Why do companies regulate financial reporting?

Why do companies regulate financial reporting?

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Why regulate?

It can be said that companies are separate legal entity from its owners who are the shareholders. The company is therefore accountable t these group of people called shareholders. They also have maintain a lasting relation with the bank who are the fund suppliers to the company and an important user of the financial report. Other entities are also users of the financial statement which are employee, the public and the government. Therefore it is required that companies produce it financial statement to meet the regulatory requirement and also to meet the needs of its users. The Companies Act also requires companies on formation to company with the period financial reporting requirements. (need to find reference). For the reason that company has to produces information of various user, it therefore has to be consistent with the regulation accounting standards.

The report now discusses the accounting treatment of defined benefit under IAS 19,financial reporting issues in the debate, assess the current requirement of the IAS 19 Employment Benefits in relations to defined benefit plan, determining the amount to be expensed to a company’s financial statements for the cost of a defined benefit.

DEFINED BENEFIT PLAN

Employee benefits are classified into two categories; short-term employee benefits and long-term employee benefits. Pension benefit is a long-term employee benefit and is the most important out of all. The pension systems is then broken down into three types namely state pensions, pension received from employee resulting from employment contract and individual pension saving plans. The state pension is provided by the government as well as the payment and it is based on number of qualifying years gained through the National Insurance contributions paid. Individual pension plan involves making a personal contribution apart from state and companies which provides a regular source of income in the future after retirement. The focus would be on the second type of pension, “Pension received from employee that is company pension” (Alexandra)

Company pension is an agreement between the employee and the employer on signing a contract over a period of time for the employer to give some form of pay benefit after retirement. This plan is known as the defined benefit plan. The employee does not get to know how much would be paid until retirements. The contributions made are over the period of employee contract with the company and it is usually made to a different entity as a form of investment to receive a later return.

Defined benefit plans are those plans where the benefits are guaranteed amounts. Employee make contribution to towards benefit plan which is the amounts employee are paid as at retirement which determined by reference to a formula with is in compliance to the accounting standard adopted. Under the defined benefit plan, a number of factors are considered when determining the formula such as employees’ earnings or salaries, age, length of service and compensation. Consequently, the expense recognised for a defined benefit plan is not necessarily the amount of the contribution due for the period. (IAS 19)

With the defined benefit plans, it may either be unfunded, or wholly or partly funded by contributions made by an entity, and sometimes its employees, into an entity, or fund, that is legally separate from the reporting entity and from which the employee benefits are paid. Company not only reveal its financial position and investment performance of the find when determining funded benefits but also put into consideration its ability and willingness to make good and shortfall in fund’s assets. This therefore facilitates entity to assess its actuarial and investment associated with the benefit plan.

“The employer retains the actuarial and investment risk plan” (ACCA Global). Therefore if a company does not make ensure contribution towards an employee pension, upon retirement, the employee would still receive its full entitled which thereby has negative effects on this profits statement and balance. It has been said that companies are recently have problems in pension regulatory requirement.

Accounting for Pension plan under IAS 19 Benefit plan requirement

The accounting for pension plan requires that the “amount recognised in the balance sheet should be the present value of he expected future payment required after the employee year of service of contract.” The present values are therefore determined using the “Projected Unit Credit Method” [IAS 19.54-64]. The value of any plan asset should be carried out on a regular based to ensure the amount recognised in the financial statement does not differ from those that would be determined at the balance sheet date. This valuation should be unbiased and also meet with the compatibility requirements of financial statement. [IAS 19.102-104].

Reliability - important

“Actuarial profits and losses gain and losses are determined by the expected return on plan assets and the realized return on plan asset“. [IAS 19.92-93]. If the gain realised is more than the expected return than it is an actuarial profits whereas if the return realised is lesser than expected return then it is an actuarial loss. IAS 19 allows “the Corridor approach”, unrealised gains and looses balance which exceeds 10% does not need to be accounted for. This would help reduces the impact it have on the financial statement. On the other hand, deferring the recognition of gains or losses could lead to producing misleading figure which therefore affects comparability of the financial statement.

3) The critical factors are thus the retirement benefits that are fixed or determinable, without regards to the adequacy of assets that may have been set aside for payment of the benefits. (Wiley IFRS workbook and Guide) - importanthis essay is a

Past service cost is “recognised immediately and on a straight line basis over the average period until the amended benefit becomes vested“. These costs occurred before the defined benefit plan was introduced [IAS 19.96-101]. Gains and losses that occurs as a result of “curtailments and settlements” is required to be recognised when the “curtailments and settlement” occurs [IAS 19.109-115]

KEY ISSUES IN THE DEBATE – EMPLOYEE BENEFIT

Why are companies facing such problem with the pension plan? The approach used by companies in determining amount to be expensed in their financial statement is one of the most areas of concern for companies employing the IAS 19. This may include the approach taken by companies in reflecting the figures. The accounting for pension under IAS 19 pointed out early discusses the procedures or approach to be taking when calculating the amount to be recognised.

Companies’ treatment of this figure whether as a one off payment or ongoing (accumulate over the employee year of service). The IAS 19 employee benefit requires the accounting and disclosure of the employed benefit. The accounting standard requires that companies recognise the cost of providing employee benefits in the period the benefits are earned by the employee, rather than when it is paid or payables (Deliottes). Reflecting these benefits figures over a period would reduce the huge impact it would have had on companies’ financial statement if it was to be reflected when the benefit was actually realised.

A number of companies and commentators have been recently reported lastly that the Pension plan is have violent on effects on the companies’ balance sheet. Therefore Companies’ wants to take significant measure in other gains back its financial strength. Therefore they are considering closing the pension plan or reduction in the pension plan and other alternatives. A survey was carried out be defined benefit executives and in their findings, “Forty-four percent reported that defined benefit plan plan’s performance in the past year has substantially affected their company’s overall financial performance”. It pointed out that more than half of this group of companies are having a rethink about the plan and only a few are ready to terminate the plan.

No matter what recognition procedure used, the pension plan is bound to have an impact on the company as it is a cash outflow out of the organisation. This therefore becomes a cost burden upon the company on the other hand; companies can take investment measure which produces a positive return. This return therefore could be used to pay for the pension benefit. The pension plan is also seen as accrue which the employee had delivered services or finished contract. At this point, the employee owes the employee a certain amount which is determined on various factors discussed earlier.

IAS 19 pointed out the accounting procedure but failed to look in the companies’ ability for meet up with the funding. It also does not allow that much disclose the risk associated with funding pension scheme. The company’s ability to fund the plan decided whether or not it would have a negative or positive impact on this financial statement. Also companies should be taking reasonable investment measure to fund this pension plan.

ANALYSIS

What does the IAS 19 says/ IAS requirements? Approach to reporting… (Assessing current requirements of IAS 19 employee benefits in relations to:

· Defined benefits plans

· The context of the IASB’s framework for the presentation and preparation of financial statements as a theory of financial accounting.

PROS

(1) Retentions of employee, the pension plan attract employee

(2) compliance with the regulatory standard would attract future investors as the financial statement ensure comparability

(3) One of the objectives essences of a financial reporting is the comparability with other companies and decision useful. Companies complying with the IAS 19 would ensure reporting is done the same where which makes financial statement more useful and increased comparability. Producing various financial reports would not make the information useful for investor as they would not be able to compare financial statement since the same regulatory requirements were not followed.

The CFA institute for centre for financial market integrity also commented that, “different financial reporting standard result in inconsistent delivery of information which does not meet the requirement of the CBRM”. Investors loose decision the usefulness of the financial statement as it cannot be compared with each other.This essay

CONS

The IAS 19 requires the recognition of the pension obligation in the financial statement using a required accounting this statement companies have take reasonable a approach estimate employee pension obligation. Various commentators opinion is that the requirement is a difficult approach. ACCA global expressed the fact that user and producer of the financial statements criticised the accounting requirements as it fails to clear and complicated information about the post-employment benefits. Understanding and the difficulty in producing the pension obligation could also be one of the problem

faced by company. The IASB framework expects information in the financial statement to be understandability. This therefore poss a question on the understandability IAS 19 as the users and prepares feel it does not give a clear approach in accounting.

ACCA global pointed at the [IAS 19.92-93 accounting approach to pension recognition is a subjective assumption because the expected return which is based on the market value is perceived to be expected loses. This could be seen as an unrealiable measure market because the behaviours of the market which determines the return.

“With no doubt the pension obligation are hard to measure” (Rangecroft 39.269). Adpotation of the accounting standard means that company has to company manage the pension plan as well as taking reasonable approach manage the business risk attached to providing the pension obligation. This therefore bring out the point at the providing pension obligation under the IAS19 exposures the company to so many risk. (Koisse and Peasnell 39.256) identified that the defined benefit pension plan posed the “risk of longevity, interest rate, inflation and investment return on employer. The IAS 19 only states how the plan obligation should be recognised but does not look into make provision for company to protect them of the future risk involved.

Alternatives to reduce pension risk

Companies have gone through a rough period with the requirement of IAS resulted in then taking varieties of other measure in other to the reduce this risk. (Rangecroft 39.270) discussed the measure that had been adopted by companies in other to reduce this risk which is to change pension provision by closing plan, freezing plan and or reduced benefits. The other alterative that has been adopted is to focus on managing risk; changed cash strategy, integrated financial strategy, reduced asset-liability mismatch.

The survey carried out by defined benefit executives also agrees which the alternative plan of managing risk . It states that senior executives are begin to act on while some had already taking these alternative measure. Other measure reflected on in the article is the adopting a more conservative asset allocation and also increase contributions to the defined benefit plans to meet defined benefit plan obligations in the near term/future.

These alternative has been reported to have help companies effectively reduced its risk and more are more company are taking this measure.

Tesco Plc publish that the implementation of the IAS 19 resulted in risk of the accounting valuation deficit would increase if the return on corporate bonds is higher than the return on investment on the pension assets. They considered the risk associated with the pension plan and took action by adopting the investment strategy - contingency funding strategy .

Conclusion

ACCA GLOBAL pointed out that the accounting for post-employment benefits is an important financial reporting issue. It has been suggested that many users of financial statements do not fully understand the information that entities provide about post-employment benefits. Both users and prepares of financial statement have criticised the accounting requirements for failing to provide high quality, transparent information about post-employment benefits.