answer the above sections and with appropriate section headings
  6. Conclusion
  7. f. List of references.
  8. 2. Diagrams and tables clearly labelled and explained.
  9. 3. Ensure  all  materials  are  correctly  referenced.  Plagiarism  will  be severely penalised.

Background  Information

Positive Theory of Accounting (PAT)

PAT seeks to explain and predict accounting-related phenomena, for example, study of capital market’s reaction to particular accounting policies; what motivates managers to select a given method of accounting; reasons for the existence of particular accounting – based contracts. It relies upon a fundamental assumption that individual action can be predicted on the basis that all action is driven by a desire to maximise wealth. It argues that selection of accounting methods can be explained by either efficiency or opportunistic arguments. So the  theory provides insights into why managers favour particular accounting methods in preference to others. PAT also maintains that Accounting methods can impact on cash flows associated with debt and management compensation contracts .The use of particular accounting methods can have conflicting effects, For example, might ‘loosen debt covenants’ but increase political costs. The theory Emphasises the way in which accounting numbers are actually used throughout society and how a change in accounting methods can have implications for relationships with managers, debtholders, and the broader political environment

Normative theories of accounting

Prescribe how accounting  should be practised. Argue typically that a central role of accounting theory is to provide prescription and inform about optimal accounting approaches and why a particular approach is considered optimal. Examples: Conceptual Framework Project, current-cost accounting, exit-price accounting and deprival-value accounting . It seek to provide guidance in selecting accounting procedures that are most appropriate and  prescribe what should be done

The Conceptual Framework:

  • is considered a normative theory
  • seeks to identify the objective of general purpose financial reporting
  • seeks to provide accounting guidance within a ‘coherent’ and ‘consistent’ framework
  • identifies the qualitative characteristics financial information should possess
  • makes recommendations that sometimes depart from current practice

Other normative theories

Three main classifications

  • Current-cost accounting
  • Exit-price accounting
  • Deprival-value accounting

Financial statement preparation process (from Business Activities to Financial Statements) and influencing factors:

Financial statements are an important source of information to the capital markets. Quality financial reporting provides much-needed relevant and reliable information to capital market participants.

The Following features of accounting systems facilitate quality information:

  1. a) The role of accrual accounting
  2. b) Accounting standards or generally accepted accounting principles (GAAP)
  3. c) Auditing of financial information
  4. d) Delegation of reporting to management

Delegation of Reporting to Management

The efficiency perspective of PAT concludes that Accounting methods adopted by firms best reflect the underlying financial performance of the entity and might select the most efficient way to portray the performance of the entity.

Management  is  responsible  for the  application  of  accounting  methods  (recognition, measurement and disclosure) in financial statements. Management have some discretion in the choice of accounting policies and the estimates made in financial statements.

Management can use this discretion in revealing their private information about the firm or in distorting the accounting numbers. Distortion of accounting may reflect incentives facing managers.

It is not optimal to use accounting regulation to eliminate managerial flexibility completely.  Accounting  systems  leave  considerable  room  for  managers  to  influence financial statement data. Corporate managers can choose accounting and disclosure policies to hide the true economic picture of their business and manipulate investors’ perceptions. Superior disclosure strategy will enable managers to communicate the underlying business reality to outside investors.

Accounting and Reporting Standards

Accrual accounting is subjective and relies on a variety of assumptions. Managers have incentives to use accounting discretion to distort reported profits. Accounting standards are developed to improve the quality of financial reporting. Accounting standards ensure that managers are not able to use their accounting flexibility to disguise reality for self- serving purposes.

Accounting standards try to eliminate unsatisfactory reporting practices, thereby promoting consistency and comparability. Many countries in the world are now reporting or  converging  to  International Financial  Reporting  Standards  (IFRS).  IFRS  have  been described as more principles-based (rather than rules-based).

External Auditing of Financial Statements

Audits  provide  an  independent  (third party)  opinion on the  quality  of the  financial statements. Audits are required for many companies, private and public. There is a move towards international auditing standards by many countries. Audit committees enhance the auditing process

Auditing is a verification of the integrity of the reported financial statements by someone independent of the preparer. Auditor ensures that managers use accounting rules and conventions consistently over time. Auditing improves the quality of accounting data. Threat of lawsuits and resulting penalties has the beneficial effect of improving the accuracy of financial information and disclosure.

Accrual accounting

Need for accrual accounting arises from investors’ demand for financial reports on a periodic basis. Corporate financial reports are prepared using accrual rather than cash accounting. Accrual accounting distinguishes between the recording of costs and benefits associated with economic activities. Effects of economic transactions are recorded on the basis of expected and not actual cash receipts and payments.

 The conceptual frame work defines the following financial statement elements  and  the irrelation:

Assets = Liabilities + Equity Profit = Revenues – Expenses Another important relation:

Comprehensive income = profit for the period + items recognised directly in equity

Financial statement preparation process

In summary, Corporate managers acquire physical and financial resources to create value for the firm’s investors through business activities. Financial statements measure and summarise the economic consequences of business activities. Financial statements are a source of widely available data on publicly traded corporations. Accrual accounting attempts to accurately reflect expectations of economic performance, but requires careful analysis. Accounting standards and auditing ensure quality of financial reports.

Types of Financial Statements

According to the International Accounting Standards Board (IASB), a ‘complete set of financial statements’ comprises:

–   Statement of financial position as at the end of the period

–   Statement of profit or loss and other comprehensive income for the period

–   Statement of changes in equity for the period

–   Statement of cash flows for the period

–    Notes (comprising a summary of significant accounting policies and other explanatory information).

Factors Influencing Accounting Quality

It is necessary to allow managers some discretion in applying accounting standards. As a result, three potential sources of noise and bias in accounting data include:

  1. a. Random estimation errors & Rigidity in accounting rules

Efficiency perspectiv e of PAT argues :

  • Accounting methods adopted by firms best reflect the underlying financial performance of the entity—might select the most efficient way to portray the performance of the entity
  • Regulation is  therefore  argued  by  PAT  advocates  to  impose unwarranted costs on reporting entities—it causes the firm to provide an inefficient perspective of the performance and position of the organisation as it requires movement to a one-size-fits-all approach to reporting

Accounting standards may not reflect the economics of the firm’s transactions. So, some flexibility in accounting required. Accrual accounting requires forecast estimates that can be incorrect.

b. Manager’s accounting choi

Managers have a number of incentives to choose accounting disclosures that are biased as suggest by Positive Accounting Theory (PAT):

  • Accounting-based debt covenants
  • Management compensation contracts
  • Contests for corporate control
  • Tax considerations
  • Regulatory considerations
  • Capital market and stakeholder considerations
  • Competitive considerations.

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