The current economic downturn has led more countries to give way to foreign investment. Countries especially Australia are recognizing the need for the adoption of globally accepted accounting and auditing standards like the International Financial Reporting Standards (IFRS). The adoption of the accounting standard will enable its country to converge towards a single set of globally accepted standards thereby benefiting its economy. The benefit of global capital markets is that its more consistent, uniform and offer high-quality regulatory and standard accounting regimes. In July 2002, Financial Reporting Council (FRC) announced the adoption of Australian Internal Financial Reporting Standards (AIFRS) as a basis for reporting financial statements for the period starting January 1, 2005. It required all entities to report under the new accounting principle.
Australian companies acknowledge that the adoption of AIFRS will not adequately address the underlying economic condition of reporting entities since AIFRS has implemented a taxation concept that has affected a range of taxpayers. Some of the tax concepts include Consolidation, Thin Cap, Share Capital Tainting, Disqualifying Accounts, TOFA, Trading Stocks, Trusts and PAYG Instalments. On the other hand, AIFRS tax concepts will have a positive impact on the economy since taxpayers will be reporting their financial accounts through AIFRS which will result in greater certainty, balanced neutrality, maintained compliance cost, a neutral tax environment that does not hinder the location of Australian financial activities and creates a positive environment free from arbitrage and deferrals. Since the administration is aligned with AIFRS, the government ensures an effective comparative corporate reporting and governance processes thereby reducing the cost of capital in the country and improving its access to foreign capital that entities can borrow from resulting in a stronger economy (Australian Government, 2005, p.9).
The international convergence of IFRS will facilitate a cross-border listings and comparison of financial investment for Australia thereby reducing its cost of capital and improving its access to foreign capital for its entities. AIFRS will improve the comparability of financial information. Allocation of capital across borders will be efficient thereby reducing the burden of an economic downturn. Compliance costs for corporations will be greatly reduced and the consistency of audit quality will be improved (Australian Government, 2005, p.9).
New responsibilities for companies
Once the AIFRS is adopted, all entities preparing financial reports will be required to comply with the statement for financial years beginning 1 Jan 2005. AIFRS application on assets and liabilities will cause an increment in liabilities and a decrement in the number of assets reported on the balance sheet. For instance, assets such as brands and mastheads that are created internally will be scrapped out of the assets list and be deleted altogether on the balance sheet. Also, AIFRS will change the basis on how they recognised and measure liabilities and there is a possibility that new liabilities will be recognised. Companies will be required to run much tougher tests on examination of small business units under AIFRS to justify the carrying value of their assets, a thing that did not happen in the past. The examination will include retailing businesses and individual stores. Under AIFRS goodwill will not be amortised as it used to be in the old accounting standards but instead subjected to strict impairment requirements. This move will have a great impact on the stability of the economy (Australian Government, 2005, p.17).
In equity-based remuneration, AIFRS requires entities to report to expense remuneration. This would mean that equity-based expenses would be debited to the profit and loss account and credited to shareholders’ equity account. Reporting entities will also be required to recognize deferred tax for tax assets only like equity raising costs. AIFRS standards are effectively aligned to fair value accounting requiring reporting entities to carry more assets and liabilities at fair value reporting increments and decrements to the profit and loss account. With AIFRS in focus on fair value accounting, companies will be forced to book additional profits and losses of unrealised assets. However, AIFRS in fair value measurement is more likely to result in the transfer of unrealized profits into retained earnings, which may have a negative impact on the economy since the transfer will initiate a credit to the company’s notional disqualifying account. Therefore, companies that apply this standard will be subjected to severe penalties since they will be unable to frank distributions generated from retained earnings account of transfers. This means that unrealized profits will be required to be paid out of the accounts first (Australian Government, 2005, p.18: Leo, Hoggett et al, 2008).
AIFRS adoption would mean that Managed Funds will no longer be reported as fixed tax. Funds and members may suffer the consequences if they comply with the new standard because certain matters will no longer be classified as fixed trusts and matters that are relevant to the entities will no longer be fixed interest for the purpose of the taxation legislation. Under the new standard, there is also a high possibility that securitisation vehicles will experience losses in some income years as the new standard requires them to account for unrealised gains and losses on transactions that are frequently used as integral part of securitisation transactions. Trustees may be held liable for taxation even though the new standard has no net income profit. This would mean that the taxed money will be poured into the economy thereby stabilising it. AIFRS recognises income and liabilities at earlier times as compared to the old AGAAP methods meaning that transactions that are likely to contribute to economic downturn will be identified earlier and eliminated. Since the laws of AIFRS are unclear, some entities will be required to record their income and deductions twice (Australian Government, 2005, p.20).
Principles of the Accounting Standard
AASB 139 of accounting standard requires identification, measurement, and classification of financial instruments balances and other activities in a particular manner. Hedges for instance must be tied to specific deals. This requires groups that run large unallocated hedge books to run their changes through profit and loss statements. AIFRS will not, therefore, qualify Reset Preferences shares as quality as it would be reclassified as debt and treated as interest. This would result in reduced companies’ profit due to the flow in tax effects. Forex rules are not inconsistent with AIFRS and its adoption would change the existing accounting rules for reporting Gains and Losses on short-term contracts. AIFRS allows entities to choose their functional currencies in measuring items in their financial statements and presentation of currencies saving entities time and money on having to report on a particular currency (Australian Government, 2005, p.20).
AASB 112 accounting standard is based on general principles that require current and future tax of all transactions to be reported in the entity’s balance sheet which gives rise to current and deferred tax liabilities and assets. The AIFRS application in relation to deferred tax liabilities and assets will require entities to adopt a tax base and temporary difference notion. Also, the concept of management expectation will experience some problems as a result of tax consolidation.
This means that management expectations of entity recognition of events will be brought forward therefore causing problems for the ACA calculations (Australian Government, 2005, p.21).
On tax policies, some joining entities are still using the AGAAP after 1 Jan 2005 while the head of entity changed to AIFRS. This disparity will affect the ACA process since entities would be confused on which set of the standard, they should apply at joining time (Australian Government, 2005, p.22).
The statement will increase harmonisation through international investors’ participation thereby reducing transaction costs. Accounting Practices in Australia will be able to conform to international expectations increasing the need for comparability thereby increasing the economic status of its country. Change in the accounting system would mean redistribution of wealth therefore the economy will be more competitive in an environment of increased global business environment improving the current situation of the country’s economy (Clarke, 2005, online).
AIFRS covers all financial instruments and their classification as debt or equity. It also covers measurement and hedge accounting. This financial instrument corresponds to IAS 132 but does not give a comprehensive correspondence to IAS 39. This shows variation in the current practice which could result in major financial reporting differences. Some financial instruments currently classified as equity in AIFRS may have to be reclassified as debt and other entities with redeemable shares such as unit trust and cooperatives may have no equity at all. Financial and liabilities held for trading are measured at fair value measurement through income statements which could be contributing to the current crisis due to the instability of market values which force assets to be sold at losses (Bradbury & Zijl, 2005, p.5).
Reporting Entities Concept
AIFRS adoption in the Australian entities would enhance comparability in sectors, companies and countries. There will be also an increase in the capability of companies to secure funding and listing across borders. AIFRS adoption in Australia applied to listed and non-listed companies (CD, 2007, p. 1).
CD (2007, p.3) argues that reporting entities should be retained since they have been operating successfully since 1991. Its beneficial to entities since it minimises excessive reporting obligation on certain SMEs. AICD argues that policymaking in AIFRS will increase the burden of detailing accounting standards. Also, some overseas jurisdictions will eventually link up the application of standards to public filings, subjecting Australian entities to follow this approach. In addition, public filings are likely to differ between counties because the fit will not adequately fit the local laws in each country. Also, proposed AIFRS for SMEs will create an unnecessary burden on many smaller unlisted companies such as small clubs thereby consuming large proportions of members or shareholders’ funds. AIFRS requires an appropriate size threshold to be introduced upfront when determining whether a company is limited by guarantee which is not applicable since there is no minimum number. Also, unlisted companies that fall under the current accounting on non-reporting entity classification should be left on the decision of stakeholders to decide on how financial reports are prepared.
The purpose of IFRS is to define and explain the concept of reporting entity and to establish new benchmarks that will be required in reporting the quality of financial statements. This statement clearly defines circumstances under which an entity or economic entity should be identified. It outlines the criteria for determining, criteria for financial reporting processes, and another one for creating boundaries of a reporting entity. In relation to benchmarking for quality financial reporting, the statement specifies that entities shall prepare general purpose financial reports that comply with Statement of Accounting Concepts and Accounting Standards. However, it does not consider techniques and accounting methods it presents its financial information about entities. These considerations are included in Accounting Standards (Public Sector Accounting standards Boards, 2001, p. 4).
Listed companies of the lower end of the market have relatively low capitalisation and they will be greatly affected by the transition to IFRS. This burden may endanger the integrity of the markets, therefore, increasing criticism of the IFRS process to influential groups. Small companies will experience difficulties in moving to IFRS because they do not have adequate internal resources to help them successfully manage the implementation and will always be seeking outside advice while larger companies are flourishing. Also, Companies will not be able to use their audit forms for IFRS which subjects them to enter into a relationship with other firms of advice regarding delays and inconveniences Companies in the rural Australian region will be the most affected. Therefore, if they are not able to find the required professional advice, they will be required to pay professionals for advice which increases their expenses. Smaller Australian companies will be greatly affected because as compared to international competitors, IFRS applies to all listed and non-listed reporting entities in its country (Coleman, 2005).
According to recent surveys on IFRS application, it was reported that larger companies in Australia will benefit greatly from the statement adoption whilst smaller companies will experience transitional problems. Australian companies are often not required to implement new standards in the same year they are introduced. IFRS statement has now subjected pressure on the implementation of the new standards the same year they were introduced. IFRS fails to realise the cost of implementation as smaller companies will be most affected. Also, the transition of listed companies within the first year of implementation will enhance auditors’ independence. As indicated earlier, IFRS will enable entities to gain access to international capital markets, however, smaller companies especially the unlisted ones will not benefit from the statement upfront since they will still be involved in transition expenses. Smaller companies will have trouble understanding financial instruments and impairments. For example, the impairment requirements of IAS 39 that applies to trade receivables and provisions for doubtful debts. Under dividends, the law requires that companies make write-downs of assets such as intangible assets. Application of this statement will eliminate retained profits or rather negatively retain profits without changing the fundamental performance of the underlying entity or its cash position since the write-downs are only book entries rather than cash transactions. There under Australian law, companies that fall under this category will be affected in their ability to pay dividends since they are only required to pay dividends out of profits (Coleman, 2005).
Market to Market Accounting
Market to market value is an accounting concept that determines the actual and up-to-date stock or bonds and other financial instruments. This helps a country detect and respond to fraud cases in an effort to define the overall value of all parts of the economy. This move is very essential to any economic setup as it early detects frauds in some companies that would have contributed to the economic downturn. Many companies are complaining of market-to-market accounting to be contributing to the economic downturn since they do not want to value and mark their holdings according to the current value assets of the open market because of the huge losses they are experiencing. This argument does not hold any grounds, the fluctuating assets prices are caused by companies themselves, so having been requested to report their holdings according to market-to-market value should not be the contributing factor to the economic downturn. The value of some assets has dropped significantly with the introduction of market-to-market measurement. Assets that were valued at $300 million last year will be valued at $50 million due to the economic fluctuation resulting in huge losses which contribute greatly to the economic downturn (Galore, 2009, online).
It is important for companies to report their financial statements through market-to-market values since it provides transparent disclosures of their true financial condition. However, there are doubts whether fair value accounting enhances information or provides us misleading information. Fair value is required to report the price that would be received at the assets being sold at the time of measurement but it appears that credit analysts and investors have been applying this measurement the wrong way thereby contributing to economic instability. Markets have not been orderly and this instability of market activities has been used to determine fair values. This has forced market values to be determined assuming forced liquidation where no buyers are currently in the market. This affects financial institutions whose capital position and survival depend on valuations. IFRS has provided more clarity that will help guide and alleviate bad results but the markets have not reported any significant changes (Harmon, 2008, p.2).
The economic downturn is not caused by market-to-market measurements but due to the decline in dollar for dollar in regulatory capital. Essentially, investment drops in value when the market price drops below the original price resulting in losses, a situation called impairment and later written down as worthless. This means that when a company trades an asset in losses it must write down the whole value not just the impaired prices and since the market to market value classifies this as temporary impairment, companies are forced to report losses and since the original markdown is not justified, companies can experience real loss of capital. The impact of market-to-market measurement on our economy is that entities that have triggers for reporting assets may suffer losses due to increased interest rates, an effect with will have direct negative implications in our economy.
Extra disclosures have been added to the IFRS to provide information for reclassified financial assets under the amendments. Entities argue that amendments are not clear thereby exposing companies to financial risks. Since IFRS adoption in Australia, uses of fair values have increased comparability for assets. Market value measurement will be able to control marketers, processing costs and help stabilise the economy. In 2008, one of the financial crises was mortgages. Borrowers have run high risks of defaulting loan payments that why they are usually charged high-interest rates. Banks and investment companies convert subprime mortgages into mortgage-backed securities which give investors a chance to collect the underlying payment and interest. Therefore, when loan payments in 2008 started defaulting, markets for mortgage-backed securities suffered a great deal yet market-to-market rules forced them to write down the value of mortgage-backed securities even if the investors were able to hold back until the market stabilises or when they mature. Therefore, forcing investors to sell off their assets unwillingly contributes to an economic downturn since assets are sold off at losses. An effective way of addressing the current financial crisis is to temporarily suspend market-to-market rules. IFRS should devise more realistic guidelines for dealing with liquid instruments in times of economic downturn. These standards should allow banks to hold on to their mortgages until maturity to avoid marking them to market thereby reducing the global crisis. Market-to-market rules would be effective if entities applied them early enough. Lat minute application is what has brought all these problems (McTeer, 2009).
- Australian Government. (2005). Australian International Financial Reporting standards (AIFRS): Blueprint for Tax Implication. New Law Administration Design Practice, p. 1-28.
- Bradbury, M., & Zijl, T. (2005). Shifting to International Financial Reporting standards. University of Muckland business Review, 77, 1-7.
- CD. (2007). Application of IFRS to Australian Entities. AICD Policy and Advocacy, Position Paper No. 4, p. 1-6.
- Coleman, M. (2005). Inquiry into Australian accounting standards (Inquiry). Policy & Advocacy.
- Clarke, k. (2005). Change in accounting: It Makes Sense Now. AGSM Magazine, Issue 1, p. 1.
- Galore, P.(2009). What is Mark-to-Market Accounting? Web.
- Harmon, F. (2008). Fair Value Accounting in the current Environment. Independent Community Bankers of America, File Number 4-573, p.1-4.
- Leo, K., Hoggett, J., Sweeting, J. and Radford, J. (2008). Company Accounting, 7th ed. Brisbane: John Wiley
- McTeere, R. (2009). Market-to-Market Accounting: Shooting Ourselves in the Foot. National Centre for Policy Analysis, No.648.
- Public Sector Accounting standards Boards. (2001). Definition of the Reporting Entity.Statement of Accounting Concepts, 1, pp. 1-Entity.