A Sound Financial Reporting System

“A sound financial reporting system, supported by high quality accounting standards and backed by a solid regulatory, governance and ethical framework, is a pre-requisite for economic development”. Accounting has been around since the beginning of civilization and played an important role in the development of cities, trade and the concepts of wealth. Nowadays, business is very complex and therefore there is an increased need for providing accurate and reliable financial information.

Moreover, according to ACCA’s beliefs, the importance of financial reporting and accounting standards is significant not only for the accountancy profession, but also for the world economy. [1] Dr Joe Sumners, Auburn University, defines economic development as “the process by which a community creates, retains, and reinvests wealth and improves the quality of life”.

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[2] Economic development encompasses diverse disciplines, including economics, business, political science, public administration, marketing and communications, sociology, community planning, education.

In that case, it can be questioned whether good financial reporting system, supported by accounting standards, regulatory framework, good corporate governance and ethical standards, plays also an important role for further economic development. The purpose of this report is to critically evaluate the relationship between above-mentioned terms with reference to economic development. The first part of this paper describes individual terms which are significant for accountancy field.

On the other hand, the second part represents the relationship between these terms and economic development, supported by subjective discussions. Financial reporting objectives are the key determinants of the nature of a financial reporting system.

The primary objective is to provide information useful for making investment and credit decisions. To be useful, information must be relevant, reliable, and comparable, and should be directed at these people with a reasonable level of understanding business and economic activities.

IFRS (International Financial Reporting Standards) is “a set of international accounting standards stating how particular types of transactions and other events should be reported in financial statements”. [3] IFRS are issued by the International Accounting Standards Board. Furthermore, international accounting standards are rules and guidelines which should be followed by those who prepare the financial statements of companies.

These standards are an important part of financial reporting as they define what is meant by “a true and fair view, in various contexts and circumstances” (Atrill ; McLaney, 2004).

The objective of IAS 1 (2007) is “to prescribe the basis for presentation of general purpose financial statements, to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities. “[4] IAS apply to all financial statements based on IFRS. Another important issues relate to solid regulatory and corporate governance. Good corporate governance aims to provide incentives for the board and management to pursue the objectives that are in the interests of the company and its shareholders.

The concept of corporate governance, although analysed from many different perspectives, is usually understood as a complex set of constraints that managers put on themselves, or that investors put on managers to reduce the ex post misallocation and to induce investors to provide more funds ex ante.

The main tasks of corporate governance include assuring corporate efficiency and mitigating arising conflicts, providing for transparency and legitimacy of corporate activity, lowering risk for investments and providing high returns for investors, and in addition delivering framework for managerial accountability.

Corporate governance encompasses the combination of laws, regulations, listing rules that enable the company to attract capital, generate profit and meet other legal obligations and general societal expectations. Equally important concern is regulatory framework which represents a set of laws and regulations that outlines the legal requirements to be met by the companies. The last significant issue in financial reporting relates to ethics.

Ethical standards are designed to produce relevant and reliable information for decision making. The Code of Ethics for Professional Accountants was prepared by the International Ethics Standards Board for Accountants.

IESBA is an independent body which sets standards within the International Federation of Accountants. Before starting discussion on the relationship between above described terms and economic development, it is very important to point out a negative influence of the credit crunch on the entire accountancy profession.

The causes were various, but from a corporate governance perspective, the difficulties were in the weaknesses in reporting on risk and financial transactions and a lack of accountability generally within organisations. ACCA believes that “the credit crunch can therefore be viewed, in large part, as a failure in corporate governance”. [5] In addition, this raised the issue of moral and ethical failure.

The benefits of international accounting standards play an important role for accountancy profession, however still risk of complex accounting standards exist.

The IASB issues international accounting standards and also financial reporting regulations that are imposed by the EU, and this can lead to increased complexity and overloading for businesses. For instance, the annual report of a major bank is a large document covering several hundred pages and can be difficult to comprehend. International Financial Reporting Standards (IFRSs) has added to the complexity and length of reports but has not helped clarity or ease of understanding. The IASB launched projects to tackle these problems of complexity.

However, the world is increasingly complex and financial institutions are becoming truly global operations, and reporting on the performance of these global entities inevitably results in complex financial reports. In addition, IASs may cause that the companies will deal with the national, social, political and economic pressures which will be more hard forced down to comply with additional complex and costly requirements. Furthermore, there are some costs to the economy as a whole but also to businesses that have to comply with the accounting regulations.

If a standard is changed to improve the situation in one part of the economy, this can lead to the problem that it will discriminate against another sector of the economy. The accounting standards should be developed bearing in mind two aspects: their effectiveness helping to keep investors safe but also their costs involved for companies and the economy as a whole. Corporate governance has become a popular topic in the international academic and business debate.

Researchers on corporate governance issues frequently analyse two types of problems in the linkage between managers’ interests with shareholders’ interests.

The difficulty arises when the interests of shareholders and the board of directors are aligned, but where managers’ interests are not aligned. On the other hand, the second type of problem arises when boards’ and managers’ interests are aligned with each other but are not completely aligned with the interests of shareholders. Furthermore, the importance of corporate governance proved to be crucial in line with the corporate scandals which resulted in substantial economic losses, higher risk and decrease of confidence.

For instance, the Madoff investment scandal broke in December 2008 when former NASDAQ chairman Bernard Madoff admitted that the wealth management arm of his business was an elaborate Ponzi scheme. Another example – Satyam Systems, a global IT company based in India, has been added in January 2009 into a notorious list of companies involved in fraudulent financial activities, which includes such names as Enron, WorldCom, Societe General, Parmalat, Ahold, Allied Irish, Bearings and Kidder Peabody.

Satyam’s CEO, Ramalinga Raju, took responsibility for broad accounting improprieties that overstated the company’s revenues and profits and reported a cash holding of approximately $1. 04 billion that simply did not exist. This evokes the question how this scandal affected the level of corporate governance in the country India, and has cast a negative shadow on the image of Indian industry overseas. The consequences of this were: firstly, a loss of investor confidence in Indian financial market; and secondly, a fall in overall market value.

The global nature of financial markets links companies and investors around the world.

The impact of major corporate scandals and subsequent regulatory and legislative responses from governments and regulators has been felt in all major economies. Against the backdrop of corporate scandals and fraudulent accounting practices, governments and regulators should seek to introduce stronger legislation and regulation to guard against similar collapses in the future and restore investor confidence in financial markets. Are ethical considerations also affect accounting?

Investors and creditors need relevant and reliable information about companies, and companies want to look good to attract investors, so there is a conflict of interest here. To provide reliable information, companies are required to have their financial statements audited by independent accountants, who tell whether or not the financial statements give a fair picture of the company’s situation. The vast majority of accountants do their jobs professionally and ethically, only those who cheat make the headlines. Enron Corp.

for example, was one of the largest companies in the United States before it began reporting misleading data. WorldCom, a major long-distance telephone provider, admitted accounting for expenses as though they were assets (economic resources). Consequently, this also had a negative impact on economic development thus innocent people lost their jobs, and the stock market suffered. Furthermore, since the economic crisis, the issue of ethics in business has become one of the most important issues, which faces the global business community.

However, still numerous companies are unaware that ethics is the key to sustainable business, determining the success or failure of an organization in the long term. Is there a close link between good economic performance and ethics? For many companies the prospect of short-term profits achieved by ‘turning a blind eye’ on ethical issues can be very tempting.

However, unethical solution that in the near future may bring certain benefits, in the long-term may generate exceedingly greater costs.

The accountants should be aware that the ethical operation of companies are not only for short-term projects – is a systematic and long-term building and strengthening of existing standards. A prosperous, sustainable business is one that aims to incorporate ethical standards into the strategy in all its manifestations, and one that consciously uses them in its business activities. High profile corporate governance scandals and increased shareholder activism are driving better governance practice.

As governments and regulators respond to these challenges with the adoption or revision of new corporate governance codes we are seeing an emerging consensus of accepted best practice and this trend should be likely to continue.

Furthermore, there is a need for a much greater emphasis on professionalism and ethics in business. The solution to this could be ACCA’s professional accountancy qualification, alongside the need for strong technical financial and accounting skills. The demand for people with ACCA international qualifications is growing across the world constantly.