Usefulness of accounting information for regulation of capital markets

The report is developed for providing an analysis of the news article ‘Check the numbers: Accounting Information still matters to you, me and investors around the world’ published on 9 August, 2018, in University of Western Australia. The article is selected as it is related to recent accounting news and as such will help in gaining an insight into the contemporary issues related to the field of accounting. This is done to provide a deeper understanding of the accounting issues discussed in the article to the CEO to give her assistance to give an insight about the information gained in an upcoming conference. The article has been taken in context of discussing the relation between the accounting information and share prices and the impact of current accounting practices and economic changes on the role of accounting information. It has also discussed the ways in which the IASB has addressed the issues raised in the context of loss of relevancy in accounting.

The article has primarily placed emphasis on the usefulness of accounting information for regulation of capital markets by having an impact on the share prices movements. This has been done by reviewing the findings published in the academic paper written by Ball and Brown in the year 1968. The researchers have investigated the impact of accounting information disclosed by businesses on their stock prices. The future researches carried out in the context have examined their underlying idea using empirical researches. It has been demonstrated through these researches that there is a sudden increase in the returns realized by the firms due to positive accounting news if released prior to the announcement of earnings and vice-versa. Thus, it has been analyzed from different researchers that there exists a relationship between the accounting information, share prices and market returns (Tarca, 2018).

In this context, the research carried out by the Nimalathasan (2014) has stated that Earnings per Share (EPS), Net assets value per share (NAPVS), Return on Equity (ROE), Price Earnings Ratio (P/R) on the share prices of the companies. This has been done by analyzing the secondary information extracted from the financial report of the some of the manufacturing companies. It has been illustrated that value relevance of accounting information has a direct impact on the share price. This is because the major objective behind publishing the accounting information is to disclose the news related to assets, liabilities, equity, income, expenses, cash flows and profit or losses of a business entity that helps the investors to gain an estimate of its future performance. In this context, the theory of market value relevance has stated that the accounting numbers possess high capability in summarizing the relevant information about an entity current and future performance. As such, the accounting information influences the stock prices as there has statistical association between the financial information and the prices of stocks. As such, it has been stated by the theory that relevancy of a financial information is dependent on its ability to influence the market value of a stock. Also, the accounting numbers disclosed by a company should disclose its current value to have high value relevancy (Nimalathasan, 2014).

The impact of accounting information on share price movements

The article has also discussed about the issue of growing concerns among the accounting professionals relating to loss of value relevance of accounting information. The executives and the investors has emphasized on the issue that accounting information published by the entities is providing to be less useful for decision-making (Olowe, 2009). The major reason analyzed for this is the increase in the gap between the indicators of capital market and the accounting information. The increase in the gap is due to failure of financial reports to disclose adequately the financial information about some of the financial items such as valuation of assets. The standard setters lack clarity in relation to valuing the assets and comparison of the revenue with the costs (Ademola, 2016).

For example, IFRS 3 that has provided guidelines in relation to recording of acquisition accounting have stated that assets of the company acquired need to be recorded by the acquiring company at the fair value. However, there exists an issue relating to making comparison of the companies difficult that realizes growth by acquisitions. This is because they can depict higher cost of goods sold and more expenses of amortization in context of valuing their inventory and intangible assets that are acquired. This can present a problem for the analysts at the time of comparing the financial information across the entities. The issue has been addressed by the IASB by developing conceptual framework that provide guidelines to the preparers for development of the financial report (Tarca,2018).The framework has discussed about the different types of measurement methods that can be used to report the financial information. It has stated that the basis of the section should be to depict relevant and faithful formation rather than being advocating the use of fair value method of measurement. The framework has also provided the definition of income, expenses, assets and liabilities for removing any uncertainty in relation to recording their value in the financial reports (Tran, Nguyen& Ho, 2015).

In addition to this, the accounting stand setting bodies have not attained success in modifying the rules relating to recognizing the assets to incorporate the economic changes that can result in the creation of value by the intangible assets. IAS 38 in this context have only placed importance on revaluating the intangible assets only in the condition of having a market that is active and non-recognition of intangible assets that are internal to a firm. Thus, the present accounting standard in this context is lacking to recognize the intangible assets of the balance sheet of a company. There has been discussion in the accounting setting boards regarding the future applicability of IAS 38. The board has initiated a research project in this context to gather views of different accounting stakeholders about the topic. The Board has also received some suggestions about the topic advocating the capitalization of expenses incurred on intangible assets for improving the matching of revenue or expenses and improving the quality of earnings (Tarca, 2018).

It has also been pointed out in the article that the recent changes in the operation of an entity and the nature of developing the financial reports have reduced the significant of accounting information. The information that is realized outside the financial report of a company is becoming more useful such as audited financial statements in the decision-making process of investors. The investors are adopting the use of different type of information about an entity before taking a financial decision bodies only relying on the accounting numbers published in the financial reports. Also, the accuracy of the decision relies largely on the skills and competency of investors rather than only based on quality of accounting information (Wang, Fu & Luo, 2013).

Loss of value relevance of accounting information

Conclusion

It can be concluded form the overall analysis of article that accounting information is highly relevant to facilitate the investors for making a review of the current and future performance of an entity. However, with the recent economic changes that has developed a gap between the accounting information influences on the share prices of an entity. This is due to lack of adequate standards for reporting all the useful information that is required by the investors to gain a realistic view of the financial performance of an entity. For example, there are many intangible assets that are not reported n the balance sheet by an entity as per the current accounting standards. Therefore, accounting information has failed to capture all the aspects of an entity to present an analysis into its current and further growth prospects. The Board is seeking to improve the accounting standards for promoting relevancy and accuracy in financial reporting. The conceptual framework of financial pertaining has been developed in this relation to provided enhanced guidance to the preparers about the selection of an adequate accounting policy and procedure to develop the financial reports. However, in this context, it is recommended to the investors to analyze an entity performance by reviewing the information from diverse resources besides relying only to that disclosed in the financial reports.

Exposure draft selected to make the review has been provided by International Accounting Board as International Financial Reporting Standard. This exposure draft is related to the leases and it is issued to issue the new accounting standard on leases IFRS 15 to replace the older standard IAS 17. The effective date of this new accounting standard is 1 January, 2019. Leases are an important source of flexible financing option for many companies. Through applying the accounting standard IAS 17 Leases, company’s reports only finance leases in balance sheet. It gives rise to significant issue as other leases such as operating leases have been disclosed in notes to account that makes difficult for the investors to compare financial information companies. The issue is that investors and other stakeholder’s have make estimation for the off balance sheet items in relation to the lease obligations that leads to overestimating or underestimating the leases liabilities that arises from the obligations. So to solve this issue and to help the investors to have the accurate picture of lease assets and liabilities, IASB has decided to develop the new accounting standard or model that aims to solve the issue through making mandatory for all the companies to report the all type of lease assets and liabilities in balance sheet (Leases: Exposure Draft, 2013).

The first exposure draft on lease has been published in year 2010 but there are some uncertainties in that exposure draft that has been rectified in new exposure draft issued in year 2013. The revised exposure has been rectified on the basis of comments letters received on old exposure draft. This project was undertaken jointly by IASB and US Accounting Board (FASB). There are multiple questions asked by the respondents in this exposure to receive their opinion on these questions. All such questions are based on new accounting model on leases introduced by the joint effort of FASB and IASB. The revised exposure aims to provide new definition on lease. As per the new definition on lease, lease is a contract that allows the lessee the right to use an asset for the period of time in exchange of some consideration. So to determine a contract to be lease, there need to check whether the fulfillment of contract mainly depends upon the use of an identified assets and the contract states the right to use and control such asset in lieu of consideration. The new accounting model on lease is critically defined to classify the lease and to make them recognized as assets or liabilities. As per the new accounting model the classification criteria of lease is based on the consumption principle (Leases: Exposure Draft, 2013).

Impact of current accounting practices and economic changes on the role of accounting information

The question 1 to 4 in revised exposure draft is related with definition, accounting by lessee and lessor, and classification of leases. Question 5 and 6 discuss about the measurement criteria of leases and rest question 7 is on transition procedure for lease. Lastly, question 8 requires information on disclosure requirement. There are some more questions related to nonpublic entities and related party leases (Leases: Exposure Draft, 2013).

In this section, comment letters received from various respondents have been analyzed to provide the opinion on the agreement and disagreement with the exposure draft. The comment letters are provided by the respondents to express their views on the exposure draft. Four comments letters are selected from range letters and all four letters are from four different organizations as mentioned in each comment letter.

• Comment Letter 1 (CPA Australia):This comment letter has been given by the CPA Australia and Institute of Chartered Accountant of Australia. As per views provided in this comment letter, CPA Australia has clarified that current exposure draft on leases is based on rules based approach rather than principle based approach that completely misses the most important objective of the conceptual framework. CPA Australia supports the objectives of exposure draft to include all the leases in the balance sheet. However, CPA mentions that IASB needs to work more on the exposure draft for the issues identified by them. The significant issue raised by CPA Australia was regarding the transparency issue that has been raised in exposure draft. At one point, exposure draft increases the transparency by bringing in all the leases on the balance sheet so that more information on leverage position of the company can be easily communicated to the stakeholders. On the other hand, exposure draft provides a dual model for calculating the income and expenses that certainly reduces the transparency in the new accounting standard on leases (CPA Australia, 2013).
• Comment letter 2 (Louis W. Sanford, CPA): This comment letter has been introduced by an individual and on the basis of analysis it has been found that he has provided his agreement with the exposure draft. The comment letter seeks to provide that if all the leases are shown in balance sheet will result greater transparency in financial position of the company as it reflects overall lease commitment of the company in regards to operating leases and finance leases (Sanford, 2013).
• Comment Letter 3 (The Lechner Group Limited): The Lechner Group Limited is engaged in both legal and accounting services related to lease finance market. As per the information provided in this exposure draft, company does provide its disagreement with exposure draft. Company has provided the re-exposure draft is unjustified and unacceptable as mere disclosing lease commitments in balance in form of enhanced disclosures will be sufficient and also it will more cost effective (The Lechner Group, Ltd, 2013).
• Comment Letter 4 (Royal bank of Scotland Group): It is bank with many branches in Scotland. As per their views they are not convinced with the proposals in new accounting standard on leases as it significantly changes the old accounting standard. They agree with the minor changes in the old accounting standard as new accounting standard provides complete makeover of existing accounting standard (The Royal Bank of Scotland Group, 2013).

On the basis of analysis of all the four comment letters it has been found that two comment letters are in favor of regulations (IASB) while two comments letters does not favor the regulation. The two comment letter that favor the regulation has provided that bringing in the new accounting standard in place of old accounting on leases will definitely increase the transparency and also help in better recognition. However they provided some concern over the exposure draft regarding the dual measurement concept. The comment letters that does not favor the regulations has provided their explanation that introducing the new accounting of leases has significantly change the old standard with no essential requirement and it will lead to extra burden on the companies. They have provided the new accounting standard has failed to provide its commitment on transparency due to impact of dual measurement concept introduced.

The theory of public interest has stated that economic markets are very weak and they have a tendency to operate in an inefficient manner. As such, it is very important for government to intervene for regulating the financial intuitions to work in the interest of public and ensuring effective allocation of resources. On the other hand, the theory of private interest states that individual seek to act in their own interest and the organizations seeks to influence the action of government for maximizing their own-interest. On the other hand, capture theory has identified the relation between the government agencies and the industries in which they operate. These agencies are developed by the government at central and state level for ensuring that the interest of society are not negatively impacted by the activities of organizations (Knapp, 2009).

On the basis of application of each theories of regulation on the comments letters it has been found that two comments that favor the exposure draft has critically evaluated the draft and provided their concern on it. Both of these comments letters shows views that are in public interest and has widespread impact. While rest of two letters are not in public interest as they are thinking of few stakeholders without making concern in the large level of stakeholders that faces problems while evaluating the leases disclosures in the notes to accounts.

References

Ademola, O.J. (2016). Impact of Accounting Information on Stock Price Volatility. International Journal of Business and Management Invention5 (11), pp. 41-54.

CPA Australia. (2013). Retrieved 24 September 2018, from https://eifrs.ifrs.org/eifrs/comment_letters//24/24_2168_KerryHicksInstituteofCharteredAccountantsAustraliaandCPAAustralia_0_20130820JointIASBSubmission_ED20136_Leases.pdf 
Knapp, J. 2009. The Business of Higher Education. ABC-CLIO.

Leases: Exposure Draft. (2013). Retrieved 24 September 2018, from https://www.ifrs.org/-/media/project/leases/revised-ed/published-documents/ed-leases-may-2013.pdf 

Nimalathasan, B. (2014). Value relevance of accounting information and share price: A study of listed manufacturing companies in SriLanka. Merit Research Journal of Business and Management 2(1), pp. 001-006.

Olowe, R.A. (2009). Stock return, volatility and the global financial crisis in an emerging market: the Nigerian case. International Review of Business Research Papers, 5(4).

Sanford, L.W. (2013). FASB Exposure Draft-Leases (topic 842). Retrieved 24 September 2018, from https://eifrs.ifrs.org/eifrs/comment_letters//24/24_6792_LouisWSanfordIndividual_0_ED201306_CL13LouisWSanford.pdf 

Tarca, A. (2018). Check the numbers: Accounting information still matters to you, me and investors around the world. Retrieved 23 September, 2018, from https://www.ifrs.org/news-and-events/2018/08/ann-tarca-cpa-lecture-check-the-numbers/

The Lechner Group, Ltd. (2013). Retrieved 24 September 2018, from https://eifrs.ifrs.org/eifrs/comment_letters//24/24_10990_PaulLechnerTheLechnerGroupLtd_0_ED201306_CL79TheLechnerGroupLtd.pdf 

The Royal Bank of Scotland Group. (2013). Retrieved 24 September 2018, from https://eifrs.ifrs.org/eifrs/comment_letters//24/24_2379_RajanKapoorTheRoyalBankofScotlandGroupplc_0_RBSGcommentletterED20136Leases.pdf 

Tran, T.T.H., Nguyen, N.D., & Ho, Q, B. (2015). The relationship between accounting information reported in financial statements and stock returns – empirical evidence from Vietnam. International Journal of Accounting and Financial Reporting, 5(1).

Wang, J., Fu, G., & Luo, C.(2013).Accounting information and stock price reaction of listed companies — empirical evidence from60 listed companies in Shanghai stock exchange. Journal of Business & Management, 2(2).