AbstractThe changes to the trilogy standards which comprise of AASB 1018 ‘Statement of Financial Performance”, AASB 1034, “Financial Report Presentations and Disclosures” and AASB 1040 “Statement of Financial Position” created confusion within the accounting profession and business community. The changes were designed for the purposes of international harmonisation and for a paradigm of change away from the profit and loss approach. Many of the issues that arose are being addressed by Exposure Drafts and a emphasis on making the disclosures relevant and reliable is a key issue for the profession. This assignment covers the changes that took place, it looks at the response to the changes and is supported by evidence resulting from a study of the Australian Securities and Investment Commission (ASIC) and Ernst and Young (E&Y).
The relevance and reliability issue as in the Statement of Accounting Concepts (SAC) 3: has created debate over whether the trilogy standards meet such requirements. The overall concern is eliminating the misinterpretation and confusion caused so the financial information is both relevant and reliable.
IntroductionThe current AASB 1018 ‘Statement of Financial Performance” was issued in October 1999, along with two other presentation and disclosure standards, AASB 1034, “Financial Report Presentations and Disclosures” and AASB 1040 “Statement of Financial Position”. These three standards became generally known as “the trilogy” and were first pertinent for 30 June 2001 year-ends. The introduction of the trilogy was the largest change to the presentation of financial reports in Australia in recent times with the balance sheet and profit and loss account being replaced with a Statement of Financial Position and Statement of Financial Performance. The two main reasons behind the change are the international harmonisation program and the move towards a balance-sheet emphasis. After the first year of the trilogy implementation, a significant number of issues arose in relation to professed inconsistencies, differences in interpretation and lack of comparability owing to the flexibility of presentation allowed under the revised standards. In this essay, we will explain the changes that took place within the trilogy standards as well as drawing on some issues and evidence that have evolved because of the changes. Furthermore, we will argue that the trilogy satisfies SAC 3, (“Qualitative Characteristics of Financial Information”), fundamentally, however point out paradoxical issues that have taken place as a result of the trilogy standards.
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Question 1- Give a Brief summary of the significant changes to the disclosure requirements of the trilogy standards.
AASB 1018 Statement of Financial PerformanceParker (2002) explains that under the changes, the face of the Statement of Financial Position requires more disclosure than was required in the out of date Profit and Loss Account. Disclosure, which was previously in the notes to the financial statements, can now appear on the face of the statement. Adam-Smith (2001) adds, that a more detailed income and expense breakdown is required, therefore summarising expenses by either function or nature.In addition, Adam-Smith (2001) points out that if revenue from the sale of goods is exposed in the revenue disclosures then the associated cost of goods sold will also be required. This in effect will disclose the gross margin.Thirdly, “abnormal items” no longer exist, nevertheless Curtis (2001) mentions, the standard requires disclosure of individually significant expenses where they materially influence the result of the company.Finally, Curtis (2001) adds that the concept of errors and fundamental errors were also introduced, together with specific rules applying where errors were acknowledged.
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AASB 1034 Financial Report Presentation and DisclosuresCurtis (2001) explains this standard sets out disclosure that is required in financial reports that are not already covered by specific accounting standards. The standard outlines general formatting requirements of financial reports and introduces some new disclosures. Curtis (2001) highlights each disclosure that includes: number of employees, the legal form of the entity, who the parent and ultimate parents entities are, dividends and attaching franking credits, economic dependencies and a narrative discussion on material changes to comparative information.
AASB 1040 Statement of Financial PositionUntil recently, Curtis (2001) mentions that the presentation of assets and liabilities had been very unyielding. More recently, the format has been made more flexible and is dependant upon the operations of the entity and, according to Curtis (2001), the most useful source for presentation of information to the users of the financial reports.This standard requires assets to be classified in the Statement of Financial Position, (replacing the balance sheet) according to their nature or function. Curtis (2001) highlights that classification may now be based on liquidity, marketability, physical characteristics, expected timing of realisation and subsequent cash flows, or the purpose of holding the asset.Finally, Curtis (2001) adds that additional information is required to be disclosed in respect of the rights attaching to equity entitlements, for example shares, and options.
Question 2. Suggest possible reasons for the complaints received by the accounting profession with respect to trilogy standards Even though accounting rules have given companies a lot more flexibility, especially with respect to how they report their earnings, Kavanagh (2002) states that the trilogy standards have ‘come under fire’ for creating confusion and leaving the way open for abuse.
This statement is supported by evidence taken by one of the four biggest accounting firms Ernst and Young (E&Y).
E&Y surveyed 100 companies and found, of the companies surveyed, several found varying interpretations of the standards and a considerable degree of confusion.
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More particularly, Kavanagh (2002) highlights that the survey found that application of the standards made it more difficult to compare the performance of companies within an industry sector. The Australian Securities and Investment Commission (ASIC) reviewed 80 companies accounts and found that aside the confusion, there where instances where it had to justify the interpretations made.Above all, the interpretations were inconsistent mainly due to the lack of definitions of the terms used within the trilogy. For example, Kavanagh (2002) mentions that the wording of standards makes it clear that companies are to treat “significant items” as different from the old abnormal, however the word significant is not defined. Thus, Kavanagh (2002) supports this by mentioning that E&Y through their survey had discovered a substantial level of confusion was found in the number of different terms used to describe abnormal significant items.
Other generic problems included, as quoted to Kavanagh (2002) is that Ruth Picker from E&Y states, “ The extent of flexibility the standard allows is controversial. Shareholders may become confused and be drawn to the profit lines”. Picker was referring to the headline profit figure, stating it was not comparable. Ravlic (2002) supports the abovementioned issue by adding that the new rules on how to draw up profit and loss accounts and balance sheets have made it more difficult to read and compare crucial corporate reports.In addition, Ravlic (2002) adds that users were finding the reports less useful. Another major reasons being for the eradication of abnormal items from the Statement of Financial Performance.In particular, Ravlic (2002) pinpoints problems such as the lack of precision in the definition of cost of sales, an absence of a definition of gross profit and the non-disclosure by companies of significant accounting policies.After a study by Pierre Prentice (executive director from JFC Putres), on reviewing the annual reports of Woolworth’s, Coles Myer, David Jones, Foodland and Harvey Norman, found that 40% lacked transparency because of the trilogy standards. Ravlic (2002) quotes Prentice on saying “the new standards is a big step backwards… that user friendliness and utility have been sacrificed on the alter of harmonisation with international standards.”To be more particular with respect to changes Ravlic (2002) discovered from Prentice that items, such as abnormal items were hardly being reported on the face of the Statement of Financial Performance, therefore companies were not truly showing the impact of these items. Moreover, what profit after tax was in comparison to sustainable cash flows.
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A more specific example why the trilogy standards have been scrutinised can be seen in the evidence of the E&Y Survey. With respect to the companies reporting their margins on sales, there was a wide range of gross margin amounts within particular industries that were not meaningful. From this, the report says the problem lies in the way companies calculate their cost of sales.As the standard requires disclosure of the cost of sales, Kavanagh (2002) adds, when revenue from the sales of goods is reported; the definition of the cost of sales refers to the carrying amount of inventories, however the standards are silent on the application of the cost of sales to providers of services, as distinct from goods.Kavanagh (2002) quotes Picker of E&Y by stating “they believe the AASB should consider the applicability of the cost of sales to service entities in any future revisions to AASB 1018”. The abovementioned is an example on how the trilogy standards have bought confusion and varying interpretations within the profession.
Kemp;(2001) Knapp;(2001) add that apart from the generic problems associated with the trilogy standards, some organisations do not like having to disclose cost of sales as it gives away too much information to the companies competitors. According to Kemp;(2001) Knapp;(2001), this is principally a problem for an entity that is a ‘pure play’ in a product or service, where the cost of sales data of their competitors is clouded up by diversified operations.
Kemp;(2001) Knapp;(2001) also explain how large listed entities may often have other movements in equity and therefore have “total changes in equity other than… as the bottom line”, other companies will have different bottom lines. To be more specific Kemp;(2001) Knapp;(2001) draw on an example where, a single entity with no extra-ordinaries could arguably use “profit from ordinary activities after related income tax expenses or net profit or net profit attributable to members of the parent entity”. The problem within this issue is which of these three should be chosen.The evidence gathered by both E&Y and the ASIC give reasons to suggest why the trilogy standards have been scrutinised for creating discontent and confusion. The examples above are few of many and in recent times Exposure Drafts (ED) have been issued to make amendments to the trilogy. An example of this is ED 105 whereby the AASB intends to issue this ED as revised Accounting Standard AASB 1018 “Statement of Financial Performance”.
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Question 3.Do the trilogy standards meet the requirements of SAC 3 Qualitative Characteristics of Information?
SAC 3 identifies the characteristics that financial information should have to meet the objectives in SAC 2 whereby there are dependant users of financial reports. As SAC 3 suggests, GPFR’s should be relevant and reliable so the users of the reports can get a true and fair view of the reporting entity. However, confusion and misinterpretation by the preparers of the financial reports because of the trilogy has questioned whether the information is either relevant or reliable.
By drawing on the issues arising from the trilogy, it is quite evident that the two characteristics are not fully and/or consistently satisfied. For instance, the lack of definitions with respect to significant items has allowed entities to interpret the definition independently. Therefore, any information disclosed in respect to this issue may be unreliable when comparing entities in a similar industry. Therefore Parker;(2002b) Porter;(2002) (p.67) define SAC 3 whereby, relevant information is information that influences the economic decisions of users and assists with their assessment of the accountability of those responsible for governing the entity, the trilogy standards would need be consistent and interpreted in accordance with standards that are not transparent. In more detail, with respect to cost of sales, figures provided by the E&Y survey showed that a number of the companies surveyed reported gross figures that were not meaningful, or in other words irrelevant. Therefore, this behaviour was deemed a consequence of the trilogy standards, so it is evident that the standards in such instances allow information to not be relevant.
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The second issue concerning SAC 3 is that of reliability. Parker;(2002b) Porter;(2002) (p.67) describes reliable as information that presents faithfully the transactions and other events, which is neutral and free from undue error. At the present, the ASIC has found in a report of 80 companies there where instances where it had to justify the interpretations made. In other words, the ASIC had to validate the methods used by the reporting entities when the entities used the trilogy standards. As there were many interpretations, it could be argued that the reports may not have provided faithful and neutral information free from undue error. An instance of this can be seen in how extra-ordinaries could be included in either profit from ordinary activities after related income tax expenses, net profit or net profit attributable to members of the parent entity. Therefore, the information disclosed may vary in the levels of reliability as there are three alternatives given to the users of the financial reports.
Nonetheless, the AASB standards are prepared in accordance with SAC’s, so the fundamental characteristics of standards aim to meet all SAC requirements. The abovementioned issues are problems that have arisen from the trilogy standards due to parody of the definitions and lack of detail within the standards. Thus to argue that the trilogy standards do not satisfy SAC 3 on face value is categorical as shown above, however the professional accounting bodies have recognised the contradictory nexus so they have addressed the issues with exposure drafts.
ConclusionThe overall aim of the trilogy standards is to align Australian standards with the International Harmonisation Program and to move towards a balance-sheet emphasis. The AASB have been following a program to bring Australian standards closer to the overseas accounting bodies that are aligned with the International Accounting Standards Board (IASB).
The aim is so financial information between all counterparts concerned can be compared so that preparers of the information may benefit from overseas capital investment to their firms. The balance sheet emphasis consigns itself to the SAC’s whereby a focus is put towards whether items satisfy the definitions of an asset and a liability rather than matching income and expenditure to arrive at profits. Therefore, the trilogy has many bona fide characteristics and besides the early dissatisfaction and confusion; the accounting profession has made many amendments through exposure drafts. Ultimately the trilogy will aim to satisfy most characteristics of the SAC’s with a greater degree of significance, thus allowing users and preparers a more effective and efficient tool with respect to disclosure. Reference List1. Parker, C. 2002, Assessing the trilogy, Australian CPA, Melbourne, Australia.
2. Adam-Smith, M. 2001, Changes to the Statement of Financial Performance for 30 June 2000 financial reports, Fasttrack, Grant Thorton, Melbourne, Australia.
3. Curtis, R. 2001, The Trilogy Standards Audit and Assurance, WHK, Sydney, Australia.
4. Kavanagh, J. 2002, AASB’s trilogy under fire, Feb 28-March 6, 2002, BRW, Sydney, Australia.
5. Ravlic, T. 2002, New Rules Make Accounts Harder To Fathom, 7/1/2002, Sydney Morning Herald, John Fairfax Group Pty Ltd, Sydney, Australia
6. Kemp, S. 2001. Knapp, J. 2001, Testing the Trilogy, CACHARTER, Sydney, Australia.
7. Parker, C. (2002b) Porter, B. (2002), AUSTRALIAN GAAP, 6th edition, Parker Publishing, a Division of Accountnet Pty Ltd, Melbourne, Australia.