Accounting Theory and Practice 1 PDF

EMA1316 Accounting Theory and Practice 1 B.COM 1ST YEAR NOTES  DISCLAIMER ASCS does not claim to have authored these past papers, and in no way are they assuring their quality. ASCS is therefore not responsible for any misuse of these past papers, as they are only intended as extra material which...

EMA1316 Accounting Theory and Practice 1 B.COM 1ST YEAR NOTES  DISCLAIMER ASCS does not claim to have authored these past papers, and in no way are they assuring their quality. ASCS is therefore not responsible for any misuse of these past papers, as they are only intended as extra material which may be referred to if required. These past papers are a useful study resource meant to supplement the content provided during lectures, yet they are in no way intended to replace lecture notes or lecturer’s guidance. It is imperative to note that there may have been changes in some study-units, syllabi, and methods of examination over the years, rendering sections of these past examination papers outdated. ASCS does not guarantee that the most recent past paper is available to students due to factors out of their control. These past papers are available to ASCS members only and sharing to third parties is strictly prohibited. Always check relevance with the class notes, lecturer notes, and syllabus available on www.um.edu.mt. REGULATION AND FINANCIAL ACCOUNTING We can define Financial Accounting as a process whereby we Recognize, Measure and Present Financial Information which will assist the users to make Economic Decisions and Choices amongst Alternative Courses of Action. Recognition, Measurement, Presentations, Economic Decisions and Alternative Courses of Action. RECOGNITION: For each and every transaction which the company carries out, the Accountant will have to recognise an Asset or a Liability and a Revenue or an Expense; and the decision of how to recognize such transaction will impact the Statement of Comprehensive Income (SOPL) and the Statement of Financial Position (SOFP). Example 1: Let us say that Right Here P.L.C has purchased 2 Laptops for €1,000. These Laptops are going to be used for Administration Purposes. DR Computer Equipment CR Bank / Cash (SOFP) (Cash Book) €1,000 €1,000 We have recognised the Laptops as Assets. This is because the Laptops are going to be used for Administration Purposes, and so they are not going to be sold, hence serving Right Here P.L.C for more than a year. the Accounting Standard IAS16, states that when a company makes Purchase of something, in this case Equipment, which will be used by the Company that Expense is to be considered of a Capital Nature, and therefore it shall be recognised as an Asset in the SOFP. Example 2: G.O.R.G.E.O.U.S Ltd has forked out €500 for the Maintenance of its Computer Servers. DR Computer Expenditure CR Bank / Cash (SOPL) (Cash Book) €500 €500 The above transaction is being recognised as Expenditure, since the Maintenance being carried out for the Computer Services shall boost up the production of G.O.R.G.E.O.U.S Ltd. IAS 38 and IAS 16 state that any Maintenance Expenditure has to be expensed in the Income Statement when incurred. Example 3: Kesħa Ltd is in the business of selling Machinery. A Machine is sold for €1,000 during the year, having no remaining obligations towards the buyer. DR Bank / Cash CR Sales (Cash Book) (SOPL) €1,000 €1,000 This transaction is being recognised as Revenue, since this is a normal Sale of good carried out throughout the year. Example 4: How to Live Ltd. is going to sell machinery for €1,000. However, after 2 years the company is going to receive back the Machinery from the purchaser, and will be giving the money back in return. DR Cash / Bank CR Trade Payable / Loan (Cash Book) (SOFP) €1,000 €1,000 Risks and obligations remain with the seller, in this case How to Live Ltd. Therefore, the company still has to buy back the Machine regardless of its condition. This is known as a Sale and Repurchase, which is treated as a Loan. The Machine is used for Security. Hence, we can deduce that is not a transaction of revenue nature, but a Financing Transaction. It only impacts the Statement of Financial Position, having no impact at all on the Profit or Loss for the year. MEASUREMENT: Once you recognise something as an Asset or a Liability, the next step is to measure it year in, year out, and the Accountant must find the correct methodology to account for this. Methods of Measurements: 1st Obligation Historical Cost – It is where we show the Original Value of the asset at which we had bought it in the first place, Less Depreciation. This is more appropriate for Machinery, Cars and Laptops. But, there’s a question mark on how to evaluate the value for Land and Buildings where the value is constantly changing and going up and down the scale. The other way of Measurement is therefore: 2nd Obligation Fair Value – This is the Current Market Price of the Asset if it is sold now. Hence, Land and Buildings are valued at the price as of today. PRESENTATION: We summarize all the transactions which happened during the year. These transactions are therefore summarised in the form of Financial Statements. So for example, all the Sales which were carried out during the year, are shown in one line in the Profit or Loss Account. Such transactions are summarised into a One Complete Set of Financial Statements. This Set of Financial Statements will be made up of: 1. Statement of Comprehensive Income (SOPL / 2. Statement of Financial Position ( SOFP / Balance Income Statement) Sheet) 3. Statement of Changes in Equity (SOCIE) 4. Statement of Cash Flows 5. Notes to the Accounts (to summarise these transactions) These Financial Statements will be then made available to those who are interested in them - to the users of Financial Statements, who are generally parties interested in the company operating. These users could be parties who invested their money in the company, which would enable them to see whether the company is daring and to check whether the company is in the position to make pending payments. The Users of the Financial Statements are: 1. Lenders, e.g. Bank 2. Owners / Shareholders (Investors) 3. Creditors (Trade Payables) Whether it is making Profit, paying out Dividends, Lenders and Banks would want to know whether the company has a healthy Balance Sheet to pay out Interest and Loans. Other Trade Payables would need such information to be to let the company buy something on credit without being charged interest. They would also need to know that the company at the end of the day will be paying the debt due, as a result of a Healthy Cash Flow. Financial Accounting is only prepared for the users, and not for the management or employees. Example: Company A Company B Money having the € € Intention to Invest: Profit 20M 30M €100,000 in either companies Equity 100M 300M ROCE 20% 10% Since the money may be invested in either companies, they are Mutually Exclusive Choices. Company A seems to be more Efficient in utilising the Net Assets. In other words, Company A has more Power and Potential in generating future Accounting Profits when compared to Company B. We can say that this investor in order to execute the decision, will be making use of information from the Financial Statements. In summary, one could say that the users are going to depend on the Financial Statements to make decisions. In turn, the Financial Statements are prepared and based on the Accounting Rules to be followed by the Accountant. So the Accountant would have applied the Recognition and Measurement Rules for Assets and Liabilities, Revenue and Expenditure. So one could say that Accountants would have to follow the Accounting Rules when deciding on the Recognition and Measurement of Assets and Liabilities. This is true, since Financial Accounting is heavily regulated by several ways including the IFRSs and IASs. 3rd Obligation IFRSs (International Financial Reporting Standards) / IASs: These Accounting Standards are issued by the IASB and are followed worldwide. 4th Obligation Chapter 10 - The Companies Act: This deals with Financial Reporting for Maltese Companies. 5th Obligation Listing Rules: Are specifically made for Maltese Companies which are quoted on the Malta Stock Exchange, i.e. Farsons, MAFRE. Therefore, the mentioned companies (quoted on the MSE) in addition to the IFRSs and the Companies Act they would need to follow the Listing Rules. 6th Obligation Chapter 5: Deals with the Financial Reporting of Maltese Companies. 7th Obligation GAPSME (General Accounting Principles for Small and Medium Sized Entities: Companies who fall within the threshold of size, being that of a small or medium company, may not prepare their Financial Statements in accordance to the IFRSs. They can prepare such Financial Statements in accordance to GAPSME, which is the Local Accounting GAAP. This GAPSME will have a substantial amount presentation rules, which Maltese companies will have to abide by (a completely different GAAP from IFRSs). 8th Obligation IFRIC (International Financial Reporting Interpretations Committee) / SIC (Standards Interpretations Committee): These are also issued by the IASB. An IFRIC is an interpretation issued by the IASB, where there is a lacuna on a particular subject matter that is not covered by an Accounting Standard. Example: IAS 38 deals with Intangible Assets - issued during the early 1990s. At that time, the internet was still in its infancy, and there were no companies trading over the Internet. During the early 2000s, the Internet was becoming more widespread, and many companies were using their websites to buy and sell products. So, the website was acting as an Online Shop, similar to the Brick and Mortar Shop which they used to have to sell their products previously. Therefore, these websites was generating revenues for the companies. Such a website was considered as an asset and a resource for the company. Hence, may Accountants were asking how one should account/recognise and measure the cost of the website year in, year out. IAS 38 was silent about this subject matter, since it didn’t deal with website costs. So the IASB issued an interpretation on website costs about how Companies should account for (recognise) and measure the expenses incurred throughout the process of the building and running of the website. SIC32 deals with the Building of Websites. In summary, there quite a number of regulations and interpretations which Accountants have to follow, bringing about Advantages since everyone must and will be following the same set of rules. This would enable Companies to Compare Financial Statements with each other and all the way minimizing the risks, hence there will be less Fraudulent Financial Reporting cases. However, reality over the past 20 years have shown a kind of different story. So in early 2000s, there was the Dotcom Bubble. At the time, a number of IT companies were starting their business on the Internet, similar to Facebook, Instagram, Twitter and Snapchat. Since these companies were just starting up, the key indicator as to whether the company had potential or not, is not seen from the Profit figure before Tax is charged. It is irrelevant when you have start-up companies, since such companies usually generate loss and not profits. Therefore, the most important figure and main indicator will be that of Revenue. These Dotcom Companies started entering into fictitious sales transactions simply to inflate their sales figure. Example: Both Dotcom Companies reach an agreement through which the companies will both be exchanging a package of advertising at the same level of traffic. Revenue increase by €100 while Advertising Expenditure would also increase by €100. This would have no effect on the Profit and Loss Account in reality, since as such they cancel each other out. Therefore, these transactions in reality do not have any Commercial Substance. This is what is known as a BARTER TRANSACTION. When these type of Bartering Transactions take place, there is no commercial substance as to why these has happened. These companies were inflating their sales, and hence misleading investors about their potential in generating future revenue. Result of such instances were that they ended up being bankrupt instead. Specifically because of such transactions the IASB issued SIC31 (IAS 28), whereby it stated that Revenue Transactions that are carried out through Barter of the Same Product lack Commercial Substance and therefore they cannot be shown, recognised or recorded as revenue. In 2002, Enron one of the biggest multinational companies in the US, filed for bankruptcy a few weeks after it had published Financial Statements showing a Healthy Balance Sheet and good chunks of Profits. Many people were saying how come this has happened (that this company has gone bankrupt and few weeks after showed such healthy profits). The Directors of Enron had made us of Complex Accounting Structures to hide their liabilities. One must note that after the failure of Enron, the Auditors of Enron who were Arthur Anderson (Audit Firm) also went bankrupt/bust. Because of this huge accounting scandal whereby the lenders lost all their money, the US introduced another piece of legislation, which is called the Sarbanes Oxley Act, in order to avoid/prevent similar accounting fraud from happening again. New regulations were issued, but were these enough? With each fraud there will be new regulations. A year later, Parmalat was also hit by a huge accounting scandal whereby it was using companies in questionable jurisdictions to hide liabilities. In spite of all these additional regulations, each and every time there was/is an accounting scandal. In 2008, the Lehman brothers (largest banking company in the US and worldwide) went bankrupt (filed for liquidation), again a case where the company had just shown a healthy balance sheet and a healthy profit. Because the Lehman Brothers were a banking company, even the Deposit Holders lost all their money not only the shareholders. This occurred because the Lehman Brothers were misleading its users and hiding their Liabilities from its Balance Sheet, while not having enough Assets to pay back such Liabilities (in reality these Liabilities amounted to $300 Billion but were shown to make up $100 Billion). Since many people had lost their money, the world was faced with a crisis called the Global Credit Crisis. It was a case where the whole world was plunged into a recession. An Accounting Scandal done by Accountants themselves is what triggered this. A lot of people lost their money and therefore in one instant a lot of people became poor because they lost their money. Therefore, such people had to cut down their spending on holidays, travelling, clothes and food. Hence, the demand by people decreased, because people now have less money in their pockets. What follows is that the companies seeing this change and decrease in the Demand for their products, they (the companies) will decrease the Supply of these products in order to match the Demand and Supply Curves. Since companies are now producing less goods, they don’t need the same work force, the same number of employees which they had before. Hence, they would make people redundant. Those people who are made redundant will have less money in their pockets. People with less money in their pockets would again result into a Decrease into the Demand and Supply figures for goods and services. The process goes on and on repeatedly for every time such an instance happens. This is where an economy goes into a Recession (when the economy no longer grows), since the economy will start to shrink instead of growing substantially. All of this as mentioned in brief above, was called the Global Credit Crisis which triggered a Global Recession. Summarising the Global Credit Crisis was triggered by the failure of the Lehman Brothers, an Accounting Fraud perpetuated by Accountants by which many people lost their money because of this Accounting Fraud. Instead of being better off they were then worse off. Understandably, people were therefore very angry with Accountants, since they said that Accountants were there to supposedly provide information to help them to make economic decisions, but instead had provided them misleading information with fraudulent accounting information. Because of this situation people started to put pressure on the politicians, where they started telling them that they (Politicians) had to do and create something to prevent the situation from happening once more and losing all their money. Because of all this pressure on Politicians for the very first time the issue of Accounting Regulation made it to the very top of the Agenda of the G20. The G20 are the largest 19 World Economies + a Representative of the EU. Hence, in 2009 the topic of Accounting Regulation made it for the very first time on the Agenda of the G20. Therefore, one of the largest Political Bodies around the world was discussing the notion and issue of Accounting Regulations. The G20 came up with a number of action points which can be subdivided into 2: 1. Short-Term Action Points & 2. A couple of Medium-Term Action Points. Medium-Term Action Points A. The first point was that the 2 Main Accounting Standard Second-Bodies should start working together in order to come up with one single high-quality Accounting Standards. Up till 2009 there were 2 Main Accounting Standards Second-Bodies: 1. IASB - International Accounting Standard Setting Body (World-wide Body, which standards are followed in the EU, Africa, Asia and Australia) 2. FASB – American Accounting Standard Second-Body (the body which issues standards for US Companies including the US GAAP) Compare & Contrast: IASB vs. FASB The Standards of each body are very different from each other. The IASB are more Principle Based whereas the FASB Standards are more Rule Based to try to cover a large number of scenarios. The G20 were telling them to start converging with each other and to start working with each other to ensure to come up with one single Set of Standards that have no differences and that will ensure consistent application throughout the whole world. The G20 meant business, because 1 year later in 2010 they reminded both bodies ( IASB and FASB ) that they should put this Convergence of Standards highly on top of their Agenda. The G20 addressed the Bodies [ We reemphasize the importance in place in achieving a single set of high quality improved Global Accounting Standards. We urge the IASB and the FASB to increase their efforts to complete their Convergence Project as soon as possible. ] As a reaction to this and the pressure, the G20, IASB and FASB; from 2009 up till 2015 they started working together and they started issuing Standards together. The first thing that they’ve done, they issued IFRS 10, 11 & 12 with respect to Consolidation to avoid and ensure that a similar scandal to Lehman Brothers won’t happen again. IFRS 15 with regards to Revenue was also implemented together by the IASB and the FASB having no particular differences on this standard between both bodies. They have also worked on coming up with a similar Conceptual Framework, whereby the Concepts of underpinning the Accounting Standards will be the same for both the IASB and the FASB. B. The 2nd Medium-Term Action which the G20 came up with was that Accounting Regulation on a stand-alone basis is not enough. Someone has to see that such Accounting Regulation is being correctly applied and enforced. Therefore, they put a lot of pressure on the regulators such as the MFSA, the Listing Authority to start supervising companies and ensure that they are correctly and diligently applying the Principles of Accounting Standards. We may deduce that with each and every Accounting Scandal there will be a reaction, there will be more Accounting Standards (Regulations) which will be put into force, with the hope to avoid the repeat of such Scandals. Does Accounting Regulation really help in reducing or eliminating Accounting Frauds and Scandals? There are 2 Schools of Thought: 1. Those who are in favour of Accounting Regulation (they see it as being very important to reduce fraud) 2. Those who think that Accounting Regulation does not really reduce Fraud because with or without regulation there will always be some form of self-mechanisms to protect the Users of the Financial Statements. Those who are against say that Accounting is like a normal good, a good for which there will always be Demand and Supply. The Supply of Accounting Information will always be at that point where the Supply Curve meets the Demand Curve. So, with or without regulation Companies will still provide Financial Information that is accurate to the Users because companies have a private incentive to do so. i.e. Example 1: Company Inside You Ltd is interested in building up a new factory and wants to finance this factory in one way or another. Inside You Ltd decides to raise finance for the new factory by the issue of new shares, and hence issuing a Share Certificate to the person investing in the company showing that the persons own a number of shares. In return, Inside You Ltd is given money to build up the new factory. The latest Financial Information will be asked for by Investors, to see the Profit which will be generated inspected by the use of the Balance Sheet, the Dividends which are payable, whether one is able to meet the Payments for the Liabilities which the company has. If such Financial Information will not meet the desired expectations, an Investor won’t buy the shares. With or without regulation the Company will have a private incentive into providing Financial Information to go on with the Project in mind. Example 2: Underneath the Sky p.l.c will be borrowing money from the Lenders. Again, the Lenders will be asking for the latest Financial Statements, to look at the Profitability of the Company, Type of Assets on the Balance Sheet, Gearing Ratio, etc. If such information doesn’t meet the requirements, then the Lenders may decide not to provide the money. Also, if such Financial Information is not provided, the Lenders may find another alternative. This is by deciding to increase the Rate of Interest: for example, instead of charging Interest for 4% it will be charged at 9% because of the high risk within the company itself, if Underneath the Sky p.l.c will be given the money requested. This would mean that the cost of raising capital will go up, meaning more costs will be incurred and generating less profits. Or else, there are the chances that the Lenders won’t give a penny to the company. Here, there is an incentive to provide the Users with Financial Information irrespective whether there is Accounting Regulation or not. If Companies do not provide Financial Statements (information) in a regular and timely manner, the market will react badly, and the market will start asking questions why the company is not providing such Financial Information, and hence will start to question of having problems and/or something to hide. No news is bad news. In other words, Companies have an incentive to provide Users with Financial Information, so that Users do not speculate whether there is something wrong within the Company. This “no news is bad news”, actually took place 9 years ago in Malta. There were 2 companies on the Malta Stock Exchange who hadn’t yet published their Financial Statements by 18 months (after year end) later than the date they were supposed to submit such Financials. One fine morning The Times of Malta ran an Article in its Business Section, about how come these 2 Companies had not yet published their Financial Statements. Do they have bad news that they do not want or are afraid to share with the rest of the market? Reputational Risk: Accountants do not have an incentive to mislead the Users by carrying out Accounting Fraud. This is because if Accountants carry out Accounting Fraud, there is the risk that they will be caught and if they are caught their reputation will go down the drain, they will never be employed again and there is a huge risk that they will end up in jail. Therefore, because of this Reputational Risk, Accountants with or without regulation will always strive hard to provide accurate and fair views of information to the Users of Financial Statements. Arguments put forth by those in favour of the Regulation: 1. The exact opposite of the first one when we were discussing about those who were against regulations. There we were speaking about those who think that accounting is a normal good which is dictated by the market forces – Demand and Supply. Those who are in favour of regulations state  that accounting is not really a Normal Good but in reality it is a Public Good. A Public Good in economic terms is a good or a service, where it’s Supply cannot be restricted to only those who pay for it. So there will be a number of instances where people who have not paid to consume such product will still consume such product, and because of this failure there will be no supplier who is ready to supply something where there is the risk that consumers will consume it without ever paying. So in these cases of Market Failures it is understood that the Government will enter into the frame to correct such market failure, and provide the good or service itself. An example will be the Street Lighting. It is very difficult to restrict the service of street lighting to those people who pay for it. This is because if there is a particular street and two residents within such street do not pay for such street lighting, one cannot lock them up inside their homes and tell them not go out as soon as darkness falls. Hence, it is very difficult to restrict someone from not making use of such product. This is why the Government in Malta decided to provide such street lighting to everyone without anyone paying directly for such service. Those in favour of Regulation, look at accounting or financial information in this manner. Example: Let us consider how most of us usually watch a movie. Movies are widely in a pirated manner. Having said this, it means that the producers do not know about your Demand, since you are downloading the movie from an illegal site, the demand is showing nowhere. Because of that Piracy, the Demand that is reaching the Suppliers is in actual fact understated. When Demand is understated Supply will also be cut, decreased; so that the Supply Curve will meet the Demand Curve at a lower point. This is what happens in Accounting. If there won’t be any Regulation, someone will buy financial information/statements) and will distribute them to any other users who may be interested in these Financial Statements. The problem is that then the companies will then be saying that only a couple of people are interested in our Financial Statements and only a few people have paid for such Financial Statements, and hence there is no real high interest in our Financial Statements. What they will be doing is that they will be decreasing the Supply, since no one is interested in the Company. This would result that instead of providing the Financial Statements once a year, the Company will start to provide these Financial Statements to its users only once each and every two years. Furthermore, the Company will be decreasing the amount of financial information it will be providing the users. i.e. it will decrease the amount of explanatory notes attached with the Financial Statements. This is the whole reason why those who are in favour of regulation states that there should be some type of legislation that dictates the minimum number of times Companies should provide the Financial Statements. Also, the format and the minimum content which such Financial Statements shall have. This is why the Companies Act dictates that as a minimum, Financial Statements should be provided once a year to the users of Financial Statements and that is why the Companies Act dictates the format and the content that there should be in the Financial Statements. 2. The second argument is that within each group of users there are different types. For example, if we look at the investor group, there will be those investors who hold a sizeable / significant share in a company ( i.e. 40%, 50%, 70% ) and so they will be very strong shareholders. Then there could/will be those who are less powerful, those who own a handful of shares ( i.e. 1000 shares or 500 shares). The same applies for Lenders, Powerful Lenders (i.e. Banks) and the less Powerful Lenders (i.e. Trade Creditors).  So in each and every group there will be those who are the most powerful ones and those who are less powerful. And this is where the problem lies. This is because the Powerful Investors can demand information whenever they want, but those who are less powerful cannot do so. So Accounting Regulation is also there to protect the less powerful users. Example: There is the CFO of Uprising Holdings Ltd and there is a person who owns 90% of the shares. The person having 90% of the shares, needs to look at the financial information urgently to be able to decide whether to take up a new project or not. Since, the person owning shares is dominant for the company, the CFO will work overnight to provide such Financial Statements even if you’re going to suffer time. If one owns 2% of the shares, Financial Statements won’t be given as soon as possible, since this particular shareholder isn’t powerful enough to be able for example to fire the CFO. Therefore, the Regulation is there to protect the smaller investors and lenders. Hence, they will be ensuring that Shareholders are receiving the Financial Statements once a year to evaluate such financial information. 3. With Accounting Regulation everyone will follow the same rules and regulation. Therefore, the Financial Statements will be prepared on the same basis. This means that all companies are going to prepare their Financial Statements in accordance to the same rules. Thus, one can deduce that given that the Financial Statements are prepared using the same methodology the Financial Statements of different companies can still be compared with each other. This is because they are following the same set of rules. So, users of the Financial Statements can compare the Financial Statements of a company operating in the Manufacturing Industry with the Financial Statements of a company operating in the Retail Industry. Although they are operating in different industries they can still be compared, since the Financial Statements all follow the same rules. 4. Accounting Regulation reduces the risk that there is Accounting Fraud. This is because companies will have to follow some sort of written rules, which rules will be there for the sake of providing accurate information. It can be said that if a company follows the Accounting Rules and Regulations that company is said to have issued Financial Statements which show a true and fair view of the company. In other words, the Financial Statements of the company are considered to be accurate. So, the concept is that if there rules and regulations to follow, and companies will actually follow such rules and regulations, there will be less scope of accounting fraud... STANDARDIZATION AND HARMONIZATION OF ACCOUNTING STANDARDS Harmonization is when you would have two different things and you will start reducing eliminating the differences, but you do not eliminate all the differences. So, there will be still some differences between the two subjects, but you would have made them in some way similar but not completely the same. Standardization is when you would have two different things but now, you’re going to remove all the differences – completely eliminate. So, once we eliminate all difference, these two things will be the same – carbon copy. One of the medium term actions that the G20 had asked from the IASB and the FASB was to come up with one single set of Accounting Standards and that means that in other words the G20 was telling the IASB and the FASB to eliminate all the differences that there are between IFRSs that are issued by the IASB, and the US GAAP which are the American Accounting Standards issued by the FASB. In other words, the G20 was telling the IASB and the FASB to standardize their accounting standards, it’s not enough to harmonize the accounting standards. The G20 wanted the two main Accounting Standards embodies standardize the accounting standards to come up with one single set of high-quality accounting standards. In 2009, the G20 told the 2 main accounting standards setting bodies (IASB & FASB) to come up with one single set of high-quality accounting standards. In other words, the G20 told the 2 main accounting standards setting bodies to standardize their accounting standards, therefore, to completely eliminate all the differences present between the IASB accounting standards and those of issued by the US GAAP. The IASB and the FASB from 2009 onwards, up till 2015 embarked on this project where they started to standardise their accounting standards. As a matter of fact, in 2011 the IASB and the FASB issued 3 accounting standards in relation to Consolidation, namely IFRS 10, IFRS 11 and IFRS 12. These standards issued by the IASB were the same as those that have been issued by the FASB. Therefore, there are no differences in the Consolidation Standards between the IASB (IFRSs) and the US GAAP. Furthermore, the IASB and the FASB worked on the Financial Instruments Project - IFRS 9 and they also came up with one single accounting standard agreed on both by the IASB and the FASB. Another significant project issued in 2013 was with respect to the Revenue Standard. First of all, there were a number of differences between the old revenue standards of the FASB and the revenue standards under the US GAAP. Revenue is a very important line item in the Income Statement, so the IASB and the FASB set out on a journey to eliminate all the differences in their Revenue Standards. Therefore, to come up with one single accounting standard which will be the same for both the IASB and FASB. In fact, in 2015 they announced that they have come up with IFRS 15 - Revenue from Contracts with Customers, which principles are the same for both the IASB and the FASB. The IASB and the FASB also embarked on a very important project which was to align the Conceptual Frameworks together. So, up till 2009, the IASB had its own Conceptual Framework. The FASB also had its own Conceptual Framework and there were differences in the said frameworks. What did this mean? This meant that the framework which has the main/basic Accounting Concepts of which all the Accounting Standards are developed upon, were not the same (different) between the 2 accounting standards setting bodies. So, from 2009 onwards, the IASB and the FASB started writing a Conceptual Framework that was the same for both the IASB and the FASB. In fact, this Standard was referred to as The Joint Conceptual Framework, a joint exercise between the IASB and the FASB. And as a matter of fact, the FASB and IASB wrote together Chapters 1, 2 and 3 of The Joint Conceptual Framework and hence the Chapter of the Framework were the same for both the IASB and the FASB. However, this joint exercise came to a stop in 2015, whereby the IASB and the FASB failed to agree on certain Accounting Concepts that were to feature in the next Chapters. Therefore, they decided to part ways. So, the marriage between the IASB and the FASB lasted 6 years. Nowadays that means from 2015 onwards we no longer speak of The Joint Conceptual Framework. Hence, we are back to square one. The IASB will have its own Conceptual Framework, and the FASB will have its own Conceptual Framework. All be it, we have to say that the differences between both frameworks have been vastly (greatly) reduced. This is because at the end of the day certain Chapters are the same. From 2015 onwards, this is the way that the FASB and the IASB have taken, so instead of completely eliminating (reducing) all the differences the IASB and the FASB are trying to reduce a number of differences, but not completely eliminating. As an example: IFRS 16 – Leases The new standard on Leases was published in 2017, applicable from 2019 onwards. This Standard issued by the IASB was not written in conjunction with the FASB. So, it was considered as an IASB Standard, so the FASB did not contribute to its writing. However, if you read IFRS 16 you will notice that the main principles and the main conclusion of the Leasing Standard is more or less similar to that of the US GAAP Standard in relation to Leases. In other words, the IASB, when it has issued its Leasing Standard, it has tried as much as possible to eliminate the main differences. There still remain some differences with the US GAAP but it has tried to eliminate all the differences. In other words, it has tried to harmonize the Leasing Standard. (Standardisation Perspective to a Harmonization Perspective) The differences in the Accounting Concepts between the IFRS and the US GAAP will ultimately lead to different profits being reported. The reason is very simple because when you will have different recognition and measurement rules for assets, liabilities, revenue and expenses; all of that would lead to different profits being reported. Example 1 There still exists a company called AstraZeneca which is a pharmaceutical company. This company is listed on both the London Stock Exchange and also the New York Stock Exchange. Because the company is listed on 2 main stock exchanges, the company had to prepare 2 sets of Financial Statements, one set in accordance with the UK GAAP to be filed with the London Stock Exchange and another set of Financial Statements which are to be filed with the New York Stock Exchange under the US GAAP. So, for the same year and for the same set of transactions, the company had to prepare 2 sets of Financial Statements. In 2002 the company reported 23 Million profits under the UK GAAP, while for the same year the company reported a profit of only 3 Million under the US GAAP. Therefore, for the same year, set of transaction the company reported two completely different set of profits. So, if one is an investor of AstraZeneca how much one would be jumbled up? How come that this company for the same year, same set of transaction have reported 2 such varied profits? The answer to all of this is very simple because there are huge differences between the UK GAAP and the US GAAP. The UK GAAP has different recognition and reporting rules compared to the US GAAP. Therefore, because of these different rules you will come up with different values for profits. Example 2 Because of these differences in the recognition and measurement rules you should note that LIFO (Last In First Out) is not allowed under IFRSs, and therefore not allowed by IAS 2. Under the US GAAP LIFO is allowed, so a US Company or company that is preparing the Financial Statements under the US GAAP can value their inventory using LIFO. Dive In Ltd: Inventory is valued by using FIFO Method. Mistake Ltd: Inventory is valued by using LIFO Method. On 1st January both companies purchased 40,000 units at €3 each. On 1st June both companies also purchased 70,000 units at €4 each. On 1st October both companies sold 60,000 units.  FIFO Inventory Value for Dive In Ltd Date Purchases Sales Running Balance Units €/Unit € Units €/Unit € Units €/Unit € 01-Jan 40,000 3 120,000.00 40,000 3 120,000.00 01-Jun 70,000 4 280,000.00 40,000 3 120,000.00 70,000 4 280,000 01-Oct 40,000 3 120,000.00 20,000 4 80,000.00 50,000 4 200,000.00 LIFO Inventory Value for Mistake Ltd Date Purchases Sales Running Balance Units €/Unit € Units €/Unit € Units €/Unit € 01-Jan 40,000 3 120,000.00 40,000 3 120,000.00 01-Jun 70,000 4 280,000.00 40,000 3 120,000.00 70,000 4 280,000 01-Oct 60,000 4 240,000.00 40,000 3 120,000.00 10,000 4 40,000.00 50,000 160,000.00 For the same type of stock because they use different valuations for stock, they arrive at different results. How does Closing Stock affect Profit? It increases Profit and hence reducing the Cost of Sales. So, the company applying IFRSs will show higher profit than the company applying the US GAAP. It will show a higher profit because it simply used different Accounting Rules to measure its Assets. Example 3 The terminology (wording) used in accounting. There are differences between the terminology used under the US GAAP and the terminology under the IFRSs. For example, a lease that covers the whole economical life of an asset under IFRSs is called a Finance Lease. Under the US GAAP it is called a Capital Lease. The Statement where we show Profit / Loss of the company under the IFRSs it is called Statement of Comprehensive Income, whereas under the US GAAP it simply called an Income Statement. Finally, the Share Capital issued by a Company under IFRS is called Equity, whereas in the US GAAP it is called Stock. So, there are not only differences in Accounting Policies / Principles between the IFRSs and the US GAAP, but there are also differences in the terminology used. Hence, these differences can jumble up the Users of the Financial Statements. This therefore makes it very difficult for the user of Financial Statements to understand properly the Financial Statements and therefore it would make it difficult for the same users to make economic decisions amongst other alternative clauses of action. Advantages and Disadvantages of Standardisation ADVANTAGES 1. It increases Cross-border Finance. This is when you would have a company that would be registered, for example in the UK and it decides to raise capital from another country other than the UK. For example, this British Company decides to raise capital from Germany and hence it would have a listing in the UK, but it would also have a listing in Germany and thus having a Dual Listing. This is similar to the example w.r.t AstraZeneca. AstraZeneca was listed on both the UK Stock Exchange and also the US Stock Exchange, and so in other words it had a dual listing. AstraZeneca would have raised capital both from the UK and also in the US. If there will be no standardisation of Accounting Standards, then that means that each and every country would require that Financial Statements will be prepared in accordance with the local GAAP. If we take again the example of AstraZeneca, it was listed on 2 Stock Exchanges and hence the company had to prepare Financial Statements in accordance with the UK GAAP and another set of Financial Statements for the same year in accordance with the US GAAP. So, the fact that one had to prepare 2 sets of Financial Statements was understandably difficult for the company. It was quite burdensome for AstraZeneca to prepare 2 sets of Financial Statements using different rules simply because the company was listed on 2 stock exchanges. Imagine a world where everyone is using the same Accounting Standards, including the UK, Germany, and the US. If everyone will be using the same set of Financial Statements there is no need for a company to prepare 2 sets of different Financial Statements in other words, there will be no need. This is because everyone around the world will be using the same standards and therefore there is no need to prepare 2 sets of Financial Statements, because everyone will be applying the same rules / standards. In other words, referring back to AstraZeneca example, the UK and the US will be using the same Accounting Standards and therefore both the UK and the US Stock Exchange will accept the same Financial Statements. Once this burden goes away, and everyone will be using the same set of accounting standards and therefore there is no need to prepare 2 sets of Financial Statements, companies will be more induced to carry out cross-border finance (i.e. raise capital from other countries). 2. Accounting for companies will become more Simplified. In the sense that if there is no standardisation a company will have to account for the same set of transactions twice, one in accordance (AstraZeneca example) with the UK GAAP and the other one in accordance with the US GAAP. Therefore, this will take more time, because instead of one double entry for each and every transaction the company will have to carry out two double entries for each and every transaction. The other complication is that at the end of each and every year the company will have to prepare 2 sets of Financial Statements. So, for AstraZeneca would have to prepare 2 Financial Statements, one in accordance with the UK GAAP and the other one in accordance with the US GAAP. So, the company would incur more costs in publishing 2 annual reports, having 2 annual reports audited as well as employing financial experts in both the UK GAAP (IFRSs) and the US GAAP. Thus, all of this, if there is no standardisation will create more costs for the company which can be avoided if there is standardisation. 3. Easier to Understand. If there would be standardisation and everyone will be using the same set of standards the investor will find it much easier to understand the Financial Statements. For the same year in 2002 (AstraZeneca) reported 2 sets of profits, 2 different profit figures under the UK GAAP and the US GAAP, and there if you were an investor you would have been totally jumbled up seeing 2 different profit figures for the same company for the same set of transactions during the same year. The same goes with the wording (terminology) of the Financial Statements applied by the US GAAP varies significantly from that of the IFRSs. For the Americans (under the US GAAP) Stock means Capital. Imagine a European investor looking at Financial Statements and seeing Stock under Capital. They will be jumbled up.  4. Easier with regards to Comparability. If everyone is using the same set of rules then Financial Statements will be more comparable, and investors will be able to compare Financial Statements of the same companies across the years and Financial Statements of different companies across various industries. Bear in mind that if there is no standardisation (i.e. different accounting rules being in use) this will affect the profitability of the company. Referring to the example w.r.t LIFO and FIFO. With FIFO we arrived at a different closing stock figure when compared to LIFO and this will ultimately affect / impact profit. Profit will be different to because the company was efficient and effective compared to the other company but due to the use of different Accounting Standards. The Role which the EU played in the Standardisation Process The EU first of all is founded on 3 Main Principles: 1. Freedom of People (go anywhere within the EU without any major controls); 2. Freedom of Goods and Services (offer them to the whole of EU without incurring import duties); & 3. Freedom of Capital (I should be able to raise capital from anywhere in the EU). i.e. A Maltese entrepreneur should be able to raise / generate capital from Germany, UK or France etc. without any restrictions. This last part (Freedom of Capital) was the most problematic part. This is because companies were facing a number of disadvantages when trying to raise capital from another EU member country. The answer lies in the examples given in the advantages. All of this meant that the company would incur extra costs if the company would have decided to raise capital from another EU country. If a French wanted to raise capital in another country (i.e. Germany), this French company would have had to prepare 2 sets of Financial Statements one in accordance with the French GAAP and the other in accordance with the German GAAP. This meant that in realty there was a restriction in the movement of capital. Companies were incurring more costs to raise capital from another EU country, and this went against the main principle of the EU, the principle of Freedom of Movement of Capital. So, the EU had to do something. It had to come up with a solution so as to remove this constraint. In 2002 it issued a Directive (an EU law that needs to be applied by all member countries) The Single Accounting Directive whereby it stated that from 2005 onwards each and every company listed on an EU Stock Exchange needs to prepare its Financial Statements in accordance with the standards issued by the IASB. With one single law the EU managed to standardize accounting standards within the bloc (EU). So, from 2005 onwards a Maltese Listed Company would have to prepare the Financial Statements in accordance with IFRSs issued by the IASB. On the other hand, a German listed company, from 2005 onwards also needs to prepare Financial Statements in accordance with the IFRSs issued by the IASB. Now, every listed company in the EU need to prepare Financial Statements in accordance with IFRSs. However, with this move the EU lost all of its political power in standard setting. A political body in order to function normally, it needs to have power. Therefore, the EU wanted to come up with a mechanism to ensure that it regains some power in the setting of accounting standards. What happened was that the EU decided to create a body called EFRAG and this stands for European Financial Reporting Advisory Group. The role of the EFRAG was to advice the European Union whether to accept a new accounting standard or otherwise. Just 2 years later in 2007, the EU was saying we’re not going to accept any accounting standards that are issued by the IASB, first it has to pass through the checks of EFRAG and if EFRAG says that we can accept this new standard we will accept it. If EFRAG believes that a new accounting standard will have a negative impact on EU companies, the EU will not adopt it. That is why today EU Listed Companies write down in their first note of their Financial Statements that: “ These Financial Statements have been prepared in accordance with IFRSs issued by the IASB and endorsed by the EU. ” A company which is listed on the Tokyo Stock Exchange (∴ not in the EU) will write down that,  “ The Financial Statements have been prepared in accordance to the IFRSs issued by the IASB. ” To summarize the EU helped a lot with the Standardisation of Accounting Standards because with one law it standardised the Accounting Standards to be applied by all Listed Companies in the EU. However, on the other hand, the EU through EFRAG created another set of Accounting Framework, because the EU is not following exactly IFRSs, the EU is following IFRSs that are endorsed by the EU. The EU is using IFRSs only with a carve out, Standards that are not endorsed by the EU. The Role that the US played during the Standardisation Process of Accounting Standards First of all you have to bear in mind that the US followed the Standards issued by the FASB (which stands for the Financial Accounting Standards Board) not the IASB. The FASB issued what is called the US GAAP. Hence, American Companies were following the US GAAP, which Standards were issued by the FASB and up till today companies which are registered / incorporated in the US still follow these Standards. It is to note that American Companies do not follow IFRSs. Before all the scandals that had happened (which scandals we referred to in Chapter 1) such as Enron, Lehman Brothers (being all US Companies); the US GAAP was considered to be a much more superior set of Standards than the IASB Standards. That is why the US always resisted the Introduction of IFRSs in America. Any European Company who used to raise or have raised finance in America as well, it would have had to prepare 2 sets of Financial Statements. Referring back to our prime example, AstraZeneca, it had a listing in the UK and it also raised money from the American Capital Market, for the simple reason that it was listed as well on the New York Stock Exchange, having a dual-listing. When this Company was incorporated in the UK, from 2005 onwards it prepared Financial Statements in accordance with IFRSs. However, because this Company was also incorporated in the US (having a listing in the US), it also had to follow the US Rules. The US Rules dictated that Financial Statements can only be prepared in accordance with the US GAAP, and the American Regulator will never accept Financial Statements in accordance to IFRSs. So companies, like AstraZeneca as already mentioned, had to prepare 2 sets Financial Statements one in accordance with IFRSs and another set in accordance with the US GAAP. However, following the first spate of major accounting scandals, at the turn of the Century (2000 – 2003), the US relaxed a little bit. From 2003 onwards it said that there is no need for these type of companies to prepare 2 sets of Financial Statements. They can prepare 1 set of Financial Statements in accordance with IFRSs, but then they would have to prepare a reconciliation between the profits reported under IFRSs and the profits that would have been reported under the US GAAP. In other words, this meant that the only relaxation from the US was for Companies to prepare only 1 set of Financial Statements. Why? This is because given that the companies had to prepare reconciliations between IFRSs’ profits and profits under the US GAAP, they still had to record each and every transaction twice. They still needed to employ experts in both the IFRSs and the US GAAP, they still had to maintain 2 books of accounts, one in accordance with the IFRSs and the other one in accordance with the US GAAP. Up till now the US was heavily against Standardisation of Accounting Standards. However, what happened was that as we should know in 2008 there was the scandal of Lehman Brothers that triggered the Global Credit Crisis. This matter (situation) was what the proverbial English refers as the straw that broke the camel’s back. This is because after this scandal many people were saying that the US GAAP may in practice not really be superior than IFRSs and the Chairman of that time Sir David Tweedy had said that if Lehman Brothers was an EU company following IFRSs, such accounting manipulation would have never happened and the reason given was that the US GAAP is more Rule-Based while IFRSs are more Principle-Based. Due to all the pressure on the US, in 2008 a few months after the Lehman Brothers scandal the Listing Authority in the US known as the SEC and stands for Securities Exchange Commission, announced that from 2009 onwards Companies with a dual-listing having one of the listing is in the US, need not prepare a reconciliation between the profit derived using IFRSs Standards and the profits derived for the same year when applying the US GAAP. In other words, the SEC for the very first time was saying that it is willing to accept Financial Statements that are prepared in accordance with IFRSs. That was not the only part that the US played in the Standardisation. Bear in mind what we had said at the very beginning that the G20 had urged both the IASB & FASB to join forces and start issuing Standards together, so that the Accounting Standards will be the same for both. Examples were w.r.t IFRS 10, IFRS 11, IFRS 12, IFRS 9, and IFRS 15, and the example of when they had started working on the Framework. What happened? In 2008 after the failure of Lehman Brothers there were a lot of criticism towards the US GAAP and the FASB started worrying that it will lose its significance / relevance in the setting of Accounting Standards. In order to arrest this sphere (stop it), the FASB headed the advice of the G20 and joined forces with the IASB. From 2009 till 2015 they were issuing Standards together. They even started the Project to create a common Conceptual Framework and to have a common conceptual framework is quite significant because in other words you are saying that both the IASB and the FASB are agreeing on the Basic Accounting Principles on which all the Accounting Standards are developed upon. However, this sort of marriage between the IASB and the FASB only lasted 8 years and in 2015 they announced that they cannot agree on very particular concepts that should be put in the Framework and because of such disagreement they have decided to part ways; they decided that from 2016, they will no longer pursue the Standardisation Project. In other words, they are no longer working with each other. Up till today they have never gone back together. Can Standardisation actually happen in today’s world? Here we will be outlining the Disadvantages with respect to Standardisation. DISADVANTAGES 1. Certain Standards allow for Options. Standardisation can never be achieved because if you look at certain Standards (IASB), some standards within themselves they allow a number of options such as IAS 2 (allowing any company to value inventory using FIFO or AVCO), IAS 16 & 38 (allows 2 models, either value the PPE and Intangible assets at cost or else at the revalued amount). Even though everyone will be using the IASB Standards, Companies will have the right to choose between different options. This means that one company might be using FIFO valuation method while another company is adopting the AVCO valuation method, which are both allowable under IFRSs. Hence, Standardisation can never be achieved because of the multiple methods even though everyone will be making use of IFRSs. 2. Certain Countries may be following the IFRSs by the IASB however, they modify that application. The perfect example is the case of the EU which adopted IFRSs but with one condition. That is that the Standards issued by the IASB will need the approval of EFRAG. If any particular Standard is not approved by EFRAG then the EU will not adopt it. Therefore this means that the EU has modified the application. EU Companies do not write that the Financial Statements have been prepared in accordance with IFRSs as issued by the IASB. They would write: “ These Financial Statements have been prepared in accordance with IFRSs issued by the IASB and endorsed by the EU. ” 3. Different Implementation, Enforcement and Monitoring. Even if everyone will be using the same Accounting Standards, the different implementation, enforcement and monitoring of the correct application of the main principles of IFRSs, differ between one country and another. For example in UK, Germany, and France (Main EU Countries), the Regulator reviews the Financial Statements that have been issued by each and every company and sends back a list of questions challenging the companies about the correct application of such Standards as well as the Disclosures. Thus, in those countries because there is a lot of monitoring and enforceability these Companies will make sure that they are following IFRSs to the dot. Compare and contrast this to Malta. In Malta nothing happens, Companies submit their Financial Statements and the Regulator never challenges the correct application of IFRSs. This is an argument that  although Malta follows IFRSs, Companies may be incorrectly applying such Standards. Obviously if one Country is correctly applying these Standards and another Company is not applying such Standards it will simply create differences even if everyone is following the same Standards. 4. The IASB has a number of Standards whereby a lot of Valuation and Judgement needs to be carried out. In these Standards such as IFRS 9 - Financial Instruments, IAS 36 - Impairment, IAS 38 - Intangible Assets, these do not provide detailed rules of how evaluation should be carried out. Therefore, because there exist a number of valuation models that are applied on the market a Company can choose any model and thereafter will still be in line with IFRSs. Another Company may choose another method to value and it will still be within the parameters of IFRSs. Even if everyone will be using IFRS, Companies will apply different models to value their Intangible Assets, Property, and Financial Instruments. 5. Difference in Taxation Systems will also lead in differences in Financial Reporting. i.e. Under German Law the Tax charged to a Company will be very similar to: 𝐆𝐞𝐫𝐦𝐚𝐧 𝐓𝐚𝐱 𝐑𝐚𝐭𝐞 × 𝐏𝐫𝐨𝐟𝐢𝐭 𝐛𝐞𝐟𝐨𝐫𝐞 𝐓𝐚𝐱. In Malta this is not the case. In Malta, the Tax Laws do not allow for certain items, such as Provision for Bad Debts. Under Maltese Tax Regulations, Provision for Bad Debts is not allowed and therefore it would have to be reversed back in order to calculate tax. Consider you have a Profit of €100 Less: Provision for Bad Debts of €10 and hence the Final Profit before Tax is €90. Under German Law you just take 45% x €90. Under Maltese Law you cannot do it in the same manner, you have to apply the 35% x €100, without taking into consideration the Provision for Bad Debts. Therefore, Maltese Companies because of the way of how Tax is calculated, they may be less prudent therefore taking into account less Provisions in their Financial Statements because it does not pay them to book a lot of Provisions in their books. Firstly booking a lot of Provisions will decrease the profits and secondly booking a lot of Provisions will not decrease their tax charge since Provisions would have to be added back. 6. Religion also has an impact on the Standardisation of Accounting Standards and even if everyone in the whole world is using the same Standards there will still be differences. This is because Islam does not entertain the concept of charging interest. This is not allowed because it goes against the Principles of the Islam Religion. Most of the recent Accounting Standards issued by the IASB, are built upon the Concepts of Discounting and Accumulation, which Concepts require the use of Interest Rates. Examples of these Standards are IFRS 9, IFRS 15, IFRS 16. So in reality Companies that are regulated by Muslim Law even if they follow IFRSs they cannot follow to the full the Standards issued by the IASB. For the simple reason that such Concepts in IFRSs directly goes against the concepts of Islam... THE ACCOUNTANCY PROFESSION ACT – CHAPTER 281 OF THE LAWS OF MALTA Why do we have an Accountancy Profession Act? This is done to Regulate Accountants and the Profession in general, and to ensure that Accountants will carry out their duties in the outmost good faith and in the public interest. This is very important, do not forget that Accountants are going to produce work on which other people will rely on. Other people will base their decisions on such work. If Accountants are going to mislead the people by not doing their work properly, by carrying out accounting fraud then the public in general will be affected. We have the examples of Lehman Brothers, PriceClub where creditors were never paid or not paid the full amounts. Therefore, this piece of Legislation ensures that an Accountant will always work within the parameters of safeguarding the general public, of providing the best service to the general public. If not, the Accountancy Profession Act has a number of Provisions (Paragraphs) whereby action would be taken against those Accountants who do not follow the Rules or those Accountants who do not carry out their duties in the most diligent manner and in favour of the public at large. The Accountancy Profession Act is there as well to ensure that not everyone can be an Accountant. There are a number of Rules and Criteria that a person needs to meet/attain in order to be called an Accountant. If one looks at this from another perspective, it can be said that the Accountancy Profession Act creates an exclusive membership group of people who can carry out certain functions. Before we had the Accountancy Profession Act there were a number of Bank Clerks who used to call themselves Accountants. Nowadays, thanks to the Accountancy Profession Act, in order to be called an Accountant you need to meet certain criteria: 1. You should have an Accounting Qualification specialising in Accounting. The Accountancy Profession Act states that this should be either an Accounting Degree from University or an equivalent Accounting Degree to the one at University such as the ACCA. 2. Someone who can call himself/herself an Accountant should have at least have 3 years of experience, with one year of experience obtained after the person would have attained his/her Qualification. This means that once you have graduated from University with an Accounting Degree, you cannot call yourself an Accountant, but you need 3 years of experience with at least one year coming after your qualification. 3. You must also have a clean Police Conduct. So, if you have a tainted police conduct, one may be in trouble because you may never work out as an Accountant. Once these criteria are met, you can submit documentation (evidence) showing that you meet all of these criteria and the Minister of Finance will evaluate your application. If you are successful you will be a given an Accounting Warrant. It is at that point in time that you can call yourself an Accountant, once you have such a Warrant. This is the case, for a very simple reason to ensure that whoever is going to provide a service to the public will be specialised in Accountancy, will have studied specifically Accounting, and has never violated laws and regulations. This is necessary since if someone has violated laws and regulations there is a risk he/she will violate rules and regulations again. Last but not least, a Degree is not enough, you need to bridge theory with practice and hence the 3 years of experience are needed and are very important. All of this will serve to ensure that we always give the public the best service, ensuring that the public is never mislead. The Accountancy Profession Act also states that whoever wants to specialise in a particular field of Accounting, in addition to the Warrant they require a Practicing Certificate. For example, who is working and specialising in Auditing requires a Practicing Certificate in Auditing. Therefore, it’s not enough to have an Accounting Warrant. If you want to work as an Auditor you need to have the Accounting Warrant and on top of that the Practicing Certificate in Auditing. The Practicing Certificate in Auditing is to be obtained after obtaining the Accounting Warrant being the basis of everything. Then you would also need to show evidence that you have at least one year of experience working in Auditing. The Accountancy Profession Act also contemplates the fact that rules change, Standards change over time and also Tax Laws change. So once someone has obtained a Degree it does not mean that whatever they studied and have learnt will remain relevant throughout the following years, so the Accountancy Profession Act mandates that each and every year a warrant holder has to carry out 24 hours of studying, attending conferences and seminars on current Accounting Matters, such as new standards, new tax laws and this is what we called the Continued Professional Education (CPE). Again, this is done to ensure that the public is always provided with the most up-to-date service, and to ensure that the Accountant remains relevant and knowledgeable on current issues. The Accountancy Profession Act also contemplates that certain work can only be carried out by Warrant Holders. There are 4 pieces of work that are mentioned by the Accountancy Profession Act which stipulate what an Accountant is able to do. These are: 1st Piece of Work When a Company is going to issue Bonds on the stock exchange in order to raise finance that company would need to issue a document called the Prospectus. In this Prospectus there will be listed down the main risks that the Company is expected to face in the future, and it would also show a budgeted Income Statement and Balance Sheet for the following 3 years after such Bonds are issued. Such Prospectus can only be signed by a Warranted Accountant. The reason is very simple since people, the public are going to rely on such Prospectus when deciding whether to buy the Company’s Bonds or otherwise. So, there is going to be an element of trust between the Accountant who is the person signing the Prospectus and the Public who is going to use such Prospectus to buy the Bonds. This is what the Accountancy Profession Act tries to preserve, the element of trust between Accountants and the Public. If this element of trust is severed (broken) then the Accountancy Profession will no longer exist, it is as simple as that. If this certainty of trust is severed no one will rely on Accountants and no one will trust Accountants anymore. If there is no trust, then there is nothing. 2nd Piece of Work When Companies want to rise finance from Private Banks. Private Banks will always require prospective information such as Budgets, Forecasts and the Accountancy Profession Act states that if a Company is going to prepare forecasts and budgets on which the Bank is going to rely on, in order to decide whether finance will be provided or otherwise. Such forecasts and budgets together with the underpinning assumptions can only be prepared and validated by a Qualified Warranted Accountant. 3rd Piece of Work The Valuation of Shares in Companies. It is very common that Companies are sold, and shareholders will sell their shares (within Private Companies) to other Shareholders. In such cases a Valuation Report will have to be prepared, sold by the seller and the buyer will agree on a price. Such valuation work can only be carried out by Warranted Accountants so that both the buyer and the seller will not be misled. 4th Piece of Work When there would be an Audit Report attached to the Financial Statements, asserting that the Financial Statements show a true and fair view, in other words that the Financial Statements reflect reality. Such reports can only be issued by Qualified Warranted Accountants with a Practicing Certificate in Auditing. Why? People and Users of Financial Statements will be relying on such a report before taking economic decisions and therefore such work can only be carried out by Qualified Accountants who are also experts in the Auditing Field. Imagine a situation just like the one of Lehman Brothers, where a clean audit report was issued when in reality the Company was hiding a lot of liabilities from its Financial Reports. People relied on that report, the company went vast and people lost all the money which they had invested in that company. The Accountancy Profession Act has a number of Provisions which need to be followed by all the Warranted Accountants and Auditors, however the question is this: who is going to ensure that the provisions within the accountancy profession act are really adhered to? The answer for this is that the Accountancy Profession Act created a body called the Accountancy Board. This is the body that ensures that Accountants follow the Laws and Regulations as mandated by the Accountancy Profession Act. The Accountancy Board has a number of duties and obligations. These are the following: 1st Obligation The Accountancy Board has the duty to check that all documents have been submitted by those who wish to become Warranted Accountants and the Accountancy Board will then have to check the correctness and factuality if such documents submitted. Once the Accountancy Board is satisfied, meaning that all the criteria for that person to become a Warranted Accountant were met, the next step is that the Accountancy Board advice the Minister of Finance to issue the Accountancy Warrant. 2nd Obligation The Accountancy Board has the right to suspend/withdraw a Warrant of a particular Warrant Holder if it deems that such Warrant Holder didn’t act in the public interest and has put into jeopardy the trust between Accountants and the Users of Financial Statements. 3rd Obligation The Accountancy Board has the right to delegate or else undertake particular projects that it deems that such projects will be beneficial for the Accounting Profession as a whole. Example: In 2012 the Accountancy Board was seeing that in the coming years companies will have a big problem in following IFRSs, since IFRSs were becoming very complex for the type of businesses that exists here in Malta. One must remain aware of the fact that most of the businesses here in Malta are owner managed companies that is where the shareholders are the same as the managers and directors of the company. In view of this the Accountancy Board felt the need to have a Maltese GAAP (Financial Accounting Standards). It delegated this task to the Malta Institute of Accountants to come up with Accounting Standards that befit Maltese Companies. The MIA came up with what we originally called the GAPSE, which was General Accounting Principles for Smaller Entities. In 2015, the Accountancy Board felt also the need to tweak GAPSE because it wanted to reach a wider audience, to be able to not only reach small companies but also medium- sized companies. In 2016, it published an updated set of Maltese GAAP called the GAPSME, which GAPSME superseded GAPSE. When GAPSE and eventually the GAPSME was launched, many people praised GAPSE / GAPSME since they thought that it is highly beneficial for Maltese Companies and it will also benefit the Accountancy Profession at large. 4th Obligation The Accountancy Board has a duty to maintain an updated register of people who are Warranted Accountants. Why? This is because anyone who is not on such register cannot act / work / cannot call him/herself an Accountant. This register also provides a list of Warranted Accountants to those who wish to use the services of an Accountant. Hence, if I wish to use the services of an Accountant I can simply go on the Accountancy Board Website → Accountants Register → A list will appear together with the Addresses, Warrant Number of all the people in Malta who are warranted Accountants. There are two Principles which exist in the Accountancy Profession Act, that also highlights the importance of Accountants serving the Public Interest. It also highlights the importance of the element of trust between Accountants and the Users of Accounts. 1st Principle Accountants can form a Civil Partnership, which Civil Partnership can take the form of Limited Liability Company. The Concept of Limited Liability is that the Partners/Shareholders Liability towards the Public is  kept up to the amount of Capital that they have in that business. So any creditors cannot take the personal assets of that Shareholder/Partner. However, the Accountancy Profession Act states that although it allows an Accountancy Firm to be a Limited Liability Company, the Partners who are also working as auditors within that Accountancy Firm can never be Partners with Limited Liability. So the Audit Partners, irrespective of the type of Civil Partnership will always have Unlimited Liability towards the Public. To put into context this principle, if an Auditor misleads the Public by issuing a wrong audit opinion, that Auditor can be sued for damages (taken to Court). Let us say that the Court has found the Auditor to have been negligent. Therefore, he’s liable to pay €5 Million in damages. If that Auditor does not have €5 Million Capital in that Partnership the Creditors/Claimants can turn to the personal assets of the said Auditor. This is because there doesn’t exist the Concept of Limited Liability for Auditors in the Accountancy Profession Act. 2nd Principle This Principle is linked to the previous. The Accountancy Profession Act makes it mandatory for each and every Warrant Holder or a Holder of a Practicing Certificate (i.e. of Auditing) to be covered by a Professional Indemnity Insurance. This is a type of Insurance whereby a Warrant Holder will pay a sum of money to an Insurance Company each and every year, which sum of money is called Premium and the Insurance Company will be liable to pay to Claimants if I am negligent in my work. In the previous case (mentioned above) if I do something wrong and the Court orders my put self to pay €5 Million, I can ask the Insurance Company to pay those €5 Million if I have a Professional Indemnity Insurance. This is very similar to a Car Insurance (you buy a policy, you pay a premium and if you have a car accident, the Insurance will pay all the damages). Why are these 2 Provisions within the Accountancy Profession Act very important? The answer to this is very straightforward. 1. In the first case, the fact that Auditors do not have Limited Liability, there is the risk that if they do something wrong or mislead the public, or manipulate the financial records, they may end up with nothing. This is because the Claimants (those who had suffered the damages) may take all the personal possessions of that Auditor. So, because of this risk/fear, the Warrant Holder will pay a lot of attention to ensure that he carries out his/her duties in the most professional manner and most rightful manner. 2. With respect to the second principle (the Profession Indemnity Insurance) it is also there to safeguard the public interest. Imagine a situation where an Auditor is fined €5 Million, however this Auditor doesn’t have enough money to pay that €5 Million, even when taking into consideration his/her personal possessions. In those instances, who would be worse off? The most worse off persons will be those who suffered the damages because of the Accountant’s actions because the Accountant was negligent. So to ensure that an Accountant will always pay all the amounts that the Court orders if he/she is found negligent, they should always take (are mandated) a Professional Indemnity Insurance, so if they do not have enough business and personal assets to pay off, the Insurance will pay these charges o.b.o the Accountants to those who suffered damages and losses because of the accountant’s negligence/actions. All of this serves to safeguard the public’s interest, the public at large as well as it helps to build trust between the Accountancy Profession and the general public at large... THE COMPANIES ACT – CHAPTER 10 Article 163 Article 163 states that a Company is required to keep proper Accounting Records. By Accounting Records, we mean supporting documentation of all the money received and paid, that is to keep all the receipts of the cash in and the invoices for the cash paid out as expenditure. It must also keep Accounting Records for all the Assets and Liabilities of that Company; it must also keep an updated list of Inventory if such a Company deals with stock day in day out. Such Accounting Records will have to be kept at the registered office of the Company that is the address of the Head Office of the Company, or in any location that the Directors deem fit. The most important thing is that if the Directors are asked to present such Accounting Records, they would have to make available such Accounting Records at a reasonable time and therefore without undue delay. Such Accounting Records would also have to be kept by a Company for a period of 10 years. So, a Company cannot delete or shred any Accounting Records for which the ten-year period has not elapsed. To ensure that proper Accounting Records are kept by the Company, the Directors have to ask these two questions: 1st. Question Can the Accounting Records that the Company is keeping show with reasonable accuracy the Financial Position of the Company at that point in time? In other words, can the Company prepare a Statement of Financial Position at any point in time of the financial records that the Company is keeping? 2nd. Question Can the Company prepare an Income Statement for the period from the Accounting Records that it is keeping? Article 164 This Article relates to the Accounting Reference Period. This is also known as the Accounting Reference Date. This is the date that shows the year end of the Company, so a Company’s Accounting Period is determined by reference to its Accounting Reference Date. The Law states that a Company’s Accounting Reference Period should not be less than 6 months and it should not be more than 18 months with respect to the First Accounting Reference Period. So, if I have registered my Company on 1st January 2019, I cannot put as my year end the 31st May, 2019. Why? This is because in the period 1st January 2019 - 31st May 2019 there are only 5 months, and an Accounting Reference Period cannot be less than 6 months. There are instances where the Company would wish to prolong its Financial Year, because it wants to change its Accounting Reference Data, in other words the period end. Let us say that the Financial Year of a Company is usually between 1st January and 31st December. Now the Company wishes to change its Accounting Reference Date from 31st December to 30th June. It can change Its Accounting Reference Date from 31st December to 30th June and therefore it can issue Financial Statements covering an 18-month period, from 1st January 2019 to 30th June 2020, because it will still be within the 18-month bracket. Let us say that a Company wants to change its Accounting Reference Date i.e. the year end from 31st December to 30th September. In this case the Company cannot and is not allowed under the Companies Act to issue one set of Financial Statements covering 1st January 2019 up till 30th September 2020. This is because in that case the period will be a 21-month period and as we were told beforehand the Accounting Period cannot exceed 18 months. In such a case, the Company will have to issue Financial Statements covering 1st January 2019 up till 30th September 19 (9-month period, which is allowed since the Law stipulates between 6 and 18 months) and then the next Financial Period will be from 1st October 2019 till 30th September 2020 (a 12-month period). The Law also makes it very clear that the normal Accounting Period (Accounting Financial Year) should always be 12 months. So the only time it will allow an Accounting Reference Period not to be 12 months i.e. shorter than 12 months or longer than 12 months, in cases when it would be the first year of the Company and when the Company decides to change its Accounting Reference Data in other words the period ending. The Companies Act also makes it very clear that a Company cannot change its Accounting Reference Period each and every year, but 5 years would have to pass before the Company can change again its Accounting Reference Year. Article 167 This Article states that the Directors of each and every Company in Malta, shall prepare for each Accounting Period, Financial Statements comprising of the Balance Sheet as at year end, the Income Statement for the period and the Notes to the Financial Statements, and any other information or Statements that may be required under General Accepted Accounting Principles (GAAP). The Companies Act does not define what is GAAP but after going into a merry-go-round in the Maltese Law you will found out that in one of the Directives that is attached to the Accountancy Profession Act, General Accepted Accounting Principles refer to GAPSME (General Accounting Principles for Small and Medium Enterprises) and IFRSs for other Companies that do not meet the definition of a small or medium company. This Article states very clearly that the Company would have to state very clearly that such Financial Statements are prepared in accordance to GAPSME or IFRSs (found in the very first note of the Financial Statements). Furthermore, this Article states that the Directors are responsible to ensure that the Financial Statements of a Company show a true and fair view of the Assets and Liabilities that the Company has at the Accounting Reference Date i.e. at period end; as well as the Profit/Loss of the Company during that Financial Year. As one can notice, we are making a lot of emphasis on the Directors. Even the Companies Act does not put the onus (duty) on preparing Financial Statements on the CEO, CFO or the Accountant it puts the onus on the Board of Directors. If the Company does not prepare Financial Statements, the Board of Directors are liable and will be considered to have violated the Companies Act. This Concept is further highlighted in Article 172. Article 172 Article 172 again repeats that the Directors of the Company, all of them, not only those who sign the Financial Statements, but all of them. The Directors of the Company have the Collective Responsibility to ensure that the Annual Financial Statements and the Directors’ Report are prepared in accordance with the applicable GAAP and the Companies Act. As you can note, Article 172 has introduced another report. Article 172 brings into frame the Directors’ Report. In addition to the Annual Financial Statements for each and every Financial Accounting Year, the Board of Directors are responsible for preparing a Directors’ Report. What should a Directors’ Report consist of? The answer is provided in Article 177 of the Companies Act, and also in the 6th Schedule. A common exam question is to describe the contents of the said Directors’ Report. Article 177 Contents of the Directors’ Report: ✓ It shall list all the Directors of the Company that have been in office during that Financial Year. ✓ It shall also list the Principal activity of the Company. In other words it shall describe the main operation activity of the Company. e.g. to produce chocolates or to carry out business of Retailing. ✓ The Directors should also provide a fair review of the development of the business of the Company during that Financial Year. In other words, they have to describe the main events that had happened to and within the Company during that Financial Year. ✓ The report must also highlight the Financial Position of the Company at that particular point in time. i.e. whether it has a Net Asset Position or whether its Total Assets increased when compare to prior year. ✓ The Directors’ Report should also include a paragraph describing the principal risks and uncertainties that the Company is expected to face in the coming years. ✓ It should also present the analysis w.r.t the main events that had happened during the year, information about the Financial Position of the Company as well as a description of the risks should be provided in both Financial and Non-Financial Explanations. So, we need to provide figures (Quantitative Assessment) of the points mentioned above, but there should also be a qualitative/descriptive write-up assessment of the areas mentioned above. This paragraph (Article 177) also makes it very clear that the information that is provided in this Directors’ Report, shall be commensurate with the size of the company. In other words, if we have a small company there is no need to provide a lot of details in its Directors’ Report, however a large company like Farsons would have to provide more details than those presented by a small company. The 6th Schedule, provides additional requirements to what should be included in the directors’ report. These requirements are as follows: ✓ The Directors would have to describe any important events that took place between the year end and the date when the Financial Statements were approved by the Board of Directors. Let us say that the Financial Year End of Company ASM, is 31st December 2018. These Financial Statements were approved on 30th April, 2019; being approved 4 months later than the year end. On 31st March, one of the main warehouses where goods are stored caught fire, and all inventory was lost. This event happened after year end (31/12/2018), however it also happened before the Directors’ Report and Financial Statements have been approved by the Board of Directors. So, the 6th Schedule makes it mandatory that the Directors disclose such an important event in the Report. ✓ Another piece of information that shall be provided is w.r.t the likely future developments that the Board is expecting to materialize to happen in the coming months. e.g. If the Board of Directors expects that in 2020, they are going to build up a new factory, that is a significant future development that the Users of Financial Statements, would like to know and hence it shall be disclosed in the Directors’ Report. Another example will be when the Board of Directors are expected to introduce a new product on the market, which is a very important future development for the business. Therefore, it has to be disclosed in the Directors’ Report. ✓ Information about any Research and Development Expenditure that the Company is currently undertaking. This is important to disclose because a Company that is undertaking research, is a Company which seeks to improve, innovate and that would be a positive signal for the Users of Financial Statements. ✓ The 6th Schedule dictates that the Board of Directors would have to disclose any proposed or declared Dividend that the company is expected to pay or has paid during that Financial Year. ✓ The last point is w.r.t Disclosure of the Company’s Branches. The Directors in their Report would have to disclose the branches together with their addresses that the company has. If you look at the Annual Report of BOV, HSBC, MAPFRE Middlesea, you will see that there will be a list of all the branches together with their registered address. The only reason why they are there, is only to comply with the requirements of the 6th Schedule of the Companies Act. Given that the Directors have the responsibility to prepare the Directors’ Report and Financial Statements, where such responsibility is considered to be unanimous between the directors i.e. the Directors have a collective responsibility, there needs to be some type of evidence that the Directors have taken responsibility for the wording of the Directors’ Report as well as the Financial Statements. Article 176 Article 176 states that the Directors’ Report and the Balance Sheet of the Company shall be dated with the date on which the Directors approved the Financial Statements, and the Directors’ Report and Balance Sheet shall be signed by two of the Directors of the Company. Such signature to the Balance Sheet and the Directors’ Report is a way to show that the directors have approved the wording and the information that there exists in the whole Annual Report (Directors’ Report + the Financial Statements). Article 181 Once the Board of Directors approves the Financial Statements and the Directors’ Report, they have to send those documents to the Shareholders so that such documents can be approved. Such documents will be approved in a General Meeting that will be held each and every Financial Year. In addition to the Annual Accounts and the Directors’ Report, the Directors also have a responsibility to send to the Shareholders a copy of the Auditors’ Report. This Report shall also be read to the Shareholders during the Company’s General Meeting. This process where the Directors send the Financial Statements, the Directors’ Report and the Auditors’ Report to the shareholders under the Companies Act is called the duty to lay the accounts to the shareholders. This requirement is found under Article 181 of the Companies Act. Article 182 This Article provides the timeframe by when such Laying of Accounts and approval by the Shareholders can take place. Sub-Article 2 of Article 182 states that a Private Company has 10 months after its year end to lay the Accounts and get them approved. The term private company refers to all those Companies that have limited or Ltd. after their name. The Law says that for a public company, the laying of accounts and approval by the Shareholders cannot take place beyond a period exceeding 7 months after year end. This means that the Laying of the Accounts and the approval would have to take place within 7 months from year end. Example 1: If the year-end of Tragic Optimistic Limited is 31st December 2019, the Company has till 31st October 2020 (10 months after) to get those Financial Statements approved by the Shareholders. Example 2: If the year-end of Ruben Plc. is 31st December 2019, since it is a Plc., the Financial Statements would have to be approved by 31st July 2020 (7 months after). Any company with the letters Plc. after its name is considered to be a public limited company. These are usually larger than private companies. The difference between private and public companies is very simple; the shareholder in a public limited company can offer to sell their shares to the public whereas shareholders in a private limited company cannot sell their shares to the public because they have to offer them to the other existing shareholders. Any listed company on the Stock Exchange is a public company. You will never find a listed company that does not hold its AGM (Annual General Meeting) after more than 7 months from the year end. Article 180 Article 180 also dictates who shall receive the Financial Statements of a company. It states that once the Board has approved the Financial Statements and a Meeting has been convened for the Shareholders to approve such accounts, as per Article 181 of the Law of the Companies Act, by not later than 14 days before the date of the meeting, such Accounts and Directors’ Report shall be sent to each and every Shareholder of the Company, as well as to each and every Debenture Holder in the Company. In other words, they have to be sent to all Shareholders and the main lenders of the company i.e. the users of the company. Example 1: The year-end of Ruben Plc. is 31st December 2019. The Directors have approved Financial Statements on 30th April 2020. Following such approval, on 31st May 2020, the Company announced that it will hold its AGM for the Shareholders to approve the Financial Statements on 15th July 2020. 15th July is within a period of 7 months from year end so there is no issue. So, the Accounts are going to be laid to the Shareholders on 15th July 2020. Therefore, if the Laying of Accounts is going to take place on 15th July, the Shareholders and the Debenture Holders of the Company have to receive the Annual Report by latest 1st July 2020 (14 days before the AGM). Once the Shareholders approve the Financial Statements, the next step is to submit the Directors’ Report and Financial Statements to the Registrar of Companies, nowadays called the Malta Business Registry. The Accounts and the Directors’ Report will have to be filed by 42 days after the date of approval and Laying of Accounts and approved by the Shareholders. Example 2: In our previous example of Ruben Plc., the Laying of Accounts took place on 15 th July 2020. So basically, the Company will have to submit the Financial Statements to the Registrar by 26th August 2020. Article 185 This Article contemplates some exemptions for those Companies that are considered to be small. There are a number of quantitative criteria that need to be met in order for a company to be classified as a small company. Article 185 states that Companies are considered to be small if they do not exceed the following two out of 3 criteria: 1. Balance Sheet Total of €4 Million (i.e. Total Assets = €4 million and hence, Total Equity and Liabilities = €4 Million); 2. Turnover (Revenue + All Other Income that the Company would have generated during the year) not exceeding €8 Million; & 3. Average No. of Employees not exceeding 50 (n≤50) If a company exceeds two of these 3 criteria, it cannot be considered to be a small company. If it exceeds only one of these 3 criteria, then i