Accounting Forms the Overall Backbone of the Term Paper

Excerpt from Term Paper :

Accounting forms the overall backbone of the financial world. Financial markets are predicated on consumer and user confidence. Without confidence, consumers attempting to make financial decisions will be doing so using inaccurate and incomplete information. The lack of transparency regarding the truthfulness of reported numbers creates uncertainty within the capital markets. This uncertainty regarding the accuracy of information ultimately undermines the overall financial system, causing harm to society in the process. Investors will require higher rates of return, individuals will become unlikely to invest, and innovation could become stifled, harming the quality of life for society overall. Accounting standards, particularly those from the IFRS, are required to help maintain confidence in the reliability of reported financial performance. These standards, such as IFRS 8, are often amended to reflect the economic realities of business transactions. These changes, although well intended, may often have unintended consequence. This is particularly true for IFRS 8 Operating Segments, which has been heavily criticized by pundits and practitioners alike (Ashish, 2010).

What is the purpose of segmental information?

To begin, the intent of IFRS 8 is to ultimately create a standard for the disclosures regarding an entity's operating segments, products, and services. IFRS 8 also attempts to provide clarification regarding the overall reporting of geographical areas in which a firm operates in. Finally, IFRS 8 provides further transparency regarding the major customers a firm has. This enables investors to better ascertain the overall concentration of revenues with a select few customers. These standards are all designed to allow users of financial statements to better analyze a firms business activities.

Segmental information helps investors, businesses, pension funds, governments, and other users of in financial information to better ascertain the overall economics of the business. Through segmental information, investors can see the performance of individual segments relative to the entire business as a whole. This furthers the IFRS' goal of creating meaningful standards that allow users of financial information to make better informed decisions. Through the use of segmental data, users of financial information are in a better position to deploy their capital in a more meaning and profitable manner. Companies for instance that are using investor capital to expand into low return and high risk projects will see their cost of capital increase as investors deploy their capital elsewhere. This activity will ultimately make the company better consider project cash flows and risk prior to frivolously deploying investor capital (Crovitz, 2008). This benefit for both investors and the business could not have been accomplished without segmental information.

Without segmental information, management could simply lump, unprofitable business segments with those that are profitable to mask or otherwise "smooth" performance. This smoothing effect however, does not provide investors with an accurate depiction of the overall performance of the business. In many instances, management can easily hide blunders in operations. Through segmental information, management must now be clear and transparent with results. This is particularly true for large, multination companies that operate in a litany of different business segments. Many of these large multinational enterprises provide groups of products and services throughout the world. These products are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. For instance, projects may be exposed to risks associated with inflation, interest rates, political uncertainty and much more (Perks, 1993). By segmenting this information, investors are in a better position to determine the risks inherent in the different types of products and services of an enterprise and its operations in different geographical areas (Oler, 2010).

What are the requirements of IFRS 8 in relation to segmental information and how do they differ from other past and present accounting standards?

There are major differences between IFRS 8 in relational to segmental information. Many of these differences pertain to the overall implementation and disclosure of financial information. IASB has stated that they would like their rules to be implemented with very little transaction costs incurred by the firm. As such, many of the differences pertain to what information is disclosed and how it is disclosed. Under the IFRS standards, it appears that more detail and disclosure is obtained that allows the investor to make better decisions. In many instances, IFRS 8 is more flexible than its segmental information counterpart (Coyne, 2010).

To begin, under IFRS 8, for the purpose of identifying reportable segments, no distinction is made between revenues and expenses relating to transactions with third parties and revenues and expenses relating to transactions with other parts of the group. This means that vertically integrated operations may be composed of several segments for the purpose of IFRS 8. This, according to many investors and pundits does not create more transparency. However, under the segmental information standard a business segment or geographical segment qualifies as a reportable segment only if a majority of its revenue is earned from sales to external customers, whom investors believe, is a true reflection of economic reality. This key difference will require more segments being reported under IFRS8 as oppose to the segmental information requirement. This requirement has created two distinct opinions among investors (Droms, 2010). One group of investors believes the added disclosure to be a positive for the financial community, as results are more transparent. However, others believe the added information will cause confusion for investors.

A second difference between IFRS 8 and segmental information is the overall reported standards. For example, when businesses' financial reporting systems are not based on product lines or on geography, the segmental information standard requires the entity to choose one as its primary segment reporting format. This requirement is different under IFRS 8 however. Under IFRS 8, a company is not required to report segment information on a product or geographical basis. This could created confusion as it relates to uniform standards as in some cases this may result in a different segments being reported under IFRS 8, that would otherwise be reported using the segmental information requirement. Therefore a company reporting using IFRS8 and a company reported using U.S. GAAP will be difficult to compare due to how they disclose operating segments. This could potentially cause uncertainty within the capital markets as some investors may not be able to properly assess the merits of a particular company due to their reporting.

The second primary difference between the two standards pertains to the overall disclose of results and financial information. This particular difference is vital, as in general IFRS 8 provides more information that can be used to better assess the financial position of the firm. For example, under IFRS 8, a measure of profit or loss and assets for each segment must be disclosed. Additional line items, such as interest revenue and interest expense, are required to be disclosed. As mentioned in detail above, more information can be garnered from the financial statements under this standard. This ultimately allows investors to better ascertain the merits of the enterprise. It also allows investors to better determine the overall risk of conglomerates with multiple segments and multiple activities across geographies. Interest rate risk, credit risk, inflation risk, and other economic risks vary from country to country. With these additional disclosures as compared to the segmental information requirement, investors can better compensate for taken the risk.

Under IFRS 8, disclosures are required when an entity receives more than 10% of its revenue from a single customer. This requirement again helps investors make better decisions regarding concentration risk of a firm. By knowing that a particular segment obtains a majority of its revenues from another party, investors can better react if circumstances change between the two parties. This is particularly true if a majority of revenues come from an entity such as the government. If for example, the budget of the government is constrained, the risk associated with this particular segment has increased dramatically. Through proper disclosure, investors and other users of financial information will become more aware. In this instance, the entity must disclose this fact, the total amount of revenue earned from each such customer, and the name of the operating segment that reports the revenue. There is no such requirement under the segmental information criteria.

What evidence is there whether the current requirements of IFRS 8 are adequate or inadequate in enhancing the quality of information available to users of financial statements?

The evidence supporting the fact that the requirements of IFRS 8 are adequate come from post implementation reviews from the IFRS. The findings from these reviews are particularly informative as they incorporate nearly all the opinions within the financial community. Managers, for example discuss how costly the implementation could become for their respective firms. Investors also provide information as to how the disclosure helps them make better informed decisions. Auditors and financial regulators also provide input as to how the rule can better implemented or interpreted. The IFRS even reviews if the rule helps create a more thorough and accurate flow of information that reflects economic reality. All sides are therefore represented in a post implementation review which…

Sources Used in Document:

8) Jeffers, Agatha; Mengyu Wei; Sidney Askew (2010). "The Switch from U.S. GAAP to IFRS." Proceedings of the Northeast Business & Economics Association: 48 -- 54

9) Oler, Derek K., Mitchell J. Oler, and Christopher J. Skousen. 2010. "Characterizing Accounting Research." Accounting Horizons 24 (4): 635 -- 670

10) Perks, R.W. (1993). Accounting and Society. London: Chapman & Hall. p. 16. ISBN 0-412-47330-5.

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