Topic 2

Accounting Regulations,
Financial Reporting and
Disclosures

Learning Objectives/outcomes
Understand

the theories of regulation

Understand the financial reporting regime in
Malaysia
Understand the standard setting process
Convergence/Migration with IFRS
Issues of standard setting

 Managers

incentives
to voluntarily
The theories have
of regulation
relevant
to
provide accounting
information, so why do we
accounting
and auditing
observe the regulation of financial reporting?
Explanations are provided by:

theory of efficient markets

agency theory
theories of regulation

Theory of efficient markets

The forces of supply and demand influence
market behaviour and help keep markets
efficient
This applies to the market for accounting
information and should determine what
accounting data should be supplied and what
accounting practices should be used to prepare
it

Theory of efficient markets

The market for accounting data is not efficient

The free-rider problem distorts the market
Users cannot agree on what they want
Accountants cannot agree on procedures
Firms must produce comparable data
The government must therefore intervene

Agency theory
The

demand for accounting information:

for stewardship purposes

for decision-making purposes

framework in which to study the

relationship between those who provide
accounting information - e.g. a manager and those who use it e.g. a shareholder or
creditor

Agency Theory

Because of imbalances between data suppliers

and data users, uncertainty and risk exist
Resources and risk are likely to be mis-allocated
between the parties
To the extent the market mechanism is
inefficient, accounting regulation is required to
reduce inefficient and inequitable outcomes

Theories of regulation
There

are three theories of regulation:

public interest theory

regulatory capture theory
private interest theory

These theories are derived from economics.

Public interest theory

Government

regulation is required in the

public interest whenever there is market
failure (inefficiency) due to:

lack of competition
barriers to entry
information asymmetry
public-good products

Public Interest Theory

Accounting

information is considered as a public good.

Assumption of potential market failures.
Argues that firm is the monopoly supplier of information.
Favors regulation to protect consumer interests
Market failures" occur where the price mechanism that
regulates supply and demand breaks down, forcing
government to take action.
For exampleIn USA, Monopoly power enjoyed by railroad
companies gave rise to discriminatory freight charges--to
the detriment of farmers and industries located in remote
areas. Interstate Commerce Commission (ICC) was created
to correct for this market failure.
Criticism : There is a good deal of evidence that socially
undesirable results of regulation are frequently desired by
groups influential in the enactment of legislation setting up
the regulation scheme.

Public Interest Theory and Market Failure

This theory of economic regulation is rooted in perception that

government must step in to regulate markets in instances when
markets are unable to regulate themselves.

Natural monopolies and external costs ( e.g., "externalities") are the

most prominent types of market failure. Natural monopolies occur
when the fixed costs of supplying a good are so great that it makes
sense for only one firm to supply that good.
Public utilities like the delivery of electricity or water/wastewater
services to your home usually require so much money to build the
necessary infrastructure (erect utility poles and lay pipelines) that no
company would take on the task without confidence that it would
control a sizeable portion of the market.

Public interest theory

Governments intervene:
to get votes
because public interest groups demand intervention
because they are neutral arbiters

Regulatory capture theory

@ life-cycle theory of regulation
All members of society economically
rational/self interested
Although it starts out in the public interest,
regulation later becomes an instrument for
protecting the regulated group.
Difficult for regulatory body to remain
independent because survival depends on
its policies being accepted by the group
being regulated.

Capture theory of regulation

In effect, the government agency is "captured" by the

industry it is regulating.
The capture theory of regulation indicates that
government regulators act as the decision-making
"head" of a now monopolized industry.
This is achieved by a "rotating door" between the
government agency and the industry, with members of
the regulating agency being former and future
employees of the industry.
Rather than promoting efficiency, the regulating agency
creates an inefficient allocation of resources.

Capture theory of regulation

Capture theory of Regulation :

It proposes that parties subject to regulation seek to
control the Govt. or its agents.
Individuals are rationalists and they will pursue their
self-interest
They act to increase and protect their wealth by
seeking control of the regulatory bodies.
They dictate the agenda . They ensure that agents
performance is ineffective.

Indicators
of Capture theory of regulation

Four situations in which capture may occur:

1) Control the regulation and regulatory agency
2) Succeed in coordinating the regulatory bodys activities with their
own activities so that their private interest is satisfied
3)Ensure non-performance by the regulating body
4) Mutually shared perspective, giving them the regulation they
seek

Capture Theory of Regulation

The public interest is not protected because those being

regulated come to control or dominate the regulator
The regulated protect or increase their wealth
Assumes the regulator has no independent role to play
but is simply an arbiter between battling interest groups
Professional accounting bodies or the corporate sector
seek to control the setting of accounting standards

Private-interest theory
Regulatory

activity reflects relative power

of interest groups
The power to coerce where politicians are
not neutral arbiters
Regulation sought by producer i.e.
private interest groups
Prefers free market/self-regulation

Private Interest Theory

(or Capture Theory
Stigler and Friedland (1962): They formulated an
econometric model to test the effect of regulation
on electricity prices:

Price = f(Population, Fuel, Income, Hydro, Dummy)

Results: Regulation (the dummy variable) had

insignificant effect on the average price of
electricity; regulation was more likely to protect
commercial and industrial consumers than
domestic consumers.

Private Interest Theory

Governments

are not independent arbiters,

but are rationally self-interested
They seek re-election
They will sell their power to coerce or
transfer wealth to those most likely to achieve
their re-election (if they are elected officials)
or increase their wealth (if they are appointed
officials) or both

Applications of Private Interest

Theory
The

Sarbanes-Oxley Act (US, 2002)

Accounting Standards Review Board (AUS,
1984)
But:

Managers have incentives to voluntarily correct

market failure perceptions about their firms

Some issues?
Was

the ASRB captured by the accounting

profession?
Is international harmonisation evidence of
capture by large companies, the ASX and the
accounting profession?
Has the IASB been captured by the FASB?

Similarity of private interest theory with capture

theory

The two theories suggest that politicians aim at

maximizing their utility.
The politicians aim at maintaining political
power in their efforts to design regulations for
the industries. They seek money, votes and
resources from the groups that are favored
by the regulations (M. J. R. Gaffikin,
Regulation as an Accounting Theory, 2009,
para 25).

Free market/self-regulation
theories
Political

economy theory
Legitimacy theory
Stakeholder theory
Institutional theory

Political economy theory

Political economy theory is concerned with how
people allocate resources and makes decisions.
These decisions also involve the institutional
arrangements of power and the resulting conflicts
as well as notions, morality, equity and justice
Political economy explains the need for standards
to reduce the cost of producing information as
well as the institutionalisation of standard setting
processes

Political economy theory

Corporate reports not considered neutral and
unbiased, but are a product of the interchange
between the corporation and its environment
Classical political economy posits that
Accounting reports and disclosures are a means
of maintaining the favoured position of those
who control scarce resources
Bourgeois political economy theory branches
into legitimacy theory and stakeholder theory

Systems based theories

Legitimacy Theory, Stakeholder Theory and Institutional

Theory are all systems-based theories
Focus on the role of information and disclosure in the
relationships between organisations, the State,
individuals and groups
The entity is influenced by, and influences, the society in
which it operates

For

example, research on social and

environmental disclosures fall under these
theories

Social Contract Theory

An agreement among the members of an organized society or

between the governed and the government defining and limiting the
rights and duties of each.
The social contract theory - explaining the boundaries of acceptable
interaction between participants within society
Example: Social contract between X brand and its consumers:
We recognize that we live in a new world where reckless profit and
self-interest hurt our business, our own lives and those of people we
care about, as well as millions of human beings around the world. We
believe that a better future depends on an integration of profit and
purpose within the private sector. To that end our company and our
customers must become partners in a social change to build a better
world. We agree that certain principles guide our own behaviour in the
relationship between us.

Companies and communities

Companies employ people in communities to make products that

they can sell for "business interests." By coming into a community,
they often become major employers, and can affect the
environment. If they pay substandard wages, work their people to
death, leave the community, or harm the environment, they can
leave a trail of destruction in their wake.Too often, companies feel
no responsibility for these things.
Everything is a resource for their taking, and they can do anything
that they can get away with. We believe that companies do have a
long term responsibility to the people, families, communities, and
environment that they impact, as well as to customers and investors,
and when they refuse to agree to these responsibilities, then they
are undesirable.

Legitimacy theory
Organizations seek to ensure they operate
within the bounds and norms of their respective
societies
Activities are perceived to be legitimate
Bounds and norms not static so require
organization to be responsive
Relies on the notion of a social contract
Thus, in legitimacy theory, corporate management
seeks to meet societys expectations, thereby
gaining organizational legitimacy

Communication to maintain
legitimacy

Seek to educate and inform the community about

changes in performance and activities
Seek to change perceptions but not behaviour
Seek to manipulate perception by deflecting attention
from the issue to other related issues
((More pesticides found in Coca-Cola,
PepsiCo ... - Beverage Daily)
Seek to change external expectations

Stakeholder Theory
Two

branches of Stakeholder Theory

ethical (moral) or normative branch

positive (managerial) branch

Many

similarities between Legitimacy Theory

and Stakeholder Theory

should not be treated as two separate theories

but two (overlapping) perspectives of the issue
set within a political economy framework

Stakeholder theory
Management

should manage the

organisation for the benefit of all stakeholders
Firm is a vehicle for coordinating stakeholder
interests
Management have a fiduciary relationship to
all stakeholders
Reporting is assumed to be a responsibility
rather than demand driven

Stakeholder theory

Sometimes the organisation will not respond to all

stakeholders equally, but to the most powerful
Stakeholder power is a function of the stakeholders
degree of control over resources required by the
organisation

e.g. labour, finance, influential media, ability to legislate, ability to

influence consumption of the organisations goods and services

Expectations and power relativities of various

stakeholders change over time
Organisation must continually adapt operating and
disclosure strategies

Institutional Theory
Provides an explanation about why organisations
tend to take on similar characteristics and form
Particular organisational forms might be adopted
in order to bring legitimacy to the organisation

Organisations conform because they are rewarded for

doing so through increased legitimacy, resources and
survival capabilities (Scott 1987, p. 498)

Organisations often copy other organisations

practices for competitive advantage and to reduce
uncertainty and cost ( e.g. Pepsi and Coca Cola)

Institutional Theory
Although managers might see a need to be
adopting particular structures and practices,
actual organisational practices can be very
different from the formally sanctioned and
publicly pronounced processes and practices
For example, the organisational image
constructed through corporate reports and other
disclosures might be one of social and
environmental responsibility when the actual
managerial imperative is maximisation of profit of
shareholder value

Political nature of regulation

Democracy means that due process is an important

ingredient in the regulatory process
Important to maintain the legitimacy of the regulatory
process (acceptable to the public)
Although accountants believe that standard setting
should be neutral and apolitical, because of its
negotiated nature, it is inevitably political
Without legal (political structure) mandate to enforce
compliance, standard-setting bodies are ineffectual.

Standard setting as a political process

Standard setting is a political process because it
can affect many conflicting and self-interested
groups
The regulator must make a political choice
The regulator must have a mandate to make
social choices
The recognition of doubtful debts can affect
entities differently

Financial instruments

The adoption of IAS 39 Financial Instruments

Recognition and Measurement in the EU has
been a highly political process during 2005.

Intangible Assets
The

adoption of IAS 38 Intangible Assets in

Australia illustrates the role of politics in the
standard setting process

Should accounting be regulated?

Opponents to regulation argued using agency theory. They believe

there are already incentives for financial reporting to monitor
employment contracts, and to judge and reward managerial
performance.
Proponents of regulation believe that market failures as a result of
firms reluctance, fraud and underproduction of accounting information
means only with regulation that desired social goals of financial
reporting is served (i.e. fairness of reporting, information symmetry
and protection of investors)
Regulation is considered desirable where there are windfall profit and
to ensure that profit skimming (removing/pocketing) does not occur.
For example, This is the central issue in respect of the privatisation
of Telecom Australia. The government has to ensure that
telecommunication services continue to be provided as equally
and fairly as possible to all Australians irrespective where they live;
rural or urban.

Regulatory framework for financial

reporting

A financial reporting environment is made up of:

legal setting
economic setting
political setting
social setting
The elements of a regulatory framework are :
statutory requirements
corporate governance
auditors and oversight
independent enforcement bodies
Both auditors and auditing are usually regulated
statutory regulation
self-regulation

Statutory requirements
Company

law
Securities market law
Accounting standards

force of law

Taxation

law

Politics behind Malaysias

standards setting

Pre 1997:
difficulty in ensuring compliance with standards
absence of any conceptual framework
allowance of alternative treatments with accounting standards
general nature of standards rather than detailed procedures
Post 1997:
new regulatory regime
force of law
development of conceptual framework
due process in standard setting

Malaysias financial reporting

regime

Financial Reporting Act 1997

Financial Reporting (Amendment) Act 2004
CompaniesAct 1965
Income Tax Act 1967
Guidelines of the Securities Commission 1995
corporate disclosure
post-listing obligations
accounting standards and valuation/revaluation of assets
Bursa Malaysia Listing Requirements
submission of reports
additional disclosures
Bank Negara Malaysia

Financial Reporting Act 1997

Section 27 -compliance with MASB approved

accounting standards
monitoring of compliance within jurisdiction of SC,
BNM and CCM
because of FRA 1997, MASB approved accounting
standards have force of law
statutory duty of directors and management of
reporting companies and other business, industrial
or commercial enterprises to ensure financial
statements of their respective companies or
enterprises comply with MASB approved accounting
standards

Companies Commission of
Malaysia

Set up to amalgamate activities of former Registered of

companies (ROC) and Registrar of Business (ROB)
to ensure that provisions of the Acts and laws are administered,
enforced, carried out and complied with
S 169(4) of Companies Act 1965 requires every company
incorporated under Act to have its P/L and B/S duly audited
before being presented at AGM
Companies should comply with approved accounting standards
in preparation of accounts
Coordinated efforts undertaken with accounting profession and
MASB to identify issues that impact financial and reporting
environment

Securities Commission

Set up under the SC Act 1993

to promote strong and healthy securities market and to
maintain confidence of investors in line with provisions
of the SC Act and Securities Industries Act 1983
prior to 1993, no single authority in Malaysia entrusted
with responsibility of regulating and systematically
developing capital market
self funding statutory body with investigative and
enforcement powers
reports to Ministry of Finance and accounts tabled in
Parliament annually

Securities Commission (cont)

Also enforces Capital Markets and Services Act 2007

Member of International Organisation of Securities Commission
(IOSCO)
A public company has obligation to fully disclose to public
information necessary to make informed investment decisions
if listed, it must immediately release information which are
expected to have material effect on market activity in, and prices
of, its listed securities
appropriate action taken where improper use being made of
price-sensitive information
http://www.sc.com.my/

Auditing Oversight Board

The Audit Oversight Board (AOB) is established under Part IIIA of the Securities
Commission Act 1993. Part IIIA was incorporated into the Securities Commission
Act 1993 by virtue of the Securities Commission Amendment Act 2010 (the Act).

The Act came into force on 1 April 2010

The AOB's mission is to assist the Securities Commission (SC) in overseeing
the auditors of public interest entities and to protect the interests of investors by
promoting confidence in the quality and reliability of audited financial statements
of public interest entities.
The AOB will do this by:

registering auditors of public interest entities; and

conducting inspections and monitoring programmes on registered auditors to assess the extent of
their compliance with recognized auditing and ethical standards.

The AOB is also empowered by the Act to sanction any registered auditors for
failure to comply with any provisions in Part III A of the Act, notices or guidelines
issues by the SC.

Malaysian Accounting Standards

Board (MASB)

FR Act 1997 establishes Financial Reporting

Foundation (FRF) and MASB; main functions of
FRF are to provide financing arrangements for
MASBs operations and to review its performance
MASB as an independent authority to develop and
issue accounting and financial reporting standards
in Malaysia
MASB with FRF make up framework for financial
reporting in Malaysia

Organisational structure of
MASB
Financial Reporting Act
1997

Financial Reporting
Foundation

MASB
Issues
Committee

Working Groups

Secretariat

Reasons for establishing

standards

To provide public accountants with guidelines and

rules of action
Relates to theories of regulation

Identify technical
issues

Identify technical
issues & preliminary
research
(Issues Committee)

Identify technical
issues

MASB initiates a
Working Group
Issues Discussion Paper
(optional)
Issues Exposure Draft
(ED) or Draft Statement
of Principle (DSOP)
Submission to
IASC

Issues Revised ED or
DSOP
Issues MASB Standard
or other pronouncements

International standards
organisation

Comments from
stakeholders

MASB Activities

Implementation and
compliance
Malaysian
organisations &
individuals

Working group
Appointed

by MASB to debate the issues

Chaired by a member of the MASB
Comprises of a project manager
Representatives from

Industry
Auditors
Regulatory bodies
Academia

Exposure draft

Draft exposure drafts are prepared by MASB WGs

and refined through discussion
The draft document is presented to the MASB for
review and then to the FRF for comments (14 days)
The draft pronouncement is then published as an
exposure draft by MASB, which invites comment
from all interested parties, usually over a certain
period

Migration from MASB to FRS

On 1 August 2008, the FRF and MASB announced

their plan to bring Malaysia to full convergence with
IFRS by 1 January 2012.

IFRSs are used by more than 100 countries around

the world, and other economies such as Korea,
India and Canada have also announced IFRS
convergence by 2011 whilst the United States have
issued a proposed roadmap for the potential use of
IFRS by US issuers.

Issues on convergence
Harmonisation

or adoption/standardization?
Harmonization looks at differences between
standards, and sets bounds to the degree of
their variation.
Adoption or standardization means having a
uniform or exactly the same standard as
others

Objection to standardization
Accounting

standards may need to serve

national economic priorities

E.g. in Malaysia the prevalence of related party

transaction differs from the Western culture of
arms length transaction

Standards overload
Accountants

may lose sight of their real jobs

because of the excessive data required when
complying with existing standards
Audit failures may occur when compliance is
the focus rather than basic audit procedures
Implications for legal liability, erosion of
professional ethics, loss of public support and
dissonance within the accounting profession.

Solving the standards

overload problem
Not all standards apply to everyone. e.g IFRS 6 or Property
Development 201 or FRS 204: Accounting for Aquaculture etc.
SMEs do not have public accountability. ( so a separate accounting
standard for SMEs have been developed by IASB in 2009)
Cost-benefit considerations apply.
The optimal information for one user will not be optimal for another.
Consequently, the Board which must try to cater to many different
users while considering the burdens placed on those who have to
provide information, constantly treads a fine line between requiring
disclosure of too much information or requiring too little.

How can theory help to find ways

to encourage compliance?
Every

capital market is different. So in each market, the

behavior of the players (i.e. corporation, brokers and investors)
can be studied to determine
What is the current compliance level?
What are the characteristics of those who complies and those who
dont?
Why do those who comply do and those who dont comply dont?
Would penalties deter? What kind of incentives can work?
Experimental research can see if any penalties imposed or
incentives actually work to see if they will influence those who
dont comply?

Review of learning points

Understand

the theories of regulation

Public Interest, Regulatory Capture and Private

Interest

Understand

the financial reporting regime in

Malaysia
Understand the standard setting process
Convergence/Migration with IFRS
Issues of standard setting