Table of Contents

Abstract .......................................................................................................................................... 2

Introduction ................................................................................................................................... 2

The Relevance of Positive Economic Theory for Financial Reporting .................................... 3

Implementation of IFRS in the UK and Australia .......................................................................... 4

Reasons for the Australia and England Accounting Bodies Adopting IFRS ...................... 5

Transitional Issues Faced ......................................................................................................... 6

Challenges Faced by Reporting Entities ..................................................................................... 7

Benefits of Adopting IFRS ........................................................................................................ 8

Similarities and Differences in the Adoption of IFRS ........................................................... 9

Adoption of the IFRS- Successful or Not? .................................................................................. 9

Conclusion and Recommendation ............................................................................................. 10

References .................................................................................................................................... 11
Abstract

Positive Accounting Theory (PAT) is concerned with the choice of accounting policies by the

management of a firm and how the management would respond to the newly proposed financial

reporting or accounting standards. The managers can choose to make accounting policies that

suit their personal interests as compared to protecting the owners’ interests. Australia and the UK

have adopted IFRS in 2005 as the European Union had adopted the IFRS. It was expected that

the adoption would benefit the economy and the listed companies and this proved to be highly

successful as it not only benefitted the companies but also to the economy. The cost of capital is

reduced whereas the comparability of the financial statements has improved greatly and foreign

firms are not required to recast the accounts and many others. So the IFRS implementation

proved highly successful.

Introduction

This paper is about the role of positive accounting theory in financial reporting. The positive

accounting theory was developed by Watts and Zimmerman in 1978) in order to determine the

accounting standards. It is highly relevant to the adoption of international financial reporting

standards, particularly the accounting policies. This paper will review the relevance of positive

accounting theory to the adoption of accounting policies. Moreover, the paper will also evaluate

the adoption of IFRS by Australia and the UK and the benefits and drawbacks of this exercise.

The paper will also evaluate the similarities and differences of the adoption of the IFRS and how

it has benefitted the company and the economy. In the end, the paper will look at the possible

ways with which the local accounting body can ensure that the financial reporting standards are

relevant to the users and all kinds of companies.

The Relevance of Positive Economic Theory for Financial Reporting

Positive Accounting Theory (PAT) is related to foreseeing actions like the choice of accounting

policies by the management of a firm and how the management would respond to the newly

proposed financial reporting or accounting standards. “The authors seek to appreciate and

explain the concept of economic consequences of the interests of managers and financial

accounting and reporting.” The main purpose of the theory is to explain why the accountants and

managers choose a particular accounting policy or method as compared to other available

options. The theory also explains that the attributes of a firm like its size and leverage are

predictive variables of the accounting choice of a firm. (Kaya, 2017)

The word “positive” refers to the theory that seeks to make appropriate predictions of the events

in the real world. The positive accounting theory was developed by Watts and Zimmerman in

1978) in order to determine the accounting standards. They explore the factors that impact the

attitude of the management regarding the accounting standards that include production of the

information like bookkeeping, taxes, regulation, political cost, and management compensation

issues, etc. according to them, the managers of a firm act in order to optimize their personal

utility and the management’s lobbying about the accounting standards is pretty much related to

their self-interests. For example, the management has an incentive for choosing the accounting

standards that result in reporting lower income as it would have benefits regarding tax, lower

regulation and political pressures being a low profile company regarding its earnings. So the

positive accounting theory is highly relevant for financial reporting. (Osho and Ayorinde, 2018)

Positive accounting is quite different from the traditional accounting approach. This is because

this theory assumes that traditional accounting does not provide optimal results. This is because

conservative or traditional accounting needs a lower level of verifiability in order to recognize

the losses. On the other hand, it needs a very high level of verifiability in order to recognize the

actual gains. It can be said that the contractual view of the positive accounting puts it in tension

with value relevance studies in accounting. The main idea of positive accounting is that the main

role of accounting is to measure the value of a firm that shows that positive accounting is

actually in favor of an efficiency perspective. The efficiency perspective puts emphasis on how

different managers select accounting methods in order to show the actual representation of the

performance of a firm. (Osho and Ayorinde, 2018)

However, there is another facet of this efficiency perspective as well. It can also be seen as an

opportunistic approach by the managers who act for their self-interest rather than in the interest

of the shareholders. They only choose accounting policies wherever there is some choice that

benefits them even if they are not benefitting the firm or the shareholders. According to Watts

and Zimmerman (1978), there are three main assumptions for the positive accounting theory

which are “political cost, bonus plan, and debt hypothesis that reveal the motives of the

managers in choosing one accounting method over another.” (Osho and Ayorinde, 2018)

Therefore, positive accounting theory is highly relevant to financial reporting. This is because it

explains the motives behind the choice of accounting methods by a company. For example, the

shareholders and the company may benefit more if the company adopts the double-declining

method as the tax Burdon would be lower. However, the management may choose a straight-line

method because the income would be higher and so their bonus.

Implementation of IFRS in the UK and Australia

Both Australia and the UK adopted the IFRS in 2005 whereas they principally agreed on the

adoption of IFRS in 2002. This is because Europe has also adopted IFRS. While the UK is part
of the European Union while Australia has also had significant trading with the European Union

and therefore it also adopted the IFRS at the same time as Europe did.

Reasons for the Australia and England Accounting Bodies Adopting IFRS

Australia has adopted IFRS due to several reasons. The major reasons are as follows,

As Europe has decided to adopt IFRS, it would help to keep the Australian accounting practices

with those of the European Union and thus more attractive for the multinational companies.

IFRS was expected to lower the cost of capital and help attract capital to the country.

As there would not be any need for recasting the financial statements, hence it resulted in lower

costs for the companies, auditors and users of the financial statements.

It was also expected to fill some of the gaps in Australian GAAP, like accounting treatment of

the financial instruments.

(Australian Accounting Standard Board, 2009)

United Kingdome mainly adopted the IFRS because the European Union decided to adopt it.

“The IAS Regulation requires companies with securities (either equity or debt) admitted to

trading on a regulated market of any member state of the European Union to use ‘international

accounting standards’ in preparing their consolidated financial statements.” (Iasplus.com, 2020)

The main reason why the European Union decided to adopt IFRS is to restore its position in the

World Economy. This is because a huge number of European companies have invested in

American Capital markets as well and those companies are required to prepare accounts

according to American standards. So the companies were forced to prepare financial reports

using American Standards even when they are European companies as compared to national
standards. Therefore, Europe decided to adopt common standards in order to restore its dominant

position in the world economy by maintaining its market competitiveness. Moreover, increasing

globalization, international trade and internationalization of the European companies also made it

started using IFRSs. (Lei, 2020)

Transitional Issues Faced

Transition in Australia from local GAAP to IFRS was quite smooth for most of the sectors.

However, there were some issues with the adoption of the IFRS. One of the main problems is the

lack of training and education. Then, there were more choices regarding the accounting treatment

in IFRS as compared to local standards which required more professional judgment and thus

made adoption difficult. There were inconsistent interpretations of the standards between

preparers of the financial statements and auditors that have caused problems with regards to the

comparability of the financial reports, for example in the application of the “Fair Value”. Then

the reporting requirements for some sectors like not for profit entities were quite cumbersome

and confusing and the costs of implementation of these standards outweigh its benefits.

(Australian Accounting Standards Board, 2017)

Asiemo (2013) says that the issues about the subjectivity and instability in IFRS adoption also

made the transition difficult. Particularly, according to the IFRS, the fair values were to be used

in many of the standards. Moreover, IFRS adoption also impacted the presentation of the

financial results as the treatment was different in IFRS as compared to the local standards and the

business contracts were required to be re-negotiated so that exact valuations can be depicted in

the financial statements in accordance with the IFRS requirement.

The challenges regarding the IFRS implementation are also quite great for the UK. Lack of

training and experience with the IFRS is one of the major transitional problems. Then the
organizations also faced difficulties in developing and aligning accounting policies in accordance

with the IFRS. Then the lack of support from the management and the failure of the management

to anticipate the wider business implications also caused difficulties. Then, gathering suitable

data for IFRS implementation and accounting was also tough. Then the compliance costs also

caused difficulties in the IFRS implementation in the earlier periods. (Weaver and Woods, N/A)

Challenges Faced by Reporting Entities

In Australia, the reporting entities faced many challenges during the adoption of the standards

other than the transitional issues explained above. Asiemo (2013) says that the issues about the

subjectivity and instability in IFRS adoption also made the transition difficult. Particularly,

according to the IFRS, the fair values were to be used in many of the standards. Moreover, IFRS

adoption also impacted the presentation of the financial results as the treatment was different in

IFRS as compared to the local standards and the business contracts were required to be re-

negotiated so that exact valuations can be depicted in the financial statements in accordance with

the IFRS requirement.

Moreover, the costs of implementation were also quite high and the firms did not expect that

they would get as much benefit as the costs they were incurring. Then the firms also needed to

hire experts in order to help in the implementation and training of their employees for this

purpose. (Pawsey, n.d)

The transition from UK GAAP to IFRS also caused several issues for UK firms. First of all,

there was a lack of training and experience of the employees regarding IFRS. Then, the

implementation cost was also high. Audit cost alone increased by over five percent in the first

year of adoption. Then there were also technical issues for several companies regarding the
implementation of the IFRS which took a lot of time in getting resolved. These technical issues

involved resourcing, time and communication issues, as well as issues, have arisen due to

substantial differences between UK GAAP and IFRS. For example, UK GAAP requires residual

values of property plant and equipment be estimated once only on purchase date however, IFRS

requires it to be evaluated at each balance sheet date. Then the computer software was to be

reallocated from tangible to intangible assets. Then in case of business combinations, IFRS tend

to recognize a lot more type of intangible assets than required under the UK GAAP. Many of the

pharmaceutical companies required under the IFRS to capitalize on the development cost of the

medicine whereas under the UK GAAP it was previously expensed. (ICAEW, 2008)

In the case of Differed Tax, UK GAAP required that the companies required that the deferred tax

is only recognized when there is an obligation to pay whereas in the case of IFRS the deferred

tax is to be recognized in all cases almost. Then, “One of the biggest challenges for UK

companies, however, was in the identification and analysis of embedded derivatives. This was a

new concept for the UK to get to grips with. (ICAEW, 2008)

Benefits of Adopting IFRS

The benefits of adopting IFRS for the companies are pretty much similar in both countries i.e

Australia and the UK. For both countries, it was necessary because many of the companies

depend on the business with the European Union. Then it is helpful for the companies seeking

international business. Although for small and medium-sized unlisted companies its costs may

have outweighed the benefits, for listed companies it decreased the cost of capital due to more

confidence by the investors as well as the lenders. IFRS also helped to improve the

communication and coordination of the activities with foreign parents and subsidiaries. (Pawsey,

n.d)
The benefits of adopting IFRS for UK firms are also pretty much the same as for Australian

firms. For multinational firms, it also helped fulfilling stock exchange requirements in several

countries. The major benefit is the reduced cost of capital due to increased investors' and lenders’

confidence. (Shodhganga.inflibnet.ac.in, n.d)

Similarities and Differences in the Adoption of IFRS

There are many similarities in the adoption of IFRS for both Australia and the UK. Both

countries adopted the IFRSs at the same time and mainly because the European Union was

adopting the standards. However, while the adoption of the IFRS in the UK was rather slow with

only listed companies required to comply with the IFRS to start with, for Australia, all

companies irrespective of the size and listing were required to adopt IFRS. The expected benefits

for the firms and economies in both countries were also pretty much the same. There were other

technical differences as well but they depend on the local standards and how they address the

particular matter.

Adoption of the IFRS- Successful or Not?

From the research, it appears that the adoption of the IFRS is highly successful in both Australia

and United Kingdome and almost all the benefits anticipated before adopting the standards are

realized.

In Australia, AASB has Financial reporting council has concluded that the Australian Financial

reporting has improved since the adoption of the standards. Moreover, “local accounting under

IFRS has had a positive impact on the Australian economy, been well received by investors and

analysts of publicly-listed Australian companies, and has improved the comparability of

Australian entities’ financial reporting against global peers.” This is because the comparability of
financial reports with even foreign companies is increased. It also resulted in reducing the high

cost of capital for the companies. (CAANZ, 2020)

Moreover, the adoption of IFRS helped the internationalization of Australian companies and

decreased their costs of financial reporting because there is no need to recast the reports. An

AASB research report has also concluded that the adoption of IFRS is really successful in

Australia and the economies and the companies as well as the shareholders, everyone has

benefitted. (Iasplus.com, 2020)

The benefits of adoption of the IFRS for the UK are also similar. With the adoption, not only the

comparability of the financial reports has improved but the quality of the reporting has also

improved. In the same way, the UK based companies do not need to recast the financial

statements. The adoption has also impacted the UK economy positively. The cost of capital has

also reduced with the increase in investor confidence. There are also technical issues that are

resolved by the accounting standard-setting board.

Conclusion and Recommendation

Positive accounting theory is concerned with how management decided about the accounting

policies and due to their selfish nature, they may prefer personal gains as compared to acting for

the shareholders.

Australia and the UK have adopted international financial Reporting in 2005 as the European

Union was adopting the IFRSs. The implementation in the UK was mandatory for the listed

companies only to start with but Australia decided to absorb it in the first year. The companies in

both countries faced pretty much similar problems adopting the IFRS and when they did it

finally, both the countries got similar benefits as well as the companies. With the adoption, not
only the comparability of the financial reports has improved but the quality of the reporting has

also improved. In the same way, companies do not need to recast financial statements. The

adoption has also impacted the economies positively. The cost of capital has also reduced with

the increase in investor confidence. There are also technical issues that are resolved by the

accounting standard-setting board.

In order to ensure that the IFRS remains relevant to all users and sectors of the economy, the

standard-setting board of the country like AASB in case of Australia should actively take part in

the standard-setting process and should offer suggestions in accordance with the needs of all the

stakeholders and companies in its local economy.

Moreover, the standard-setting body of the country can also issue interpretations of the standards

in order to ease the implementation and ensure the consistency of the reporting.

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