TOPIC 4 ACCOUNTING STANDARDS

Introduction
The law by its very nature is not dynamic. It will usually fall behind new ideas and
developments and will not always cover the technical aspects of financial reporting. In addition
to the legal stipulations, accounting practice is heavily influenced by the pronouncements issued
by professional accounting bodies in the form of Accounting Standards. Companies not only
need to meet the requirements of the law but must also comply with the requirements contained
in these statements of Accounting Standards operating in their countries. In Kenya, these
standards were issued by the institute of Certified Public Accountants of Kenya (ICPAK) which
is also a member of the International Accounting Standards Committee.
With effect from 1st January 1999 Kenya adopted International Accounting Standards issued by
International Accounting Standards Committee.

Definition
Accounting Standards are methods of or approaches to preparing accounts, which have been
chosen and established by the bodies overseeing the accounting profession. They are essentially
working rules established to guide accounting practice. Accounting Standards usually consist of
three parts.
- A description of the problem to be tackled.
- A reasonable discussion of ways of solving the problem.
- The prescribed solution.

The purpose of the standards:

- To reduce the number of acceptable alternative treatments of accounting issues and
facilitate comparison of financial statements.
- Financial statements can hardly be said to be useful if they are produced on numerous
acceptable bases.
- There is great need for uniformity.
- In an attempt to reduce the range of choice of accepted accounting approaches to improve
the users confidence in the accounting figures and make accounting reports more
understandable it was deemed necessary to introduce accounting standards.
- The prime objective of accounting standards is to improve the quality and uniformity of
reporting and introduce definitive approach to the concept of what is ‘’true and fair’’

Advantages and disadvantages of accounting standards

a) They provide the accounting profession with useful working rules.

b) They force improvement in the quality of the work of accountants.

c) They strengthen the accounts resistance against pressure from directors to use an
accounting policy, which may be inappropriate in the circumstances.

d) They ensure that users of financial statements get more complete and clearer information
on a consistent basis from period to period.
e) They assist in the comparison users may make between the financial statements of one
organization and another.

f) They direct financial statements towards establishing the economic trust of the
organization performance.

g) They provide a focal point for debate and discussion about accounting practice

h) They are a less rigid alternative to enforcing conformity by means of legislation.

Disadvantages:

a. Accounting Standards are bureaucratic and lead to rigidity. The quality of the work of
accountant is restricted since firms and industries differ and change also environment
within which they operate.
b. The official acceptance of an accounting standard reduces the account’s power to resist
the use of accounting Standards applications of inappropriate standards when the
directors wish to follow it.
c. Accounting Standards reduce the scope for professional judgment of accountants.
Accountants are thus reduced to technicians rather than being professional.
d. Most users of financial reports are made to believe that financial statements
produced using accounting standards are infallible. This is misleading.
e. Standards have been derived through social or political pressures, which may reduce the
freedom or lead to the manipulation of the profession.
f. Standards inhibit the development of critical thought (why think when the standards are
there?).
g. The more standards there are the more costly the financial statements are to produce.

Application of accounting Standard in Kenya

They are intended for application to all financial statements issued by public companies,
parastatals and organizations including: co-operative societies, sole proprietorship, no-trading
concerns, estates and trusts, and other business entities reporting to the public.

How far have the accounting standards improved the usefulness of accounting information?

a) Understandability
Standards make financial statements more understandable by requiring increasing disclosure of
accounting policies.
b) Objectivity
Standards are not objective because there is no universally agreed theory of Accounting and a
universally accepted Conceptual Framework of Accounting.
c) Comparability
Standards have definitely improved comparability as they call for consistency and disclosure of
the effect of any deviation from the existing practice or standards.
d) Completeness
Standards help financial statements be more complete as they call for the production of such
additional figures as those in the Cash Flow Statements, Statements of Changes in Equity and
notes to the financial statement
e) Relevant
Standards make information more relevant but some standards are said to make financial
statements less relevant.
f) Reliable
There is no reason to believe that Accounting Standards improve reliability of financial
statements.
g) Consistency.
It is useful to the extent that it assists comparability. With standards there is now greater
consistency in the application of accounting concepts and policies.
h) Timeliness.
The standards have not improved timeliness of accounting reports and may infant have largely
contributed to the late production of reports.
i) Prudence:
Writers as introducing bias into accounts have criticized standards and therefore prudence should
not be regarded as a desired characteristic of financial reports.
J) Economy of presentation.
Standards may infarct call for extra information and therefore result in extra cost.
On the whole, accounting standards setting is an attempt to improve the reporting system and
generally, the standards have improved the quality of financial reports.

The stock exchange rules

Where companies are listed on the stock exchange, they must comply with additional
requirements laid down by the stock exchange. The rules require the provision of both greater
and more frequent information than that required by law. For example, those companies listed
on the Nairobi Stock.
Exchange, publish and interim report which contains certain minimum information. The interim
report must either be circulated to shareholders or published in at least one newspaper.
Arguments for and against the regulation of the accounting profession
The question that has been extensively debated is whether or not the accounting profession
should be regulated. This has been argued on the basis that companies have certain incentives
that force them to report to interested parties without necessarily making them to do so through
regulation. Thus, the need to unregulated accounting profession. The arguments for and against
an unregulated the accounting profession are discussed below.

Arguments for unregulated Accounting Profession

1. Agency theory.
The theory argues that since management is engaged in agency contracts with the owners of the
company, they must ensure that information is supplied to the shareholders regularly and
management since the shareholders would like to monitor management and such monitoring
costs like audit fees may have a direct bearing on the compensation paid to management, is
compelled to report regularly so as to enhance their image and compensation. Thus firms will
disclose all information voluntarily.

2. Competitive Capital market

Firms have to raise capital funds from a competitive environment in the capital markets. This
will compel them to disclose voluntarily so as to attract such funds from investors. It is generally
accepted that firms that report regularly in the capital markets have an enhanced image and could
Easily attract funds from investors. Thus firms have an incentive to give regular financial reports
otherwise they cannot secure capital at a lower cost. Thus regulating accounting will be imposing
rules in a self-regulating profession.

3. Private contracting opportunities theory.

It has been argued that users who need information may enter into a contract with private
organizations that can supply them with such information. This will ensure users get detailed and
specific information suiting their requirements instead of the general-purpose information
provided by financial report as regulated by the legislation. Such all-purpose data may be
irrelevant to the users’ need. Under such circumstances there is no need to regulate accounting
profession.
Arguments against unregulated Accounting Reporting
Arguments in support of accounting regulation are usually based on the doctrine of ‘market
failure’. Market failure refers to a situation where the market is unable to efficiently allocate
resources because of imperfection that exist in that market or because the way the market is
structured is poor.
Market failure occurs when the market is unable to provide information to those who are in need
of it. Because of the existence of market failure in providing accounting information, it has been
argued that the accounting profession should be regulated so as to serve its users effectively and
efficiently.
Specific Reasons why market failure occurs include the following:
1. The monopoly in the supply of such information in the accounting entity.
The reporting entity is the enterprise that is in control of the supply of internal information about
the entity; this introduces certain imperfections in the supply of such information. There will be
restriction in the supply of absolute information about the accounting entity and the information
may not be available to those who need it.
Even if suppliers of such accounting information were to charge prices fears have been expressed
that such prices will be prohibitive for most users. Further doubts have been expressed on
whether firms can supply all the necessary information, both positive and negative, especially
where such firms operate in a competitive environment. This will be common in countries like
Kenya where the capital markets are not well developed.
There is therefore an urgent need to make financial reporting mandatory through a regulatory
framework.

2. Failure of Financial Reporting and Auditing.

Financial reporting standards have failed to correct instances of public fraud through fraudulent
reporting and this has been so because of laxity in regulating accounting practices. The existence
of a variety of methods of doing one thing and too much flexibility in accounting practice, have
enabled the management of firms to manipulate accounts to suit their needs.

3. Auditing itself has been inadequate and not geared towards detection of fraud because auditors
hardly ever carry out 100% examination of records and transactions. There is therefore a serious
need to control accounting practice through stringent standardization guidelines. This calls for a
regulated accounting profession.

4. Public good characteristics of Accounting Information.

Accounting information has the characteristics of a public good. The moment accounts are
released to one person; the information contained therein cannot be restricted from getting to
other persons. This implies that purchasing accounting information through private contracting
will be virtually impossible because its supply cannot be restricted and thus they cannot make
money out of it and will be difficult to decide on the price to charge.

Problems created by the regulations of the accounting profession

In practice, regulation of any field leads to a misallocation of resources because production is not
geared towards the market forces of demand and supply. Regulating the accounting profession
has led to the following problems:
1. Standard Overload
Overstatement of demand for standards, there led to over-production of standards. Many people
who contribute during the standards setting may not be active demanders of information to be
supplied by such standards and very often, the standard setting committee takes into account the
views of such people leading to the misallocation or resources.
This was the case in the United States of America prompting the Security Exchange Commission
to ext small companies from complying with certain standard requirements.

2. Politicization of Standard Setting

Regulating is a political process intended to protect the conflicting interests of various user
groups. This leads to dilution of accounting standards, as they are compromised by being based
on bargaining instead of technical suitability.

3. Social Legitimacy.
The standard setting process requires social legitimacy in order to be effective. The regulating
bodies should consist of persons presenting various user groups of financial reports.

4. Economic Consequences.
Regulations sometimes, overburden companies with unnecessary regulations which might have
negative economic consequences. This is especially so when companies devise ways and means
of avoiding certain regulations for one reason or another.

For instance, when FASB No 13 on accounting for leases was used in America requiring
companies to capitalize certain leases and reflect in the balance sheet as both asset and liabilities,
companies tended to restructure their leases so as to improve their debt structure. This means
incurring unnecessary legal costs due to regulation.

Adoption of international accounting standards and internal standards on auditing

(international standards)

International Accounting Standards (IAS)

These are guidelines & working notes and procedures formulated by the international accounting
standard board (IASB) to guide accounting practice.
They describe the methods of accounting deemed mandatory for application to all financial
statements other than those prepared for internal rules.

Background
Back in the early 80s, ICPAK made a decision to develop its own standards in both accounting
and auditing (Kenyan Standards). This decision was primarily driven by the young Institutes
desire to be associated with truly national standards which addressed the unique circumstances
prevailing in Kenya at the time. Those standards borrowed heavily from existing international
Standards on auditing and addressed those components which were considered to be most
common in financial reporting in Kenya.

Since that time, the accounting profession has undergone tremendous change, as have the
economies that the profession serves. New alliances and affiliations have taken root and
globalization continues unabated. It is against this background that council has decided to adopt
International Standards and to phase out Kenyan Standards.

Why adopt International Standards?

Council believes that there are compelling reasons why the change to International Standards is
necessary:

a) International trends.
The last few years have seen dramatic developments and changes on the International Standards
setting scene. Along with this has come a rapid adoption of international Standards in a number
of countries which previously had their own national standards-take most of Europe and a
number of countries in the pacific rim for example International Standards are now virtually
accepted as the common yardstick for international reporting, with the only major pockets of
resistance being the US and the UK. By the time we start the new millennium, acceptance and
use of use of International Standards will be virtually universal. International flows of investment
capital and capital instruments across geographical boundaries will add a new impetus to the
current push for adoption of International Standards.

b) Regional Considerations
Kenya is a member of both IFAC and ECSAFA, organizations which strongly support adoption,
rather than adoption, of International Standards. With the current trend in which most countries
in the region have decided to adopt International Standards, Kenya will be risking its leadership
role if it lags behind on this issue.

c) Local Pressure
Regulators particularly the Central Bank of Kenya and the capital markets Authority) have
continuously turned to International Standards rather than Kenyan Standards as an indicator of
what the best practice should be. The capital markets Authority is currently in the process of
developing disclosures standards for listed companies as well as those seeking to be listed. In
doing so the authority is turning to international, rather Kenyan Standards. The institute runs the
distinct risk of being marginalized in this important exercise unless it takes initiative on adoption
of international Standards.
In addition, the increasing numbers of entities operating in Kenya that are part of a bigger group
which reports under a number of jurisdictions has fuelled the pressure for adoption of
International Standards.
 d) Resource Limitations
Over the last few years, some major changes have been made to the International Standards as
part of the “comparability” exercise. These changes have affected virtually all the Kenyan
Standards in force. Following these changes, the existing Kenyan Standards are hopelessly out of
date.
Updating Kenyan Standards to comply with International Standards and to also cover areas
which are not covered currently is a monumental task. The institute just does not have the
resources, human or financial, to carry out this task to a satisfactory level of proficiency. And
even if it did, what purpose would it serve?
Council believes that an effort to update Kenyan Standards will merely reproduce International
Standards under a different name. In the circumstances, therefore the resources available to
ICPAK could be put to better use if they were used to interpret International Standards, assess
their implication on local practice and where necessary, to issue technical bulletins and local
guidance on those standards.

e) Past Experience
Every Kenyan Standard issued so far is intended to comply with IAS and says so in a paragraph
labeled “Compliance with International Standards”. ICPAK has never found it necessary to
challenge any International Standards and no Kenyan Standard has ever been designed to deviate
from International Standards. This then begs the question as to whether it is worthwhile
expending scarce resources and energy in paraphrasing of existing International Standards which
leads to no discernible change in substance.

Implication on Local Reporting

Council does not anticipate much of a problem in the larger entities in Kenya adopting
International Standards- most of this is already in compliance. However, the adoption of
International Standards would have an impact on smaller national businesses, but so would a
wholesale revision of Kenya Standards.
The question therefore, is how quickly reporting entities operating in Kenya can conform fully to
the requirements of International Standards. Council believes that a reasonable transition period
is necessary to give reporting entities a chance to conform in a systematic manner

Advantages of adopting International Standards

By adopting International Standards, ICPAK will reap certain benefits:
- Kenya will be recognized as a leading International player in cross-border reporting in
the region.
- The institute will remain on top of events taking place in the accounting and auditing
fields, particularly where International players or regulators are concerned.
- The scale and voluntary human resources are available to the institute will be relived of
Standard development responsibilities and will therefore be available to devote their
energy to helping members interpret International Standards and to communicating their
implications to technical bulletins.
- These are the common basis for the preparation and reporting of financial information
usually referred to as “the generally accepted accounting standards”
- Accounting standards are also referred to as principles assumption, postulates and
concepts.
Board /Organizations that have responsibilities for setting accounting standards
1). Financial Accounting Foundation (FAF)
2). Financial Accounting Standard Board (FASB)
3). Government Accounting Standard Board (GASB)
4). Financial Accounting Advisory Council (FAAC)
5). Government Accounting Advisory Council (GAAC)
6). International accounting standards board (IASB)

The major difference in Financial Accounting Standard Board and the others are:-
1). Membership Number
2). Financial Independence
3). Reporting autonomy
4). Board representation
5). Increased staff & advisory support
Since 1973, the Financial Accounting Standards Board (FASB) has been responsible for
establishing the accounting standard that constitute generally accepted accounting procedures

The FASB currently follows a due process procedure in developing accounting standards. This
process uses an open format that provides an opportunity for interested parties to express their
views.
The standard process uses the following steps:-
i. Select and prioritize issues of the Boards Agenda
ii. Appoints a representation task force to identity & define the problems & alternatives
related to each and conduct a research & analysis about it.
iii. Prepare a discussion memorandum on the issue to interest parties
iv. Invite public comment of the memorandum
v. Schedule public hearing following the discussion memorandum, Analyze the
comments given.
vi. Determine whether to issue a standard, if yes prepare an exposure draft of the
standard & distribute to all interested parties
vii. Analyze the comments about the explosive draft from the public
viii. Public hearing
ix. Approve / disapprove the exposure as revised by a vote for at least of the seven
Board members. If approved, it becomes a new standard.