Motivations for Directors not to Revalue Property, Plant and Equipment
The primary reasons behind the criticism of the financial accounting standards and the IFRS in the article, `Unwieldy rules useless for investors“ has various reasons behind it. The primary objectives of the financial reporting have been given as below:
- They provide useful information which assists in making various investment decisions
- The different years cash flow are analyzed carefully using these decisions.
- The different changes in the structure of the business can also be analyzed.
Given below are the conceptual framework`s characteristics:
- Comparability- The information which is given is required to be compared with other entities that belong to the same financial year. The given characteristic which define comparability help the users of the system in order to evaluate the similarity and the differences among the different items.
- Relevancy- The information which is present needs to be relevant in nature and must possess the capacity to influence the investor`s decisions. The primary key aspect of the financial reporting is relevancy.
- Representation of information faithfully- It is necessary for the users of the financial statements who are commonly known as the stakeholders to have access to the faithful information represented in the financial statement. The meaning of faithful representation is that the information which has been represented in the financial statements needs to be free in terms of error, should be complete in nature and needs to represent neutrality. The framework also states that there needs to be prudence while all judgements are to be made with respect to uncertainty.
- Timeliness- The information that needs to be provided should be available and utilized in time so that the decisions can be taken in a timely manner.
- Understandability- The information in the statements needs to be understood by the users. The given information should not be misleading the users in any manner (Scott 2015). If this is not followed, then the purpose of the financial reporting will not be withheld.
After these points it has been analyzed that, the article information varies and the article quotes that the characteristics which have been stated above have not been satisfied by the present reporting practices which are related to the IFRS. The article mentions that IFRS adjustments are not relevant to the scenario and not faithful to it. The given information is quite misleading for the given set of investors. Additionally, the different investors are unable to compare the information while making investment dictions.
However, the views which have been given in the article match with the view and perception that the financial reports of the corporates just tend to satisfy the objective of financial reporting which have been stated in the Conceptual Framework. The primary motives of the financial reports is to provide relevant data and information to the different users of the system with regard to the assets, liabilities and the equity of the organization (Ahmed, Neel and Wang 2013). This tends to be useful to all the stakeholders who are present.
It is the duty of the financial reports of the corporates to satisfy all the mentioned characteristics of the Financial Framework which acts as a guideline required to meet the requirements and needs of the different stakeholders who use information from the financial statements.
The public interest theory states that there exists an assumption whereby the economic markets are extremely volatile and delicate. They do not tend to operate in a manner with respect to which they are designated to operate (Brown, Preiato and Tarca 2014). The theory states that primary importance is given to the people and hence there exists a need to the performance of the economic markets by the government.
A.C.Pigou formed the theory in 1932. He stated that the regulations may be raised with respect to the economic environment assessment, when the public demands for it. The regulations act as a measure which tend to uphold the interest of the society more than the interest of the given individual. This is because it lies the duty of the regulation to secure the interests of the society.
Effects of not Revaluing on Financial Statements
The public interest theory makes it necessary that the regulation is passed effectively and it becomes crucial for all corporate enterprises to give detailed information about the harm which is being made upon the given environment and the society for their activities. The government needs to conduct a survey and this survey should be published online. The government then can assure that the information is accessible for people online and their queries can be cleared accordingly.
The Capture Theory states that the different workers present in the industry tend to dictate the agencies of the Government and tend to work with the motive of safeguarding the different interests of the industry. The workers in the industries can take part in jeopardizing the distribution of the resources in the given society so as to manipulate the distribution in a manner that the needs of the society are fulfilled accordingly. It is based on the nexus that government agencies and the industries are required to maintain (Teixeira 2014). The government establishes the regulating agencies at the central, local and the state levels in order to provide them the responsibility and the duty of securing the needs of the society and save it from the ill effects of the activities of the industry (Ball 2006). According to the theory, a discrepancy tends to take place when the industry workers tend to get involved with the different people working in the governmental organization.
Hence, it is the need of the hour to ensure that the regulating agencies have people who have expertise and knowledge with respect to the area in which they are operating. It often happens that certain people who have profound knowledge in a particular domain then it may happen that the workers in the government agency have been former industry employees, then they start acting as informers of the industry which then helps them to gain work. Hence, in this manner the governmental organizations get captured by the industrial workers and this acts as a discrepancy.
The given theory states that the different groups which are present in an industry tend to be formed with the motive of securing the economic interest of the industry (Nobes 2014). The industry has a presence of various groups which tend to compete with one another. Using this majority they tend to pass legislations in their favor and secure their needs (Lequiller and Blades 2014). The different economic groups act with respect to their self-interest and aim to secure their position in the market. They tend to provide various offers to the different groups and then they ask them for favors (Leuz and Wysocki 2016). These groups are quite powerful in nature and tend to act in their own interest and then they often violate the environmental and social norms which they should have to solve.
Impact on Shareholder Wealth
The FASB Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets , it has been stated that the different companies are not allowed to conduct the revaluation of the assets but in fact they need to consider the costs of impairment when they are conducting the valuation of the non- current assets. The non-current assets are required to undergo impairment costs. In other manner, these rules tend to hold relevance and faithfulness in the US corporate financial statements. The costs of the impairment tend to have negative impacts on the companies as it tends to increase their operating costs in the form of impairment costs. However they do not tend to have an impact on the physical net cash flow balance (Jorissen et al. 2013). The given set of rules have been formed with the benefit of providing the users of the different financial statements a better and clear image about the different activities which are ongoing. It is the primary purpose of a financial statement to provide a clear picture to the different users.
However, in the given scenario, the historical perspective is ignored in the realm of the financial statements. The depreciation of the different assets which are present are adjusted every year and the carrying value of the assets keeps changing continuously (Christensen et al. 2015). It is given in these statements that the carrying value of the different assets are required to undergo changes.
Hence, the impact of the United States Financial Accounting Standards Boards with respect to relevance and representational faithfulness of the different financial statements of the US corporate have been discussed accordingly (Ifac.org. 2018).
There are various reasons for which the revaluation of assets is done. The primary reason behind this is the assessment of the true value of the assets in a given point of time. The reasons for the revaluation are given as follows:
- In order to reflect the fair and true value of the assets
- To understand the current rate of interest with respect to the capital which has been employed.
- In order to conduct sales of a particular asset (Christensen, Hail and Leuz 2013).
- To help in decreasing the debt equity ratio of the organization
- It assists in the negotiation of the asset pricing before any acquisition takes place.
However there are various reasons for which the companies do not prefer to revalue the assets and adopt a cost model. These reasons are as follows:
- It leads to reduction in the satisfaction of the investor
- It brings avoid higher liquidity in the asset value (Hoyle, Schaefer and Doupnik 2015)
- It contributes to loss of historical perspectives.
Due to the above reasons, the directors of the organization are motivated not to revalue their property, plant and equipment.
In case a company chooses not to revalue its assets then there may be several consequences. The first one of these will be that the financial statements would not reflect the true and fair value of the organization. The debt equity ratio of the organization will also reflect a huger rate than the original value (Deegan 2013). Secondly, the rights issue to the shareholders will not exist. Lastly, they will not be able to reflect the correct net profit margins and the assets will be understated.
The share prices act as a reflection of the information which is available in the financial statements in cases where the capital market is inefficient. The net asset backing per share along with the decreasing value of the assets tend to have an impact on the share prices severely, however this may be offset by the perception that the profit might be higher. Hence, in scenarios where the capital marketing is inefficient, the revaluation of the assets tends to have little to no impact on the prices of the shares and hence accordingly on the wealth of the shareholders.
References
Ahmed, A.S., Neel, M. and Wang, D., 2013. Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), pp.1344-1372.
Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), pp.5-27.
Brown, P., Preiato, J. and Tarca, A., 2014. Measuring country differences in enforcement of accounting standards: An audit and enforcement proxy. Journal of Business Finance & Accounting, 41(1-2), pp.1-52.
Christensen, H.B., Hail, L. and Leuz, C., 2013. Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics, 56(2-3), pp.147-177.
Christensen, H.B., Lee, E., Walker, M. and Zeng, C., 2015. Incentives or standards: What determines accounting quality changes around IFRS adoption?. European Accounting Review, 24(1), pp.31-61.
Deegan, C., 2013. Financial accounting theory. Graw-Hill Education Australia.
Hoyle, J.B., Schaefer, T. and Doupnik, T., 2015. Advanced accounting. McGraw Hill.
Ifac.org. ,2018. Does IFRS Have a Future in the US? | IFAC. [online] Available at: https://www.ifac.org/global-knowledge-gateway/business-reporting/discussion/does-ifrs-have-future-us [Accessed 19 May 2018].
Jorissen, A., Lybaert, N., Orens, R. and Van der Tas, L., 2013. A geographic analysis of constituents’ formal participation in the process of international accounting standard setting: Do we have a level playing field?. Journal of Accounting and Public Policy, 32(4), pp.237-270.
Lequiller, F. and Blades, D., 2014. Understanding national accounts.
Leuz, C. and Wysocki, P.D., 2016. The economics of disclosure and financial reporting regulation: Evidence and suggestions for future research. Journal of Accounting Research, 54(2), pp.525-622.
Nobes, C., 2014. International Classification of Financial Reporting 3e. Routledge.
Scott, W.R., 2015. Financial accounting theory (Vol. 2, No. 0, p. 0). Prentice Hall.
Teixeira, A., 2014. The International Accounting Standards Board and evidence-informed standard-setting. Accounting in Europe, 11(1), pp.5-12.
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