Discuss about the Corporate Governance Reduce and Capitalization Practice.
The recent adoption of the International Financial Reporting Standards by the corporates that are conducting their business operations within Australia the financial statements of these entities were impacted significantly. For illustrating the effect of the financial statements the changing impact of the accounting, standards have been used. The main purpose of the following report is to determine the impact of the adoption of the International Financial Reporting Standards on thinly capitalised position of the companies operating in Australia.
It was announced by the Australian Financial Reporting Council that International Financial Reporting Standards will be formerly adopted by the country and will be made applicable from reporting periods commencing on or after 1st January 20005. It was conclude by the FRY that the adoption of the International Financial Reporting Standards by the companies of Australia would help in conducting cross border comparisons by ensuring the improvement in the transparency and comparability in financial reporting this would lead to better contracting among the various capital market participants. In addition to this, it can lead to lower cost of capital and at the same time will enable in increasing the ability of raising funds and being listed overseas (Alshamari et al. 2018). The adoption of the International Reporting Standards by the companies of Australia has resulted in the significant changes and had a profound impact on the recognition, measurement and disclosure of the assets, liabilities, equity and profitability of the entity. The process FO converting into the IFRS had a fundamental impact on several aspects of financial reporting and taxation. It involved changes being made to the existing standards and introduction of new accounting standards. It is very much possible that the IFRS adoption can affect adversely the thin capitalisation calculations of the firm. The reason considering it a significant change is that these firms can be denied income tax deductions in respect of the interest payments and the associated borrowing fees to be paid by the company on its borrowings (Pratama 2017).
The main purpose of the study is to determine the impacts of the Australian equivalents to the International Financial Reporting Standards on the thin capitalisation position of Australian listed companies. There are mainly two objectives of this project, firstly the determination of the fact how and why the significant IFRS is capable of affecting the thin capitalisation compliance of the Australian companies and secondly the quantification of these changes and relating them back to the accounting and taxation policy initiatives.
The process of adoption of the IFRS o 1st January 2005 brought with itself the major consequence of impacting the dividend decisions of a firm and the franking policy adopted by it, its thin capitalisation position, and the application of the Australian with holding the taxes and the income tax consolidation (Bond et al. 2016). It was strongly voiced by the group of 100 (G100) and the Institute of Chartered Accountants in Australia that the adoption of the International Financial Reporting Standards is going to negatively and inappropriately influence the tax consequences. This was to be observed specifically in case of the thin capitalisation position FO the companies (De George et al. 2016). The changes that have been brought about in respect of the recognition and the valuation of the assets and the liabilities and equity under the IFRS is going to result in some of the companies that previously complied with the provisions fo the thin capitalisation rules under the Australian Generally Accepted Accounting Principles, to fail the tests now. This failure on the part of the companies will not be the result in the change in the financing mix of the entity or any changes in the business operations FO the entity but due to the compulsory compliance with the IFRS.
After the introduction of the IFRS, it was directed by the Federal Treasurer to allow a transitional period of three years period to 31 December 2007, under which the companies had the option of electing on an annual basis, the use of IFRS or the GAAP, as they existed pre-1st January 2005 for calculating their thin capitalisation position. It has been further viciously argued by the G100 and Institute of Chartered Accountants in Australia that a longer period is required for ensuring that the companies are not worse off under the provisions of the thin capitalisation rules subsequent to the adoption of the IFRS than they were prior to its adoption (Richardson and Taylor 2015).
The major consequences of the adoption of the IFRS are as follows:
One of the key concerns of the companies after the adoption of the IFRS is that it is possible that the debt to capital ratios will be increased under IFRS to such an extent that it will lead the companies to cross the safe harbour of the debt limit of 75%. The possibility increases significantly if the entity had a debt to capital ratios in the range of 60%-75% ratio prior to the adoption of the IFRS (Conaway et al. 2016). The safe harbour in respect of the debt capital ratio is considered to be 75% of the average asset value of the Australian operations that is netted of by non- interest bearing liabilities and the investments that are being made in the associates. The consequences will be that the deductions in respect of the debt like the interest payments, loan fees is going to be disallowed by the statute once the entities are going to cross the safe harbour of the debt to capital ratio. In order to restrain from this the large multinational companies of Australia undertook recapitalisation programs under which the debt to capital ratio are being maintained in the range of 50%-75% in respect of the Australian Group. This range of safe harbour is being achieved by the entities by ensuring the introduction of the debt into the Australian corporate group and the positions of the asset are being adjusted through revaluations of the assets. With the introduction of the IFRS, several other adjustments in respect of the elements of the balance sheet are expected that are going to influence the compliance with the thin capitalisation provisions of these provisions.
There are substantial and key differences in the provisions of the GAAP and the IFRS that have been recently implemented in the corporate world of Australia. these variations have various flow-on impacts in respect of the calculations of the thin capitalisation position of an Australian entity in respect of the recognition, measurement and the classification of the financial assets and liabilities, intangibles, asset impairments and goodwill and the income taxes (Hale et al. 2017). This is because the values that are being adopted in respect of the assets, liabilities, the debt capital of the company and the equity capital of the company must comply with the accounting standards. The provisions of the IFRS that are going to have the greatest impact in respect of the application of the thin capitalisation provisions are as follows:
The impacts that these provisions are going to have on the on the thin capitalisation position of the entity are supposed to be industry specific. For instance the adoption of the AASB 139: Financial Statements: Recognition and Measurement has ensured that proper recognition is being conducted in respect of recognising the available-for sale-investments and all the financial instruments of derivative nature such as assets and liabilities at fair value in the balance sheet. Under the provisions of the GAAP, these instruments are not being recognised in the financial statements of the companies (Cashman et al. 2015). This can lead to substantial change in the valuations of the assets of the companies especially if there is a presence of marked valuations at fair value up or down. This can eventually lead to the impact on the thin capitalisation provisions of the company under the provisions of the IFRS. As per the provisions of the AASB 132 significant amount of more financial instruments are classified as debt rather than equity. As per the provisions of the AASB 112 Income taxes the companies are required to make use of the balance sheet method to conduct the comparison between the carrying values with that of the tax bases of the assets and liabilities for the purpose of determining the temporary differences which went on to form the basis of the deferred tax balances. The recognition of the deferred tax assets and the deferred tax liabilities are conducted in all case except some cases like that of the goodwill. The recognition of the deferred tax assets are also conducted in case of asset revaluations and the fair value adjustments that are being conducted in respect of the business combinations. Under the provisions of the AASB 138, Intangible Assets that have been generated internally like goodwill, brands, mastheads, publishing titles, customer lists and items that are similar in nature in substance are not being recorded. As peg rate provisions as laid down by the AASB 138, the companies of the country are not being able to record certain intangible assets that are at present been reflected in the balance sheets of the company like brand names and the expenditure that are being incurred in respect of the research activities conducted by the companies (Kusi et al. 2016). As per the provisions of the AASB 138 the intangible assets specifically those that are being generated internally like brand names or items that are of similar nature is prohibited to be recorded in the financial statements of the company. The companies, which had large amount of such intangible assets in their balance sheets, the present written down value of these assets greatly, affected their asset base for the purpose of thin capitalisation provisions of the companies for capitalisation purposes.
For the purpose of conducting the study of the impact of the IFRS on the thinly capitalised companies a sample of 105 top non-financial, non-AID, non- Insurance Australian listed companies were being selected. The significance of studying the impact of the IFRS on the thinly capitalised companies is important because thin capitalisation rules is being made applicable to those companies which funds its assets by a high level of debt and relatively less amount fo equity. Companies that generally make use of debts for financing their projects or investments do so for maximising the tax deductibility of interest payments that are being made allowable in Australia (Cheong and Zurbruegg 2016). The benefits of the associated with the adoption of the standards for the purpose no valuing the financial statements elements for thin capitalisation purposes are being stated by the treasury. As per the report or the analysis of the treasurer, the International Financial Reporting Standards are comprehensive, transparent and objective. The adoption of the IFRS result in the reduction of the compliance costs as accounting standards are being used for calculating thin capitalisation positions. In addition to this it is found that the companies that are subject to the thin capitalisation rules are mostly multinational companies operating in wide range of jurisdictions making use of the IFRS for the purpose of thin capitalisation facilitates the comparability as the jurisdictions are most likely to utilise Australian IFRS equivalents.
The adoption of the IFRS has led to the significant increase in the interest bearing liabilities to proxy measure of safe harbour of debt amount. The ratio experienced an increase of 13.19% that is from a mean of 37.98% under the provisions of GAAP to 42.99% after the adoption of the IFRS. This clearly demonstrates that the adoption of the IFRS in Australia has had a significant impact on the thin capitalisation position of the Australian listed firms.
This has led to many significant policy implications. One of the most significant policy implications is concerned with the adoption of the fair value accounting. There have been significant changes occurring subsequent to the adoption of the provisions of the IFRS in respect of the recognition of the financial assets and liabilities (Zielke 2014). The determination of the fair value can involve high amount of assumptions on the part of the management that led to inherent uncertainty in the process of valuation of the assets, liabilities and the equity of the company. therefore the adoption of the provisions fo the IFRS in this respect i.e. measurement and recognition of the financial statement elements can in turn lead to sever impact on the thin capitalisation provisions of the company.
The second significant policy implication is centred on the thin capitalisation compliance costs. The compliance costs under the provisions of the IFRS may increase significantly, as the companies are required to conduct independent verification of the revalued assets under the provisions of the IFRS and in respect of the fair value assessment of the financial assets and liabilities of the entities (Bob 2016). The uncertainty of the stakeholders is reduced, as there is an increased alignment between the taxation provisions and the accounting standards, which subsequently reduces the compliance costs and increasing the consistency. However, the compliance cost of the companies will increase significantly if the depending upon the fair value measurements of the financial statements elements the thin capitalisation position of the companies varies greatly (Docherty and Viort 2014).
Conclusion
After the an indepth analysis of the various implications of the adoption of the IFRS on the reporting that is done by the thinly capitalised companies within Australia it can be concluded the impact of the adoption have significantly affected the reporting requirements and the quality of the financial reporting that is done by the companies. Two of the most significant implications can be identified as the adoption of the fair value measurement of the value of the assets and the liabilities and the reduction in the cost of compliances. This can significantly improve the quality of the reporting that are dine by the corporates of the country.
Reference
Alshamari, A., Raghavan, M. and Shantapriyan, P., 2018. Analysis of IFRS on foreign capital inflows to Australia using endogenous structural break and ARDL approach.
Bob, V., 2016. An examination of base erosion and profit shifting exposure for South Africa (Doctoral dissertation).
Bond, D., Govendir, B. and Wells, P., 2016. An evaluation of asset impairments by Australian firms and whether they were impacted by AASB 136. Accounting & Finance, 56(1), pp.259-288.
Cashman, G.D., Harrison, D.M. and Sheng, H., 2015. Know Thy Neighbor: The Impact of Cultural and Geographic Distance on Information Asymmetry.
Cheong, C.S. and Zurbruegg, R., 2016. Analyst forecasts and stock price informativeness: Some international evidence on the role of audit quality. Journal of Contemporary Accounting & Economics, 12(3), pp.257-273.
Conaway, J., Liang, L. and Riedl, E.J., 2017. Market Perceptions of the Informational and Convergence Effects of Fair Value Reporting for Tangible Assets: US and Cross-Country Evidence.
Conaway, J.K., Liang, L. and Riedl, E.J., 2016. Market Perceptions of the Informational and Comparability Effects of Fair Value Reporting for Tangible Assets: US and Cross-Country Evidence.
De George, E.T., Li, X. and Shivakumar, L., 2016. A review of the IFRS adoption literature. Review of Accounting Studies, 21(3), pp.898-1004.
Docherty, A. and Viort, F., 2014. Better Banking: understanding and addressing the failures in risk management, governance and regulation. John Wiley & Sons.
Hale, G., Kapan, T. and Minoiu, C., 2017, June. Shock Transmission through Cross-Border Bank Lending: Credit and Real Effects. Federal Reserve Bank of San Francisco.
Kusi, B.A., Agbloyor, E.K., Fiador, V.O. and Osei, K.A., 2016. Credit referencing bureaus and bank credit risk: evidence from Ghana. African Finance Journal, 18(2), pp.69-92.
Pratama, A., 2017. Does Corporate Governance Reduce Thin Capitalization Practice? The Case of Indonesian Manufacturing Firms.
Richardson, G. and Taylor, G., 2015. Income shifting incentives and tax haven utilization: Evidence from multinational US firms. The International Journal of Accounting, 50(4), pp.458-485.
Zielke, R., 2014. Anti-avoidance Legislation of Mayor EC Member Countries with Reference to the 2014 Corporate Income Tax Burden in the Thirty-Four OECD Member Countries: Germany, France, United Kingdom, and Italy Compared. EC Tax Review, 23(2), pp.102-115.
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