International Regulation, Accounting Standards and Australia Background

¶ … International Regulation, Accounting Standards and Australia

Background and Need for Regulation

International regulation is a necessity in the finance arena as the world bears a high rate of interconnection, particularly via banking and accounting. In 2008, Europe was given international accolades for its attempts to strengthen the world financial system and protect nations all over the world from a serious crisis. "Europe led the way last year in facing down the global financial crisis, restructuring our banking system and strengthening the global financial system. The European Union was also at the forefront in calling for a new forum for economic cooperation of G-20 leaders. And from the outset of the crisis, it was Europe that promoted the fiscal stimulus -- and sought to coordinate it globally -- that has been a major factor in preventing recession becoming a world-wide depression" (Brown & Sarkozy, 2009).

The reality is that in order for health global finance to occur, there truly needs to be global regulation. A clear example of this was when the EU created a thorough set of rules for the financial sector so that the crisis of 2008 was not repeated again; this consisted of elements like tight control over credit rating agencies, stricter capital requisites on intensive products such as securitization, and a bolstering of the deposit guarantee schemes (Brown & Sarkozy, 2009). These are all forms of international regulation which ensure that risk taking does not become the standard and that capital rules for banks are stronger and tighter (Brown & Sarkozy, 2009).

Benefits of Regulation

All of these decisions have the interest of the world and the global economy at heart and attempt to protect international interests. In many respects, there's a strong argument for this type of regulation; as Deegan illuminates, many markets for information simply aren't efficient and generally, "on average" market efficiency arguments tend to dismiss or devalue the rights of individuals (2009). Other arguments for regulation demonstrate how regulation can be so effective because it enables the regulators to demand information from certain entities and get it, whereas in other circumstances this just wouldn't be possible (Deegan, 2009). Regulation is vital because it protects individual investors from fraudulent organizations that can hide behind fabricated or invented information (Deegan, 2009). Regulation creates an environment where more and more entities are forced to adopt uniform methods which thus bolster comparability (Deegan, 2009). It's easy to see how regulation can so clearly benefit the world economy. Regulation forces companies and banks to adopt a greater level of transparency, protecting investors, local and national stock markets and holding everyone to a higher standard of business practices.

Transparency is nothing that should be underestimated, as it's related to quality. Quality is defined as, "the extent to which accounting information reflects the underlying economic situation of the firm. It is related to the concept of 'transparency,' defined as the ability of users to 'see through' the financial statements to comprehend the underlying accounting events and transactions in the firm" (Gallery, 2006). Regulation is one way, some argue, that transparency/quality can be achieved, and other argue for standardization or harmonization of accounting practices.

Main Theory in Support of Regulation

There are numerous theories which support regulation, such as the most commonly cited one is the "public interest" theory of regulation, a theory which is founded in two assumptions (Shleifer, 2005). The first assumption is that markets which go unregulated generally fail because monopolies take over or externalities disrupt; the second assumption believes that governments are mostly benign and are able to correct these types of failures and forms of corruption through regulation (Shleifer, 2005). "According to this theory, governments control prices so that natural monopolies do not overcharge, impose safety standards to prevent accidents such as fires or mass poisonings, regulate jobs to counter the employer's monopsony power over the employee, regulate security issuances so investors are not cheated, and so on" (Shliefer, 2005). As the last hundred years have demonstrated, the public interest theory of regulation is the cornerstone of modern public economies" (Shleifer, 2005).

Criticisms of Regulation

This is just one example of a common theory which supports regulation; however, it's a theory which has been criticized and derided by experts, scholars, economists and professionals for a very long time. The three main criticisms that this theory is normally on the receiving end of are as follows: markets and private orderings can look after and deal with the bulk of market failures without the intrusion of government, or even regulation (Shleifer, 2005). Furthermore, in the particular instances where a market might need extra help or guidance, government regulation isn't needed as litigation can address whatever conflicts exist (Shleifer, 2005). Finally, if markets and courts can't adequately address the issues or problems that markets are having, it's highly unlikely that government regulators will be able to achieve this, as they have reputations of being "incompetent, corrupt and captured" so there's the very real possibility that government regulation will indeed make things worse (Shleifer, 2005).

There are some very real and immediate drawbacks to government regulation. As Deegan explains, accounting regulation is not necessary because people generally pay for information to the extent that it has use (2009). Capital markets generally act to punish or discipline organization which fails to provide information, thinking that no news is equivalent to bad news (Deegan, 2009). Regulation can also create a situation where there's a surplus of information as a result of the fact that users who do not want to deal with the price of supply can tend to overstate their needs. Regulation can also limit the accounting methods that an organization is able to use -- this can be tremendous headache, making an entity unable to use methods which truly reflect their performance and position (Deegan, 2009). Unfortunately, this isn't a simple matter of convenience; regulation in this case can mean that it can impair the efficiency with which the firm informs the market about operations (Deegan, 2009).

Drawbacks to International Accounting Standards

As we've seen, in recent years, Australia among other countries such as those in the European Union have opted to adopt accounting standards such as those stipulated by the IASB. The average person might find this both reasonable and logical; in order to follow international regulations it can help to adopt international standards. However, as recent history has demonstrated, such an attitude is completely over-simplistic and incorrect. International standards can have a truly negative impact on profits of major corporations, which is often the reason they're in existence in the first place: to make profits. Deegan gives an apt example of The New Corporation Ltd. In 2000, they reported $1.92 billion in profit (2009). However, according to documents filed with the U.S. Securities and Exchange Commission that profit almost of $2 billion dollars would have been filed as a $329 million dollar loss (Deegan, 2009). This example highlights how the standards and regulations of one country can be meaningless and detrimental to another.

Advantages of International Accounting Standards

At the same time, many people within the international community are pushing for the adoption of international accounting standards for a variety of reasons. These reasons are indeed legitimate and offer a range of benefits; for example, such standards means that international investors are able to better comprehend the financial performance and standards of companies all around the world (Deegan, 2012). With this greater level of understanding and transparency abounding, there's the expectation that a greater amount of capital inflow will be created and that it will be even easier for companies to be listed on the stock exchanges of foreign countries (Deegan, 2012). If a particular company is listed on more than one stock exchange, this would mean that company would only need to produce one set of financial statements for a host of cost savings (Deegan, 2012).

The team members working for international entities in the arenas of accounting and auditing will have greater mobility to move to other companies as a result of this unification of the standards. The cost savings will orbit around the accounting-standard setting function, as opposed to the individual companies attempting to mimic the work of others; the bulk of functions of the standard-setting process will orbit around the IASB (Deegan, 2012). Furthermore, there is an expectation that the IFRS will help develop more accurate and comprehensive and timely financial statement information, in connection with the information that would have been generated from the national accounting standards that were replaced (Deegan, 2012). Deegan also points out that "to the extent that the resulting financial information would not be available from other sources, this should lead to more-informed valuations in the equity markets, and hence lower the risks faced by investors" (2012).

In the case of Australia, many experts believe that there is absolutely no point in Australia having standards that the rest of the world cannot understand. Even though for the longest time, Australia had its own way of dealing with incorporated companies and other entities and their means of reporting (Greite, 2007). These experts find such practices to be isolating and do little to attract business, capital or investors to the country. "Even if those standards were considered to represent best practice, Australia would not necessarily be able to attract capital because foreign corporations and investors would not be able to make sensible assessments, especially on a comparative basis of the value of the Australian enterprises. The need for common accounting language to facilitate investor evaluation of domestic and foreign corporations and to avoid potentially costly accounting conventions by foreign listed companies are powerful arguments against the retention of purely domestic financial reporting regimes" (Deegan, 2009, p.110). Essentially, this sentiment makes a truly powerful argument: while a country like Australia committing to their own unique accounting standards is indeed a good idea if the nation just wants to live in isolation, but in order to be an active member of the world economy and to attract foreign investors, they truly need to engage in a greater degree of standardization. One expert even accused Australia of lagging the Europe in regards to lagging IASB standards and asserted that this was something that simply could not be afforded by the world economy (Godfrey & Chalmers, 2007).

Thus, when the question is posed, whether or not it's appropriate for foreigners to set accounting standards and regulatory practices for local questions, the answer is not so simple. As we've seen, a country like Australia can very well keep to their own standards of practice, and whatever they feel is in their best interest, but the reality is that could very likely drive potential business and investment away from the country, leaving it more isolated. There's simply a consequence of action (or lack of activity and development) that the nation will thus have to prepare for. While it might not be beneficial for the world economy if a country the size of Australia opts to not even harmonize the rest of the world, one can still make the argument that the final course of action for Australia remains to be Australia's decision.

Standardization, Regulations and Australia: Recommendations

Fundamentally, while harmonizing one's accounting practices might be an adjustment for the first five years or so, it's generally a very practical decision and one which is incredibly future oriented as it essentially encourages foreign investment to Australia and allows Australian companies to truly expand. The goal is to get Australia more firmly on the world's playing field, and the only real way to do that with any success is through compliance to world accounting standards. This is because investors are constantly making economic choices and undergoing the task of comparing information, harmonized of standardized accounting standards are essential otherwise a particular nation is going to get left out of the comparison because their methods appear strange, foreign or unreadable (Beke, 2011).

"Without harmonization in the underlying methodology of financial reports, real economic differences cannot be separated from alternative accounting standards and procedures. Harmonization is used as a reconciliation of different points-of-view, which is more practical than uniformity, which may impose one country's accounting point-of-view on all others. Organizations, private or public, need information to coordinate its various investments in different sectors of the economy. With the growth of international business transactions by private and public entities, the need to coordinate different investment decisions has increased" (Beke, 2011, p.38). For a country like Australia, making these changes might seem like a hindrance, but ultimately such changes will enhance the nation tremendously. Adoption of these standards mean that Australia will experience a reduction in financial reporting costs and many barriers to international capital flows will be eliminated (Bowrey, 2007).

As stated earlier, Australian businesses and banks want to be able to participate in the world playing field, and the adoption of such rules can only benefit the nation in its entirety. For example, the increased comparability of financial reports with others from different countries will minimize analyst costs and increase the standard of financial reporting in Australia and of course provide a greater wealth of information for decision-makers (Bowrey, 2007). This is not to imply that previous Australian accounting standards were not of high quality; in fact, they have always been of the highest quality and were recognized in the world for being of such a high standard. But the issue at hand is not the quality of Australia's standards, but the fact that they're different (Bowrey, 2007). Australia had long needed to standardize they're accounting practices for a long time historically, and in recent years has begun to do so. However, this process should not be seen as Australia being overly-flexible to arbitrary standards set by nations around the world. Australia has a representative on the International Accounting Standards Board so everyone should be aware that Australia is still a respected country that is a partner in shaping the standards.