The implementation effects of expanded consolidation: the case of consolidating special purpose entities

This article examines the impact of FASB Interpretation No. 46 (Revised), FIN 46(R), on perceived earnings informativeness of companies with special purpose entities (SPEs). We find that the impact depends on the pre‐FIN 46(R) incentives for using SPEs. The implementation of FIN 46(R) improves perceived earnings informativeness of companies that previously used SPEs less for the manipulation of financial reporting, but does not generate the same improvement for those otherwise. Furthermore, these differential effects are more pronounced when companies reacted to FIN 46(R) by restructuring their SPEs to keep them off financial statements.     

The impact of financial reporting flexibility on auditor risk judgement: Evidence from the implementation of FIN 46R

This paper investigates how auditors respond, in terms of their pricing and audit work, to a reduction of clients’ financial reporting discretion upon the implementation of FIN 46R, which requires firms to consolidate the variable interest entities (VIE) under their control. Using a difference-in-differences research design, we find that auditors charge relatively fewer audit fees and have shorter audit report lags for firms that are significantly affected by FIN 46R, compared to a group of control firms. This result concurs with the view that auditors react favorably to the reduction of clients’ financial reporting discretion. Our finding is concentrated among clients with higher accrual earnings management constraints, auditors with less client-specific knowledge, and auditors who have no recent experience of audit failures (e.g., severe client restatements). Our results are robust to alternative identifications of treatment and control samples, and our conclusion remains valid after controlling for the contemporaneous adoption of Sarbanes-Oxley (SOX) Act. We also show that the relatively reduced audit fees and audit effort do not lead to the deterioration of audit quality.     

A Study of Accountants' Judgments With Respect to the Provision of Consolidated Financial Statements

The release of the Australian Accounting Standards Board AASB 1024. Consolidated Accounts. in September 1991 represents a fundamental shift in concept, criteria and approach. The Standard is based on the entity concept and adopts 'capacity to control' as the sole criterion for identifying related entities for the purpose of preparing consolidated financial statements. A conceptual (substance-over-form) approach is used to implement the control criterion. In essence, this approach requires accountants to make professional judgments about the existence of control based on the substance of group structures and arrangements rather than their legal form. Concerns about the subjectivity and possible variability of accountants' judgments cast some doubt on the operational effectiveness of the conceptual approach. In response to these concerns, this paper reports the results of an experiment that examines the consolidation judgments accountants make in response to a number of hypothetical scenarios. The purpose of this paper, therefore, is to provide some insights into the likely quality and reliability of consolidation judgments under the conceptual approach adopted by AASB 1024. The results indicate that accountants can be expected to exhibit broad consensus in their consolidation judgments. In addition, an analysis of the variables suggests that the degree of share ownership is the most significant factor in making such judgments. Nevertheless, other factors including the composition of the board of directors, the existence of a special arrangement, and interactions with the other variables also proved to be significant. Overall, the study provides tentative support for the conceptual approach adopted in AASB 1024.     

The valuation and reliability implications of FIN 46 for synthetic lease liabilities

We examine whether adoption of FASB Interpretation No. 46/R (FIN 46), Consolidation of Variable Interest Entities–an Interpretation of ARB No. 51, changed the market valuation and related measurement reliability of synthetic lease liabilities. Adopted in 2003, FIN 46 requires financial statement recognition of many previously off-balance sheet structures, including synthetic leases. Synthetic leases are hybrid financing structures that, prior to FIN 46, allowed firms to maximize the benefits of asset ownership for tax purposes while retaining operating lease treatment within the firm’s financial statements. We identify a sample of 125 synthetic leasing firms impacted by FIN 46. Utilizing methodology consistent with Dhaliwal et al. (2011), we constructively capitalize these lease liabilities in the period preceding FIN 46 and compare market valuation of these liabilities with capitalized leases after adoption of the standard. We find that the market places greater weight on synthetic lease obligations recognized within the body of the financial statements than it does liabilities disclosed within the associated notes. Finally, we rely on econometric procedures developed in Barth (1991) and extended in Choi et al. (1997) to examine whether the differential market valuation of lease liabilities post FIN 46 is due in part to perceived differences in measurement reliability. The results indicate there is a post FIN 46 reliability effect for all lease liabilities examined. However, while the synthetic lease amounts are the most unreliable examined, they also experience the greatest increase in reliability post FIN 46, indicating that perceived measurement reliability explains in part differential market valuation associated with FIN 46. Our findings have the potential to inform the ongoing standard setting debate surrounding the possible capitalization of all leases. Further, our study also has economic implications for managers concerned with the potential constraints on asset financing options imposed by accounting regulation.     

Altering Investment Decisions to Manage Financial Reporting Outcomes: Asset‐Backed Commercial Paper Conduits and FIN 46

We evaluate the manner in which sponsors of highly leveraged asset‐backed commercial paper (ABCP) conduits responded to Financial Accounting Standards Board Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities an Interpretation of ARB No. 51, and its Canadian counterpart Accounting Standards Board of Accounting Guideline 15 (AcG‐15), Consolidation of Variable Interest Entities. By matching commercial paper investors with corporations seeking liquidity, ABCP sponsors facilitate a significant amount of short‐term, securitized financing in the United States. FIN 46 and AcG‐15 require sponsors to consolidate their ABCP conduits with their financial statements. We demonstrate that the volume of ABCP began to decline when FIN 46 was first proposed, and that this decline is primarily attributable to a reduction in North American banks' sponsorship of ABCP. We also demonstrate that North American banks entered into costly restructuring arrangements to avoid having to consolidate their conduits per the new accounting standards. Our results suggest that, in certain settings, accounting standards appear to have real effects on investment activity and product‐market competition.     

Implications of Applying a Private Sector Based Reporting Model to Not-for-Profit Entities: The Treatment of Charitable Distributions by Charities in New Zealand

In this paper, we investigate the practical and conceptual difficulties caused by applying a private sector based reporting model to the not-for-profit sector. We deal specifically with reporting on charitable distributions by charities in New Zealand. We find a majority of the entities report charitable distributions in the Statement of Financial Performance (as expenses). This approach is conceptually justifiable, complies with international best practice, and is in line with the accountability argument made in this paper. While the number reduced between 2003 and 2007, a significant minority of the entities report charitable distributions in the Statement of Movements in Equity (and therefore report higher surpluses). These two approaches lead to very different results, yet both are apparently seen as acceptable by the entities and their auditors. While this raises questions as to the understandability and comparability of the financial reporting by these entities, it also raises questions about the suitability of the for-profit sector reporting requirements for the not-for-profit sector.     

Whole of government accounts developments in the UK: conceptual,technical and timetable issues

When published, the UK's much-delayed whole of government accounts (WGA) will provide valuable incremental information on UK public finances. The WGA will complement existing fiscal indicators such as net debt, which excludes public assets other than liquid financial assets, by establishing a more complete picture. Emphasising the relevance of accounting consolidation to the public sector, this article assesses potential uses of WGA and discusses why the UK WGA timetable for publication—originally 2005–06 and now 2009–10—slipped so badly. A series of conceptual and technical issues is examined, including how the WGA boundary is defined; the emphasis the UK places on alignment with the national accounts; and the proposed treatment of taxes paid by entities within the WGA consolidation.     

The Challenge of Risk Reporting: Regulatory and Corporate Responses

Corporate collapses such as those of Ansett Australia, Centaur Mining, Enron, HIH and One. Tel have rekindled regulators' concerns about the lack of transparency in financial reporting on risks and uncertainties. This paper examines the broad conceptual issues and regulatory responses so far in leading jurisdictions and investigates risk reporting of Australian entities operating in the mining sector. The limited and uneven level of reporting on risk found, in this study, if replicated in other industries and jurisdictions, provides justification for standard-setters considering more explicit requirements than the existing piecemeal rules of restricted scope.     

Revitalising Group Accounting: Improving Accountability

This article questions conventional consolidation accounting's effectiveness as a governance mechanism. Disclosure of the aggregate financial outcomes of a set of related business entities is of commercial importance. Currently that information is disseminated through financial statements underpinned by assumptions contradicting fundamental principles of corporate law and contestable propositions of commercial fact. Corporate accountability could be improved if the traditional approach to consolidation accounting were supplanted by reporting on an individual company basis, with assets marked to market, augmented with a statistical annexure of assets and liabilities of all related entities and a related companies' cross-claims matrix. Recent revelations related to Enron's collapse reinforce the need for improved corporate group accountability mechanisms.     

Participatory budgeting,community engagement and impact on public services in Scotland

ABSTRACT

The institutional engagement and analysis needed to effectively integrate the requirements of equality legislation into participatory budgeting (PB) processes requires a transformational approach. Equality processes appear to exist in parallel with PB activity, rather than being operationalized as integral to the objectives and character of PB activity at local level. This paper proposes that PB and the Public Sector Equality Duty (PSED) in the Equality Act 2010 share a transformative intent and potential, but that this is undermined by siloed thinking on equalities and enduring discriminatory behaviour and practices. The paper concludes with propositions for aligning the conceptual links between equality and community empowerment and, thereby, participation in local financial decision-making in practice.     

IPSAS and local government consolidated financial statements—proposal for a territorial consolidation method

This paper presents a new consolidation method to improve local government accountability. After a brief review of consolidated financial statements in the public sector, the International Public Sector Accounting Standards approach to consolidation is described. The authors explain why this approach does not adequately consider the distinctive features of local governments. A case study is presented to illustrate the principles underlying the new method.     

Model-based auditing using REA

The recent financial crisis has renewed interest in the value of the owner-ordered auditing tradition that starts from society's long-term interest rather than management interest. This tradition uses a model-based auditing approach in which control requirements are derived in a principled way. A problem with this approach is that it has been proven hard to apply it in modern complex organizations. Making it feasible requires at least an adequate enterprise modeling approach. In this paper, it is shown that the REA ontology fulfills most of the requirements for such a model-based approach. The analysis also suggests some directions in which REA can be extended.     

Introducing More IFRS Principles of Disclosure – Will the Poor Disclosers Improve?

Abstract

The current paper was prepared for the International Accounting Standards Board (IASB) Research Forum 2017 and evaluates the effects of introducing more principles of disclosure as part of the IASB Disclosure Initiative. We perform a literature review of academic research on how entities have complied with disclosure requirements in the past. The review shows high levels of non-compliance and high volatility across entities, including poor disclosers being far below the average. We find no clear pattern of higher compliance for International Financial Reporting Standards (IFRS) with more reliance on disclosure principles as compared to specific requirements (i.e. IFRS 7, IFRS 8), but note the methodological problem of measuring compliance with disclosure principles. Academic research suggests that the degree of compliance depends on entities’ incentives for providing or withholding information in combination with local conditions for primary users, auditors and regulators. Based on our review, we argue that increased reliance on entities to act in ‘good faith’ when complying with disclosure requirements, in capital-market contexts where entities may be in high-incentive situations and have low costs of non-compliance, is potentially risky in terms of how well the Standards protect primary users from poor disclosers. More emphasis is needed on ensuring that the disclosure requirements are enforceable and auditable in order to secure a certain minimum level of disclosure.     

Pricing defaultable bonds: a middle-way approach between structural and reduced-form models

In this paper we present a valuation model that combines features of both the structural and reduced-form approaches for modelling default risk. We maintain the cause and effect or ‘structural’ definition of default and assume that default is triggered when a state variable reaches a default boundary. However, in our model, the state variable is not interpreted as the assets of the firm, but as a latent variable signalling the credit quality of the firm. Default in our model can also occur according to a doubly stochastic hazard rate. The hazard rate is a linear function of the state variable and the interest rate. We use the Cox et al. (A theory of the term structure of interest rates. Econometrica, 1985, 53(2), 385–407) term structure model to preclude the possibility of negative probabilities of default. We also horse race the proposed valuation model against structural and reduced-form default risky bond pricing models and find that term structures of credit spreads generated using the middle-way approach are more in line with empirical observations.     

Conflicting norms: Impact of the Model Law on Chapter 11's Global Restructuring Role

The Model Law's emphasis on the debtor's center of main interest (COMI) as the proper jurisdiction for the main insolvency proceeding is at odds with the traditional United States approach of applying Chapter 11 to restructure foreign entities with no significant US connection. This paper explores whether adoption of the Model Law has made Chapter 11 less available for debtors with a foreign COMI. The Model Law has had no direct impact on the US courts approach to foreign‐entity Chapter 11 cases. However, shortly after the Model Law's adoption, several reported US decisions added the pendency of a foreign insolvency proceeding as a factor supporting discretionary abstention or dismissal of foreign Chapter 11 cases. While those decisions do not refer to the Model Law, it is possible that the Model Law's COMI‐centric approach influenced this new trend.     

A Critical Learning Outcome Approach in Designing,Delivering and Assessing the IT Knowledge Syllabus

Although the accounting profession has embraced a competency-based approach in the education and training of students, some educators struggle to adapt the delivery and assessment of their accounting programmes to bring them in line with these outcomes. The challenge for all educators is to seek ways to marry the curriculum, the design and delivery of the syllabus and assessment in such a way as to maximize students’ learning in relation to priority goals. The aim of this paper is to discuss how the IFAC curriculum on the general knowledge of IT (IEPS 2) could be analysed using an alternative approach based on critical learning outcomes to develop a syllabus that would enable educators to deliver and assess it in line with the learning outcomes and competency requirements. The newly-developed syllabus should direct educators to adopt a holistic approach in the delivery and assessment of the IT course. This approach should ensure that students understand how information technology can support them as accountants in producing information in the format required by users.     

Loan pricing under Basel II in an imperfectly competitive banking market

The new Basel II Accord (2006), established new and revised capital requirements for banks. In this paper we analyze and estimate the possible effects of the new rules on the pricing of bank loans. We relate to the two approaches for capital requirements (internal and standardized) and distinguish between retail and corporate customers. Our loan-equation is based on a model of a banking firm facing uncertainty operating in an imperfectly competitive loan market. We use Israeli economic data and data of a leading Israeli bank. The main results indicate that high quality corporate and retail customers will enjoy a reduction in loan interest rates in (big) banks which, most probably, will adopt the IRB approach. On the other hand high risk customers will benefit by shifting to (small) banks that adopt the standardized approach.     

Are Financial Reports Useful? The Views of New Zealand Public Versus Private Users

This study reports on surveys conducted with users of financial reports in New Zealand. We compare findings for users of reports of two types of for‐profit entities, namely those with public accountability (public entities) and those with no public accountability (private entities). The findings indicate that both types of users have similar perceptions regarding the usefulness of financial statements, with the income statement and balance sheet rated as the most useful components. Furthermore, both types of users, especially private users, perceive financial statements as the most important information source for decision making. Public users have a greater interest in supplementary information than private users. The findings of this study contribute to the debate around differential reporting for private companies and have policy implications with regard to the user‐needs approach to accounting standard setting.     

Value-at-risk versus expected shortfall: A practical perspective

Value-at-Risk (VaR) has become a standard risk measure for financial risk management. However, many authors claim that there are several conceptual problems with VaR. Among these problems, an important one is that VaR disregards any loss beyond the VaR level. We call this problem the “tail risk”. In this paper, we illustrate how the tail risk of VaR can cause serious problems in certain cases, cases in which expected shortfall can serve more aptly in its place. We discuss two cases: concentrated credit portfolio and foreign exchange rates under market stress. We show that expected shortfall requires a larger sample size than VaR to provide the same level of accuracy.     

THE DEVELOPMENT OF CONCEPTUAL FRAMEWORKS OF ACCOUNTING FOR THE PUBLIC SECTOR

This paper offers a review of the conceptual framework projects that have been done by, or on behalf of, accounting standard-setting bodies, and that have concerned themselves with public sector accounting. Developments since 1966 in North America are the primary focus, although the UK and New Zealand are also explicitly addressed. The major theme identified is the ubiquity of the user/user needs approach, despite the continuing lack of evidence about user needs. The paper tries to explain this and concludes that standard-setting bodies have used these conceptual frameworks to establish their own legitimacy, by appealing to the public interest.