Financial Accounting Essay
Introduction
In any business, the harmonisation and standardisation of financial accounting is a crucial factor. For most businessmen, shareholders and stakeholders, harmonisation and standardisation of financial accounting could affect the success and failure of a certain business entity. Actually, financial accounting acts as an evaluation tool of business in terms of financial aspect. Financial evaluation is very vital to the development of a certain organisation since it is the distinction whether the certain organisation are growing or not (Atril & Mclaney, 2004). Basically, it can be evaluated by simply looking at the financial statements of a certain organisation. Financial statements are, according to Bandler (1994 p. 1), the ‘universally accepted tools for analysis of a business entity’. If properly understood, they let the users know how good a company looks and how well it has been doing. They are, at best, an approximation of economic reality because of the selective reporting of economic events by the accounting system, compounded by alternative accounting methods and estimates (Fried, Sondhi & White 2003). The purpose of financial statements is to provide users (business owners, shareholders, lenders, managers, stakeholders, suppliers, customers, attorneys and litigants and employees and job seekers) with a set of financial data that, in summary form, fairly represents the financial strength and performance of a business (Bandler 1994). They reveal opportunities and provide protection against financial pitfalls. Ideally, financial statements analysis provides information that is useful to present and potential investors and creditors and other users in making rational investment, credit and other similar decisions (Fried, Sondhi & White 2003). Further, they are comparative measurements of risk and return to make investment or credit decisions as they provide one basis for projecting future earnings and cash flows. With this concern, it is also important to know if the harmonisation and standardisation of financial accounting is an advantage to shareholders and other stakeholders.
Actually, harmonisation and standardisation of financial accounting allow the advantages from the global economy to be fully realized, it is argued that accounting policy should be standardized among nations. The idea of "harmonization” for accounting standards is a great help for global economy. A so-called "level playing field" will become apparent globally as harmonization of accounting policy was initiated. Aside from this, auditors and regulators will be receiving the identical data, accommodating the evaluation procedure. Harmonisation and standardisation of accounting policies will be able to make business managers and investors have more valuable decisions. World resources will be better administered and owed. It is likely, due to their inevitability, to comprise international accounting standards (IAS) harmonization.
Discussions
Major user groups of financial statements (FS) in which harmonization and standardization of financial accounting considered includes investors/shareholders, employees, lenders, suppliers, customers, government and the public. Basically, shareholders and some stakeholders are concerned on income (from dividends) and gain (from stocks price), employees on wage, salary and employment opportunities, lenders on the resources of the firm (both cash and non-cash), suppliers on financial stability of cash flow, customers on ability to supply quality goods, government on performance for the purposes of taxation and the public on employment, environmental and other social responsibility disclosures (cited in ACCA 2006). In general, firms must comply with the FS and harmonized and be standardized in accordance to the needs of these shareholders and stakeholders to concede their legitimacy to exist in the society (Deegan & Rankin 1996 p. 62). Otherwise, the latter can implore aggressive or indirect actions (strikes, pull-out of investments, litigation, etc.) that can ultimately lead to corporate demise.
Listed or public companies are, more than anybody else, responsible to these stakeholders and impart in protecting its legitimacy. This is because they come full contact with the public, therefore, exposed their companies to several and trickle-down effects on the public at large. As a result, other than maximization of shareholder’s wealth, corporate finance is also intended to aim objectives for other stakeholders. But the question is how they are consistent with shareholder’s primary aim?
Poor accounting feeds speculative beliefs which can lead to stock market bubbles and inefficient markets that ultimately direct to damage economies (Penman 2003; 77+). This is because even if entrepreneurs with poor business models can easily obtain cash through hot IPO markets which in turn affect the chance of more productive firms to ensure capital for more positive community impact. Further, the primary reason of poor accounting is non-compliance with sound accounting practice (Penman 2003; 77+) which can stem from management and accountants’ inability to separate facts from forecasts (Glover et al 2005; 267+). This temptation is fueled with the need to sustain shareholder confidence to the company as well as attract another set of investors.
Such method will hardly be prioritized and isolated by international standards (e.g. International Financial Reporting Standards) because it is bias to capital-providers and undermine the need of other stakeholders for efficient allocation of resources. In effect, this lead to a conclusion that companies, to be able to continue operations, should be initially compliant to the requirements of its legal owners (e.g. shareholders) before it can serve other stakeholders. Leniency of IFRS is necessary for companies to obtain flexibility; otherwise, it would not be able to continue operations due to shareholder dismay and may as well be unable to serve larger part of the community.
Investor focus, however, is not always the case. For example, employees and managers are considered as internal stakeholders. Listed companies are bound to provide them with equitable compensation and maintain their motivation during growth or recession. Such objective should not be ignored due to the fact that human resources and capital is the most important asset of the firm (Hitt, Hoskisson & Ireland 2003). Consistency on the primary objective is observed when internal stakeholders are strictly recruited, trained and continuously motivated through certain reward systems. This would make the labor force more productive and loyal that can reflect the long-term achievement of the investor’s objective. However, the experience of General Motors wherein its financial difficulty arose from implementation of retirement plans for its employees showed the conflict between labor force and investor needs.
In what case it may be, public communication through social responsibility disclosure is necessary (McGraw-Hill, 2006). Even if the society as well as the legitimacy pressures maintains a certain status quo for the whole year, organizations should comply with social disclosures because this type of disclosure is never neutral but the by-product of an “entity and society relationship”. In addition, legitimacy theory is derived from system-based theories which mean that a firm can affects its environment on top of the societal changes and its impacts to the firm. In effect, activities that is thought to have, having or previously had impacted the society and environment in both positive and negative manner should be properly cited. Political economy framework also related the economic activities of a firm to political, social and institutional environments stating that economic issues are not are discernable (or profitable and strategic for that matter) if these factors are undermined in corporate operations (McGraw-Hill, 2006).
Social disclosure is a set of information firms used to comply with one of its functions which is “to account for certain corporate actions” (McGraw-Hill, 2006). As reporting is driven by responsibility rather than societal demand, the indirect stakeholders also find their worth in social disclosures even if their expectations are largely implicit. The managerial side of stakeholder theory provides the identity and ultimately the strengths and weakness of annual reports. Aside from the fact that ethical nature of stakeholder theory is non-testable (therefore, no strict standards can be imposed to firms), listed companies are responsible in emphasizing the social responsibilities of their organizations. In effect, companies accomplish disclosures an integrated and sufficient social responsibility reports as it reflect the managerial capabilities and ethical considerations.
As stated, financial evaluation is very vital to the development of a certain organisation since it is the distinction whether the certain organisation are growing or not (Atril & Mclaney, 2004). So let say in some country, e.g. Australia, financial reporting should comply with Australian Accounting Standard Board (AASB). This obligation should conforms to the needs of users of financial information (i.e. investors or suppliers) are dependent on the reports for the information they need in making financial decisions and are unable to command specific information from the organisation. Basically, the said concept can be translated differently at large public companies and at small private businesses at different countries. Concepts and ideas that apply to a certain group don’t mean that it is also applicable to another (Atril & Mclaney, 2004). In large public companies reporting entity context should circumscribed to the area of economic concern, or is required to, set up general purpose “external financial reports" and that "controls" the authority and benefits of other entities (Australian Accounting Standards Board 2008). However, in small-business arena, in which large number of people often control or own a number of small businesses, things get intricate pretty fast. As seen in most small businesses, the mutual kind of relationship, where two entities are aligned, is pretty common. In some cases, business with a so-called parent company is a crucial issue in reporting entity (Australian Accounting Standards Board 2008). Further complicating the issue in which the parent is, let say, a human parent who owns Company A and Company B. Must contain the assets of the "parent" — his house and his car, for example — in a collective financial statement that also comprises the accounts of his two businesses?
In connection to this, it shows that financial reporting in businesses is a must and it should conform to a certain standard to have basis of the report. Atril & Mclaney (2004) also mentioned that by calculating a relatively small number of ratios in a financial report, it is often possible to build up a reasonably good picture of the position and performance of a business. Ratios in financial reports help to highlight the financial strengths and weaknesses of a business, but they can not, by themselves, explain why certain strengths or weaknesses exist, or why certain changes occurred. Just by details investigation will find the reasons. Ratios can be grouped into certain categories; each of them identifies a particular aspect of financial performance or, position. There are five broad categories which define as follows: (1) Profitability; (2) Liquidity; (3) Financial Leverage; and (4) Asset Management (Pike & Neale 1999).
With regards to the importance of harmonisation and standardisation, financial reporting should demonstrate the accountability of a unit for the financial affairs and resources entrusted to it, and provide information useful for decision making by providing and indicating the following (IFAC PSC Study 1, 1991, paragraph 63):
Indicating whether resources were obtained and used in accordance with the legally adopted budget.
Indicating whether resources were obtained and utilized in accordance with legal and contractual requirements, including financial limits established by appropriate legislative authorities.
Providing information about the sources, allocation, and uses of financial resources.
Providing information about how the government or unit financed its activities and met its cash requirements.
Providing information that is useful in evaluating the government’s or unit’s ability to finance its activities and to meet its liabilities and commitments.
Providing information about the financial condition of the government or unit and changes in it.
Providing aggregate information useful in evaluating the government’s or unit’s performance in terms of service costs, efficiency and accomplishments.
Apparently, the harmonisation and standardisation of financial accounting in accordance to purchase method of accounting should be also considered. Basically, Pike & Neale (1999) argued that this is useful as safeguards not only for the benefit of the company but also as protection of its stakeholders and shareholders. There are previous accounting standards that allow two methods of accounting for mergers and acquisitions and these are merger and acquisition accounting. Actually, the former was generally a more favourable cure in its impact on the P & L. In accordance to this, the purchase method of accounting is now compulsory not only Australia but also in EU and US and wherever International Financial Reporting Standards (IFRSs) have been implemented.
The accounting purchase method must recognise the purchaser (the entity that acquires control over the other entity). Under the rule of IFRSs, acquisition must be appreciated at fair value. Moreover, the distinction involving the fair value and purchase price should be acknowledged as goodwill.
Based on the context of purchase method, a certain firm cannot make a reformation condition to give for future losses or reformation costs as a consequence of an acquisition. All costs must be considered as post acquisition costs. This creates the impact of reformation costs on profits more noticeable, and thwarts the abuse of provisions to take an overstated hit to profits on acquisition and afterward boost stated profits in following years.
Basically, the use of the purchase method perks up accounts, but investors are prone to disregard the impact of goodwill, which is the biggest change. The abolition of provisions is more useful as of the extra visibility and the avoidance of abuses.
Apparently, financial reporting is one of the factors that need consideration not only by the stakeholders or shareholders of some business organizations but also by the global community especially to those who are responsible in setting up the international financial reporting standard (IFRS) and accounting standard of a certain country in which the business operates. In line with this, the values reported by a certain company should conform to the standards given by (IFRS) and accounting standard of a certain country. Fair values given to companies should also comply with their status in the market. Meaning to say, fair values should reflect to the factors in business like its earnings, growth and market.
In accordance to this development, extensive accounting and auditing procedures must be practiced. This includes everything from external audits of accounting management policies and procedures to internal reviews of quantitative exposure measurement models. In essence, this process involves the evaluation whether or not its management process is working properly and efficiently. This must be done to assess if the company addresses the problems and risks being identified in the first process. Without this step, businesses would not be able to come up with policies and regulations and would not be able to know if their measuring, monitoring and controlling processes are effective enough to suggest improvement of their operation and profit.
From the factors to be considered in financial accounting, businesses can counter the risk and classified it if harmonisation and standardisation are considered based on categories i.e. credit risks, liquidity and funding risks, market risks, operational risks, reputation risks, insurance risks and pension risks. The processes or steps could be a possible means of providing solutions or answers to the problems or crises being faced by most businesses, and this should be based on standards.
In accordance to the previous discussions, businesses need to know about their financial performance to access what are the things they are doing right. Businesses use accounting as a method to know how they are performing and to see if there is a balance between what the company acquires and what the company takes out. Financial accounting is focused on the financial issues of the company and it provides financial related information to internal and external people concerned with the company. Standardization and harmonization is needed to determine the degree of success or failure of a company. As a complement to financial accounting, companies make use of management accounting to check its performance and know which operating part of the firm they are not doing well. There is said to be a linkage between the financial and management forms of accounting. This linkage is also said to create a short term, narrow focus that is not supportive of effective operations.
Evaluation
Moreover, it can be said that companies with their financial reposts conforms the accounting standards are said to be beneficial to both shareholders and stakeholders. To sustain the development, the company should regularly assess the value of their portfolio of its business. Both shareholders and stakeholders should be given importance by the company. Stakeholders, sometimes also called sponsors, or management, are extremely important to the business. Standard financial information are important to them because they are the ones that give political as well as resource support for the project. However, normal stakeholders are people that are influenced by any business decisions - they include stockholders but are hot limited to just that. They also include employees, surrounding businesses, competing businesses, neighbourhoods of the business, customers, etc. They have to be positioned on fast-growing opportunities, whether geographically or by market segment through choosing to invest in businesses with long-term tail-wind profiles. Thus, standardized and harmonised reporting is also vital for them. If the current financial situation carries on consistently, a certain company would well achieve their vision of becoming the leader in their industry and a major player in each of their market segments and key geographical markets.
References:
ACCA Global 2006, viewed on 2 November 2008, <www.accaglobal.com>
Atrill, P & McLaney, E 2004, Financial Accounting for Decision Makers, 4th edn., Prentice-Hall, New Jersey.
Australian Accounting Standards Board 2008, viewed 03 November 2008, <http://www.aasb.com.au>
Bandler, J. 1994, How to use Financial Statements: A Guide to Understanding the Numbers, McGraw-Hill, New York.
Deegan, C & Rankin, M. 1996, "Do Australian companies report environmental news objectively? An analysis of environmental disclosures by firms prosecuted successfully by the Environmental Protection Authority”, Accounting, Auditing and Accountability Journal, vol. 9. no. 2. pp. 50-67.
Fried, D. Sondhi A. & White, G. 2003, The Analysis and Use of Financial Statements, 3rd edn, John Wiley & Sons Inc., New Jersey.
Glover, J, Ijiri, Y, Levine, C & Jinghong Liang, P 2005, “Separating Facts from Forecasts in Financial Statements”, Accounting Horizons, vol. 19, no. 4, pp. 267+.
Hitt, M, Hoskisson, R & Ireland 2003, Strategic Management: Competitiveness and Globalization, 5th Edition, South Western; Thomson Learning, Singapore.
IFAC Public Sector Committee 1991, Study 1, Financial Reporting by National Governments, IFAC Public Sector Committee
McGraw-Hill Publications 2006, Financial Accounting Theory by Deegan, C. (Chapter 8), McGraw-Hill Website, viewed on 03 November 2008 <www.mcgraw-hill.com>
Penman, S 2003, “The Quality of Financial Statements: Perspectives from the Recent Stock Market Bubble”, Accounting Horizons, vol. 17, pp. 77+.
Pike, R & Neale, B 1999,Corporate Finance and Investment Decision and Strategies, 3rd edn., Pearson Education Limited, England.
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