QUESTIONS

1. General acceptance of accounting standards is important to the accounting profession. By

whom does the profession require general acceptance of the standards, and why is it important to
the profession?
Answer : Until the establishment of the ASRB and subsequent legislative support for accounting
standards, compliance with accounting standards could not be legally enforced. The profession
could take disciplinary action against members for non- compliance; however, large-scale
monitoring was impossible, and so discipline was on a very ad hoc basis. The problem of
enforcing standards detracted from the professional status of the accounting profession and also
meant that the standard-setting process may be lost to a third party. As such, the profession
sought legislative backing for standards in order to enforce compliance and increase the
professional status of the accounting bodies. The profession did not want to lose control of this
standard-setting process, but sought to use legislation to enforce compliance. The profession
sought to make its standards ‘generally accepted’:

 to ensure control of accounting outcomes and the regulatory process

and to maintain effective barriers to entry to the accounting profession

 to legitimise the accounting process, particularly in the face of

increased criticisms of the standards of accounting information reported

 to increase status by virtue of association with legislative support

 to increase demand for full GAAP statements and for interpretation

of accounting standards and financial statements

 to reduce risk associated with abidance with a set of legislated rules.

2. The standard-setting process is highly political. Describe an accounting regulation that would
be politically controversial, and the types of political pressures that could be brought to bear in
the standard-setting process.
Answer : Students might choose any accounting issue as long as they can explain why it is
political in the sense of affecting the wealth of parties in the political process. Legislating for
accounting standards reduces the outcomes to one of the political trade-offs of competing
interests. The political process, as identified by Watts & Zimmerman (1978), involves
competition for wealth distributions between different interest groups. In the accounting arena it
involves politicians who have incentives to increase government resources and retain their
political positions; companies who have an incentive to avoid political costs, such as increased
taxes or regulations; and voters whose participation in the political process is a function of the
cost of nterpreting and processing vast amounts of information. Managers have incentives to
adopt procedures that would decrease the political sensitivity of reported earnings and/or
increase their personal wealth.
There are many groups who will lobby in the standard-setting process for preferred outcomes.
The groups include trade unions, financial institutions, analysts and social groups. Individuals
also lobby in the process. Overall, the political process is seen as a means of pursuing individual
or group self-interest (Watts & Zimmerman, 1979). Some ways in which organisations have
lobbied to affect the requirements of an accounting standard">accounting standard include:

 writing responses to exposure drafts

 writing to members of the accounting standard boards putting forward their views

 making oral presentations to the boards, or to individual members of the boards

 holding meetings where key issues are discussed and ensuring that members of the accounting
standard boards are invited, or get to hear of the meetings

 holding demonstrations against a proposal that they do not favour — as occurred in Silicon
Valley where executives demonstrated against proposals for accounting for executive stock
options

 releasing media releases expressing their disagreement with proposed accounting regulation;
these releases would then result in articles in the media or announcements over the news

 forming groups to lobby for using any or all of the above methods

 offering to provide funding to the regulatory bodies for an accounting standard that suits them.
The lobbying may also be indirect and framed in a manner that draws attention away
from the direct benefits of those lobbying

6. How do you think accounting standards should be set? Is that the approach
currently taken by the IASB?
Answer : Here is one possible answer. The most feasible way may be to be aware of both the
politics of the environment and the significance of scientific evidence in the formulation and
implementation of standards. Where there is substantial theoretical and empirical evidence in
support of a proposal, the IASB should be resolute in seeking to establish the standard. But
presently such strong support does not occur often. The fact is that pressing issues need to be
resolved immediately, and there may be little, if any, empirical evidence pointing to any
particular direction. In such cases, the IASB needs to follow a theoretical (rational) argument,
based on the objective of providing more useful information. There is no question that the IASB
needs to be politically aware. However, to be aware of the political environment means different
things to different people. If it means to do a better marketing job of explaining to all interested
groups why a given proposal is being made, then that is acceptable. To receive and be aware of
the points of view of various groups of a proposal should be helpful to the IASB because the
proposed standard may not be as rational as the IASB believes. The due process procedure
should be taken seriously and not be a perfunctory routine. Contrary arguments may have salient,
legitimate points. The IASB does attempt to be independent in the formulation of accounting
standards">accounting standards. Because the support of its standards is mainly theoretical
(based on rational arguments), and interpretation of theory can result in different viewpoints,
strong opposition is seriously considered and is likely to cause a change in the proposed
standard. Empirical evidence is considered. However, that the evidence is often not persuasive;
perhaps because it is not understood by the non-academic community. With the adoption of
international financial reporting standards (IFRS), it has been suggested that the AASB and
Australian constituents will have less influence over the IASB due process than was possible in
the domestic standard setting environment. The AASB has a specific strategy of contributing to
standard setting at the IASB to maintain its influence

7. ‘We should disband national standard setters. They are of no use following the adoption of
international accounting standards.’ Explain whether you agree or disagree with this statement.
Answer : People who agree with this statement would argue that the national standard setters
such as the AASB no longer have a role to play in standard setting. The standard setting function
is carried out by the IASB and interpretations are issued by the International Financial Reporting
Interpretations Committee (IFRIC). Australia has made a commitment to use IFRS and therefore
it will be accepting all standards issued by the IASB. The AASB is no longer necessary as it will
not be developing private sector standards. A common interpretation of IFRS is necessary to
assist companies in producing comparable financial reports. However, this must come from an
international body not the AASB or a body associated with the AASB. People who disagree
with this statement would point to the fact the AASB has a role in developing standards for the
public sector and not-for-profit entities. This role has not been assumed by the IASB. In addition,
the IASB relies on the contribution of national standard setters in the development of its
standards. National standard setters such as the AASB can contribute technical expertise based
on its past experience and skill of current staff. They can work on research projects for the IASB.
In this way, the AASB can actively contribute to international standard setting. By maintaining
the AASB, Australia can contribute to international standard setting on issues of national
importance. One example is the forthcoming extractive industry standard which could be
important for Australian companies and the national extractive industry

8. What are ‘free-riders’? How can a system ensure that those who benefit most from an
accounting standard requiring certain disclosures also bear the greatest costs of it?
Answer : Free-riders are people that can utilise information once it is publicly available.
Although information may be sold to certain people only, others who did not pay cannot be
easily excluded from using the information. Examples of free-riders are financial analysts and
potential investors. There is no simple solution to the problem. Students should be encouraged to
offer ideas. Companies may act to restrict access to the financial statements to shareholders and
associated parties. Companies may establish a user-pays system where financial information is
available to non-shareholders on a fee-for-information basis. If the fee was sufficiently high,
those who pay are less likely to share the information. Nonetheless, such systems would be
difficult to administer and control, and are unlikely to be successful.

15. The IASB and FASB began a convergence project in 2002.

(a) What are the expected benefits of the convergence project?
(b) What factors make convergence difficult?
(c) How is the future of the IASB tied to convergence?
Answer : (a) Convergence is the process of aligning US GAAP and IASB standards (See Chapter
3). The Norwalk Agreement (2002) was a memorandum of understanding entered into by the
FASB and the IASB whereby they would work together to eliminate differences between the
requirements of US GAAP and IAS/IFRS. They would also align their work agendas. The
benefits of convergence are to reduce the differences between financial statements prepared in
accordance with US GAAP and IFRS thus increasing international comparability of reporting.
This has potential benefits for investors and companies.
(b) There are some significant differences between US GAAP and IFRS which make
convergence difficult. Resolution of these differences requires one party to make a significant
adjustment to reporting practices which may not be supported by constituents. Two such
examples are capitalisation of development expenses (required under IAS 38 but not permitted
under US GAAP) and upward revaluation of fixed assets (prohibited in the US since the 1930s,
but allowed under IAS 16). Political issues also make convergence difficult. The FASB issued
proposals to expense stock options in the early 1990s that did not become mandatory because of
extensive lobbying by companies and employees with stock options and the threat of
intervention by congress to prevent FASB from issuing the standard. The IASB issued IFRS 3
requiring expensing of stock options. Subsequently, the FASB introduced (from June 2005)
similar but not identical requirements.
(c) The future of the IASB is linked to convergence. The IASB’s aim is to develop private sector
standards for use throughout the world. If the US does not use or recognise these standards as
high quality, the IASB’s aim has not been achieved. If US GAAP are considered to be the ‘best’
standards, then IFRS are second best and the goal of one set of international standards has not
been realised. Convergence is a process of dealing with the differences between US GAAP and
IFRS and working toward one set of high quality international standards

18. Why would the quality of accounting and auditing standards affect the development of
financial markets? Why is the strength of enforcement of the standards and investor protection
important in this relationship?
Answer : High quality accounting standards assist the production of high quality financial
information which is useful for decision makers, including investors. High quality auditing
standards guide auditors to conduct audits which are more likely to reduce the risk of material
misstatement due to fraud or error in the financial statements. High quality and credible financial
information allows investors to have less uncertainty, and greater confidence in trading.
Confident investors are more likely to participate in the share markets, providing greater
liquidity. Greater trading volumes mean that share prices are more likely to reflect all publicly
available information. Enforcement of the standards and investor protection laws are vital to
ensure the high quality accounting and auditing standards impact positively on share market
trading. Investors gain confidence from standards only if they are enforced. Unenforced
standards are ‘not worth the paper they are printed on’, that is, they may as well not exist because
all parties know there are no consequences of breaching the standards. Investor protection laws
give investors the right to sue if accountants and auditors are negligent, particularly when they
also include provisions that ensure the audit firms are likely to have the resources to meet their
negligence liability.