Case study of United Kingdom’s financial reporting standards

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Five characteristics of the development factors that would predict low levels of transparency and disclosure in the financial statements of German listed companies

1.        Traditionally bank credit plays a major role in corporate finance.

2.         German accounting is heavily influenced by tax law.

In Germany, tax law has a strong influence on accounting and financial reporting. The reason for this link between taxation and financial reporting is historical. When corporate income taxation was introduced in Germany in 1874, the requirement for annual accounting had already been codified in the Commercial Code in 1862. It was convenient to link corporate income taxation to existing financial statements. 

3.         German accounting rules allow companies to smooth income over time by using hidden reserves.

4.        There are two main external factors that have influenced financial reporting in Germany in recent years. They are, EU Directives and the forces of globalization. The 1985 Accounting Act implemented the Fourth, Seventh, and Eighth Directives and transformed them into German Commercial Law.

Although the EU’s Fourth Directive requires companies to present a true and fair view in their financial statements, it appears that extensive note disclosures are seen as a way of achieving this without changing the tax-based, income smoothing approach to financial reporting – i.e. Germany still only allows one set of reports.

5.            The EU’s decision to adopt IFRS from January 1 2005, was in recognition of the global trends in financial reporting. Even before the EU’s decision, large German companies like Daimler-Chrysler that had their shares listed on foreign stock exchanges were already using internally acceptable accounting standards.  

Since January 2005, all German listed companies are required to use IFRS in preparing their consolidated financial statements. However, German accounting practices differ from IFRS in some important respects.

German accounting law contains no specific rules in some areas. Examples include the translation of foreign currency financial statements of foreign subsidiaries, disclosures of fair values of financial assets and liabilities, and earnings per share.

Advantages and disadvantages of internal versus external corporate governance mechanisms

Internal corporate governance mechanisms are established to insure the proper actions of management. Because providers of capital do not control the daily operations of the business, so they set up corporate governance mechanisms to insure that management acts in the best interest of the owners. This mechanism is controlled directly by the owners of the firm. It can be applied to monitor corporate risks and assurance corporate controls

Examples for internal corporate governance mechanisms include the following: 1. Set up a board of directors which are normally composed of members of management and outside members who do not participate in daily operations of the firm to represent the interest of owners (typically shareholders). The board hires, controls and fires management and determines management’s compensation. 2. It could have voluntary codes of conduct. 3.  Internal auditing should be conducted. 4. Voluntarily provide internal information on firm’s operations.

Advantages of internal corporate governance mechanism include: 1 allow directors such as Woolworth who can both won major awards for their excellent governance practices, to differentiate themselves from their competitors. 2. The voluntary, internal and additional governance controls can make sure that their stakeholders such as customers, employees and investors are well protected and looked after.

Disadvantage: 1. additional cost could be generated. 2. Some countries tend to be secrecy; they are unwilling to disclose more information such as china. So cultural influence should be noted. Thirdly, “bad” companies will simply not adopt any internal governance requirements on their directors – requiring only the external ones be complied with and nothing more – even if some internal mechanisms are adopted by these companies, remember, given they are voluntary, they can be removed at any time. 

External governance mechanisms are not directly controlled by the current owners of the firm. Example can include 1. independent auditors. 2. Legal system which highlights directors duties and obligation and ensure the company comply with the accounting standards. 3. To comply with stock exchange list rules. 4. External taker-over market.

Advantages: they are imposed on all listed companies and a not subject to control by directors in terms of whether they will comply or not.

Disadvantage: although these mandatory rules do not allow companies to differentiate themselves in the market – i.e. all listed companies must comply with CG rules, thus no one company can claim to their shareholders/ the market that they are better at governance than any other company- not in terms of strictly external mechanisms.

Have US corporations lobbied against the US adoption of international financial reporting standards?

I think the US corporations have lobbied against the US adoption of international financial reporting standards.  The key issue to understand is the reason why corporations want to become involved in lobbying of the accounting standard process. The answer lies in the fact that the accounting standards set out mandatory rules for recording business transactions – e.g. they control when sales revenues can be recognised/ recorded as a sale in the accounts of the corporation.

If the standard rules are too restrictive or difficult to comply with, then corporation may be required to delay the recognition of some sales to a later financial reporting period – this delay would meant that the current overall profits of the corporation would fall.

Another example is the valuation of assets . The US accounting standard developed by the FASB, required banks to record their asset values at their market value. The back directors were very unhappy at this rule within the standard as they argued that they should be able to value their assets at Directors’ valuation –i.e. that the Directors should have total control of the asset values not the market. Again Directors were concerned here because low asset values could prevent investors from buying shares in the company and could also prevent banks from lending money.

Thus, it’s important to remember the connection between the rules in accounting standards and their impact then on the final accounting numbers – sales and asset values – in the financial reports for the listed companies.

Will the IASB and the FASB eventually merge, or will they remain separate accounting standard-setting bodies?

We doubt that the IASB and FASB will merge in the future.  First of all, various points discussed in the chapter mean that it is unlikely that the IASB will disappear and the FASB will become the global standard setter.  It also seems unlikely that the FASB will go away.  It is difficult to believe that the United States will cede its authority over accounting standard setting to a multinational group.  Even if the FASB felt that a merger was advantageous, would politicians or even the SEC allow international interests to supersede domestic ones? 

Another issue is principles- versus rules-based standards.  Generally speaking, IFRS are principles-based while U.S. GAAP are rules-based.  While it is true that IFRS are getting more rules-based and U.S. GAAP are (supposed to be) getting more principles-based, the litigiousness of the U.S. environment probably means that the United States will need additional implementation guidance even if IASB and FASB standards are converged.

Financial resources are another consideration.  Operating expenses for the IASC Foundation in 2005 were approximately €12 million (or approximately $15.6 million).  Operating expenses of the Financial Accounting Foundation in 2005 were approximately $31 million.  These numbers suggest that the FASB has a budget twice as large as the IASB.  Whether the IASB can match the resources of the FASB is unclear. 

Taken together, we argue that the IASB and FASB will remain separate accounting standard setting bodies in the future.

The key rationales that support and against the development and widespread application of International Financial Reporting Standards

Evidence of support for IFRS

A growing body of evidence indicates that the goal of international convergence of accounting, disclosure and auditing has been widely accepted.

All dimensions of accounting are becoming converged worldwide.

Increasing numbers of highly credible organizations strongly support the goals of the IASB.

National differences in the underlying factors that lead to variation in accounting, disclosure, and auditing practices are narrowing as capital and product markets become more international.

International standards will improve the comparability of international financial information.

Time and money will be saved on international consolidations, the components of which now are subject to different national laws and practices.

There may be a tendency for accounting standards throughout the world to be raised to the highest possible level.

Widespread application of IFRS might also result in:

Improved managerial decision making within multinational enterprises.

Improved allocations of corporate investment money worldwide.

Better international understandability of financial statements. Cost reductions in accounting information processing and financial disclosure costs for multinational enterprises.

Greater international credibility for published financial statements.

Some countries disallow IFRS for domestic firms but allow foreign companies to use them.

U.S. and Japan, for example will allow foreign countries listing on their respective exchanges to file financials prepared in accordance with IFRS without reconciliation to U.S. or Japanese GAAP.

International Convergence Issues

The complicated nature of standards such as financial instruments and fair value accounting

The tax-driven nature of the national accounting regime

Disagreement with significant IFRS, such as financial statements and fair value accounting

Insufficient guidance on first time application of IFRS

Limited capital markets = little benefit

Investor satisfaction with national accounting standards

IFRS difficulties in language translation

Significant differences in standards currently exist.

The political cost of eliminating differences.

Overcoming “Nationalism” and traditions. 

Perhaps it will not provide significant benefits.

It will cause “standards overload” from some firms.

It diverse standards for diverse places is acceptable.

Distinguish between the terms “harmonisation” and “convergence” as they apply to accounting standards

Just start with thinking about the fact that prior to the introduction of IFRS, most nations had their own national accounting standards.
The ideal position to move to from this point - where there would be no differences at all in the accounting standards in place in every country - is FULL CONVERSION - in this case each nation totally removes its old, national standards and adopts only IFR standards - and nothing else. This is the accounting standard setters ideal as every company's performance could be very fairly compared as they would all be using exactly the same rules (or very close to this) for the recording and reporting of their key business transactions.
However, the reality is, as we saw during the semester with the EU, there have been a lot of concessions made to powerful countries - such as Germany and Japan and China - which allows them to only "harmonise". Under this guideline, nations simply and gradually change/modify one standard at a time until they have all their old, relevant accounting standards aligned or consistent with any matching IFRS - e.g. there is an international standard on segments - IFRS 8 as we have seen - each nation that is "harmonising" only will modify their existing segment reporting standard to be as closely aligned with the IFRS 8 std. as possible - but differences will and do occur as we have seen as a result of legal rules etc. that operate within each nation.
Once all the national accounting standards are aligned with matching IFR standards - then, for the business transactions covered by the IFR standard, there is a form of convergence - i.e. all the nations should be adopting the same or very similar, global rules for that business transaction.
However, this convergence process is flawed in that nations such as the US retain a range of their existing national standards - which listed companies have to comply with as well as the IFRS - i.e. THEY HAVE NOT FULLY CONVERTED TO COMPLYING ONLY WITH IFRS - this is very confusing to the market - as US company reports are complying with over 300 accounting standards related to a wide range of business transactions while Australian companies by comparison ONLY HAVE the IFRS in place and nothing else.
Where there is doubt and "opaque" practices, mismanagement and fraud can occur and the investment risk in those countries increases as a result.
Thus: Harmonisation is the slow process of modifying existing national accounting standards to be more aligned, one by one, with any matching IFRS - it leads to inconsistent accounting rules across countries as the alignment is not perfect.

Five characteristics of development factors that help to predict low levels of transparency and disclosure in the financial statements of German listed companies

1.  Traditionally bank credit plays a major role in corporate finance

2. German accounting and financial reporting are heavily influenced by tax law

The reason for this link between taxation and financial reporting is historical. When corporate income taxation was introduced in Germany in 1874, the requirement for annual accounting had already ben codified in the Commercial Code in 1862. It was convenient to link corporate income taxation to existing financial statements.


3. German rules allow companies to smooth income over time by using hidden reserves.


4. EU directives and the forces of globalization have influenced in German financial reporting. The 1985 Accounting Act implemented the Fourth, Seventh, & Eight Directives and transformed them into German Commercial Law. Although the EU’s Directive requires companies prepare a “true and fair view” in their financial statements, it appears extensive note disclosures are seen as a way of achieving without changing the tax-based, income smoothing approach to financial statements.

5. Since the EU decided to adopt IFRS in January 1 2005, all German listed companies are required to use IFRS in preparing their consolidated financial statements. However, German accounting practices differ from IFRS in some important respects. For instance, German accounting law contains no specific rules in some areas, such as the translation of foreign currency financial statements of foreign subsidiaries, disclosures of fair values of financial assets and liabilities, and earnings per share.

What is ROI, RI, and EVA ?

ROI (Return-on-investment):

To calculate ROI, simply get profit divided by total assets of the firm

ROI = profit / assets

Disadvantages of ROI: Actions that increase divisional ROI can make the corporation worse off & conversely. ROI gave the illusion of insight and control when managers were taking actions that increased ROI but decreased the long-run value of their business units. These perverse incentives happen whenever performance is measured by a percentage or a ratio.

RI (Residual Income):

RI is calculated as net investment base multiply by risk-adjusted, then deducted by ner income before tax

To simplify:

RI= Net income (before tax) – ( net investment base x cost of capital (risk-adjusted ))

The RI measure will always increase when we add investments earning above the cost of capital or eliminate investments earning below the cost of capital.

Thus, this evaluation method can eliminate the ROI perverse incentives, and more closely align manager’s incentives with the value of the firm

Econimic Value Added (EVA)

EVA is a specific form of RI (developed by Stern Stewart) with adjustments made to the inputs (i.e. Accounting numbers, e.g. earnings and assets; Investments in intangible assets, e.g. R&D, advertising, training; Leased assets; Changes in general and specific price levels; Depreciation methods.

And adjustments with purpose of correcting distortions introduced by generally accepted accounting principles (GAAP)

EVA more closely aligns with economic income. However, cares need to be taken that ensure any adjustments made to GAAP are warranted, otherwise it would lead to manipulation.

Market participants may apply a different set of adjustments. EVA and residual income contain little news beyond earnings. Under EVA, there is little incentive for managers to seek out the top level (high yield) investments as long as their investments are just above the company’s cost of capital. Although EVA doesn’t create incentives to over or under-investment per se, it may create the perverse incentive to heavily invest in mediocre investments rather than seeking out high performing investments. Investing in too many mediocre projects, rather than high performing projects not only affects risk, but may affect liquidity. Thus, EVA should be used only as one indicator among many. 

The performance evaluation systems

The performance evaluation system is one the three legs of organisation architectures (i.e 3 legs of stools). To be successful in the competitive environment, the first thing that every firm need to consider is whether their 3 legs of stools are in balance.

To measure the performance of the firm, firstly, you need to classify the firm’s divisions into 5 centres (i.e. Cost Centre, Expense Centre, Profit Centre, Revenue Centre, and Investment Centre)

For now, we just focus on Cost Centre, Profit Centre, & Investment Centre.

Cost centre:

Task: Produce some output

Decision rights: Input mix (labour, materials, and outside services) used to produce the output

Evaluation: Efficiency in applying these inputs to produce output (i.e. use budgeted cost vs output.) Note: Quality must be easily observable and must be monitored

Profit Centre:

Task: Run a specified part of the business profitably.

Decision rights: Input mix, selling prices, marketing techniques, but nothing on the cost side

Evaluation: Profit (i.e use actual versus budget).

Investment Centre:

(this centre is quite similar to profit centre, but it has a power over the expenditures of the company):

Task: Run a specified part of the business, earning an adequate return on investment

Decision rights: Similar to profit centres but with additional decision rights for capital expenditures.

Evaluation: Using ROI, RI, & EVA

What is Market Sentiment

In technical analysis, sentiment comes in only two flavours — bullish (the price is going up) or bearish (the price is going down). At any moment in time, a bullish crowd can take a price upward, or a bearish crowd can take it downward. When the balance of sentiment shifts from bullish to bearish (or vice versa), a pivot point emerges. A pivot point is the point (or a region) where an up move ends and a down move begins (or the other way around). At the pivot point, the crowd itself realizes that it has gone to an extreme, and it reacts by heading in the opposite direction. As far back as the early 1900s, traders observed that if they were patient and waited for a pivot point to develop, they could trade at the right psychological time — just as the crowd is beginning a new move. When the crowd is reaching an emotional extreme, the crowd is usually moving in the wrong direction. A reversal point is impending. You should do the opposite of what the crowd is doing, or at least get ready to.

How to start trading

If you don’t already know trading basics, you need to get a few things under your belt to get the most out of this blog — things like what a securities exchange is, exchange hours, what trades in after hours, what brokers do (and don’t do), trading conventions like “bid and offer” and order types, how to read a brokerage statement, and oh yes, what securities you plan to trade. After that, all you really need is a newspaper that publishes securities prices, a sheet of graph paper, and a pencil. Fortunes have been made with nothing more than that. But these days, a computer, an Internet connection, and at least one piece of software that allows you to collect data and draw charts are also standard issue. You can also do charting directly on technical analysis Web sites without buying software. Don’t skimp on tools to put in your technical analysis tool belt. Buy the data, books, magazines, and software you need. Pay for lessons. Get a trading coach. You wouldn’t try to make a cordon bleu dinner on a camp stove with three eggs and a basil leaf, so don’t try to make money in the market by using inadequate tools. Your first task when you’re ready to take your technical knowledge out for a trial run is to earn back the seed capital you put into the business, the business of technical trading.

What is Technical Analysis ?

Technical analysis is the study of how securities behave and how to exploit that information to make money while avoiding losses. The technical style of trading is opportunistic. Your immediate goal is to forecast the price of the security over some future time horizon in order to buy an sell the security to make a cash profit. The emphasis in technical analysis is to make profits from trading, not to consider owning a security as some kind of savings vehicle. Therefore, technical analysis dictates a more active trading style than you may be used to.

Home Loan Analysis

Home loans are one sort of mortgage which is similar with credit union. There is a large market which offers numerous produce of home loans to Australian homes existing in every corner of Australia. This report summarises a pair of datasets regarding RBA cash rate and 198 standard variable home loan products’ detail information.
Due to the collapse of the Bretton Woods System and American extremely loose monetary policy and oil dollars rolling into the third world countries in late 1970’s and early 1980’s, the cash rate had a large reduction. After 1990’s Asian Financial Crisis, the cash rate fell down and never rises again. Then the first part of the report includes the chart of RBA cash rate historical change data through 1976 to 2010 and the analysis of this chart which highlights the main trend and feature of cash rate change.
Another part of report shows five different factors that impact the variable rate to which factors (if any) most influence the variable rate of these 198 kinds of home loans products. There are over five tables and charts being used to summarise five relevant factors that are institution type, redraw, portability, offset, total upfront fee and yearly service fee respectively. This report illuminates the key features and analysis paragraphs for each factor. It can be seen that institution type influenced the variable rate most and other factors had tiny impacts on the variable rate.
In conclusion, this report talks about the historical data of cash rate from Reserve Bank of Australia and the data of different home loans products in current market. Furthermore, this report analyses these two datasets in terms of the variation of historical cash rate as well as the influences from the different factors of the home loan products. From all the findings we find that the institution type influenced the variable rate most. However, other factors had tiny impacts on the variable rate. The advice for consumer is that they should pay attention to the institution type when they choose home loan service in the future as it impacts variable rates the most.

In Australia, there are different types of home loans products currently available in the market that provided by banks and other organizations. Interest rate is one of the major determining factors in many borrowers’ decision. Two types of interest rates - variable rates and fixed rates are based on different financial market indicators. According to Gambacorta(2008), variable rate refers to an interest rate that fluctuate over time based on the changes of an underlying interest rate index. Moreover, variable rates can be influenced by kinds of factors such as institution types, total upfront fees and yearly service fees. This report will focus on analyzing two sets of data which are interest rate data and historical data respectively.

2.0 Outliers
Outlier is an observation that lies an excessive distance from other data which lies outside the overall pattern of a distribution. However, sometimes it is difficult to realize what factors caused this situation. Therefore, it is important to identify the outlier due to it is possible to affect the accuracy and cause the systematic errors if people cannot handle it properly.
Z score formula is adopted to identify potential outlier. When the Z score is above 3.0 or below -3, it is considered to be an outlier. It has been calculated that from the data that has been provided, the Z score is within the range of -3 and 3 (see appendix 1). As a result, the outlier will not remain in the data of this report.

3.0 Historical analysis on cash rate tendency

Cash rate is the interest rate paid by bank which affected by transactions between the central bank and other financial institutions. Figure one illustrates the variation in the percentage of cash rate from May 1976 to March 2010. As can be seen in this line graph, there was a significant increase in cash rate during the first six years and it reached a peak at 20.77% in August 1982. However, an obvious decline was seen in cash rate since September 1983 and the percentage dropped to 4.76% which was the lowest point within nearly eight years. Moreover, the cash rate fluctuated a lot over the next six years and it reached a peak again in November 1989 at 18.18. Whereas, from this year onwards, the growth of cash rate was suddenly replaced by a sharply downward trend. This is probably because RBA tried to decrease the negative effects which were brought by savings and loan crisis in the early 1990s to Australia. It is interesting that after September 1991, although the cash rate still changed with some ups and downs, it tended to be stable and maintain below 10%. Besides, from May to September 2009, the percentage of cash rate keeps remaining at 3% which is the lowest data over the 15 years. It shows that the world economy seems to be growing again and Australian economy is recovering as well after the global financial crisis which started from 2008.

4.0 Current market 

The global financial crisis had resulted in the economic downturn since 2008. In Australia, in order to decline the negative effects brought by this severe crisis, the main financial institutions decreased the percentage of home loan interest rates at that time. However, at the beginning of 2010, RBA improve the interest rates which means homeowners have to pay more on their mortgages. Meanwhile, there are some major banks include ANZ, the Commonwealth Bank also followed the RBA, lifting their interest rates by a few points. On the other hand, it shows the world’s economy is growing while the economy in Australia is recovering as well. In this section of the report will focus on the home loan variable rate and what factors influence it.

4.1 Distribution of variable rate

The distribution of variable rate will be discussed in the paragraph below. This histogram demonstrates the changes of variable rate in relation to the different types of institutions. According to the data that has been provided, the institutions are tending to the interest rate of 5.75 to 7 percent which located in the third, fourth and fifth highest group of rate in the graph. In addition, only four institutions have the lowest rate and two have the highest rate. Therefore, it can be concluded that most institution may located in the interest rate group that is not too high or too low. This can be also revealed in the Table1 that the mean and the median is within the range of 5.75% to 7%. The reason for this circumstance is that if the rate is too low, institutions may be not able to earn profit and if the rate is too high, customers may not choose them. 

sum	1268.57
mean	6.41
max	7.26
mini	5.67
median	6.38

4.2 Bivariate relationships

4.2.1 Relationship between variable rate and institutions types

This paragraph will analyze the different institution types in relation to variable rate. Accordingly, most bank institutions concentrate on the rate between 5.75 and 7.25 percent. A vast majority of banks is located in the group of 7 to 7.25 percent which is the second largest group. Furthermore, there is no apparent relationship in terms of the types of financial institutions. Therefore, the types of financial institutions may not influence the variation of interest rates predominantly. 

4.2.2 Relationship between variable rate and redraw facility

Figures 4 represents the relationship between interest rates and redraw facility. As can be told from the chart, when variable rate is intermediate between 5.5% and 6%, all financial institutions allow customers to redraw their extra funds. However, there are some mortgage lenders reject borrowers’ requests of redrawing money when interest rate fluctuates between 6% and 7%. If borrowers’ money is tight, they can access the funds later when interest rate is above 7%. The redraw facility gives borrowers an incentive to make extra loan repayments, because it helps them repay the debt and saves money on interest which is one of the most significant advantages of this home loan feature.

4.2.3 Relationship between variable rate and loan portability

The bar chart above shows information about variable rate and loan portability. It can be observed that this relationship is similar to variable rate and redraw facility. Around 23% financial institutions do not permit borrowers to move a mortgage from one property to another when the interest rate varies from 5. 75% to 7%. But when the interest rate is over or below that range which was just talked about, almost all lenders agree that borrowers can transfer the outstanding balance of the existing mortgage loan at the same rate. This may because the interest rates are higher than the traditional loans to some extent, so borrowers need to have perfect credit.

4.2.4 Relationship between variable rate and offset facility

This bar chart illustrates whether the financial institutions have offset facility in relation to the variation of interest rate or not. It can be shown from figure 6 that the percentage of institutions to offer offset facility seems to be distributed similarly. That means the amounts of institutions in different groups are distributed equally. Offset facility can not only decline the unpaid balance of customers’ home loan but also accelerate the speed of paying home loans. The reason why some financial institutions refuse to offer offset for customers might be the risk of paying back the loans. 

4.2.5 Relationship between variable rate and total upfront fee

Figure 7 gives a description about the association of variable rate and total upfront fees. Based on this data, the scatter diagram shows a strong positive relationship. It means that the more total upfront fees are required, the more variable rate will be allocated. Hence, the total upfront fee plays an important role in the variation of interest rate. In addition, this figure also most points concentrate between 6 and 7 percent of variable rate. In the next section of the report the relation between one year service fee and variable rate will be examined. 

4.2.6 Relationship between variable rate and yearly service fee

With respect to Figure8, the yearly service fee and the variable rate are displayed. Figure8 indicates a weak negative relationship of the yearly service fee and variable rate. The correlation is calculated to be -0.097 which means the tendency of linear regression goes down slightly. Subsequently, decreasing of yearly service fee may give rise to the increase of variable rate. 

5.0 Conclusion 

In conclusion, the variable rate of home loan is an important factor in relation to diverse home loan products in the current market. It has been proved that the Z score of the values is between -3 and 3 which indicates that the data can be treated as an outlier. The historical data illustrates that the cash rate changes frequently for the reason of financial crisis. Moreover, in consideration of the factors including institution type, redraw facility, mortgage portability, offset facility, total upfront fee and yearly service fee, it has been discovered that total upfront fee and yearly service fee may impact the variation of interest rate.