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Early Warning Signals of Corporate Collapse - Rats Desert the Sinking Ship

2018-07-10T20:11:00.000-07:00

Rats desert the sinking ship is an old English proverb which is used to indicate that people start to bail out on a project or abandon colleagues at the difficult times.

In old wooden ships there would always be rats on board. When the ship is about to sink the rats jump off and start swimming toward a safer place. It is said that that rats could instinctively detect the imminent collapse before human could. When rats leave a ship this is an ominous sign that the ship would sink.

Similarly at the initial stage of the failure of corporate the strategic personnel vacate their positions. When things are heading seriously downhill the top management realizes that the current financial distress is irreversible and the ultimate result will be the demise of the business. The drivers of the vehicle see the fatal end of this journey but not the poor passengers. So they leave the entity! Therefore the situation will get aggravated when the coxswain abandon the entity which is on its last legs, then you know the entity is doomed.

Car Dealership Market in Australia

2018-07-09T21:41:00.002-07:00

Introduction

Success of any business depends on how well it has analysed its external environment (micro and macro) and its own business. This understanding is crucial for businesses to survive, sustain and reap advantages from opportunities and to combat threats from external forces. An industry analysis is of paramount importance for any business to analyse various trends, degree of competition market share. Similarly, business can understand its own strengths and weaknesses by addressing external threats and opportunities from external market by through SWOT analysis.

In this backdrop, purpose of this article is to understand both macro and micro environmental characteristics influencing on car dealership market in Australia and then to develop a SWOT analysis for a top major players in the industry and to make recommendations.

Figure 01.2 Environmental Analysis

Australian Car Dealership Industry

Though car brands were able to have a strong position in global market they are now surpassed by other trending industries, such as apparel and luxury items (Snyder, 2006). However, global car sales are growing at a rate of 4.8% and main reason for the growth is rapid economic development in China (Scutt, 2017). Chinese cars are currently well popular among their own country, where in 2016 they were able to manufacture and deliver over 28Mn auto mobiles (China Today, 2017).

Similar to global growth trends, Australia too experienced a turmoil in the industry. Despite volatile growth in car dealership industry[1] for the last decade, the industry generated over $ 66 Billion revenue in 2017 (AADA, 2017).

Figure 01.2 Car Dealership Industry Revenue Growth

In comparison to other developed markets, Australian new car dealers face a fierce competition, where they offer 67 branded cars under franchising agreements, compared to 49 brands in Canada, 53 in the UK and 51 in the USA (AADA, 2017). Among these brands Toyota (18.2%) has the highest Australian market share (Selwyn, 2018).

Market composition

Car dealership market in Australia is at its maturity stage of the life cycle with an annual growth rate of 0.05%. In terms of new car retailing, there are approximately 2,600 vehicle outlets operated by 1,500 car dealers in Australia (AADA, 2017). Market comprised of public listed companies such as AHG Ltd, AP Eagers Ltd and Autosports Group Ltd and other small and medium enterprises (SME)s. It is noteworthy that this market is not dominated by few companies nor it has a monopoly. However, in 2015 onwards the small car dealerships experienced a losses and have been subject to acquisition by large companies.

Figure 01.3 Market Share in Terms of Brands

Competitors

Car dealership market has number of other competitive industries such as used car dealerships, customer direct imports and alternative public transport. The vehicle importation has been decreased over the past decade steadily due to the strict government regulations. Total used car imports were 12,000 in 2007 has been reduced to nearly a half by the end of 2017 (RAWS Association, 2017).

Figure 01.4 Market Share in Terms of Companies

Despite the increase in number of cars sold by dealers profit margins have shrunk due to low priced cars are being in demand. The industry is having only 2% of net profit on revenue compared to 5-7% of net profit margin in retail industries (Deloitte, 2016). Thus for the industry to boom there should be incentives for car dealers either by enhancing the profit margin or by increasing the volume. Currently it is estimated that growth of the car dealership market to be 0.05% (Thomson, 2018). Current population growth in country is 1.4% and the increase in migration population growth by 3% (Australian Bureau of Statistics, 2017) could contribute immensely by widening customer base.

Suppliers

In terms of supply side of value chain, major supply industries are vehicle manufacturing, wholesaling, electrical service and parts and maintenance. Changes of these industry conditions could have a direct impact on dealership market. Cessation of domestic car manufacturing of by 2017 (Motor Trade Association of Australia, 2018) caused a considerable impact on dealership market which brought new opportunities as well as created threats.

Due to intense price competition among local car manufacturers and imported cars owing to high wage rate, technological costs, domestic production ceased in 2017. Thus, new car brands such as Toyota and GM Holden are now solely imported. This has given car dealers new opportunity to seek for low cost cars to capture wider margins which was not presented when cars were locally manufactured.

Demand

Demand side of value chain is the customers. Industry caters to diverse auto mobile requirements, ranging from; taxi and limousine transport; passenger car rental and hiring and end retail customers. There are over 400 models to choose from 67 branded cars, which gives customers wide range of options. Thus competitiveness within the industry is undoubtably intense.

Due to environmental concerns and increase in petroleum prices in last decade customers are now moving towards more eco- friendly electric and hybrid vehicles. Thus, small cars such as Mazda3, Hyundai i30 and Toyota Corolla have reported a growth in sales (Thomson, 2018). Despite considerable reduction in fuel prices in recent years, customers still prefer to switch to smaller-cheaper and fuel-efficient cars.

Contrariwise, boom in SMEs has increased demand for utility and commercial vehicles (Thomson, 2018), which are comparatively more expensive than smaller-cheaper and fuel efficient cars. This is supported by Toyota HiLux, being a commercially used vehicle, becoming the best seller in year 2016-17.These utility vehicles can attract more profit margins to dealerships as they are priced well above passenger vehicles.

02. Market analysis

Demographic factors

The industry is currently at a saturated point where there are nearly 685 cars per every 1,000 people in Australia (Thomson, 2018). Thus, unless the population growth is increased demand for cars will be stagnant without a growth. According to Figure03.2 most densely populated states, such as New South Wales, Victoria and Queensland, are home to more than 77% of the population. Conversely, little over 78% of the car dealers operated in these regions.

While population and car dealership distribution appeared to be rational, new opportunities could be seen in states such as in Northern Territory and Western Australia, where there is a considerable increase in population compared to the previous year. This could be further supported by the new migration policies to direct the immigrants to the low populated areas. Though the overall population growth in Australia is at 1.6% the immigration growth is at 3%.

Figure 02.3 Population and Car Dealership Distribution

Legal

Local dealers are facing a challenge due to new amendments made to Motor Vehicle Standards Act 1989, which enabled customers to personally import cars from 2018 onwards (SBS News, 2016; AADA, 2017). This has increased choice for customers while creating a threat to local car dealers. With these changes in legislation, it is estimated that nearly 30,000 vehicles be imported to Australia every year (RAWS Association, 2017).

Further, Australian Competition and Consumer Commission (ACCC) has restricted insurance companies to pay 20% commission payment to car dealerships when selling insurance policies to their customers (ACCC, 2017). According to BDO forecast this legislative influence could reduce the annual dealership income by nearly $1,000 million.

Taxation

More than 20% of the price of car is comprised of taxes and charges (AADA, 2017). This includes, 10% GST and 33% of the luxury car tax charged above luxury car threshold[1]. Thus, due to stoppage of car manufacturing in Australia all are imported which are subject to additional importation taxes. As a result profit margins have decreased.

Conversely, tax exemption of cars importing from South Korea (since 2014) and Japan (since (2015) helped reduced the tension on prices (Thomson, 2018). Despite Australian dollar being depreciating against these currencies, removal of the taxes caused prices to be reduced in the market attracting more customers.

Environmental

The environmental concerns and go green concept is not a mere fad among the producers. It has been firmly grounded in the today’s business models due to reasons such as government, pressure groups influence, change in consumer lifestyle and awareness, overwhelming evidence of human impact on environmental degradation and also partly due to the companies genuine concerns on the environment (Leonidou & Leonidou, 2011). In contrast, some businesses perceived environmental issue as an opportunity to exploit by changing their strategies and to place their product top of competition (Curtin, 2007). Due to these reasons environment has a great impact on the industry at large and on individual businesses.

Similarly industry too has an influence on environment. It is estimated that approximately 19% of carbon-dioxide emission can be linked to vehicles on road (PricewaterhouseCoopers, 2007). With constant increase in the global temperature and awake of awareness, the customers are now moving towards alternative transportation methods such as public transport and the bicycles.

Economy

Real household income of Australian residence has increased in the past decade by 19% [2] (simple growth rate). When household income increases there is more demand is created for the non-essential items like cars (Thomson, 2018).

Since the dealership market solely rely on the imported cars the exchange rate plays a vital role. The weak Australian dollar has caused profits margins to shrink and it was reported that most small scale car dealers in 2015 reported a loss. However, major players like Automotive Holdings Group and AP Eagers maintain steady growth.

03. Audit of Major Players in the Car Industry

As discussed in the previous section Toyota, Mazda, Hyundai, Holden and Ford are the top five brands in Australia in terms of the market share. In this section two major players will be analysed in terms of their marketing mix.

Toyota

Toyota[3] is a Japanese car manufacturer founded in 1937. Today Toyota has fifty-one production and nine R&D bases across the globe, including Australia. Unlike other brands, Toyota does not recognize its country of origin, rather it states “Made by Toyota”, which emphasises philosophy: every vehicle is produced with high quality in “Toyota Way” (Toyota-Global, 2018). The following sections describe marketing mix of Toyota. Toyota-Australia is an unlisted public company which is at the 38^th position within the 2,000 companies in Australia (IBISWorld, 2017b).

Product

Toyota-Global categorised 42 models under 9 classes (Appendix1) compared Toyota-Australia categorization of 21 models under 4 classes (Appendix2). The product mix in Australia is comprised of vehicles that suitable for the lifestyle and the legislative framework. Since the cessation of the production of manufacturing in Australia in 2017, all the vehicles are imported for the local market.

The demand for large vehicles have been diminished which could be seen by gradual decline in sale of Aurion[4] (Thomson, 2018) and discontinuation of the production. Similarly, the importance placed on medium cars declined (Camry) due to shift in consumer preference for small cars. As a result demand for Corolla has increased. In particular large passenger vehicles (Tarago) demand has decreased owing to high fuel consumption. Similarly grow in SME businesses has created a great demand for utility (HiLux) and commercial (HiAce) vehicles.

Thus in terms of the product mix a greater emphasis has been placed on utility, small-fuel efficient and commercial vehicles.

Price

Price is the only element in the marketing mix that does not entail an actual cost to the business (Rao & Steckel, 1995). In 2017 Toyota-Australia generated $8,827,889,000 revenue. This is from the full range of low priced to premium models. The pricing model is designed based on the model and customer segmentation.

Due to high competition among dealers and higher range of customer choices, the pricing strategy has been the economy pricing for the small-fuel-efficient vehicles and for luxury models, premium pricing strategy has been applied. However, the pricing strategy has been revised for Toyota86 sports car model by lowering its price in order to popularise the product in Australia (Thomson, 2018).

Japan-Australia free-trade-agreement has removed the import tax on vehicles. Toyota being a Japanese company were able to receive the benefit of the government policy and lower their prices to gain the competitive edge (IBISWorld, 2018). As a result, lowering the price of sports car category (Toyota86) has attracted more customers.

Promotion

Toyota has branded itself as “making clean-cars” (Toyota-Global, 2018). The advertising strategies have been designed to emphasised qualities of different models. For instance slogans such as “Hilux-tougher than you think” Yaris-treat it with respect, “Prius-lower emissions than a goat” encapsulates features and value of models. Toyota’s commercial sponsorship has been driving force of their brand image. Among their sponsorship policies they embrace innovative environmental reliability safety high and quality (Toyota-Global, 2018).

Place

Distribution channel is greatly dispersed as Toyota uses 313 dealerships to reach the customers dispersed across the country.

When the dealership distribution is compared with the population it can be seen that both has the same degree of dispersal.

Figure 03. 4 Distribution of Toyota Dealerships Vs Population

Mazda

Mazda-Australia, which has its roots in Japan, is a foreign owned private company which is at the 119^th position within the 2,000 companies in Australia (IBISWorld, 2017a). It generated a revenue of $3Mn including the sale of vehicles and other revenue.

Product

Mazda-Global categorised 11 models under 5 classes (Appendix3) and Mazda CX8, a large SUV model is about to be introduced to their product range. Unlike Toyota, Mazda is well known for its product for being made for passion and people with passion. The product designs are much towards sports car models than for family-type wagon.

As a result of consumers shifting towards low priced-small cars, demand for Mazda3 has been increased creating more emphasis on their product range. Mazda is well known for its SUVs (CX5 and CX9) and there has been a recent increase in demand among upper-middleclass buyers.

Price

The prising is very competitive as there are number of models are in the market under numerous brads. Mazda follows different pricing strategies based on the target market, for instance CX9 is a premium priced vehicle targeted for upper-middleclass buyers whereas Mazda3 is following competitive pricing strategy with lower prices to increase the profits by increasing the volumes.

Promotion

Zoom-Zoom slogan has been the heart of the promotional campion of Mazda since 2010. This represents Mazda’s fuel efficient SkyActiv engine. Among other promotional strategies Mazda aggressively take part in commercial sponsorships. It has been the sponsor for number of sporting events and gained popularity.

Recently, Mazda-Australia has a range of drive away offers for the private buyers. Further Mazda has introduced an end-of-year tax time value for a limited time period as a method of promotional strategies.

Place

Mazda manufacturing in different plants across the country and imported to Australia. Having affiliations with dealerships provided Mazda with competitive edge by being close to the target customers. Unlike other brands, Mazda targets the urban youth in upper and middle-class-upper

SWOT Analysis of Toyota

04. Recommendation

Change in the product mix

In the review of information related to Toyota-Australia it was noted that popularity for small-fuel efficient cars is now in demand due to shift in customer preference. Further it was noted that Australia is not importing all the product ranges available to the global market. Out of a total of 42 models only 21 models are available in Australia. Thus, it is recommended that Toyota-Australia expanded its product mix by importing brands such as Mirai, Prius Plug-in Hybrid and electronic car model iQ EV, which is an ultra-compact size car.

Conversely, it was noted that the demand for the commercial and utility vehicles have been increased due to the growth in the SME businesses. Thus, enhancing the product mix in Australia by making the models such as Dyna, Tacoma and Tundra could help capture a growing market.

Change in regulations

As discussed before from 2018 onwards individuals are permitted to import vehicles to Australia without the necessity to go through a dealer. In this regard, also it is recommended to increase the models available for customers.

Segmentation

According to Stilinovic (2016) and Guthrie (2017), New South Wales has 9 suburbs out of the most expensive 10 suburbs in Australia, which includes Point Piper, Darling Point, Cremorne Point, Bellevue Hill the only other suburb is Toorak in Victoria. Thus, it is recommended to focus on the high-end vehicles and introduce WAKU-DoKI, new sports car to Australian market.

Under environment analysis it was noted that utility and commercial vehicles are in demand due to the growth in SMEs. It is mostly in urban areas SMEs are opened and operated. Therefore it is advisable to focus on promoting these types of vehicles in the urban areas. Conversely, young people resettle in low-rent suburbs. As per previous analysis it is understood that this age group prefers low-cost-fuel-efficient vehicles. Thus, another recommendation could be to increase the small cars range and promote them in low rent suburbs.

High-end cars

The industry is now saturated with 0.6 cars per every person. Thus, demand will not be increased unless population is increased. Therefore it is recommended that Toyota to focus on delivering high-end cars for car collectors and for upper-class consumers. This could compromise the low margins gained from small-passenger vehicles.

05. Conclusion

This report analysed the car dealership market in Australia. For this purpose, PEST analysis is used for external macro environment, Industry analysis for micro environment and SWOT analysis is employed to analyse the selected dealer-Toyota-Australia. It was understood that market is at its maturity stage and saturated with 0.6 cars per person and 0.05% growth rate. Market faces a fierce competition due to high-concentration and shift in customer demand towards low cost vehicles with thin margins.

The industry experienced number of changes in external market such, as cessation of vehicle manufacturing in Australia, deteriorating Australian Dollar, change in government policies relating to importation of vehicles and commission earned by dealerships. These changes at it face is unfavourable. Conversely, tax free agreements with major importers, consumer shift towards eco-friendly vehicles, boom in SME created new opportunities.

Toyota-Australia, being the market leader has a product range to cater to its different market segments. For pricing, they follow economic pricing for low-cost-fuel-efficient vehicles and premium pricing for high-end vehicles. Among promotional mix personal selling, through dealerships, mass advertisements, public relations and sales promotions can be highlighted as major strategies. Dealership has been the primary means of distributing the vehicles, which gives opportunity to provide differentiated approach to the market segment.

Finally, recommendations were put forward after the analysis. Firstly, it is advised to increase the product mix offered in Australia to address threats faced by Toyota-Australia. Secondly, to focus on types of promotional strategies based on the demographic characteristics of customers. In this regards more emphasis should be placed for small cars in low-rent suburbs, luxury cars in expensive suburbs and utility and commercial vehicles in urban areas.

06. References

AADA. (2017). Pre-Budget Submission. Parkes, Australian Capital Territory: Australian Automotive Dealer Association [AADA].

ACCC. (2017, March 9). Australian Competition and Consumer Commission [ACCC]. Retrieved from ACCC denies authorisation for insurance companies to jointly set a cap on sales commissions: https://www.accc.gov.au/media-release/accc-denies-authorisation-for-insurance-companies-to-jointly-set-a-cap-on-sales-commissions

Australian Bureau of Statistics. (2017). Migration, Australia, 2015-16. Australia: Australian Bureau of Statistics.

Australian Bureau of Statistics. (2018 ). Australian Demographic Statistics, Sep 2017. Canberra: Australian Bureau of Statistics.

China Today. (2017, Jun). China's Own Car Brands. China Today, pp. 7-7. 1/4.

Curtin, T. (2007). Managing Green Issues. New York, NY: Palgrave Macmillan.

Deloitte. (2016). Motor Industry Services - 2016 Dealership Benchmarks. Australia: Deloitte.

Guthrie, B. (2017, December 15). Australia’s most expensive suburbs in 2017. Retrieved from realestate.com.au: https://www.realestate.com.au/news/australias-most-expensive-suburbs-in-2017/

IBISWorld. (2017a). Mazda Australia Pty Limited. Australia: IBISWorld.

IBISWorld. (2017b). Toyota Motor Corporation Australia Limited. Australia: IBISWorld.

IBISWorld. (2018). Motor Vehicle Dealers in Australia. Australia: IBISWorld.

Leonidou, C. N., & Leonidou, L. C. (2011). European Journal of Marketing, 45(1/2), 68-103.

Mainz, U., & Khare, A. (2000). Planning for an environment-friendly car. Technovation, 20(4), 205-214.

Motor Trade Association of Australia. (2018). Automotive Industry in Australia. Retrieved from Motor Trade Association of Australia: https://www.mtaa.com.au/industry-activity/31-automotive-industry-in-australia

PricewaterhouseCoopers. (2007). The automotive industry and climate change : Framework and dynamics of the CO2 (r)evolution. Stuttgart: PricewaterhouseCoopers.

Rao, V. R., & Steckel, J. H. (1995). A Cross-Cultural Analysis of Price Responses to Environmental Changes. Marketing Letters., 5-14.

RAWS Association. (2017). Regulatory inpact of proposed government road vehicles standards bill 2017. Australia: RAWS Association.

Saxby, C. L., Peterson, R., & Abercrombie, C. L. (1995). Selecting marketing strategy through environmental analysis. Journal of Marketing Management, 5(1), 16-20.

SBS News. (2016, February 10). Personal imports of new cars from 2018. Retrieved from SBS News: https://www.sbs.com.au/news/personal-imports-of-new-cars-from-2018

Scutt, D. (2017, January 17). 2016 was a record-breaking year for global car sales, and it was almost entirely driven by China. Retrieved from Business Insider Australia: https://www.businessinsider.com.au/2016-was-a-record-breaking-year-for-global-car-sales-and-it-was-almost-entirely-driven-by-china-2017-1

Selwyn, B. (2018, February 12). January 2018 Vehicle Sales – Trends in the Australian Motor Vehicle Market. Retrieved from Aca Research: https://www.acaresearch.com.au/australian-market-research-blog/january-2018-vehicle-sales-trends-in-the-australian-motor-vehicle-market

Snyder, J. (2006, May 15). Study: Car brands are strong -- but fading. Automotive News, pp. 32D-32D.

Stilinovic, M. (2016 , June 11). The 10 Most Expensive Suburbs In Australia. Forbes, pp. 1-2.

Thomson, J. (2018, April). Motor Vehicle Dealers in Australia. Retrieved from IBISWorld: http://clients1.ibisworld.com.au.mit.idm.oclc.org/reports/au/industry/default.aspx?entid=434

Toyota-Australia. (2018). Dealer locator. Retrieved from Toyota: https://www.toyota.com.au/find-a-dealer#WA

Toyota-Global. (2018). Company Profile. Retrieved from Toyota-Global: http://www.toyota-global.com/pages/contents/company/profile/overview/pdf/companyprofile_2017e.pdf

Toyota-Global. (2018). Globalizing and Localizing Manufacturing. Retrieved from Toyota-Global: http://www.toyota-global.com/company/vision_philosophy/globalizing_and_localizing_manufacturing/

[1] The threshold for 2017-18 for the fuel efficient vehicles is $75,526 and for the other vehicles is $66,331

[2] Mean weekly equalised disposable household income in 2016 is $1,009 compared to 2005 is $843 (Australian Bureau of Statistics, 2017)

[3] Formally known as Toyoda

[4] Toyota Aurion is an Australian made car which was ceased its production in 2017

[1] “Motor Vehicle Dealers industry includes dealerships primarily engaged in selling new or used motor vehicles to consumers, companies and government entities” (Thomson, 2018, p. 2). The industry also includes the after sales services to their customers. Thus, market composed of:

-new car retaining,

-used car retailing and

-after-sales services.

Choice of accounting policies

2018-07-09T21:23:00.002-07:00

Introduction

Australia follows the principle-based accounting standards which gives the preparers the options to choose among the accounting policies and highlight the reporting under substance over form (Psaros, 2007). Unlike the rule-based accounting, under principle based accounting method there is a high chance of exercising the creative accounting. “Studies have shown that accounting choices are influenced by a range of contracting, financing and operational factors (Shah, 1998, p. 83)”. In this backdrop the purpose of the report is to analyse the choice of accounting methods of a selected company in Australia.

Overview of the selected company

South32 Limited (hereinafter referred to as South32) is a group of companies which were part of BHP Billiton Limited (BHP) prior to its demerger in May 2015. Since then South 32 is formally demerged and standing alone as a separate entity listed in the Australian Stock Exchange (ASX) and London Stock Exchange (South32, 2015; BHP, 2015). At present the company is among the top 20 ASX companies and has a weight of 2.06 (compared to 10.67 for BHP) in the total capitalization in ASX 20 List as of 1 May 2018 (ASX 20 List, 2018).

South32 is a diversified company engaged in mining and metal with its presence in South America and South Africa and having its corporate office and operations in Australia. It has an employee base over 14,000 in 7 locations across the globe. The gross revenue of the group is mainly generated through the group production and third party production where the net margins from those are significantly differ. As such, Financial Statements (FS) report the net profit or loss from these two main sources separately. The company have expected a deterioration of commodity prices in the global market and this has in part contributed to the loss reported in 2015 and 2016. Since their demerger from BHP in 2015, this might have created a pressure to the management of group. 2017 is the first year the company made a positive net income after the demerger.

Part A; Accounting Policy Choice and Creative Accounting

Creative Accounting Example No.1: Accounting Policy Choice

Identification

AASB 116 on PPE has given the option to choose cost or revaluation. South32 used the cost model in the measurement after recognition of PPE. Proponents of fair value model advocates that far value model can yield more relevant information to the users of the FS (Mandilas, Kourtidis, & Demitriades, 2013; Palea, 2014) and increase the transparency (Palea, 2014). Further revaluation of PPE could resolve the issues caused through information asymmetry (Brown, Izan, & Loh, 1992; Mandilas, Kourtidis, & Demitriades, 2013) and studies have shown that this method could thus enhance the wealth of the shareholders (Aboody, Barth, & Kasznik, 1999).

On the other hand opponents highlighted that fair value model will compromise the reliability quality of accounting information (Cotter & Zimmer, 1995). The prior literature suggests that the firms who has higher gearing or seeking debt financing opt to report PPE under fair value method to enhance the perceived borrowing capacity (Barlev, Fried, Haddad, & Livnat, 2007; Cotter & Zimmer, 1995; Barać & Šodan, 2011; Brown, Izan, & Loh, 1992; Iatridis & Kilirgiotis, 2011).

It was noted that South32 has 31% gearing ratio and not shown any obvious signs of leverage issues. Further it was observed that PPE account for 80% of the total non-current assets. Given the negative net profit reported for the past years South32 has a perceived pressure to reduce the expenses. In this light if the company were to follow the fair value method and cost to be significantly different to the fair value, the company will have negative effects on the reported income.

For instance, if the PPE to be revalued upwards the increase in the PPE will cause higher depreciation and will further deteriorate the profits. If the PPE were to have a downward revaluation there will be recognized in the profit and loss unless “the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset” (AASB 116, 2015, p. 22). Thus, fair value method can result in weakening the financial performance though it could lead to strengthen the financial position if the assets are to be revalued upwards.

It was further noted that South32 has followed the straight line method to depreciate the plant and equipment. Even though plan and equipment do not generate the same level of income over the 30 years it intends to use straight line method rather than more realistic reducing balance method. Since the demerger in 2015 the firm has followed the straight line method. If the reducing balance were to be followed the financial performance of South32 could be much worse than it had reported in the early years. This too cast a doubt as to the selection of the accounting policies to portray a picture that management purport to depict.

Reasons

As Gordon (1964) suggests management put their interest before owners and select accounting policies that could maximise their own benefit. As per his income-smoothing hypothesis, “a management should within the limits of its power, i.e., the latitude allowed by accounting rule, (1) smooth reported income, and (2) smooth the rate of growth in income” (Gordon, 1964, p. 259). South32 FS has reported a profit and paid dividend for the first time in 2017 since the demerger from BHP. This suggests that management has the perceived pressure to report the profits in order to smooth the profits.

According to Gorden, management assumes that their welfare will be increased at a greater rate when the owners have a greater satisfaction. He further stated that when owners are dissatisfied with management performance, the increase in the owners’ satisfaction will increase the management welfare at a greater rate than it had when the owners were already satisfied with the performance. On this grounds it could be argued that management had a pressure to report a profit in the 2017 due to the loss reported in the previous 2 years. Thus, the management used the cost model in the measurement after recognition of PPE, which will reduce the risk of having a negative impact on the income statement and greatly assist in income smoothing. Similarly, the straight line depreciation method also reduce the fluctuations in profits from one year to the other in a great deal.

Creative Accounting Example No.1: Disclosure for Influencing Interpretation

Identification

As part of IASB project to enhance the financial reporting, AASB 2015-2 Amendments to Australian Accounting Standards disclosure initiative was introduced. Among the amendments was the Amendments to AASB 101 in 2015 January. Though the standard will come into effect after 1^st January 2016, entities are permitted for an early application. This amendment has removed certain mandatory disclosures and emphasised only on material disclosures. Further it went on to supersede the mandatory minimal requirements in a standard and highlighted that an entity is not mandated to report on the prescribed disclosure if it is not material. This amendment has further broaden range of choices and has given much latitude to the preparers in the choice of disclosure and reporting of FS.

It was noted by perusing the annual report (2015), South32 has early adopted (AASB 101, 2015-2) for the financial year 2014-15 when it fact the standard will be in effect in 2016. Unsurprisingly amendment to that AASB 101 has provided more opportunities for South32 to restrain from disclosing certain information to the public on the grounds that it is not material as per application of new amendment to AASB 101. This clearly shows the opportunistic behaviour of the management by early adaptation of such amendments to their advantage.

It was further noted that in the same year the company has not opted to early adoration of other standards and interpretations such as AABD 9, AASB 15 which have profound effect on the reporting given the nature of the business. Similarly, in 2017, management has decided not to early adopt the accounting standard amendments such as AASB 107 AASB 9, AASB 16, inter alia. This behaviour of portrays that when there is an option of the timing of the adoption of an accounting policy the management will early adopt the ones that is advantageous to them and differ the adoption of other pronouncement until it is effective date.

Reasons

Managers are more likely to early adopt a mandatory standard if it can be used to their advantage (Sweeney, 1994; Affes & Callimaci, 2007). Reducing the disclosures in FS increases the information asymmetry between management and external owners. Information asymmetry could assist managers pursuing their self-interest, as explained in the neoclassical theory, at the expense of owners. Information asymmetry and self-interest will in turn increase the opportunistic behaviour of management and increase the agency problem.

Materiality can be used as a ploy to conceal information which could otherwise draw the attention of readers (Henderson, et al., 2014). Thus, by early application of a standard to reduce the disclosure is motivated by the need to conceal the information. The opportunistic behaviour of the management is “expected to decrease in investor protection because strong protection limits insiders’ ability to acquire private control benefits, which reduces their incentives to mask firm performance” (Leuz, Nanda, & Wysocki, 2003).

Creative Accounting Example No.2: Disclosure for Influencing Interpretation

Operating cash flow (CF) can be reported either under direct method, where it requires cash payment and receipts to be reported under major classes; or indirect method, where profit(loss) is adjusted for non-cash items, accrual accounting treatments, and non-operating income and expenses. This has given an option for entities to choose among direct and indirect method. However, AASB 107 (2015) emphasises the importance of direct method and it “provides information which may be useful in estimating future CFs and which is not available under the indirect method (AASB 107, 2015, p. 8)”. Despite AASB promoting the direct method, which enhances the reporting quality (Hassan & Christopher, 2007; Bond, Bugeja, & Czernkowski, 2012; Monsen, 2001; Hughes, Hoy, & Andrew, 2010), South32 followed the indirect method of as it could reduce the disclosure of the information.

Reasons

This decision could be seen as an opportunistic behaviour to use the choice of accounting standards to gain the benefits. Hassan & Christopher (2007) found that if a firm follows the direct method the firm value could be maximised through acting as a quality signalling. They further stated that this decision is influenced by managerial efficiency of the firm and financial risk, inter alia. Thus, in this grounds it could be argued that in order to reduce the disclosure of the management inefficiency and financial riskiness South32 has followed indirect method to report CFs from operating activities.

On the other hand another reason for adopting such an option could be to conceal information which could otherwise be revealed. Although owners the debt providers wish to gain more information, management could gain the advantage of information asymmetry. As noted in the previous section the key management also owns shares of South32 by way of share ownership schemes. “Insiders, such as controlling owners or managers, can use their control over the firm to benefit themselves at the expense of other stakeholders” (Leuz, Nanda, & Wysocki, 2003). When sensitive information is not released to market management can engaged in insider trading activities.

Part B; Accounting Policy Choice and Opportunistic Behaviour

Opportunistic behaviour

The most incriminatory evidence for the opportunistic behaviour of managers selecting accounting policies to enhance their own benefits by compromising the others is the use of policies relating to PPE. South32 management has used cost model in the measurement after recognition and the straight line method of depreciation of PPE though it does not reflect the “pattern in which the asset’s future economic benefits are expected to be consumed by the entity” (AASB 116, 2015, p. 26).

This opportunistic behaviour is prompted as the preparers of FS are influenced to portray a picture that matches the results expected by the outsiders. In this backdrop the role of financial acumen has been discussed by (Gordon, 1964). The “management of a corporation should seek to maximize its wealth, the accountant should not be subordinated to this objective. He should simply report what has happened but that is the nub of the problem” (Gordon, 1964, p. 259).

In review annual report of South32 it was noted that key management personnel receive around 50% of their total compensation through share based payments and only 29% of the executive remuneration is fixed and the balance is tied to several performance related compensations. Thus, there is an incentive for the management to report profits and enhance the share price. The management pressure has further increased due to the losses reported immediately after the 2 years following the demerger from BHP.

Process of contracting

According to positive accounting theory earnings related contract can have an effect on accounting policy choice of the management (Shah, 1998). Cornett, Marcus, & Tehranian (2008) stated that earning management through the use of discretionary accruals could be reduced by governance structure and compensation tied to performance. With reference to governance structure it was argued that institutional share ownership and representation of institutional shareholders in the board can greatly reduce the opportunistic behaviour of the management as a whole. According to them, options compensations encourage the management to engage in earnings management.

In this grounds it could be argued that process contracting could align the interests of the managements with that of the owners and achieving the business activities will then achieve both owners and management objectives. The simplest method to align the interest on the management with that of the owners is to have a management compensation scheme with fixed salary and a bonus tied up to the profits. However, as discuss before this invariably promotes the earning management and opportunistic behaviour.

Having bonding and monitoring arrangements can reduce the opportunistic behaviour (Henderson, Peirson, Herbohn, Artiach, & Howieson, 2014). Under bonding strategy agreements can be entered into specifying the costs that can be incurred by management. Further, this could specify the choice of accounting policies and the use of assumptions in computing relevant accounting estimates. With regard to the monitoring, such as internal auditing, external auditing and periodic reporting could be introduced. Though these could eliminate opportunistic behaviour, it will entail agency cost.

Conclusion

The purpose of this report is to study the choice of accounting methods of a selected company in Australia, where the principle-based accounting is practiced. In the review of the FS of South32 revealed that there the management has used the choice of accounting policies for creative accounting. Firstly, it was noted that PPE has been measured after recognition under cost method where as fair value method could yield more realistic picture of the valuation of the assets. Further, the straight-line method has been used though it failed to depict the manner in which its future economic benefits are expected to be utilised. The reason behind this could be the management pressure to report positive net profits and to engage in income smoothing behaviour for their own advantage.

Secondly, the entity has early adopted the standards that reduce the disclosure requirements and deferred the adoption of the other standards till the effective date. Finally, when referring to the reporting of cash flows it was observed that even though the accounting standard encourages entities to use direct method of reporting operating CFs South32 used indirect method. Reasons for these two behaviours could be to create information asymmetry and gain benefits. Finally, the opportunistic behaviour of the management has been identified and different bonding and monitoring methods have been proposed to address this issue.

References

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AASB 101. (2015-2). Amendments to Australian Accounting Standards Disclosure Initiative: Amendments to AASB 101. Victoria, Commonwealth of Australia: Australian Accounting Standards Board [AASB].

AASB 107. (2015). Statement of Cash Flows. Victoria, Commonwealth of Australia: Australian Accounting Standards Board [AASB]. Retrieved 05 11, 2018, from www.aasb.gov.au

AASB 112. (2015). Income Taxes. Victoria, Commonwealth of Australia: Australian Accounting Standards Board.

AASB 116. (2015). Property, Plant and Equipment. Victoria, Commonwealth of Australia: Australian Accounting Standard [AASB].

AASB 139. (2015). Financial Instruments: Recognition and Measurement. Victoria, Commonwealth of Australia: Australian Accounting Standards Board [AASB].

Aboody, D., Barth, M., & Kasznik, R. (1999). Revaluations of Þxed assets and future Þrm performance:Evidence from the UK. Journal of Accounting and Economics, 149-178.

Affes, H., & Callimaci, A. (2007). The determinants of the early adoption of international accounting standards: financial decision or opportunism? COMPTABILITÉ – CONTRÔLE – AUDIT, 149-166.

ASX 20 List. (2018, 05 24). ASX Top 20 Companies. Retrieved from ASX 20 List: https://www.asx20list.com/

Barać, Ž. A., & Šodan, S. (2011). Motives for asset revaluation policy choice in Croatia. Croatian Operational Research Review, 2.

Barlev, B., Fried, D., Haddad, J. R., & Livnat, J. (2007). Reevaluation of Revaluations: A Cross-Country Examination of the Motives and Effects on Future Performance. Journal of Business Finance & Accounting, 1025–1050.

BHP. (2015). Annual Report. Melbourne, VIctoria: BHP BillitonLimited.

Bond, D., Bugeja, M., & Czernkowski, R. (2012). Did Australian Firms Choose to Switch to Reporting Operating Cash Flows Using the Indirect Method? Australian Accounting Review, 22(1), 18-24.

Brown, P., Izan, H., & Loh, A. (1992). Fixed Asset Revaluations and Managerial Incentives. ABACUS, 28(1), 36-57.

Chalmers, K., Clinch, G., & Godfrey, J. M. (2011). Changes in value relevance of accounting information upon IFRS adoption: Evidence from Australia. Australian Journal of Management, 36(2), 151-173.

Chua, Y. L., Cheong, C. S., & Gould, G. (2012). The Impact of Mandatory IFRS Adoption on Accounting Quality: Evidence from Australia. Journal of International Accounting Research, 11(1), 119-146.

Cornett, M. M., Marcus, A. J., & Tehranian, H. (2008). Corporate governance and pay-for-performance: The impact of earnings management. Journal of Financial Economics, 87, 357–373.

Cotter, J., & Zimmer, I. (1995). Asset revaluations and assessment of borrowing capacity. ABACUS, 31(2), 136-151.

Gordon, M. J. (1964). Postulates, principles and research in accounting. Accounting Review, 2, 251-263.

Hassan, S., & Christopher, T. (2007). Determinants of the Choice of Reporting the Direct Method or Indirect Method of Cash Flow from Operating Activities: Malaysian Evidence. Journal of Financial Reporting and Accounting, 5(1), 139-156.

Henderson, S., Peirson, G., Herbohn, K., Artiach, T., & Howieson, B. (2014). Issues in Financial Accounting. NSW, Australia: Pearson Australia.

Hughes, M., Hoy, S., & Andrew, B. (2010). Cash flows: The Gap Between Reported and Estimated Operating Cash Flow Elements. Australasian Accounting Business & Finance Journal, 4(1), 96-114.

Iatridis, G. E., & Kilirgiotis, G. (2011). Incentives for fixed asset revaluations: the UK evidence. Journal of Applied Accounting Research, 13(1), 5-20.

Leuz, C., Nanda, D., & Wysocki, P. D. (2003). Earnings management and investor protection: an international comparison. Journal of Financial Economics, 69, 505–527.

Mandilas, A., Kourtidis, D., & Demitriades, E. (2013). Fair Value vs Cost Model. An Application on Tangible Assets in SMEs Of Greece. Conference: Proceedings of the 4th International Conference on Finance, Accounting and Law (ICFA '13) (pp. 128-138). Chania, Crete Island, Greece: World Scientific and Engineering Academy and Society Press.

Monsen, N. (2001). Cameral accounting and cash flow reporting: some implications for use of the direct or indirect method. European Accounting Review, 10(4), 705-724.

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Psaros, J. (2007). Do principles-based accounting standards lead to biased financial reporting? An Australian experiment. Accounting & Finance, 527-550.

Shah, A. K. (1998). Exploring the in uences and constraints on creative accounting in the United KingdomExploring the in uences and constraints on creative accounting in the United Kingdom. The European Accounting Review, 7(1), 83–104.

South32. (2015). Annual Report. Perth, Australia: South32 Limited.

South32. (2016). Annual Report. Perth, Australia: South32 Limited.

South32. (2017). Annual Report. Perth, Australia: South32 Limited.

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The tax treatments of Australian small businesses in Taxation Law

2018-04-30T01:25:00.000-07:00

1 Introduction

Tax provisions relating to the small businesses in Australia dated back to Simplified Tax System (STS) rule enacted by Division 328 ITAA 1997 and applied to the income years commencing from 2001. These small business concessions were added to ITAA 1997 as a result of New Business Tax System (Capital Gains Tax) Act of 1999. Though the motive was to simplify the tax regime and to reduce the tax compliance cost it attracted much criticism despite the amendments made later on to streamline the different provisions[1]. As a result in order to standardise the tax concessions which had many definitions across the legislations, Small Business Entities (SBE) regime was introduced in 2007 and was in effect from 1^st July 2007 income year and from 1^st April 2007 for the Fringe Benefit Tax (FBT) purposes[2]. Since then there has been number of attempts to grant concessions to the SBEs. The most notable and the recent change was to reduce the SMEs income tax to 25% and to broaden the SBE aggregate turnover threshold to $50 million progressively until the income year 2026–27[3].

2 Definition of small business in taxation law

Small Businesses have access to number of concessionary payments and reporting under the Australian tax legislatives. Irrespective of the type of the business, that is whether it is sole proprietorship, partnership, company or trust, the SBE concession could be claimed by the entity if it falls under the SBE definition.

The operative provision of Income Tax Assessment Act 1997 (ITAA 1997) s 328-110(1) stipulates that a business to be a SBE for an income year it should satisfy two conditions[4], in brief;

- - carried out a business in the income year and

- - the aggregated turnover is less than $10 million.

As per ITAA 1997 S328-120(2) aggregate turnover in this connection is referred to the income derived in the ordinary course of carrying on the business in the income year. Thus, the turnover does not include any non-assessable and non-exempt income for the income year, such as GST payable on the taxable income, increase adjustment relating to a supply or acquisition or adjustment occurred as a result of recoupment.

Further S328-120(4)[5] addresses the possibility of splitting the income between associates to in order to gain the tax concessions. According to the section, if any transaction between an associate, not occurred as an arm’s length, the entity’s annual turnover should include such transactions measured at market value.

The aggregate turnover of the entity should be likely to less than $ 10 million for the current year and if the entity carried out business in the previous income year the aggregate turnover for the previous year should be less than $ 10 million to fall within the meaning of SBE inter alia. However, according to S328-110(3)[6] if the aggregated turnover for the immediately two preceding years exceeds $10 million, the entity is not categorised as a SBE.

3 Tax treatments for income from businesses for small businesses

SBE concessions have been amended through Treasury Laws Amendment Bill in 2016 which will apply from the income year 2017 onwards. These amendments have further expanded and allowed more business to enjoy the tax relives. The reduced compliance cost, simplification of tax rules and record keeping requirements are benefits that could accrue to a SBE by introducing these concessions. Below are the concessions applicable under the income from business;

- Reduced corporate tax rate

- Depreciation - immediate asset write off

- Stranding stock rule

- Prepaid expenses – immediate deduction

Reduced corporate tax rate

For the income years 2016/17 and 2017/18 the corporate tax rate for SBE has been reduced to 27.5% and the turnover threshold has been increased to 10Mn and 25Mn respectively. Annexure 1 illustrates the SBE progressively reduced corporate tax from 28.5% to 25% and increase in aggregate turnover threshold from 2 million to $ 50 million from the income year 2016 to 2027.

Depreciation

As the s 328-170 of ITAA 1997 stipulates, a SBE can opt to depreciate most of the depreciating assets under an accumulated pool named as single depreciating assets using 30%[7] rate under diminishing value method rather than under division 40 – Capital allowances[8]. This concession has allowed the SBEs to accelerate the depreciation charge by introducing a higher rate or by immediate deduction. Due to this higher rate of deduction the current year tax liability of SBE becomes less than that of other non-SBEs.

Though for SBE, who carries out primary production[9] business, can elect to apply Subdivision 40-F or 40-G or even SBE depreciation under 328-170, the businesses carrying on horticultural plants with depreciating asset lease and assets allocated under subdivision 40-E – low value and software development pool cannot apply this section even if the business can be categorised as a SBE. Further if a SBE applies S328-170 for the depreciation of the depreciating assets and later if the SBE ceased to be a SBE or discontinue the use of this section, SBE can still continue to use the general small business pool for succeeding income years.

The Division 328 - Small business entities subsection 180(1) states that if the cost of a depreciating asset at the end of the income year is less than $1,000, such asset can be accumulated to the general small business pool and depreciated at 30%. However, if the asset is acquired between 12 May 2015 and 30 June 2018 the pool threshold is set at $20,000[10].

Stranding stock rule

SBE can elect not take a stock count if the difference between opening and reasonable estimate of the value of stock at the end of the income year is likely to be less than $5,000[11].

Prepaid expenses – immediate deduction

In order to restrain the tax payers claiming the outgoings which has a future benefits (prepayments) sections 82KZL to 82KZMG of ITAA 1936 regulate the timing of the these advanced payments. However, SBEs were granted with an exception where if a payment for a service is up to 12 months, such payments can be allowed for an immediate deduction irrespective of whether it extends to the next subsequent income year[12].

4. Tax treatments for income from properties for small businesses

The income/gains from properties could take two forms, i.e., recurring income as a flow [13]and non-recurring income as capital gains. For SBEs the most notable concession from property is the capital gains tax (CGT) small business relief available under Div 152 of ITAA 1997, viz.;

- 15 year exemption

- 50% reduction

- Concession on retirement

- Relief on roll-over

For the purpose of this division, a SBE is defined under subdivision 152‑5 as follows;

- The entity should be a SBE with an aggregated turnover of less than $2Mn[14].

- The entity shall be a SBE or a partner in a partnership[15]

- Net value of the assets of the entity and the related entities should not exceed $6Mn

- The CGT asset must be an active asset either tangible or intangible which is either used or held ready for the use in the course of the business (in relation to tangible assets) or inherently connected with the business (in relation to intangible assets)

- If the CGT asset is the interest of a trust, there should be CGT concession stakeholders prior to occurring the CGT event.

15 years exemption

There will not be any assessable CGT if an asset, that is active, is continuously owned by a SBE for 15 years and the taxpayer is 55 years of age or over and is retiring or permanently incapacitated.

50% reduction

The capital gains on an active asset has been reduced by 50%. This allowance is granted in addition to the CGT 50% discount rate granted if the asset is held for more than 12 months and totally allowing a 75% discount on the capital gain for SBEs.

Concession on retirement

At the retirement of the tax payer if the he utilises the capital gains arising from an asset connected to SBE, the CGT exemption can be claimed up to a lifetime limit of $0.5Mn. If the taxpayer is under 55 years of age, the exempt proceeds should be invested in a complying superfund or retirement saving account. On the other hand if the taxpayer is older than 55 years, the proceeds should not be rollover to a superfund to claim the exemption for the CGT.

Relief on roll-over

The capital gains could be deferred for two years for the whole or part of the gain if a SBE sells an active asset. This could be deferred longer if the capital asset is replaced or incurred capital expenditure in improving the existing asset.

5. Tax treatments for offsets and deductions for small businesses

ITAA 1997, subdivision 328-F deals with the small business income tax offset. This section is applicable to;

- Individual who is a SBEs

- Share of net SBE unincorporated income is included in such individual’s assessable income.

- SBE income is included in the assessable income of an individual as a result of being partner of a partnership or a beneficiary of a trust which is a SBE.

Based on this provision it could be understood that the small business tax offset could be claimed not only by an individual who carries out a business which falls under the definition of a small business but also by an individual who is a beneficiary of a trust or partner of a partnership which is eligible for the SBE.

The eligibility under this regime is a non-refundable tax offset up to a maximum of $1,000 applicable from the income year 2015/16, calculated 5% on the total net SBE income tax payable, excluding the capital gains. From the income year 2016/17 onwards the rate has been increased to 8% to 16% by the end of 2026/27 income years. In other words the offset is capped up to a maximum of $1,000 per income year. In deciding whether an entity is a SBE, $5Mn threshold test is applied. For the income year 2015/16, the income threshold was $2Mn.

For a small trader there are some eligible incomes and expenditures. Below are some income and expenditure a SBE cannot claim for this purpose;

Income

- Net capital gains

- Personal service income

- Salary and wages

- Government allowances

- Interest and dividend

- Farm managed deposit interest

Expense

- Tax related expenses

- Gifts and donations

- Personal contribution to superannuation

- Business loss for the current year

- Preceding years tax losses

For a partnership, if the share of net SBE income is less than the deductions allowed, the partnership share is treated as zero. Similarly for a trust also, if the deductions exceeds the share of income from the trust, the net income is treated as nil. In this regard the following are not deductible for both partnership and trust;

- Tax related expenses

- Gifts and donations

- Personal contribution to superannuation

The tax offset is computed as a proportion of tax payable related to SBE net small business income.

6 Other tax concessions for small businesses

Apart from the aforementioned concessions for SBEs the tax regime has granted number of other relives including administrative, simplification and lower tax regimes to encourage the businesses. With regard to tax administration, SBEs are granted with 2 years standard period for amending the assessment[16]. The below sections discuss the different tax concessions available for a SBE.

Goods and Services Tax (GST) and excise concession

An entity which falls under the definition of SBE can opt to account the GST on cash basis[17]. For GST SBE concession purpose, the turnover threshold is $10mn from 1^st July 2016 and $2Mn up to 30 June 2016.

With regard to the settlement of excise duty, SBE can opt to apply to defer the excise duty to monthly reporting from the weekly reporting cycle.

Small business car parking – Fringe Benefit Tax (FBT)

According to S58GA of Fringe Benefits Tax Assessment Act 1986, car parking provided in relation to an employment to an employee in a particular FBT year is exempted if;

- Car is parked in a place other than in a commercial parking station

- Employer is other than a public company or a government body

- Either, the total ordinary income of the employer is less than $10Mn or a SBE.

Cash basis accounting

After 1st July 2007, the STS regime has been superseded by the SBE scheme and the only test require an entity to be categorised as a SBE is the turnover test as discussed in section two of this report under definition of a SBE. In order to improve the cash flow off the SBEs, further concession has been granted allowing the entities to report and calculate tax payable on cash basis. This is an additional relief apart from reporting GST on cash basis discussed under section 6 part - Goods and Services Tax (GST) and excise concession.

Pay-As-You-Go instalment concession

A SBE has the option to make a payment towards income tax year end liability through the PAYG instalment, the amount of which is determined by the Australian Taxation Office. This amount is computed using the previous information provided by the SBE.

As per S45‑130[18] of Tax Administration Act, based on the gross domestic product adjusted national tax method SBEs are eligible to compute PAYG instalment liability. This method will not only saves time but also a simplified relief available for a SBE.

Immediate write off of start-up expenses

SBEs have granted a concession under 40-880(2A) of ITAA 1997, where certain capital nature expenditure incurred in relation to proposed structure and operation of the business can be deducted immediately in the year it incurred rather than apportioning it over 5 years, which is the provision relating to other business entities. These expenses includes, agency fees paid to the government of Australia, other taxes or charges incurred in setting up the business or its operating structure.

Annexure 1

Year	Aggregated turnover threshold	(SBE) Corporate entities under the aggregated turnover threshold	All other corporate entities
2015–16	$2m	28.5%	30.0%
2016–17	$10m	27.5%	30.0%
2017–18	$25m	27.5%	30.0%
2018–19	$50m	27.5%	30.0%
2019–20 to 2023–24	$50m	27.5%	30.0%
2024–25	$50m	27.0%	30.0%
2025–26	$50m	26.0%	30.0%
2026–27	$50m	25.0%	30.0%

Source - ATO, 2017[19]

[1] Marsden, S., Sadiq, K., & Wilkins, T. (2013). Small business entity tax concessions: Through the eyes of the practitioner. Revenue Law Journal, 22(1), 1-21. Retrieved from http://epublications.bond.edu.au/rlj/vol22/iss1/4

[2] ATO. (2017, November 02). Reducing the corporate tax rate. Retrieved from Australian Taxation Office: https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-for-businesses/Reducing-the-corporate-tax-rate/

ATO. (2017, July 28). Small business entity income tax concessions. Retrieved from Australian Taxatin Office: https://www.ato.gov.au/business/small-business-entity-concessions/concessions/income-tax-concessions/

Marsden, S., Sadiq, K., & Wilkins, T. (2013). Small business entity tax concessions: Through the eyes of the practitioner. Revenue Law Journal, 22(1), 1-21. Retrieved from http://epublications.bond.edu.au/rlj/vol22/iss1/4

Pizzacalla, M. (2009). Australia’s SME tax system: is it working? Small Enterprise Association of Australia and New Zealand Conference. Wellington, New Zealand: Small Enterprise Association of Australia and New Zealand.

[3] ATO. (2017, November 02). Reducing the corporate tax rate. Retrieved from Australian Taxation Office: https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-for-businesses/Reducing-the-corporate-tax-rate/

[4] PFGG v Commissioner of Taxation [2015] AATA 972; 102 ATR 677

[5] Income Tax Assessment Act 1997 (Cht)

[6] Income Tax Assessment Act 1997 (Cht)

[7] 30% of depreciation rate for the subsequent years after the first year of acquisition and for and 15% for the assets acquired during the income year irrespective of the date of acquisition during the year - Income Tax Assessment Act 1997 (Cht), S329-190(2)

[8] Income Tax Assessment Act 1997 (Cht)

[9] The recent change on the legislation has allowed more relives for the primary producers by way of accelerated depreciation. Under these amendments, water and fencing facilities of primary producers are allowed an immediate deduction on the capital expenditure and a deduction over three years period is allowed for fodder storage assets capital costs.

[10] Income Tax (Transitional Provisions) Act 1997 S328-180(4)

[11] Income Tax Assessment Act 1997 (Cht), S329-285

[12] Income Tax Assessment Act 1936 (Cht), S82KZM

[13] Eisner v Macomber 252 US 189 (1920)

[14] Even though the turnover threshold has been increased progressively for the SBEs under the ITAA 1997 s 328-110(1) and for the income year 2016/17 it is $10Mn, for the purpose of CGT, the turnover threshold will remain at $2Mn and the progressive increase of threshold will not be applied.

[15] Partner cannot be a SBE and the partnership should satisfy the SBE test for the partner to claim the SBE CGT concession.

[16] Income Tax Assessment Act 1936 (Cht), S170

[17] A New Tax System (Goods and Services Tax) Act 1999 (Cth), 29-40

[18] Taxation Administration Act 1953 (Cth)

[19] ATO. (2017, July 28). Small business entity income tax concessions. Retrieved from Australian Taxatin Office: https://www.ato.gov.au/business/small-business-entity-concessions/concessions/income-tax-concessions/

BHP Billiton Ltd: Identification and assessment of business risk

2018-03-05T01:22:00.000-08:00

Introduction

BHP being one of the major suppliers of minerals in the world and operating in multiple jurisdictions, it has exposed itself to a greater economic, political, socio-cultural and environmental risk. Together with the complexity of the business operations (ASA 315, 2015), these controllable and uncontrollable risks have pose an immense pressure on the entity’s management or those charged with governance in achieving its objectives and strategies. In this regard, the business risk, as defined in ASA 315.4 (b), is identified and assessed in the following section.

1 Samarco Mining Disaster

1.1 Identification of Business Risk

On 5th November 2015 Samarco[1] mine in Brazil failed resulted in killing 19 people and sweeping three communities in a deluge of mine tailing (ABC News, 2017) and further affecting the 260,000 people (Wainwright, 2015) of the downstream and the environment of Rio Doce basin (BHP, 2017; BHP, 2016; ABC News, 2017).

During the current financial year BHP and the Fereral Procecutors entered into an agreement to settle USD 53.6 Bn (BHP, 2017) to compensate for the loss and BHP charged with both criminal and civil law suites for their part in negligent business operations. The courts suspended the cliam during the financial year (BHP, 2017)and after the balancesheet date the trials were resumed the murder tials against BHP (The Sydney Morning Herald, 2017). This incident has cuased BHP to face multiple litigations by the government of Brazil, individuls and non-governmental organizations causing at least USD 53.6Bn and a loss of reputation. Not only the loss of revenue and inability ot achive objectives of BHP poses risk to the business, but also “flaws in a product or service that may result in liabilities and reputational risk” (ASA 315, 2015, pg. 23).

2.1.2 Assessment of Business Risk

Financial year 2017 is the second year of reporting after the disaster. This incident could lead to risk of material misstatement since it has a direct impact on the financial statement, especially, BHP has made a provision of USD 1.057 Bn in the Financial Statements for the year 2017. However, as per the later conclusions reached by the courts the compensation could reach up to USD 53.6Bn. Further, as a part of the audit procedures, the auditos should assess the adequacy and the relavance of the disclosure pertaining to the incedent. Since BHP follows the equity mthod of accounting for the jontventure of Samarco and this incident could have an advserse effect through impairment.

On the otherhand, the management has not reached a conclusion as to whether the dam to be reopenned causing a doubt on the continuity. Samrco, which was producing 14.5 Mt of pellet Pellets and were independently marketed and sold to 19 countries prior to the disaster and contributed nearly 9% to the total iron ore business (BHP, 2015). Though the cesation of the dam will significantly affect the financial statement as a whole, it will not impact on the going concern of the business.

2 Dispute with ATO regarding the Transfer pricing

2.1 Identification of Business Risk

As per section A40 of ASA 315, regulatory requirements could cause a business risk. The cross border transactions inherently caused the company to have tax legislative dispute over different tax authorities. In particular, BHP is currently being audited by Australian Tax Office (ATO) for the alleged tax evasion through the transfer pricing scheme between BHP Australia and Singapore marketing hub (Khadem, 2017a ; Khadem, 2017b). The total dispute and the penalty interest have accumulated to USD 1 Bn which has not been resolved yet.

Further, ATO has released a transfer pricing guidelines early 2017 and this could have a risk that BHP is compelled to abide by that law and could result in settling USD 1 Bn tax settlement.

2.2 Assessment of Business Risk

The financial consequence of the ATO tax dispute will have an impact on the financial statements, thus, the auditor should focus on the individual account balances, the classes of transactions and the relevant disclosure requirements of the tax litigation.

3 Political Risk

3.1 Identification of Business Risk

BHP has expanded their operations and customer base to developing countries which has given rise to additional risks on compliance with regulatory and environmental legislative requirement, risk relating to bribery and corruption, civil wars and terrorism and delays and disruptions in the operations.

3.2 Assessment of Business Risk

“Most business risks will eventually have financial consequences and, therefore, an effect on the financial report” (ASA 315, 2015, pg 23). On the financial statement level, these risks together with the exchange rate risks will have an impact on revenue and receivables and ultimately on the profitability.

4 Labour dispute in Chile

2.4.1 Identification of Business Risk

Due to the dispute between BHP and the labour force in Chile, the company lost USD 1Bn (18%) revenue and the operations were ceased for 44 days. This dispute has occurred since BHP resort to reduction in cost by cutting costs relating to labour contracts in order to cope with the aftermath of China-led commodity boom (2002 -2012).

4.2 Assessment of Business Risk

This dispute is not a one off incident which resulted in loss of revenue for the current period. Chile government has introduced a new legislation which has caused higher risk of operational stoppage, increased in cost and reduction in efficiency (BHP, 2017). Though the conclusions reached by both parties were not up to their satisfaction after the government intervention, the labour union agreed to resume negotiation with BHP on the new contracts in September 2018 (Sanderson & Hume, 2017). Thus, the labour dispute will continue for the next financial year resulting in an interruption in business operations.

5 Deterioration in credit rating

5.1 Identification of Business Risk

Due to the loss of revenue from the Samarco, labour strike and the sump in the prices of commodities BHP credit rating has decreased from A3 to A1 according to rating by Credit ratings agency Moody and the debt rating has decreased from A+ to A according to the debt rating by Standard & Poor (The Australian, 2017).

5.2 Assessment of Business Risk

The deterioration of the credit ratings could increase the interest cost from the debt securities and also this could adversely affect the cost of capital. BHP employs cost of capital is used to discount the future production volumes to assess the impairment of non-current assets. Since non-current assets and the depreciation thereon are a major part of the financial statements the interest cost could result in a material change in the financial statements. Currently the firm uses 7% however, this could be assessed independently by the auditors for its relevance and reliability.

References

ABC News. (2017, January 20). BHP Billiton and Vale failing Samarco dam disaster victims: UN adviser. ABC News, pp. 1-2.

ASA 315. (2015). Identifying and assessing the risks of material isstatement through understanding the entity and Its environment. Commonwealth of Australia: Australian Auditing and Assurance Standards Board (AUASB).

BHP. (2015). Resourcing glabla growth, Annual Report. Melbourne, VIctoria: BHP BillitonLimited.

BHP. (2016). BHP Annual Report. Melbourne, Victoria: BHP Billiton Limited.

BHP. (2017). BHP Annula Report. Melbourne, Victoria: BHP Billiton Limited.

Khadem, N. (2017, May 16). ATO ramps up hunt for multinationals using cross-border finance. The Sydney Morning Herald, pp. 1-6. Retrieved January 12, 2018, from http://www.smh.com.au/business/the-economy/ato-ramps-up-hunt-for-multinationals-using-crossborder-finance-20170515-gw4zae.html

Khadem, N. (2017, September 21). BHP willing to head to court against ATO tax bill. The Sydney Morning Herald, pp. 1-6. Retrieved Janury 12, 2018, from http://www.smh.com.au/business/mining-and-resources/bhp-billiton-willing-to-head-to-court-against-ato-tax-bill-20170920-gyl5qk.html

Sanderson, H., & Hume, N. (2017, May 2). BHP Billiton has no regrets over $1bn fight with Chile workers. Financial Times, pp. 1-4. Retrieved from https://www.ft.com/content/5a767dc2-2a90-11e7-bc4b-5528796fe35c

The Australian. (2017, March 4). Moody's downgrades BHP debt. THE AUSTRALIAN, pp. 1-2.

The Sydney Morning Herald. (2017, November 14). Brazil resumes murder trial in BHP-Vale's Samarco mining disaster. Business, pp. 1-2. Retrieved January 10, 2018, from http://www.smh.com.au/business/mining-and-resources/brazil-resumes-murder-trial-in-bhpvales-samarco-mining-disaster-20171114-gzku7y.html

Wainwright, R. (2015, November 20). Samarco mine costs will make for more than one ‘difficult year’ at BHP. The Conversation, pp. 34-36.

[1] Samarco is a jointventure of BHP, having 50% ownership and BHP applies equity method of accounting for the reporting of the jontventure. BHP has the rights to assets and obligations to the liabilities of Samaco but not the ownership (BHP, 2017)

Strategic Performance Measurement System : Supermarket

2018-02-06T01:13:00.000-08:00

1 Analysis of supermarkets industry in Australia

During the recent past, the supermarket industry has gone through some major challenges such as intense competition through the expansion of multinational chains to local cities, suppliers, customers, government regulations and most importantly the information technology (Mellado & Sánchez, 2005) and online marketing (Palmer & Markus, 2000). “The Supermarkets and Grocery Stores industry is one of the most fiercely competitive industries in Australia (IBIS World, 2017, p. 1)”. In order to cope with the challenges many supermarket resort to performance measurement systems.

2 Selection of strategic performance measurement system

However, initiatives such as business process reengineering, total quality management and employee empowerment do not have the integration of internal critical success factors and external key attributes (Kaplan & Norton, 1993). Unlike traditional performance measurement systems which only focus on financial measures, Balanced Scorecard focuses on further additional perspectives enabling the business to manage the competing and overlapping objectives which in otherwise be neglected. Furthermore, the traditional measurement systems rely on the outcome of the set of historical actions, whereas Balance Scorecard translate the mission into strategies and then to a measurement of performance, leading the organization to align mission with the performance.

The Balanced Scorecard can be described as a preferred system of strategic performance measurement for the supermarket chain due to its cascading top-down approach stemming from organizational mission and strategy, forward-looking approach than measure of historical performance, integration of internal and external measurements and draw the attention and the focus of the business to the critical success factors (Kaplan & Norton, 1993). Further, Balance Scorecard is one of the most famous tried and tested model in different industry settings and in different cultures and have proven that its benefits can overweigh the cost associated with the implementation of this multidimensional performance measurement system.

3 Development of a Balanced Scorecard for the Supermarket Chain

The development of a Balanced Scorecard can take seven distinctive and interrelated steps (Langfield-Smith, Thorne, Smith, & Hilton, 2015).

Step 01: Articulation of the Vision, Objectives and Strategic Priorities

Since the supermarket chain is a medium sized and operated currently in a suburban area, their main focus is to be penetrate the business into the city centre and then to the other states. For the expansion of the supermarket chain, the business should capitalise on its key competencies and deliver a service valued by the customers. The competition of the retail industry is very intense in Australia.

The industry is highly concentrated around four major branded supermarkets whose total market share is 80% (Mudditt, 2017). The arrival of the 2 discount operators ALDI and Costco have shifted the pricing strategy of leading brands such as Coles and Woolworths to a cut prices (Mudditt, 2017) and this rivalry is amplified with the arrival of Germany based discount supermarket chain which holds 8.9% of the market (IBIS World, 2017). The price cuts together with private label product ranges of the key players in the industry intensified the competition. Thus, expanding business in this context needs meticulous sculpturing of vision and translating that to actionable strategies. According to IBIS world (2017), online shopping will increase the demand within the retail industry.

Vision Statement

Is to be the most sought after customer orientated supermarket in Australia for its value for money superior shopping experience.

Objective

Achieve 40 % growth in sales within 5 years

Achieve 15% increase in return on investment within 5 years

Achieve 10% increase in market share within 5 years

Strategic Priorities

In order to retain and capture new segments of the market through not only providing low cost goods but also enhancing the customer choices by introducing wide variety quality products. In this regard the introduction of private label product ranges could stimulate the price competition within the suppliers. According to IBIS World, 2017 more than 25% of the total supermaket revenues are generated from private label product ranges. In order to succeed in the introduction of private label product ranges the supermarket has to make alliances and integrations with the suppliers, which could not only differentiates the products but also reduces the costs.

The front end of the business process could assist in realising the objectives by delivering a service that is perceived as valued by the customer. Service quality could be achieved through the multidimensional service quality model[1] introduced by Parasuraman, Zeithaml, & Berry (1991). In reserch carried out on the supermarkets it was revealed that customer satifaction and loyalty are positively related to empathy, tangibility, responsiveness and assurance (Kitapci, Dortyol, Yaman, & Gulm, 2013). In this light the below strategic priorities were selected;

· Product differentiation

· Cost and supplier efficiency

· Service quality

Step: 02 Strategic Map

Upon the identification of the objectives and strategic priorities, the next step in devising a Balanced Scorecard is the formulation of specific objectives. In this regard, the strategic map is developed linking the vision to specific, measurable, attainable and time bounded objectives. In the development of the strategy map, the multidimensional service quality model was employed as it is proven to have a positive effect on the customer satisfaction and loyalty as stated by Kitapci, Dortyol, Yaman, & Gulm (2013).

[1] Service quality model developed by Parasuraman, Zeithaml, & Berry (1991) has 5 dimensions;

(1) “Tangibles - Physical facilities, equipment and appearance of personnel.

(2) Reliability - Ability to perform the promised service dependably and accurately.

(3) Responsiveness - Willingness to help customers and provide prompt service.

(4) Assurance (including competence, courtesy, credibility and security) - Knowledge and courtesy of employees and their ability to inspire trust and confidence.

(5) Empathy (including access, communication, understanding the customer) - Caring and individualized attention that the firm provides to its customers (Shahin, 2010).”

Figure 1: Strategy Map

Figure 1 illustrates that the objective of increase in revenue by 40% in the next 5 years could be achieved through the customer satisfaction under the Customer Perspective and this together with the customer loyalty could assist the achievement of the objective of increase the market share. On the other hand to attain the objective of increase in return on investment by 15% in 5 years, the profitability is linked to the profitability under the financial perspective, which intern is further cascaded down to customer satisfaction and internal processes and facilities tangibility.

Step 03: Operationalization of Balanced Scorecard

Based on the above strategy map lead and lag indicators were developed in order to measure the future performance of the supermarket chain.

Table 1: Balanced Scorecard

Objectives	Performance Measures
Objectives	Lag Indicators	Lead Indicators
Financial · Increase profitability	· Return on investment (ROI) · Profitability of each supermarket outlet	· Average sale growth per month, per outlet · Asset utilization per outlet · Average overhead cost per supermarket per month · Value of average wastage and customer returns per month
Customer · Increase customer satisfaction · Enhance customer empathy · Improve customer responsiveness	· Customer satisfaction survey · Market share · Number of new customers who obtained loyal cards	· Number of customer complains · Number of customer refunds · Average monthly expenditure on advertising and promotions · Number of new products offered · Number of promotional campaigns introduced · Average customer waiting time in a queue · Number of self-service checkouts introduced · Percentage of loyalty cardholders coming daily
Internal Business Process · Improve tangibility (physical facilities and processes) · Increase service reliability · Product differentiation	· Total overhead cost per supermarket outlet · Cost of maintenance of IT and other equipment · Number of new private label products introduced	· Number of breakdowns of self-service checkouts and cash registers · Number of times the goods are coded erroneously · Average capacity utilization of each outlet · Average cost of maintenance of equipment and infrastructure
Learning & Growth · Enhance service assurance · Develop employee skills · Improve employee satisfaction	· Employee satisfaction survey · Number of training and development programs · Employee turnover	· Training and development provided to staff · Number of employee appreciation programs conduced per outlet · Number of grievances lodged by the employees on the working conditions · Number of customers served per employee

In the review of industry information it was noted that the German discount chain - ALDI, being one of the major players driving the retail prices down does not have self-service checkouts in any of the outlets in Australia (Evans, 2016; Evans, 2017; Groom, 2016; Brook, 2017). Thus, in order to minimise the costs as a means of enhancing profits, the supermarket chain could invest on self-service checkouts. This could be addressed under the business process perspective.

On the other hand the supermarket chain could enhance its return on investment by focusing on asset utilization under the financial perspective by streamlining an effective operation processes and capitalising on the cost reduction through the use of technology. The use of information technology make the processes more efficient but also it will reduce the employee related costs and the management could focus more on the small number of employees they have and enhance the quality of the service delivered through these employee.

References

IBIS World. (2017, October). Supermarkets and Grocery Stores in Australia: Market Research Report. Retrieved from IBIS World: https://www.ibisworld.com.au/industry-trends/market-research-reports/retail-trade/food-retailing/supermarkets-grocery-stores.html

Kitapci, O., Dortyol, I. T., Yaman, Z., & Gulm, M. (2013). The paths from service quality dimensions to customer loyalty: An application on supermarket customers. Management Research Review, 36(3), 239-255.

Langfield-Smith, K., Thorne, H., Smith, D., & Hilton, R. (2015). Management Accounting. Australia: McGraw-Hill Education.

Mellado, V., & Sánchez, M. (2005). Implementing the Balanced Scorecard: a Supermarket Chain´s Experience. Research Gate, 2-13.

Mudditt, J. (2017, March 24). Retail World. Retrieved from Rtail world magazine: https://www.retailworldmagazine.com.au/spotlight-australias-supermarkets-grocery-industry/

Palmer, J., & Markus, L. (2000). The Performance Impacts of Quick Response and Strategic Alignment in Specialty Retailing. Informations Systems Research, 11(3), 241 - 259.

Parasuraman, A., Zeithaml, V., & Berry, L. (1991). Refinement and reassessment of the SERVQUAL scale. Journal of Retailing, 67, 420-450.

Shahin, A. (2010). SERVQUAL and model of service quality gaps: A framework for determining and prioritizing critical factors in delivering quality services. In P. Sarathy, Service quality – An introduction (Vol. 1, pp. 117-131). Andhra Pradesh: ICFAI University Press.

INVESTOR RESPONSE TO AUDITORS GOING CONCERN OPINION

2018-01-09T15:57:00.000-08:00

The collapse of well-established corporations around the world during period 2000 to 2002 reopened the debate about the auditors’ responsibility (Haron, et al., 2009; Herbohn, et al., 2007) and this increased tension led the auditors being subject to high level of scrutiny by the media, public and regulators (Careya, et al., 2012; Fargher & Jiang, 2008). Some argued that auditors have a duty to signal the external parties regarding the impending collapse of the business. Mostly regulators, politicians and the media have often criticized auditors for not flagging the users of the financial statements about the impending client failures (Carey, et al., 2008).

The limited access to the business’s accurate and unbiased information has increased the dependence on published general purpose financial statements for the decision making purposes by the interested parties. Accordingly, a considerable reliance is made on the independence auditor’s report for the truth and fair presentation of financial statements. Thus there is an argument that audit reports should provide an early warning signal of imminent failure of the corporate (Herbohn, et al., 2007). Other hand some argue that issuance of a going concern opinion can be a ‘self-fulfilling prophecy’, where that the going concern opinion itself triggers a bankruptcy, which could otherwise have been avoided if not for the auditors pinion.

Among the proponents against the auditor’s liability to predict the going concern ability argue that the auditors should not be held accountable for the business failures if the auditor has exercised his professional scepticism and followed the standards. The standard requires the auditor to evaluate whether there is “substantial doubt about the entity’s ability to continue as a going concern.” The term going concern is widely used in the profession, but, curiously, not defined authoritatively in accounting standards (Nogler & Jang, 2012). Accordingly, the absence of any reference to a material uncertainty about the entity’s ability to continue as a going concern in an auditor’s report cannot be viewed as a guarantee as to the entity’s ability to continue as a going concern ( Auditing and Assurance Standards Board, 2015).

The decision to modify a client’s report for going concern reasons is one of the most difficult decisions an auditor faces (Nogler & Jang, 2012). The studies show that auditors have a tendency to avoid issuing a going concern opinion, even when corporations depict liquidity issues (Haron, et al., 2009). The auditor faces a dilemma when disclosing the qualification on the audit report. If a financially distressed corporate collapse subsequent to an unqualified opinion, the auditor is at a risk of being charged as guilt of nondisclosure of the fact. On the other hand if the report is modified as to the validity of going concern assumption, it could hasten bankruptcy by making the alert on going concern a self-fulfilling prophecy (Nogler & Jang, 2012). Therefore the auditor must be sceptics of the work he performs.

Going concern

Under conceptual framework for accounting, the financial statements should be prepared on the going concern basis of accounting unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so. The financial report is prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. General purpose financial reports are prepared using the going concern basis of accounting. Accounting Standard AASB 101 Presentation of Financial Statements requires directors when preparing the financial report to: make an assessment of a company’s ability to continue as a going concern disclose the uncertainties about which the directors were aware in making their assessment of going concern where those uncertainties may cast significant doubt on the company’s ability to continue as a going concern (Australian Institute of Company Directors, 2009)

According to Australian auditing standard ASA 570 - Going Concern issued by Auditing and Assurance Standards Board (AASB) in 2015 states that ‘the auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial report, and to conclude, based on the audit evidence obtained, whether a material uncertainty exists about the entity’s ability to continue as a going concern.’ It is the management responsibility to assess the going concern ability of the business. The standard further states that there is an inherent limitations on the auditor’s ability to detect material misstatements are greater for future events or conditions that may cause an entity to cease to continue as a going concern. The auditor cannot predict such future events or conditions. This could be further strengthened by referring to the landmark case on the auditor’s liability where the pronouncement of Lord Justice Lopes in the late nineteenth century stated that an auditor was a watchdog and not a bloodhound (Baxt, 1986).

Auditor’s evaluation on going concern

The auditor’s consideration of its client organization ability to continue as a going concern, has been in effect since 1989 (Nogler & Jang, 2012). The tension has ignited again in the following the corporate collapses and audit scandals in early 2000 where the much of the criticism were directed at the auditors for not signalling the users of the financial statements of the corporate financial distress (Fargher & Jiang, 2008). Some argue that auditors are to blame for not being able to issue the appropriate going concern opinion report. They insist that the collapses of these companies may have been avoided if appropriate reports were issued (Haron, et al., 2009).

Evidence from Indonesia suggest that, in 1997, 14 companies had been issued a clean audit report in the previous year, but collapsed in the subsequent year. Similarly, in 1998, 15 companies previously issued a clean report collapsed in the next year (Haron, et al., 2009). Many stressed the auditors’ incompetence to identify the upcoming bankruptcy the corporates during the most recent audits (Meredith & Giacomino, 2003). Judging whether a going-concern qualification is required is a difficult and unstructured task (Nogler & Jang, 2012) which presents the auditor with a dilemma, and may actually accelerate a corporate collapse.

When an auditor evaluates the going-concern assumption for a distressed client, it is required to evaluate all available information on the future (Bruynseels, et al., 2013). This is instructed and more complicated than evaluating past information on financial statements. Moreover, issuance of a going concern opinion can itself be a ‘self-fulfilling prophecy’ which triggers the bankruptcy. However, the results from an Australian settings in 2008 contradicts this idea stating that there no empirical evidence that there is a self-fulfilling prophecy of increased probability of company failure following the issuance of a going concern modified opinion (Carey, et al., 2008). On the other hand, if a financially distressed company is not qualified on the going concern basis and subsequently fails, the auditor could be seeming alleged for the professional negligence. Therefore, the auditor must be sceptical on the evidence they receive during their course of audit in order to protect themselves being charged for the noncompliance with relevant auditing standards (Bruynseels, et al., 2013).

In this context there has been an evidence that the auditors were more inclined to issue modified going concern opinion (Fargher & Jiang, 2008; Careya, et al., 2012) during the global financial crisis. In this period there were number of corporate collapses in Australia (HIH, One.Tel, Pasminco, Ansett, and Harris Scarf Holdings), creating the tension among the society. According to an Australian study on auditors’ inclination to issue going concern modification pre and pose economic distressed period between 2000 to 2002 of publicly listed companies, Fargher & Jiang, (2008) fond that auditors were more likely to issue going concern opinions to financially stressed companies immediately after the crisis period however, these results were not in consistent with the period beyond 2003. Similarly, Careya, et al. (2012) also witness ed that there has been a change in auditor’s behaviour in the period after the high-profile corporate collapses in 2001 where the auditors were more likely to issue going concern modified opinion.

The decision matrix for going concern decision identifies two types of audit reporting misclassifications by the auditors as type I and type II errors. Type I error occurs when the auditor fail to render an unmodified opinion to a financially stressed company that does not file bankruptcy in the forthcoming year Type II error occurs when the auditor fail to render an qualified audit opinion to a financially distressed company that files bankruptcy in the upcoming year (Carcello, et al., 2007 ). Carey, et al. (2012) examined the failure rates of Australian companies following an issuance of a first time going concern modified audit opinion in their annual reports in the pre and post global distressed period of 2000-2001. They have noted that that there has been a number of occasions of making type I error during post crisis period and matched sample of financially distressed firms receiving an unmodified audit opinion. The results indicated that auditor switching is positively linked with the auditor’s issuance of a modified opinion going concern ability of the client.

The main stakeholder of a publically listed company is current and potential shareholders. These investors make decisions based on the published financial statements. Based on the information available in the market the investor will change their decisions as to buy, hold or sell that particular company’s shares. It was revealed that the auditor’s going concern modified opinion act as a risk communicator of the financial distress of the firm which change the perception of the equity market (Blay, et al., 2007). In contrast, Herbohn, et al. (2007) stated that there is no short term market reaction to the public announcement of a going concern modified opinion in the published financial statements of Australian firms. Further in the study they have witnessed a significant unfavourable medium term market response in the 12 months preceding to a first time going concern opinion modification. This could be due to the continuous disclosure regime of the ASX and the publically listed companies are now liable to publish their financial affairs more rigorously and a timely manner. These results concluded the notion that an audit opinion serves as an attestation and it has the ability to confirm the deteriorating financial state of a firm.

As per the auditing standards, the auditor should obtain sufficient appropriate audit evidence to evaluate the management assessment about the going concern opinion. Haron, et al., in 2009 studied auditor judgement on going concern opinio by using quasi experimental. The study revealed that there is three factors that caused the auditors' judgement on going concern evaluation, namely, financial indicators, evidence, and disclosure. Blay, et al. (2007) examined the relationship between the auditors’ preliminary assessments of going concern and fraud risk in the planning and performance of the audit. It was found that fraud risk and going-concern risk are significantly associated.

Most of the studies focused on auditors’ evaluation of going concern on single risk level. Young & Wang (2010) diviced five-level risk class based on Australian Auditing Standard pronouncements to observe the suitability of auditors’ going concern reporting. In this regard, they have used Altman Z-score bankruptcy prediction model and asses the going concern reporting of all Australian listed companies within the building industry in 1989 and to follow them through until 2007. This study was in conformity of the current literature view that auditors are not solely functioning as a monitoring mechanism but have agency features.

In the going concern literature the most researched area is the auditor’s audit procedure and how the auditor reach his conclusion as to whether the going concern opinion should be modified or not. In contrast, relatively little research has addressed whether auditors’ circumstances and surroundings influence their propensities to issue modified opinions (Blay, et al., 2016). During the planning and the performing stage of the audit, the auditors pay special consideration to management strategies of the turnaround the distressed firm. There is a strong association between operating turnaround initiatives are the higher likelihood of receiving a going concern opinion (Bruynseels, et al., 2013).

In review of the previous literature it was noted that investor self-reliance in the quality and truthfulness of freely accessible business financial information of public companies and accompanied by independent auditor’s report is considered vital to the proper functioning of the capital markets (Robinson, 2008). In this regard most of the researchers paid their attention to the shareholders and assessed the auditor’s role in relation to shareholders reaction and perception on the audit report. However, there has been little research carried out understand how lenders in Australia perceive the modified going concern audit report and how they will react to an issuance of a going concern qualification. This study aims to contribute to the knowledge by bridging the existing knowledge gap.

Bibliography

Auditing and Assurance Standards Board, 2015. Auditing Standard ASA 570, Melbourne, Australia: Auditing and Assurance Standards Board .

Australian Institute of Company Directors, 2009. Going Concern issues in financial reporting: a guide for companies and, Sydney, Australia: Australian Institute of Company Directors.

Baxt, R., 1986. The Modern Company Auditor: A Bloodhound without Teeth or a Watchdog without Eyes?. Osgoode Hall Law Journal, 24(3), pp. 667-697.

Blay, A., Moon, J. & Paterson, J., 2016. There’s No Place Like Home: The Influence of Home-State Going-Concern Reporting Rates on Going-Concern Opinion Propensity and Accuracy. Auditing: A Journal of Practice & Theory, 35(2), p. 23–51.

Blay, A., Sneathen, D. & Kizirian, T., 2007. The Effects of Fraud and Going-concern Risk on Auditors’ Assessments of the Risk of Material Misstatement and Resulting Audit Procedures. International Journal of Auditing, p. 149–163.

Bruynseels, L., Knechel, R. & Willekens, M., 2013. Turnaround Initiatives and Auditors’ Going-Concern Judgment: Memory for Audit Evidence. Auditing: A Journal of Practice & Theory, 32(3), p. 105–121.

Carcello, J., Vanstraelen, A. & Willenborg, M., 2007 . The effect of audit standards on auditor reporting: going-concern opinions in Belgium. Paris, HEC Research Seminar .

Careya, P., Kortumb, S. & Moroney, R., 2012. Auditors’ going-concern-modified opinions after 2001: measuring reporting accuracy. Accounting and Finance, Issue 52, p. 1041–1059.

Careya, P., Kortumb, S. & Moroney, R., 2012. Auditors’ going-concern-modified opinions after 2001: measuring reporting accuracy. Accounting and Finance, Volume 52, p. 1041–1059.

Carey, P., Geiger, M. & O’Connell, B., 2008. Costs Associated With Going-Concern-Modified Audit Opinions: An Analysis of the Australian Audit Market. ABACUS, 44(1), pp. 61-81.

Fargher , N. L. & Jiang, L., 2008. Changes in theAudit Environment andAuditors’ Propensity to Issue Going-Concern Opinions. American Accounting Association, 27(2), p. 55–77.

Haron, H., Hartadi, B., Ansari, M. & Ismail, I., 2009. Factors Influencing Auditors' Going Concern Opinion. Asian Academy of Management Journal, 14(1), p. 1–19.

Herbohn, K., Ragunathan, V. & Garsden, R., 2007. The horse has bolted: revisiting the market reaction to going concern modifications of audit reports. Accounting and Finance, Volume 47, p. 473–493.

Meredith, M. & Giacomino, D., 2003. Going-concern opinions: broadening the expectations gap. The CPA Journal, 73(10).

Nogler , G. & Jang, I., 2012. Auditor’s Going-Concern Modification Decision in the Post-Enron Era. The Journal of Corporate Accounting & Finance, pp. 35-60.

Robinson, D., 2008. Auditor Independence andAuditor-Provided Tax Service: Evidence from Going-Concern Audit Opinions Prior to Bankruptcy Filings. Auditing: A Journal of Practice &Theory, 27(2), p. 31–54.

Young, A. & Wang, Y., 2010. Multi-risk level examination of going concern modifications. Managerial Auditing Journal, 25(8), pp. 756-791.

PPE: Relevance and Representational Faithfulness of Financial Reporting

2017-12-28T01:04:00.000-08:00

Scope

For the purpose of the analysis of Property, Plant and equipment (PPE), AP Eagers Limited and the group (hereinafter referred as Company) general purpose financial statements for the financial year 2016 has been selected. The financial reporting practice of PPE is critically analysed with reference to the AASB 116 Property, Plant and Equipment, AASB 13 Fair Value Measurement, Framework for the Preparation and Presentation of Financial Statements (hereinafter referred to as Framework) and drawn inferences from the extant literature.

Background

The core business of the Company is retailing of branded automotive in Australia through ownership and dealership. These dealerships are strategically clustered and operated in the properties owned and leased by the Company throughout the country. The property accounts for 84% of total PPE and 17% of total assets, and therefore could be considered as a material account balance for the financial statement.

PPE Measurement

Land and building (property) are valued at fair value and other PPE are assessed at cost. The Company policy is to state property at fair value as per the assessment by directors which is supported by independent valuer’s periodic valuation. For the year 2016, the property valuation was made by the directors based on their assessment on market conditions and the knowledge of the Company on market and its activities. According to the general principle of AASB 13 on Fair Value para 67, the entity shall use observable inputs and minimise the use of unobservable inputs. However, the Company has used unobservable inputs where it falls under level 3 in the fair value hierarchy. Level 3 inputs are subjective and biased, thus renders higher risk. To address this risk AASB 13 requires more disclosure than other 2 levels (Edgerton, 2016).

Relevance and faithful representation

The relevance and faithful representation are the fundamental characteristics of financial information[1]. It is however questionable whether the PPE of the Company could be compared with other retail listed companies in ASX as most of the entities use historical cost in their valuation (Edgerton, 2016). Notwithstanding to the fact that the Company measures property under revaluation model, it could enhance the relevance of the information published in the general purpose financial statements, the reliability qualitative characteristic has been compromised due to the estimates and the biasness in the revaluation model. On the other hand the Company reports its other assets, such as leasehold improvements, plant and equipment and motor vehicles, under cost model, which enhance the reliability characteristics and undermine the quality of relevance.

According to Framework faithful representation has 3 fundamental sub-qualitative characteristics as completeness, neutrality and free from error. When the Company elect to follow the revelation model for property, the valuation is subject to biasness. As per the Framework suggests that if an unobservable price is used (like fair value of Property reported at level 3 in this case) the amount should be explained precisely as being an estimate, the nature and limitations of the estimating process should also be stated for the information to be faithful (AASB, 2016). We noted that there is less information being presented on how the directors obtained the Key information inputs.

The Australian economy is still experiencing the property boom. In this context, the option of recording land at fair value will undoubtable result in revaluation gain. Further, reporting land at fair value will not impact on the profit or loss as land is not a depreciable asset. Therefore, it is questionable whether the attempt to revalue only property, which is subject to constant rise in price, and recording the other assets at cost, which in otherwise could have resulted in revaluation loss under fair value model, lead to faithful representation of information. It could be perceived as an attempt to inflate the balance sheet. Many critiques argue that the fair value accounting led the financial crisis by increasing the pro-cyclicality[2] of the financial system (Palea, 2014; Menicucci & Paolucci, 2016; Majercakova & Skoda, 2015).

The previous literature suggests that corporate relying on high debt tend to follow fair value model for PPE (Barlev, Fried, Haddad, & Livnat, 2007; Cotter & Zimmer, 1995; Barać & Šodan, 2011; Iatridis & Kilirgiotis, 2011; Brown, Izan, & Loh, 1992), especially for land (Guo, 1995). Having the same conviction, it could be argued that the Company has a higher propensity to revalue property as it experience a high total debt to equity ratio[3] of 1.01. Thus, it is questionable whether the motive of revaluation is to enhance the faithful representation of the of the Company’s affairs or to show an image that the management purported depict.

Conclusion

It could be concluded that the by electing to follow the revaluation model for property the relevance of the information could be enhanced at the expense of compromising the reliability. On the other hand the motive of the management for revaluing only property could be questioned in the context of rising property prices and not having a depreciation impact on the balance sheet. This could lead to impair the faithful representation of financial information.

References

AASB. (2016). Framework for the Preparation and Presentation of Financial Statements. Victoria: The Australian Accounting Standards Board (AASB).

AASB. (2015). Fair Value Measurement. Victoria: The Australian Accounting Standards Board (AASB).

AASB Australian Accounting Standards Board [Australian Government], (2009); [page 72] “Property, Plant and Equipment”; Australian Accounting Standards Board: Melbourne, Victoria.

AASB. (2014). Propoerty, plant and Equipment. Victoria: The Australian Accounting Standards Board (AASB).

Aboody, D., Barth, M., & Kasznik, R. (1999). Revaluations of Þxed assets and future Þrm performance:Evidence from the UK. Journal of Accounting and Economics, 149-178.

2016 Annual Report. (2017). Brisbaine: A P Eagers Limited.

Barth, M. E., Clinch, G., 1996. International accounting differences and their relation to share prices, Evidence from U.K., Australian, and Canadian firms. Contemporary Accounting Research 13(1), 135-170.

Barać, Ž. A., & Šodan, S. (2011). Motives for asset revaluation policy choice in Croatia. Croatian Operational Research Review, 2.

Brown, P., Izan, H., & Loh, A. (1992). Fixed Asset Revaluations and Managerial Incentives. ABACUS, 28(1), 36-57.

Cotter, J., & Zimmer, I. (1995). Asset revaluations and assessment of borrowing capacity. ABACUS, 31(2), 136-151.

David Edgerton FCPA, (2016);[page 12] “Guide to valuation and depreciation for public and not for profit sectors under AASB accounting standards” ; Australia: CPA institute.

David Aboody, Mary E. Barth and Ron Kasnik, (1998);[page 13] “Revaluations of fixed assets and future firm performance” ; USA: University of California.

Edgerton, D. (2016). Guide to valuation and depreciation. Southbank: CPA Australia.

Frank Missioner Pieria, (2011);[page 124] “Motives for Fixed asset revaluation; and empirical analysis with Swiss data” ; France: ESSEC Business School.

Guo, M. (1995). The Economic Incentives and Consequences of Land Write-Ups. Journal of International Financial Management and Accounting, 6(2), 115-129.

Henderson, S., & Goodwin, J. (1992). The case against asset revaluations. ABACUS, 75 -87.

Iatridis, G. E., & Kilirgiotis, G. (2011). Incentives for fixed asset revaluations: the UK evidence. Journal of Applied Accounting Research, 13(1), 5-20.

Lopes, A. B. and Walker, M., (2012) “Asset revaluations, future firm performance and firm-level corporate governance arrangements: New evidence from Brazil”, The British Accounting Review, No. 44, pp. 5367

Lin, Y.C. and Peasnell, K.V., (2000), “Fixed Asset Revaluation and Equity Depletion in the UK”, Journal of Business Finance and Accounting, No. 27 (3) & (4), pp. 359-394

Majercakova, D., & Skoda, M. (2015). Fair value in financial statements after financial crisis. Journal of Applied Accounting Research, 16(3), 312-332.

Menicucci, E., & Paolucci, G. (2016). Fair value accounting and the financial crisis: a literature-based analysis. Journal of Financial Reporting and Accounting, 14(1), 49-71.

Missonier-Piera, F. (2007). Motives for Fixed Asset Revaluation: An Empirical Analysis with Swiss Data. The International Journal of Accounting, 42(2), 186-205.

Palea, V. (2014). Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), 102-116.

[1] According to Framework, for “financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable.” (AASB, 2016, p. 36). In this regard comparability is qualitative characteristics of usefulness.

[2] Pro-cyclicality refers to the ability to exaggerate financial or economic fluctuations (Majercakova & Skoda, 2015)

[3] The total debt to equity ratio is calculated by dividing borrowings from total equity. Other liabilities have been disregarded in the calculation. The total liabilities to total equity ratio is 1.3

Value relevance of audit opinion

2017-11-21T15:45:00.000-08:00

The sweep the corporate failure of large conglomerates around the world in early 2000 led the critiques to revisit the discussion of auditors’ due to care and accountability (Haron, et al., 2009; Herbohn, et al., 2007) and this heated forum brought the auditors to scrutiny of the public and regulators (Careya, et al., 2012; Fargher & Jiang, 2008). The noteworthy controversial debate was whether the auditors could be held responsible for not disclosing the financial distress or the financial misstatement of their client. In this campaign the regulative authority and the media have repeatedly condemned the auditors for not signalling the users of the financial statements regarding the impending corporate failure (Carey, et al., 2008).

There is a high dependence on auditors report, by the users of the financial statements for the decision making purpose of the company, as it is said to be an unbiased opinion on the true and fair view of the general purpose financial statements. Accordingly, a significant reliance is placed on the independence auditor’s report as the external users have no or limited access to private information held by the corporation. On this grounds, it has been argued by the researchers that the auditor’s report should flag the users of an imminent failure of the corporate (Herbohn, et al., 2007) by way of qualifying the audit opinion on the basis of highlighting the inability of the firm to continue as a going concern. However, some contradicts this notion and claims that a going concern opinion could itself triggers a bankruptcy and act as a self-fulfilling prophecy (Menon & Williams, 2010).

The judgment as to whether the auditor should qualify the audit report for going concern is one of the most controversial decisions an auditor has to make (Nogler & Jang, 2012). This has cause a dilemma for the auditors when issuing a qualification. The literature reveals that if a financially distressed corporate collapse subsequent to an unqualified opinion, the auditor is at a risk of being charged as guilt of nondisclosure of the fact (Kausar, et al., 2017). Therefore the auditor must be skeptic of the work he performs.

On the other hand there is a high tendency of not issuing a qualified opinion on going concern of a corporate even though there could be an apparent liquidity crisis within the firm (Haron, et al., 2009). The reason is that the modified audit opinion on the financial stability of the firm could hasten bankruptcy by making the alert on going concern and the alert itself could be a self-fulfilling prophecy (Nogler & Jang, 2012). This could reduce the likelihood of turning around a company which otherwise could have been. Financial assistance from the investors could turnaround a company inter alia. However, in the presence of a going concern qualification the investors will be deterred to finance given the risk of losing the investment.

-Lulisha-

References

Auditing and Assurance Standards Board, 2015. Auditing Standard ASA 570, Melbourne, Australia: Auditing and Assurance Standards Board.

AICD & AUASB, 2009. Going Concern issues in financial reporting: a guide for companies and directors, Sydney: Australian Institute of Company Directors and Auditing and Assurance Standards Board.

Amin, K., Krishnan, J. & Yang, J. S., 2014. Going Concern Opinion and Cost of Equity. AUDITING: A Journal of Practice & Theory, 33(4), pp. 1-39.

Australian Institute of Company Directors, 2009. Going Concern issues in financial reporting: a guide for companies and, Sydney, Australia: Australian Institute of Company Directors.

Australian Prudential Regulation Authority, 2016. ADI Points of Presence workbook, Sydney: Australian Prudential Regulation Authority.

Carey, P., Geiger, M. & O’Connell, B., 2008. Costs Associated With Going-Concern-Modified Audit Opinions: An Analysis of the Australian Audit Market. ABACUS, 44(1), pp. 61-81.

Firth, M., 1980. A note on the impact of audit qualifications on lending and credit decisions. Journal of Banking & Finance, 4(3), pp. 257-267.

Haron, H., Hartadi, B., Ansari, M. & Ismail, I., 2009. Factors Influencing Auditors' Going Concern Opinion. Asian Academy of Management Journal, 14(1), p. 1–19.

Kausar, A., Taffler, R. . J. & Tan, C., 2017. Legal Regimes and Investor Response to the Auditor’s Going-Concern Opinion. Journal of Accounting, Auditing & Finance, 32(1), p. 40–72.

LaSalle, R. & Anandarajan, A., 1997. Bank Loan Officers' Reactions to Audit Reports Issued to Entities with Litigation and Going Concern Uncertainties. Accounting Horizons, 11(2), pp. 33-40.

Menon, K. & Williams, D., 2010. Investor Reaction to Going Concern Audit Reports. The Accounting Review, 85(6), p. 2075–2105.

Nogler , G. & Jang, I., 2012. Auditor’s Going-Concern Modification Decision in the Post-Enron Era. The Journal of Corporate Accounting & Finance, pp. 35-60.

Pucheta, M. C., Marti´Nez , A. V. & Benau, M. A. G., 2004. Reactions of the Spanish Capital Market to Qualified Audit Reports. European Accounting Review, 13(4), p. 689–711.

Schaub, M., 2006. Investor reaction to regulated monopolies announcing going concern opinions: What explains contagion among electric services companies?. Review of Accounting and Finance, 5(4), pp. 393-409.

Sustainability Reporting and Shareholder Perspective

2017-10-11T17:35:00.000-07:00

With the wake of industrialization in the twenty first century, fuelled by technology and globalization, there has been an unfortunate destruction of natural resources, social injustice and suppression of civil rights and the native knowledge of indigenous people (Collins, 2012) in more subtle manner than ever before. The man’s quest for economic wealth maximization led the unfair treatment to the environment and society the exploitation of natural and human resources. Owing to these reasons, the way in which a corporate operates is scrutinized more rigorously by all stakeholders including the regulators and the financial press (Martı´nez-Ferrero & Banerjee, 2016). Thus, pure economic or the profit motive has questioned over the last few decades.

Though the primary objective of an organization is to make profits, the society has recently challenged the profit motive. At the early stages of development of the concept of organization as a social entity they demonstrated their responsibility to society through corporate philanthropic activities (Abdeen, et al., 2016). Philanthropic responsibilities are those which society expects organisations to fulfil voluntarily and reflect a common desire to see organisations engaged in improving society (Carroll, 1979). Initially the corporate responsibility serves as a way of discharging the business’s responsibility by donating goods and providing other essentials to the needy without internalising the responsibility which stems within the organization culture, values and practices. Over the past few decades, there has been a shift in paradigm from external focus to more internal focus where socially responsible activity has been viewed as part of the daily business practice (Abdeen, et al., 2016).

As a discharge of social responsibility the business later not only engaged in corporate responsible activities but also inform their stakeholders. The later developments in business reporting have put the accent on the importance of non-financial disclosures with the conceptual shift from pure profit based responsibility reporting to the corporate responsibility reporting (Salehi & Azary, 2009; Abdeen, et al., 2016; Khaveh, et al., 2012; Gómez-Bezares, et al., 2016; Gozali, et al., 2002; Busru & Shanmugasundaram, 2016; Martı´nez-Ferrero & Banerjee, 2016; Kasbuna, et al., 2016). Many different theoretical arguments were articulated to provide rationale for corporate to elect voluntarily disclosure corporate social responsibility information to the external stakeholders.

Evolution of Corporate Social Responsibility

Though corporate social responsibility was widely researched agenda in the academic field there is no consensus on its definition. Salehi & Azary in 2009 refers it to as a company's commitment to operate in an economically and environmentally sustainable manner, while acknowledging the interests of a variety of stakeholders and maximizing economic, social and environmental value. Though currently this phenomenon has been viewed as a holistic concept embracing the importance of the stakeholders, the early scholars perceived it as a narrow concept which focused primarily on the shareholders.

Corporate responsibility concept was used for the first time by an American economist Howard Bowen in 1953. Archie B Carroll, Professor of Management Emeritus, calls Howard R. Bowen the Father of Corporate Social Responsibility due to his landmark book published in 1953, Social Responsibilities of the Businessman. This was the regarded as the first attentive discussion of business ethics and social responsibility. Since then the focus of CSR is shifting from stockholder orientation to stakeholder orientation. ‘This ubiquitous aphorism is gaining momentum in directing the conduct of human affairs towards a stance in support of life for man and all living things’ (Collins, 2012, p. 28).

The concept off CSR gained its momentum in the late 1950s and 1960s. In early days a responsibility of a corporate was perceived as giving the highest return to their owners (Bosch-Badia, et al., 2013). Early proponents of corporate social responsibility theories suggest that the primary purpose of business is to make profits, and it is not the function of business to get involved with social responsibility issues since such involvement would compromise profit maximisation (Abdeen, et al., 2016). This of responsibility is all about the pure economical field. Having the same conviction, the Nobel Prize winning economist Milton Friedman in 1970’s in his widely cited book ‘Capitalism and Freedom’, rejected the view that corporate managers have any moral obligations. The responsibility of business is to use resources to increase profits as long as it stays within the rules. Here he meant it stays within the rules as to engage in open and free competition, without deception or fraud. As explained by Bosch-Badia, et al. in 2013 Friedman held that those executives who imposed social expenses to the corporations they managed should be regarded as disloyal agents to their principals, the shareholders. Friedman propagated that the sole purpose of the corporation is to maximize the financial return to its owners.

It was argued that by making a proﬁt, corporations contributed to a growing, healthy economic system that provided employment and adequate incomes for all. In other words, corporate social responsibility was to operate portably, and the corporation could not survive without profits, much less play a social role. Carroll (1979) suggests that CSR is a multidimensional concept encompassing economic, legal, ethical and philanthropic responsibilities of a business. According to Abdeen, et al. (2016) the ultimate role of organisations to produce goods and services desired by society, be profitable and enable job creation. On the legal responsibility perspective the business should comply with the social agreements. However the ethical responsibilities goes beyond legal requirements and demonstrating the commitment of a business for the internal and external society and environment.

The perception of corporate social responsibility has been changed and it is continued to be changing. ‘It was not until the late 1970's that companies began to react more pro actively to corporate social responsibility issuing affirmative action guidelines’ (Salehi & Azary, 2009, p. 66). Currently it is becoming accepted that entities also have responsibilities to a broader group of stakeholders (e.g. local communities, customers, suppliers, employees, creditors, government and even future generations) and not restricted only to their owners. Entities are now being held responsible for their social and environmental as well as their financial performance. Changes in expectations about accountabilities in turn should lead to changes in corporate accounting.

Social Responsibility Reporting (SSR)

SRR can be understood as the provision of information about the performance of an organisation in relation to its interaction with its physical and social environment. The businesses are treated as key players of the society and do not exist in isolation. The employees depend on the business and also customers, suppliers and the local community are all affected businesses and what they do. Their products, and the way they make them, also have an impact on the environment. Accordingly, as a part of the environment the businesses have greater transparency and accountability in its reporting. This is reflected in a recent progress of reporting aspect in global context towards comprehensive disclosure of corporate performance to include environmental, social and economic factors. On this ground Corporate Social Responsibility CSR has become prominent in the language and strategy of business organisations globally as well as locally. According to a recent survey, 93% of CEOs regard sustainability as important. Similarly ninety-five percent of the 250 largest companies in the world now report on their corporate social responsibility (CSR) activities (Gómez-Bezares, et al., 2016).

When considering the reporting aspect of the corporate social responsibility, it is difficult to identify one accepted conceptual framework. One broad mechanism that companies can adopt is “Triple Bottom Line Reporting” (TBL). At present, companies are focusing on environmental and social dimensions rather than focusing on economic dimension itself. Reporting information on these three elements is referred to as TBL reporting.

Despite CSR is a voluntary reporting system having greater diversity in the degree and facets of reporting, different frameworks are in application to standardize the reporting. Among them Global Reporting Initiatives (GRI) is accepted to be superior. The Global Reporting Initiative (GRI) is a leading organization in the sustainability field. GRI promotes the use of sustainability reporting as a way for organizations to become more sustainable and contribute to sustainable development. In May 2013, GRI released the fourth generation of its Guidelines (extracted from the official website). GRI was introduced through GRI 1^st version in 2000. The second generation known as G2 was then introduced improving the disclosures in 2002. Followed by G2, G3 guidelines were launched in 2006. The latest release of the GRI guidelines would be the 4th generation introduced in 2013 and G4 guidelines have been superseded by the GRI Sustainability Reporting Standards (GRI Standards) launched in October 2016.

Corporate Social Responsibility Reporting in Australia

There are no legal requirement for sustainability reporting in Australia per se. However, there are number of reporting requirements for the publically listed companies in Australian Securities Exchange (ASX). Further there has been a greater compliance with voluntary reporting within the Australian companies listed in the stock exchange. According to Australian Council of Superannuation Investors (ACSI) seventy one cents in every dollar invested in the ASX200 is now invested in corporates which reports higher disclosure standards on their environmental, social and governance engagements. Thus, this trends reveals that the Australian investors place a higher value in the CSR activities as well as the disclosure of the same.

Since 2008, there has been a remarkable improvements in the level of corporate disclosure practices in Australian ASX listed companies, mainly due to the requirements introduced by second edition of ASX Corporate Governance Council Principles and Recommendations in 2007. The introduction of the third edition in 2014 further requires each ASX listed company to disclose material exposures to economic, environmental and social sustainability risks and how it intends to manage those risks. This corporate governance disclosure requirements have tied the governors’ (the management) actions to the environmental and social impact and making social responsibility part of the obligation of corporate governance. With the new initiatives the corporate risk has been linked to social and environment aspects going beyond the economic context. Having the same argument, Khaveh, et al., (2012) suggested that the companies need to assure shareholders about the risk and naturally potential investors look for lower risk and higher return. Thus sustainability reporting would increase share price and could be able to internalise the CSR activities of the business.

Even though there is a great momentum in the reporting practice, there are still a large proportion of corporates fail to report the sustainability related matters in a generally acceptable manner. ‘In 2015, there were still 57 companies – approximately 30% of the total ASX200 by number – that were assessed as providing either no reporting or only a basic level of information’ (Australian Council of Superannuation Investors, 2016, p. 4).

As of August 2017, there are 2,216 companies listed in ASX and the compliance of ASX Corporate Governance Council Principles (Third Edition) have been made mandatory for all listed companies in the ASX. There is no doubt that today CSR has become an important component of business strategy which emphasises transparency, responsiveness and accountability (Abdeen, et al., 2016) but the question is whether the shareholder, who are treated as the ultimate owners of the business, perceive the mere responsibility reporting as a value creation to the organization, to their own wealth and to the society at large. The recent research carried out on the area of shareholder perception of social responsibility reporting yielded a mixed results all over the world (Khaveh, et al., 2012;Gray, 2006; Nielsen & Thomsen, 2007).

Stakeholder Perspective of Responsibility Reporting

In the extant literature the customer and the shareholders have been considered as the main stakeholders and consequently it has been the subject of many studies in the responsibility reporting and stakeholder perspective. Thus, the consumer as a stakeholder plays a key role in influencing the nature of CSR strategies that organisations adopts (Abdeen, et al., 2016). In contrary, Nielsen & Thomsen (2007) argued that there are dissimlar prioriies in the Danish companies with repard to the CSR reporting and they further argued that this could be due to the interest stemming from different institutional associations, such as government, regional institutions and NGOs.

Under the customer perspective Luo & Bhattacharya in 2006 studied influence of CSR on perceived customer responses. It was found that the firms with low innovativeness capability, CSR actually reduces customer satisfaction levels and, through the lowered satisfaction, harms market value (Luo & Bhattacharya, 2006). Similarly, according to Abdeen, et al., (2016) there are broadly accepted four belives of CSR measures, namely, philanthropic ethical and legal aspects. In their study of consumers’ beliefs about firm’s CSR initiatives and their purchase behaviour, they found that only ethical beliefs have direct relationship with purchase behaviour.

In the attempt to link shareholders and CSR practices some authors perceived profit as a proxy of easuring shareholder reward. In a study of voluntary disclosure, revenue, and shareholders wealth in Singaporean companies, Khaveh, et al., (2012) found that there is a significant positive relationship between environmental and social performance disclosure as well as with revenue. Gómez-Bezares, et al., in 2016 examined the impact of corporate sustainability on stock market returns British Companies over the period 2006–2012 and showed that CS is negatively correlated with stock return volatility. Which means that investing in companies with CSR reporting not only generates higher returns during the booming period, but also reduces shareholders’ damages during period the market id declining. In the context of Maliasian companies, the economic, social and environmental sustainability reporting is positively associated with financial performance (Kasbuna, et al., 2016). In contrast, there has been a weak positive relationship between corporate gvernance and CSR disclosures with the share price companies in India and there is a negligible incluential power of CSR reporting on the share price (Busru & Shanmugasundaram, 2016).

On the other hand, there is one class of researches who argue that the CSR reporting is a mere fad and a fashion. Gray (2006) argued that social, environmental and sustainability reporting is superficial and cosmetic adjustments to that reporting through “new models of organisational reporting”. Holding a similar stance, Martı´nez-Ferrero & Banerjee (2016) argued that firms use CSR as a strategy against the negative perception received by the corporate from earnings management. They further stated that there is a favourable impact from CSR on cost of capital and the shareholders do not identify when CSR practices are used as a strategy to mask earning management. Thus, these studies have illustrated how CSR have been used as aploy to distort the market and the shareholders’ perception.

There has been many studies on the sibject of CSR reporting, corporate performance shareholder perception. The academic literature on the link between sustainable development strategies and firm performance is fragmented (Gómez-Bezares, et al., 2016) It is apparent from the review of previos litereture that there is no consensus amoung the researchers whether the CSR activities and disclosures lead to create positive impact towards shareholder perception on the corporate. With the introduction of the third edition of ASX Corporate Governance Council Principles and Recommendations mandatory disclosure requirements in 2014, there has been a gap in the literature as to whether the shareholders perceive the CSR disclosures as a value addition to the firm, their own wealth and as well as to the society and the environment, especially in the Australian context.

References

Abdeen, A., Rajah, E. & Gaur, S., 2016. Consumers’ beliefs about firm’s CSR initiatives and their purchase behaviour. Marketing Intelligence & Planning, 34(1), pp. 2-18.

Australian Council of Superannuation Investors, 2016. Corporate Reporting in Australia, Australia: Australian Council of Superannuation Investors.

Bosch-Badia, M. T., Montllor-Serrats, J. & Tarrazon, M. A., 2013. Corporate Social Responsibility from Friedman to Porter and Kramer. Theoretical Economics Letters, Volume 3, pp. 11-15.

Busru, S. A. & Shanmugasundaram, G., 2016. Corporate Disclosure Scores and Share Price Reaction: Empirical Study of Indian Listed Firms (Post Satyam Period). Research Journal of Finance and Accounting, 7(3), pp. 1-7.

Carroll, A. B., 1979. A three-dimensional conceptual model of corporate performance. The Academy of Management Review, 4(4), pp. 497-505.

Collins, N. C., 2012. Rethinking the Accounting Stance on Sustainable Development. Sustainable Development, 20(1), p. 28–41.

Gómez-Bezares, F., Przychodzen, W. & Przychodzen, J., 2016. Corporate Sustainability and Shareholder Wealth—Evidence from British Companies and Lessons from the Crisis. Journal of Sustainability, Volume 8, pp. 276-98.

Gozali, N. O., How, J. C. & Verhoeven, P., 2002. The Economic Consequences of Voluntary Environmental Information Disclosure. Lugano, Switzerland, International Congress on Environmental Modelling and Software, pp. 484-489.

Gray, R., 2006. Social, environmental and sustainability reporting and organisational value creation? Whose value? Whose creation?. Accounting, Auditing & Accountability Journal, 19(6), pp. 793-819.

Kasbuna, N. F., Tehb, B. H. & Ongc, T. S., 2016. Sustainability Reporting and Financial Performance of Malaysian Public Listed Companies. Institutions and Economies, 8(4), pp. 78-93.

Khaveh, A., Nikhashemi, S. R., Yousefi, A. & Haque, A., 2012. Voluntary Sustainability Disclosure, Revenue, and Shareholders Wealth- A Perspective from Singaporean Companies. Business Management Dynamics, 1(9), pp. 06-12.

Luo, X. & Bhattacharya, C. B., 2006. Corporate Social Responsibility, Customer Satisfaction, and Market Value. Journal of Marketing, 70(4), pp. 1-18.

Martı´nez-Ferrero, J. & Banerjee, S., 2016. Corporate Social Responsibility as a Strategic Shield Against Costs of Earnings Management Practices. Journal for Business Ethics, Issue 133, p. 305–324.

Nielsen, A. E. & Thomsen, C., 2007. Reporting CSR – what and how to say it?. Corporate Communications: An International Journal, 12(1), pp. 25-40.

Salehi, M. & Azary, Z., 2009. ‘Stakeholders’ Perceptions of Corporate Social Responsibility: Empirical Evidences from Iran. International Business Research, 2(1), pp. 63-72.

AN ECONOMIC ANALYSIS OF MEDICAL CANNABIS MARKET

2017-05-30T00:57:00.000-07:00

Introduction

The purpose of this assignment is to analyse the economic impact the changes in medical cannabis market as outlined in given article. Recently the government of Australia has legalize the cultivation of medicinal cannabis to supply domestic patients. This essay identifies the effect on the market forces by studying the changes made in Australian cannabis market. Then, these impacts were illustrated using demand and supply curves assuming other factors remain constant. The demand elasticity and the revenue impact is analysed by for cannabis medicine assuming it is an essential product. Finally, the externalities from these recent changes to the market have been analysed.

Demand and supply analysis

Australian market for cannabis alternatively called as marijuana can broadly be defined as medical cannabis market where cannabis are used as a treatment for chronic and seriously ill patients and recreational cannabis market where cannabis are traded in illegally as an illicit drug. The article discusses the market for medical cannabis in Australia in a narrow view point.

The market supply is mostly represented by imported cannabis where the supply of the cannabis is inelastic due to the fact that the medicine is not readily available in the market and it must be imported with strict regulations. On the other hand the demand for the medicine is also inelastic since it is an essential good for the patients.

With the new legislation being passed for medical cannabis, we could observe effects on the market forces;

Supply - The government new legislation has allowed the domestic suppliers to grow cannabis after obtaining licenses from the government allowing more farmers to enter the medical cannabis market. On the other hand, international producers such as Israel, USA and Canada are now contemplating entering Australian market. Further it is now easier to import them to Australia. Both could result in an increase in supply while other factors remain constant. Reducing the time lag of importing the medicine will also make the product available in the market in very short time will cause the new supply to be more elastic, given the other factors remain constant. When the market supply increases as a result of new suppliers enter the market, the supply curve for medical cannabis shifts outwards (right) and has become more elastic, ceteris paribus.

Demand - The recent harvest of first crop and its trial for the treatment of epilepsy can lead to an increase in demand if the test if successful. Currently, Australian patients purchase cannabis for epileptic patient in the black market paying a high price with low medical safety. If the government can prescribe cannabis for epilepsy, the demand for medical cannabis will be increased when the buys move from illegal marijuana market to medical cannabis market, ceteris paribus.

The combined effect of both demand and supply on the market where the new supply curve has become more elastic after the import of cannabis and making it easy to supply has made it readily available in the market than before. The new market price has decreased and the equilibrium quantity has increased. This shows that there will be more cannabis available for the patients at a lower price. The government action has benefitted the consumers who could now access the medicine at a lower price and high quality as the government regulates the product.

Externality analysis

The new legislation on medical cannabis could bring both positive and negative externalities.

When the medicine is readily available for the patients, the entire society will benefited by having a healthy nation. Allowing the manufactures to grow cannabis in Australia, there will be more job opportunities created. Also, in future the import of the medicine will be saving foreign currency from flowing out of the country, improving the foreign exchange. All these positive externalities could be enjoyed by the nation as whole.

In contrast, by allowing the producers to grow cannabis in Australia, the forests could be subject to deforestation. This could badly affect the environment. In the social aspect it could be argued that allowing producers to grow cannabis as a medical product could soon be gone to the marijuana drug addicts. “In 2013, it was estimated that about 6.6 million (or 35%) people aged 14 or older had used cannabis in their lifetime and about 1.9 million (or 10.2%) had used cannabis in the previous 12 months” (Claughton, 2013, pg 58). This means that there will be a possibility that the medical will be used as an illicit drug when it is readily available.

In order to mitigate the negative externalities, the government could introduce strict regulations to monitor the production, distribution and use of cannabis.

Conclusion

It could be concluded that the recent Australian government legislation allowing medical cannabis to produce domestically has impacted both demand and supply. The demand for the medical cannabis could be increased as a result of new research carried out by the government to treat for epilepsy and shifting buyers from illegal cannabis market to regulated cannabis market. Also, the supply too has increased due to the local production and short term import of cannabis. This would ultimately resulted in the market price of medical cannabis to fall while the quantity to be increased. On the other hand, an increase in the price of cannabis could resulted in an increase in the producers’ revenue vice versa, since the cannabis could be assumed as an essential product for the patients with no close substitutes. Finally this change in legislation could result in both positive and negative externalities, where negative externalities could be overcome by close supervision by the government.

List of References

Abel, A.B., Bernanke, B.S. and Croushore, D. (2011). Macroeconomics, (7 Ed), Prentice Hall.

Claughton, D. (2017). Interest in growing medicinal cannabis is strong. [online] ABC Rural. Available at: http://www.abc.net.au/news/rural/2017-02-22/medicinal-cannabis-new-agricultural-opportunity/8287346 [Accessed 28 Apr. 2017].

Gans, J.; Kings, S.; Stonecash, R.; Byford, M.; Libich, J. and Mankiw, N. G. (2015). Principles of Economics, (6 Ed), Australia, South Melbourne: Cengage Learning Pty Limited.

McTaggart, D., Findlay, C. and Parkin, M. (2010). Microeconomics, (6 Ed), Frenchs Forest, NSW, Australia: Pearson.

National Drug Strategy Household Survey detailed report (2013). National Drug Strategy Household Survey detailed report. The Australian Institute of Health and Welfare.

Webarchive.nla.gov.au. (2017). NLA Australian Government Web Archive. [online] Available at: http://webarchive.nla.gov.au/gov/20110309153909/http://www.nationaldrugstrategy.gov.au/internet/drugstrategy/Publishing.nsf/content/mono57 [Accessed 28 Apr. 2017].

Service Quality in Australian Higher Education Sector

2017-04-24T17:37:00.000-07:00

Over the past few decades there has been a perceptible continual progression of the service sector around the globe. Consequently, service industries are playing an increasingly important role in the economy of many nations (Abdullah, 2006a). In a world where the service sector is becoming the driving force of the economy, quality of the service has become paramount important for the service based organizations to cope with the intense rivalry. Unlike the quality of the product the assessing the service quality is a complex phenomenon due to the salient attributes of the service. Since 1970 service industry has been widely researched agenda drawing much of the researchers’ attention to the service quality models (Pena, et al., 2013).

However, until recent past the education service has not attracted much attention in the service quality research forum. With the education liberalization and international student mobility, education service industry becoming a major contributor to most of the economies. Nowadays, higher education is being driven towards commercial competition imposed by economic forces resulting from the development of global education markets and the reduction of government funds that forces tertiary institutions to seek other financial sources (Abdullah, 2006a). In the current information era, where the countries are moving towards a knowledge based economies, education service plays a vital role and it is ever growing.

According to UNESCO Institute for Statistics, global tertiary enrolments reached 170 million in 2009 and as per European Statistics 2015, in European Union alone there are 19.5 million student population in the tertiary education. As per UNESCO Institute for Statistics, 60 per cent of total international tertiary students is concentrated in the US, UK, Australia, France, Germany, Russia, Japan and Canada. It was projected that Australia will report the highest growth in the inbound international student mobility. Further Australia is forecast to lead the way with growth of inbound mobile students from the more than 50 shortlisted countries, followed by the UK, US and Canada (Beall, 2012). With the growing demand and the expansion in the higher education industry in Australia, the quality of the service provided by the higher education institutes play a major role in continuing the growth momentum and to remain a major contribute to the development of the Australian economy.

Australian Higher Education Sector

The service sector total employment counts to eighty percent across all sectors and tertiary education is the standard for forty per cent of people in the total labour force (The Australian Trade and Investment Commission, 2017). Not only the local labour market created demand for the higher education in Australia, the international students crossing borders for higher education attracted to the country for higher education. As per The Australian Trade and Investment Commission statistics Australia is the third most popular destination for the students and according to The Academic Ranking of World Universities Australia has become the sixth highest ranked country in the ranking of the world’s top 200 universities in the year 2017. The global presence of Australian higher education sector has created intense competition within the country and outside its borders as well.

Based on Australian government statistics in 2014 there are 1.3 million students enrolled in 43 accredited universities, colleges and Technical And Further Education (TAFE)s. During the recent past there has been a change in the sector with the changes made to the public policies. Some of the noteworthy changes such as the transformation of colleges and advance technology in to universities; opening of the domestic market to international students; government grants cut downs; and full fee paying domestic students have led to a greater competition whining the industry and more customer orientation. Alongside the rivalry intense competition, the quality of the service provided by higher education institutes became important not only to satisfy the customers (i.e., students and potential employers) but also the regulatory and quality assurance agencies. ‘Considerable efforts are expended within Australian universities on improving service delivery to their students as a means of enhancing performance’ (Brown, 2006, p. 3). Over the past couple of years there has been numerous changes to the delivery of lectures to cater to the diverse needs of the students.

On campus study mode is the most popular mode of study among others being offshore distance learning, online learning and blended learning. However, foreign partnerships have recently given more opportunities for the sector to the tap the students who do not wish to cross boarders for learning. There are nearly one fourth of all Australian university campuses are located outside Australia (Beall, 2012). Now the students have much more study options than ever before as the boundaries are lifted and this will continue to evolve and gives greater opportunities for the students. This in this dynamic higher education sector the higher education institutes strives to strike a balance between the service quality and price.

Service Quality

Until 1970s service marketing did not transpire as a separate agenda in the research forum. However, from 1980s service quality has gained its momentum in the research agenda (Khodayari, 2011) and been viewed as a key driver in competitive advantage which could generate repeat sales, positive word-of-mouth feedback, customer loyalty and competitive product differentiation, thus, service quality has been linked with enhanced profitability (Abdullah, 2006a). Unlike products, services in nature are more complex concept due to its attributes of intangibility, inseparability and subjectivity. Thus the elusive nature of service quality construct, rendering it extremely difficult to define and measure (Abdullah, 2006a).

The most important aspect of service quality is that from whose point of view the quality should be measured. There are many areas of disagreement in the debate over how to measure service quality, and recent research has raised many questions over the principles on which the existing instruments are founded (Abdullah, 2006a; Abdullah, 2006b). In most of the instances the customer has been targeted as the principal agent of assessing the service quality. Undoubtable, satisfy the customer, the service provider should be able to match customers’ desired outcome. Further it should be noted that satisfaction do not coincide with the service quality rather the quality is an antecedent to satisfaction (Cronin & Taylor, 1992). Dated back to 1984, Gronroos was one of the first researchers who studied service quality exclusively, where he viewed service quality is comprised of two dimensions: technical quality and functional quality (Çerri, 2012). On the other hand Lewis and Booms (1983) service quality is a measure of how well the service level delivered matches customers’ expectations. Much of the literature is aimed at perceiving service quality in the customers’ standpoint.

There has been number of attempts to measure the service quality despite its complex and ambiguity nature. In the last decade, the emergence of diverse instruments of measurement such as SERVQUAL (Parasuraman et al., 1988), SERVPERF (Cronin and Taylor, 1992) and evaluated performance (EP) (Teas, 1993a, b) has contributed enormously to the development in the study of service quality (Abdullah, 2006a). In this quest in mid and late 1980s Parasuraman et al were one of the pioneering academics to measure the service quality as a difference between the expectation and performance. They initially devised a multi-faceted scale of measurement that comprises ten dimensions namely, reliability, responsiveness, competence, access, courtesy, communication, credibility, security, understanding/knowing the customer, and tangibles. In a subsequent effort, in 1988 they developed an instrument termed SERVQUAL by reducing these ten dimensions to five which includes Tangibles, Reliability, Responsiveness, Assurance, Empathy.

The below table summerises the service quality models developed and the industries that could be applied to;

Table 1.1 Scales developed to measure service quality

Author(year)	Scale Developed	Industry
Parasuraman et al (1988) Knutson et al (1991) Cronin and Taylor (1992) Getty and Thompson (1994) Dabholkar et al. (1996) Evangelos Christou and Athina Nella (1999) Donald J. Shemwell and Ugur Yavas (1999) Parasuraman, Zeithaml and Malhotra ( 2005) (Firdaus, 2006a) Evangelos Tsoukatos, Evmorfia Mastrojianni (2010)	SERVQUAL LODGSERV SERPERF LODGQUAL RSQS Retail SQ WINE SQ Hospitals ES-QUAL HEdPERF BANQUAL-R metric	General Hospitality General Hospitality Retail Wineries Hospitals Online shopping Higher Education Banking

Source - (Randheer, 2015, p. 29)

SERVQUAL

Parasuraman SERVQUAL model adopted the notion that the perceived service quality (Q) which transpires from the comparison of expected quality (E) where the customer’s anticipated quality prior to the service being consumed, with the perceived (P) service quality which is realised during the service consumption. If service expectations are confirmed during consumption, i.e. the service performance is up to what was anticipated, the quality of service is considered positive and vice versa (Çerri, 2012). Consequently, the SERVQUAL model has 2 separate sets of statements addressing the expectation and perception and could be denoted as; service quality Q = P – E.

The most famous tried and tested service quality measurement model across different industries is the SERVQUAL. The below table illustrates the studies carried out in different industry settings using the SERVQUAL model.

Table 1.2 Studies on service quality using SERVQUAL model

Service Industry	Author(s)/year
Auto repair	Bouman and Van der Wiele, 1992
Banking	Angur et al., 1999; Avkiran, 1999, Lassar et al., 2000; Newman, 2001
Education	Kwan and Ng, 1999; Oldfield and Baron, 2000; Shekarchizadeh et al., 2011
Healthcare	Andaleeb, 1998; Babakus and Mangold, 1992; Wong, 2002
Professional services	Hoxley, 2000; Philip and Hazlett, 2001
Public services	Carman, 1990; Brysland and Curry, 2001; Donelly et al., 2006; Wisniewski, 2001
Retailing	Finn and Lamb, 1991; Mehta et al., 2000
Telecommunication	Lai et al., 2007; Van der Wal et al., 2002
Transportation and shipping	Frost and Kumar, 2001; Sultan and Merlin, 2000

Source - (Çerri, 2012, p. 666)

Despite the popularity of SERVQUAL model, a number of criticisms was directed at SERVQUAL, aimed at both the conceptual and the operational level (Abdullah, 2006b). Most notable criticism is that SERVQUAL scale is based on the satisfaction paradigm rather than an attitude model (Abdullah, 2006a; Abdullah, 2006b; Cronin and Taylor, 1992). Cronin and Taylor (1992) suggest that the SERVQUAL approach do not adequately conceptualise and operationalise the service quality as it disregards the quality as an attitude and developed a model called SERVPERF, incorporating performance. They further argued SERVQUAL scale is measuring neither service quality nor consumer satisfaction as it is a disconfirmation-based model.

There seems to be a broad consensus that service quality is an attitude of overall judgement about service superiority, although the exact nature of this attitude is still hazy (Abdullah, 2006a; Abdullah, 2006b). Whilst its impact in the service quality domain is undeniable, SERVPERF being a generic measure of service quality may not be a totally adequate instrument by which to assess the perceived quality in higher education (Abdullah, 2006a). Thus it gives rise to a need for developing a model for the education industry.

Service Quality in Higher Education

Crosby (1979) defined the quality in education as conformance of education output to planned goals, specifications and requirements’. Given the attributes of education industry the service rendered by a higher education is quite complex due to the length of the process and variety of variables affecting it (Çerri, 2012) than the other industries such as bank, restaurant or telephone users. SERVQUAL model continued to be a ground breaking approach for the measure of service quality across multiple industries including the higher education (Karavasilis, et al., 2016) although it attracted much criticism. The ten dimensional SERVQUAL approach is initially attractive and seems to fit well with the requirements of an investigation into the quality of students’ experience in higher education, however the study suggested that the five dimensional SERVQUAL approach failed to measure the service quality in higher education (Sultan & Tarafder, 2007). As claimed by (Khodayari, 2011) the much of the studies in higher education service quality have focused on students’ view of quality, while little attention has been paid on the perspective of academic and administration staff.

Abdullah (2006) proposed a Higher Education Performance measurement called HEdPERF which mostly focuses on the administrative parts of the university and comparatively fewer emphasis on acdemic aspects (Sultan & Tarafder, 2007). In a study of comparing the suitability of a service quality measurement model using SERVPERF, modified SERVPERF and HEdPERF Abdullah (2006a) suggested that HEdPERF method resulted in more reliable estimations, (Karavasilis, et al., 2016), greater criterion and construct validity, greater explained variance, and consequently better fit than the other two instruments namely SERVPERF and HEdPERF-SERVPERF.

With the change of the delivery mode of higher education programs, there has been a greater trend towards switching from on campus studies to online study modes. The distance-learning students also tend to differ from campus-based students in a number of demographic characteristics, in particularly the age (Richardson, 2005). Unlike the on campus study mode the distance learning study gives rise to challenges to the higher education institutes due to ‘transactional distance’. In fact, most distance learning institutions use various kinds of personal support, such as face-to-face tutorials, residential schools and teleconferencing, to try to bridge the gap (Richardson, 2005). Thus, the perception of the quality of the service of distance learning students could be substantially different from on campus students.

Although a few of the studies focus on the distance education quality, they are not comprehensive in terms of proper item selection and model specification (Sultan & Tarafder, 2007). There has been number of studies conducted in Australia in relation to the service quality of higher education (Ong & Nankervis, 2012; Brown, 2006; Athiyaman, 1997). However, there has been a vacuum in the extant literature relating to the service quality measure of online courses offered by higher education institutes, especially in Australia.

References

Abdullah, F., 2006a. Measuring service quality in higher education: HEdPERF versus SERVPERF. Marketing Intelligence & Planning, 24(1), pp. 31 - 47.

Abdullah, F., 2006b. The development of HEdPERF: a new measuring instrument of service quality for the higher education sector. Sarawak, Malaysia, International Journal of Consumer Studies.

Athiyaman, A., 1997. Linking student satisfaction and service quality perceptions: the case of university education. European Journal of Marketing, 31(7), pp. 528-540.

Beall, J., 2012. The shape of things to come: higher education global trends and emerging opportunities to 2020, Oxford: British Council.

Brown, R. M., 2006. Factors Driving Student Satisfaction and Loyalty in Australian Universities: The Importance of Institutional Image. Rockhampton, Victoria University, Melbourne, Australia.

Çerri, S., 2012. Assessing the quality of higher education services using a modified SERVQUAL scale. Annales Universitatis Apulensis Series Oeconomica, 14(2), pp. 664-679.

Cronin, J. J. & Taylor, S. A., 1992. Measuring Service Quality: A Reexamination and Extension. Journal of Marketing, 56(3), pp. 55-68.

Karavasilis, G., Kyranakis, D., Paschaloudis, D. & Vrana, V., 2016. Measuring service quality in higher education: the Experience of Technological. Greece, The Asian Conference on Education & International Development 2016.

Khodayari, F., 2011. Service Quality in Higher Education Case study: Measuring service quality of Islamic Azad University, Firoozkooh branch. Interdisciplinary Journal of Research in Business, 1(9), pp. 38- 46.

Ong, M. W. & Nankervis, A., 2012. Service quality in higher education: Students’ perceptions in Australia and Malaysia. Review of Integrative Business and Economic Research, 1(1), pp. 277 - 290.

Pena, M. M., da Silva, E. M. S., Tronchin, D. M. R. & Melleiro, M. M., 2013. The use of the quality model of Parasuraman, Zeithaml and Berry in health services. The University of São Paulo Nursing School Journal, 47(5), pp. 1227-32.

Randheer, K., 2015. Service Quality Performance Scale in Higher Education: Culture as a New Dimension. International Business Research, 8(3), pp. 29-41.

Richardson, J., 2005. Students’ perceptions of academic quality and approaches to studying in distance education. British Educational Research Journal, 31(1), p. 7–27.

Sultan, P. & Tarafder, T., 2007. A Model for Quality Assessment in Higher Education: Implications for ODL Universities. Malaysian Journal of Distance Education, 9(2), p. 125−143.

The Australian Trade and Investment Commission, 2017. Why Australia Benchmark Report, s.l.: The Australian Trade and Investment Commission.

Theoretical Background of Corporate Social Responsibility (CSR) Reporting

2011-06-04T22:55:00.000-07:00

As a prelude to the discussion on theoretical perspective of CSR, this section focuses on the two distinct research approaches to CSR in the prior literature. Gray et al. (1995)[1] hold the view that the research in the field of CSR poles apart due to the inherent nature and certain conundrums in CSR for which includes; the lack of agreed theoretical perspective to research; the absence of systematic reporting by organizations and CSR evokes doubt about its legitimacy.

Consequently, two polarized research approaches were emerged. In one extreme, the CSR was perceived as an supplement to the conventional accounting and was researched the subject with preoccupied assumptions and concepts in traditional accounting. In this stance, the attention was driven to the financial community and had less or nothing to offer to the societal perspective. On the other extreme, the core of CSR was social and environment perspective and examined the role of information in arena of organization-society concept. This aspect has given rise to many criticisms as to the advancement of CSR and the failure to theorize the organization-society relationship.

The latter approach detailed above has acted as an catalyst to place a theoretical framework to the empirical investigations on CSR. Many researches were carried out on the basis of as to reason of the existence of organization-society relationship. In this context, the researchers attempts to theorize the role of information in organization-society could broadly be divided into tree branches namely, decision-usefulness studies; economic theory studies and finally social and political theory studies.

Under decision-usefulness studies, CSR is perceived as an element of accounting information to the usefulness of decision. In this arena of studies the researchers attempt to investigate the value laden on the CSR when making decisions. This investigations are divided in to two sub branches as ranking studies and investigation on effects on the share price behaviour. In the former branch of studies, the financial community ( for instance bankers and analysts) are requested to rank the importance of accounting information as to value perceived by them. In this regard, the studies portrayed a moderate level of importance to them. Hence, could concluded that financial community had derived certain amount of value through CSR information. The latter branch of studies investigated the impact on CSR disclosures on the share prices.

The empirical studies in this concern is inconsistence or inconclusive according to Gray et al. (1995). Further, they criticized the studies carried out in decision-usefulness approach to investigating CSR. Yet, the literature on this branch had stirred the importance of non-financial and non-economic aspects in reporting and accountability of the organizations.

The criticism aimed at decision-usefulness studies evoked the emergence of economic theory studies on CSR. This encompasses the agency theory and positive accounting theory. These theories are based on the concept of self-interest and criticized for being unrealistically one-sided because its neglect the aspects beyond the boundary of interest of agent and principal. It was viewed under economic theory that the organizations are motivated to CSR in order to increase their wealth and therefore, unable contribute toward the development of the CSR. Moreover, as the financial community has many modes of deriving economic information, economic theory has little or nothing to contribute towards CSR. Hence, economic theory barely withstand against those criticisms.

These critics led to the development of social and political theory studies, which gives a great deal of insight in to the existence of CSR. These studies include legitimacy theory, stakeholder theory and political economic theory. Under legitimacy theory, the organization is considered as component of the society. As such, the organization should legitimise its existence through adherence to the societal expectations. This is derived through the concept that the organisation does not have an inherent right to exist, they do so by the sanction of the society. Hence, CSR disclosures are made to legitimise the existence of the organisation serve for the society.

Stakeholder theory asserts that an organisation has a wide range of stakeholders who exert their power to influences the organisation in varying degrees. Unlike legitimacy theory, the organisation is not focusing on the society as a whole, yet, it has narrowed down the concern based on the power the stakeholder who could influence on the organisation. Under political economic theory asserts that, political, societal and environment concerns should not be considered separately and in isolation of one another as those are interrelated to each other. CSR disclosures therefore need be dealt with both on legislative and societal grounds.

The concept of CSR has transformed from profit orientation of inward looking aspect to broader aspects of concerning the matters beyond the boundaries of an organization.

References

[1] Gray, R, Kouhy, R, and Lavers, S 1995, 'Corporate social and environmental reporting: A review of the literature and a longitudinal study of UK disclosure,' Accounting, Auditing & Accountability Journal, vol. 8, no. 2, pp. 47-77.

Ranasinghe, W A 2009, 'Corporate Social Reporting: A step beyond traditional financial reporting,' Accounting Panorama, vol. 1, no. 1, pp. 7-11.

Can the auditors predict the bankruptcy prior to its collapse? Review of Previous Literature

2011-04-15T20:13:00.000-07:00

Despite the increasing concern on the auditors to reveal the going concern ability of the client, it would be apparent from the literature reviewed that in many cases corporate failure was not perceived by a going-concern modified opinion in the independent auditor’s report.

Hasnah el al (2009) argued that an audit opinion on the financial statements of a company became an important issue, attracting much public attention. Further, they insisted that collapses of these companies may have been avoided if appropriate reports were issued. Waymond et al in 2008 stated that several financial scandals have implicated auditors’ lack of independence (WorldCom, Tyco, Enron, Global Crossing, Parmalat, etc.).

The fact that the auditor qualifies the opinion on the grounds of invalidation of going concern assumption, it should not merely be an indication to get away from its responsibilities. Many instances public and legislatives have bemoaned company failures without a prior warning from the auditor in the form of a going-concern modified audit report.

According to Daniel et al (2005), the going concern opinion should be disclosed sufficiently early to allow the interested groups to alter their decisions. Further, they argued if the going concern opinion does not give sufficient time for the stakeholders to change their decisions, the opinion would be nothing more than a eulogy.

Previous empirical studies have proved that the inability of the auditors to express an opinion on the going concern of client had widened the expectation gap. Parker (1994) argued that accounting profession requires adherence by its members to a clear code of ethical behaviour, both to serve the public interest and to safeguard the long-term private interests of its members.

The auditors have a moral duty to signal the interest groups of the financial distressed companies. Recent financial scandals have reopened the continuing debate regarding the credibility of the auditing profession. As a result, audit reputation and, in particular, the usefulness of auditors’ warning signals remains hotly disputed (Waymond et al 2008).

Further, early warning signals of the corporate were not forthcoming merely through the perusal of financial statements and concluding only on the consideration in absolute terms of negative profits and equity. Hence, the auditors must draw the attention to qualitative aspects as well when drawing the conclusion not merely relying on financial data.

Many hold auditors responsible for not detecting the potentials for bankruptcy during the most recent audits (Michael et al 2003). According to Wendy (1995), Judging whether a going-concern qualification is required is a difficult and unstructured task which presents the auditor with a dilemma, and may actually hasten a corporate collapse. Moreover, issuance of a going concern opinion is a ‘self-fulfilling prophecy’ in that the going concern opinion itself triggers a bankruptcy.

On the other hand, if a financially distressed company is not qualified on the going-concern basis and afterward fails, the auditor could be perceived as inattentive. Therefore, the auditor must be skeptical on the evidence they receive during their course of audit in order to protect themselves being charged for the noncompliance with relevant auditing standards.

Previous literature had perceived going concern status in three alternative approaches. i.e. firms’ current status, firms’ future status and individual judgment. With regard to first and second phenomena, the financial distressed company’s ability to continue for a foreseeable future could be determined merely by the financial indicators. Yet, the third concerns on the human ability to predict the future viability of a firm. Which means that, some has argued the going concern status continues an objective reality, independent from individuals’ actions, therefore, they developed statistical model to predict the bankruptcy. On the other hand, the researchers those who believed that the going concern is a matter of human judgment, and not analogues to a natural phenomena, adopted a behavioural approach (Sylvia, 2002).

Wendy (1995) examined the incidence of going-concern audit qualifications and corporate failure for Australian publicly listed companies within the decade of 1980 to 90. The examination included a review of annual reports for companies that had going concern qualifications but did not subsequently fail and corporate failed without receiving an qualification prior to its collapse.

Finally, she identified potential indicators of survival. The study identified the differences between the corporate that collapsed subsequent to receiving an unmodified opinion and corporate survived even with a qualified opinion on going concern. Using descriptive statistics the research was carried out in order to build relationship among going concern qualification and corporate failure. This empirical study divulges 223 instances of going concern qualifications.

The study revealed that annual 83.3% of the going-concern- qualified companies that subsequently did not fail changed their company structure and operations. This may have helped the companies to survive. The most common factor leading to failure for qualified companies was found to be incurring losses, while for non-qualified companies it was change in operations.

In determining the future status and individual judgment many researchers adopted the prediction of going concern through models. In this regard, predictions of going concern could be identified in two folds: corporate failure through financial indicators and; through behavioural studies. Various predictive models have been developed to test the consistency of going concern qualification, including Altman (1968), Dugan and Zavgren (1989), Ponemon and Schick (1991), Koh and Oliga (1990), Koh (2004) and Mc Kee (2003).

Among other behavioural models recency effect considered as one of the popular models. Many researchers have followed the recency effect (Andre´s and Francisco in 2006). With respect to evaluation of auditors’ judgment on going concern, many has adopted the recency effect model of Hogarth and Einhorn (1992), who proposed a descriptive model of belief revision that takes recency into account. Recency requires that when people evaluate a sequence of contradictory evidence items their judgments will be manipulated by evidence received later in the sequence.

Some argues that recency effect is biased (J. Behav. Dec. Making 2002).Robert and Kennedy (2002) criticised recency effect model stating that, the basic assertion is simply that judgments and choices should be based on substantive evidence features and not on features such as where the evidence happens to fall in a sequence of inputs.

According to the research done by Andre´s and Francisco (2006), study looked at Spanish auditors’ sensitivity towards financial evidence and the implications of the so-called “recency effect”. This is again a behavioural study. The study was designed to be a lab experiment to examine how presentation order affects the going concern judgments and the audit decisions of auditors, and the level of skepticism showed by auditors towards the signs of evidence. The study was primarily focused on the model of recency effect which predicts the auditor’s decision patterns when he receives short series of mixed evidence.

Andre’s and Francisco (2006) designed a simulated case to test how the presentation order affects the auditors going concern judgment and their sensitivity towards the evidence. The sample was selected to comprise 81 Spanish auditors and 104 auditing postgraduate students. For the evaluation of human decision process Hogarth and Einhorn’s (1992) mathematical model, was used.

The dependant variable in this regard is the likelihood of issuing unqualified audit reports and the independent variables and the findings were as follows; In order to evaluate whether auditors are susceptible to the recency effect the first dependent variable was identified as order in which the auditor receive mitigating factors. The study found that auditors who were exposed to mitigating evidence at the end of the series not only gave more relevance to the hypothesis of the company’s ability to continue in existence but they also issued less severe audit reports. A second attempt is to reduce the recency effects through framing (slight changes in wording or presentation of a task can alter an individual’s predisposition) hypothesis and the audit experience. Here, the independent variables were framing hypothesis and experience. Yet, experimental results found that recency effect for going concern evaluation was in existence. Finally, the attitudes of the auditor or the skepticism were recognized as the fourth independent variable which affect to the issuance of a qualified going concern opinion.

The findings of this study was similar to the that of Ashton and Ashton in 1988 for the recency effect, framing and the attitude test results were not contradicting with the study of Brenner and Moir, in 2004, Asare (1992) and Butt and Campbell’s (1989) and McEnroe and Martens in 2001. With respect to experience the study presented a different evidence than Kennedy (1993), Messier and Tubbs (1994) and Trotman and Wright (1996) due to the fact that the study was manipulated as the experience of auditors was compared with postgraduates rather than considering audit expertise.

In a critique on the quality of audit firms depend on the size, Marshall and Rama (2006) were of the view that Big 4 audit firms exhibit higher quality audit reporting decisions. There are two types of reporting errors related to going-concern modified audit. Those are: The subsequent failure rate after receiving a first-time going-concern modified audit opinion will be higher for Big 4 audit firms than non-Big 4 audit firms (i.e., fewer type I errors for Big 4 firms): and The proportion of client bankruptcies with a prior going-concern modified opinion will be higher for Big 4 audit firms than non-Big 4 audit firms (i.e., fewer type II errors for Big 4 firms). The study revealed that Big 4 firms exhibit significantly fewer both type I and type II reporting errors than non-Big 4 firms. However, the results were inconsistent with the argument that Big 4 firms would protect their ‘‘wealth at risk’’ by simply adopting a conservative reporting attitude and issuing going-concern modified reports more often than necessary.

According to Sylvia (2002), the study was carried out through collecting data through survey questionnaire by examining the three dimensions namely indicator of going concern uncertainties, action triggers and group interactions. Aforementioned three variables were selected as predictor variables in logit model through the review of previous literature and through consultation of practitioners. The dependant variable is considered as the individuals perceived going concern status of financially distressed firms.

In the construction of hypothesis, Sylvia raised three fundamental questions in her questionnaire. i.e., what is the importance of financial and nonfinancial indicators of going concern uncertainties; actions triggers leading to audit qualifications; potential group interaction; in determining the going concern status of financial distressed firms?, How are these influencing the judgment of auditors?, why these factors important? Based on the aforementioned research questions the following hypotheses were developed. Null hypothesis was the company is a going concern: and the alternative hypothesis were; Indicators of going concern uncertainties are significantly influencing the going concern opinion decision: Action trigger leading to an audit qualification are significantly influencing the judgment of the opinion:

Action triggers leading to receivership are judgment of going concern opinion decision: Group interactions are significantly influencing the judgment of the going concern opinion decision.

The sampling frame of the population was based on the directory of practicing auditors issued by ICAEW and ACCA. Then probability sampling was applied to select 300 out of the sample frame. Questionnaires were set using a five-point Likert type scale as the survey dealt with measuring attitudes. Further ANOVA procedures were used while using a logistic regression model to construct the validity of the study.

With respect to H1, the results indicated that only financial variables were influenced individuals decisions whereas non-financial indicators were not important. The latter justified a further research as non-financial indicators are important but not decisive in this context. Regarding events leading to audit qualification, the important variable is the appointment of a liquidator. The events leading to receivership, breach of dividend contracts and loan default were confirmed as indicators. Therefore the evidence supported H1, H2 and H3. Yet, group interaction and their impact on going concern decision could not be examined as the evidence was not supportive for H4. Finally through this study the so-called self fulfilling prophesy argument holds true. A self-fulfilling prophecy is a prediction that directly or indirectly causes itself to become true, by the very terms of the prophecy itself, due to positive feedback between belief and behaviour or it could be identified as statement that alters actions and therefore comes true.

Hasnah el al (2009) gave a greater insight in to relationships between financial indicators and non-financial indicators for predicting bankruptcy of corporate. The research studied three factors simultaneously for the company listed on the Jakarta Stock Exchange, namely, (a) the influence of the company's financial strength on the auditor's going concern opinion; (b) the influence of the type of evidence disclosed on the auditors' going concern opinion; (c) the influence of management effort disclosed on the auditor's going concern opinion; and (d) whether there is consensus among the auditors on their going concern opinions. In this context the consensus means the audits giving similar opinion when they face with the same scenario. Therefore, if the level of consensus among auditors is low, the decisions of the auditors are less accurate.

The independent variables in this study were the financial strength of the company, the types of evidence, and disclosure and the dependant variable is the issuance of going concern opinion. Accordingly, the study was carried out testing the following hypothesis; A company's strong financial condition (as opposed to poor or moderate) will have the greatest influence on the issuance of a going concern opinion: Positive evidence (as opposed to negative) will lead to a lesser probability of the issuance of a going concern opinion: Disclosure of information (as opposed to nondisclosure) has a lower likelihood of issuance of a going concern opinion: Two- and three-way interactions between financial strength, evidence and disclosure will have a greater effect on the probability of issuance of a going concern opinion (compared to the main effect): There is consensus among auditors on the issuance of a going concern opinion among auditors.

Hasnah el al (2009) discovered that the financial strength of a company, disclosure and the type of evidence had a significant effect on an auditor's judgment regarding the issuance of a going concern opinion. All interactions among aforementioned variables had a significant effect on auditor's decision to issue a going concern opinion. These results show that auditors examined the factors simultaneously. Thus, H1, H2, H3 and H4 were accepted. With respect to H5, it was observed that, the correlation of answers by the auditors for each case is quite high. The correlation is above 0.90 for all the cases and is significant. This demonstrates that there is consensus among auditors. Furthermore, all the findings were considered as in line with the previous research findings.

This study contained several limitations. Even though it controlled for experience and professional membership, other factors discussed in previous researchers, such as the personality of the auditor, the type of work performed and pressure from superiors, were not considered.

David and Richard (2001) examined the issue of auditors’ independence in dealing with failing companies concentrating on the treatment adopting an independent stand in reporting going concern uncertainties. This thesis was fundamentally based on the auditor’s adherence to the code of professional ethics, when the question arises whether to qualify a financially distressed firm on the grounds of going concern assumption. They selected null hypothesis H1, which expected to be rejected. Then tested the validity of the significant list belief held by auditors that adverse reactions to a going concern qualification in their client’s accounts will lead to its bankruptcy. H1: Financially weak companies with going concern qualification in their last accounts are no more likely to go bankrupt than similar firms without going concern qualifications.

The results related to all independent non-financial companies listed on the London Stock Exchange, or traded on the Unlisted Securities Market. The first part focuses on those companies with going concern qualifications published between 1986 and 1993 and a matched sample of non-qualified enterprises, and the second the complete population of firms failing between 1987 and 1994.

The study thus unable to find any empirical evidence in support of the important list self fulfilling prophecy argument. Not only that, but the finding, that more than twice as many qualified companies undergo major restructuring as fail, is consistent with the reverse hypothesis, viz. that a going concern qualification may, in fact, have a positive effect on company survival and promote timely rescue activity. David and Richard (2001) suggested that many companies with going concern qualifications are able to raise new finance. Which is controversial to the other research findings. Therefore, going concern opinion would have a positive impact as well.

Holding a similar conviction Daniel et al in 2005 suggested that, management attempt to switch auditors, considered to be a way of suppressing the negative information of the firm among others which could otherwise lead to its own survival. This study mainly focused on the development of test model and establishment of hypotheses on bankruptcy emergence (indicative of going concern opinions being an effective warning of financial distress), auditor switching and income-increasing accounting methods influence on auditors going concern opinion. The results show that firstly, the going-concern opinions are positively associated with bankruptcy emergence. This is an indicative of going concern opinions being an effective warning of financial distress. Secondly, the association between going concern opinions and bankruptcy emergence is significantly stronger for small firms than for large firms. In contrast, the study reveals that the negative association between auditor switching and the use of income-increasing accounting methods is stronger for large firms than small firms. But Lili holds a different argument which is illustrated at the latter part. These findings imply that manager’s actions at large firms may be more successful in delaying a going concern opinion. Therefore the warning is not sufficiently early for the stakeholders to intervene and reverse the financial distress. Daniel et al further suggest that as the management discretion to delay or avoid the issuance of going concern opinion could result in delay in implementing actions to turnaround the business, as such that the remaining assets are insufficient to reverse the pending financial collapse.

References

Andre´s, G. and Francisco, E., 2006. Are Spanish auditors skeptical in going concern evaluations?. Managerial Auditing Journal, 21( 6 ), pp.598-620.

Antony, Y. and Yi, W., 2008. Multi-risk level examination of going concern modifications. Managerial Auditing Journal, 25, pp.756-791.

David, B. and Richard, J., 2001. Ethical behaviour in the U.K. audit profession: the case of the self-fulfilling prophecy under going-concern uncertainties. Journal of Business Ethics, 29, pp.353–363.

Hasnah, H., Bambang, H., Mahfooz, A. and Ishak I., 2009. Factors influencing auditors' going concern opinion. Asian Academy of Management Journal, 14, pp.1–19,

Marshall, A. G. and Rama, D. V., 2006. Audit firm size and going-concern reporting accuracy. Accounting Horizons, 20(1), pp.1–17.

Michael, A., Meredith, A. M. and Don Giacomino, 2003. Going-concern opinions: broadening the expectations gap. The CPA Journal, 73 (10).

Parker, L., 1994. Professional Accounting Body Ethics: In Search of the Private Interest. Accounting, Organizations and Society, 19, pp.507–525.

Robert, H. A. and Kennedy, J., 2002. Eliminating recency with self-review: the case of auditors’ ‘going concern’ judgments. Journal of Behavioral Decision Making, 15, pp.221–231.

Sylvia, C., 2002. Auditors’, bankers’ and insolvency practitioners’ going concern opinion logit model. Managerial Auditing Journal,17, pp.487-501.

Waymond, R., Andre´s, G. and Jose´, A. G., 2008. Different pathways that suggest whether auditors’ going concern opinions are ethically based. Journal of Business Ethics, 86, pp.347–361.

Wendy, G., 1995. Addressing the issues relating to going concern audit qualifications and corporate failure. Australian Accounting Review, pp. 26-43.

Eidleman, G. J.,1995, Z scores - a guide to failure prediction. (business failure) (Auditing) [online], The New York State Society of CPAs, The CPA Journal, Available at: http://www.nysscpa.org/cpajournal/old/16641866.htm, [Accessed 20th November 2010]

Use of Bankruptcy Prediction Models as an Auditing Tool

2011-02-01T08:53:00.000-08:00

One of the best-known models for predicting corporate financial distress is the Altman’s Z-Score model (Altman, 1968, 1983, 1993). This model is constructed using linear relationship of financial ratios weighted by predefined coefficients. Initially the model was developed to assess the bankruptcy of publicly held manufacturers, but later it was re-estimated for private manufacturing, non-manufacturing and service companies. Therefore, the model is three folds: Z-model (original model); Z’-model (private firm model); Z’’-model (nonmanufacturing firm model). Eventually a firm is categorized based on its Z-score as non-bankrupt, bankrupt or gray area in each of the aforesaid three Z-score models.

From about 1985 onwards, the Z-scores gained wide acceptance by auditors, management accountants, courts, and database systems used for loan evaluation (Eidleman). Yet, the application of the model in Sri Lankan context as a prediction of future bankruptcy by the auditors is rare.

One such study was carried out by Lalith and Tanweer in the article of Altman’s Z-score models of predicting corporate distress: evidence from the emerging Sri Lankan stock. In this study the researchers purpose was to provide an out-of-sample test of the Z-score model and its variants by applying them to a sample of firms in the emerging Sri Lankan stock market.

In this regard, They examined the firms listed in the Colombo Stock Exchange during the period 1986 to 1997 to identify a sample of distressed firms and a paired control sample of non-distressed firms. They included firms, which have been delisted due to liquidation, litigation or losses as well as those with a negative net worth as distressed firms. Thereafter they selected a sample of non-distressed firms by matching the distressed sample firms’ size and industry. Finally couples of thirteen firms having similar size and within the similar industry were selected. The Z-score was calculated for both financially distressed firms and non-distressed firms.

Then examining the accuracy in classifying the distressed firms as distressed and non-distressed firms as non-distressed. The results show that these models have a remarkable degree of accuracy in predicting distress using financial ratios computed from financial statements in the year prior to distress. The overall success rate of 81%. Although this study was not constructed on hypothesis testing it gives an preliminary understanding of the application of the Altman’s Z-score models of predicting corporate distress. Nevertheless in the global arena, this concept is immensely used.

Antony and Yi (2008) used the Z-score model as a determination of risk factor by considering the agency theory when forming the judgement. The research teases out the serious agency problem in auditors’ going concern reporting and shows they have greater inappropriate reporting than the more traditional agent being the directors. The auditor is not merely considered as a monitoring mechanism but have agency features. The salient feature in Antony and Yi (2008) study is that it considered multilevel risks related to going concern opinion. In this study, they established five-level risk class which was derived from Australian Auditing Standard pronouncements to examine the appropriateness of auditors’ going concern reporting relating specifically to the likelihood of firm failure. The research focuses on all Australian listed companies within the building industry within the period 1989 to 2007. The study was based on the Altman’s Z-score bankruptcy prediction model which was practiced by many researchers. The five-level risk class was matched with the Altman Z-score bankruptcy prediction model. Companies with lower Z-scores (higher possibility of bankruptcy) are matched with a higher risk level of auditor modifications. The auditor’s risk class which were the dependant variable, were compared to Altman’s independent measure to determine the level of under or over reporting. Finally, this study established a relationship with the variables and concluded the auditor agent issue.

Lili in her study, indentified three criteria for the stress of a company. Firstly the auditor view. This criterion is most widely used in bankruptcy prediction and auditor going concern studies. Secondly the Altman’s Z-score to consider the level at which the company is in. i.e. is it in the bankruptcy, non-bankruptcy or in the group of gray area as mentioned in the previous paragraph. Thirdly , the Zmijewski Probability. Based upon this criterion, a company is considered as stressed if it has a probability of bankruptcy, calculated from Zmijewski’s (1984) model. Finally, the stock return considered as the fourth criterion. The dependent variable in the prediction models is each firm’s bankruptcy status. The independent variables are a set of bankruptcy predictors. The study revealed that there is a positive relationship between firm size and the probability of bankruptcy for stressed firms. Which is against the findings of Daniel et al in 2005 which is mentioned in the above paragraph. Among the four criteria tested, the auditor view criterion and the Altman Z-score criterion are less effective than the Zmijewski probability criterion and the stock return criterion.

When reviewing the previous literature, it was observed that many have attempted to create relationships between the financial indicators, order of auditor receiving evidence, size of the client, auditor being a Big 4, switching auditors, management accounting methods, experience and the framing of hypothesis, auditors attitudes toward the clients’ going concern, consensus of the auditors and disclosures and the auditors issuance of going concern qualification in the audit report. Apart from that some researchers found a relationship between the companies going bankruptcy and the auditor’s indication of going concern validity in the audit report. All the aforementioned dependant variables could be broadly categorize into two aspects. i.e. issuance of going concern opinion on the grounds of the indications of subject matter (in this case individual corporate) and auditors’ characteristics. Further, many have tried to validate the so-called phenomena of wealth at risk, self fulfilling prophecy and recency effect when receiving various types of evidence in the course of the audit. Among the others, Altman’s Z-score bankruptcy prediction model is considered to be a descriptive model to assess the future viability of an organization.
Despite the fact that auditors’ going concern opinion is not a guarantee for neither the future viability of the firm nor a prediction of future bankruptcy, as the code of ethics and auditing standards required the auditor should be skeptical when drawing conclusions. Further, they have a moral obligation to disclose the early warning signal of a financially distressed company to its interested parties.

References

Antony, Y. and Yi, W., 2008. Multi-risk level examination of going concern modifications. Managerial Auditing Journal, 25, pp.756-791.

Lalith P. S. and Tanweer H., Altman’s Z-Score Models of Predicting Corporate Distress: Evidence from the Emerging Sri Lankan Stock Market, Social Sciences Research Network [Online], Available at: http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1395229_code327186.pdf?abstractid=1395229&mirid=4, [Accessed 20th November 2010]

Lili, S., The effects of client size and stress criteria on bankruptcy prediction models: an empirical analysis [Online], Available at: http://aaahq.org/audit/midyear/04midyear/papers/bpt-stres%20size.doc, [Accessed 06th December 2010]

Auditors' Responsibility - Disclosure of Corporate Collapse

2011-01-19T10:43:00.000-08:00

Recent collapse of well-established business organizations around the world has intimidated the public investors to introduce new capital flows to the markets while some lose their investments. This chain of continuous corporate collapses had finally led to a global recession, threatening Sri Lankan companies to strive for their survival. Nowadays, the cost of bankruptcy of a single corporate has a fatal repercussion over the individual investors, other organizations and economy as a whole than in the past. Therefore, a mechanism of revealing the going concern ability of an organization prior to its collapse could avoid may pitfalls.

The limited access to the internal information of an organization, has increased the dependence on readily available published financial statements for the decision making purposes by the stakeholders. Accordingly, a considerable reliance is made on the independence auditor’s report for the truth and fair presentation of financial statements. In this regard the auditors' ability to warn the investing public of the financial distress and impending failure by way of a modification of the audit report has a great impact on the economic decisions of such investors.

Questioning the independence of auditors of the going concern evaluation of its client had not itself resolved since the Enron-Andersen scandal. Recent unprofessional conduct of corporate governance and auditors’ independence caused number of financial institutions and conglomerates to wind up or restructure at a loss of the investor reliance on independence auditor’s report.

Moreover, there is also evidence that the going concern decision involves economic tradeoffs of the risks of losing a substantial client and of loss of reputation. In addition to the aforementioned matter the auditor faces a dilemma when disclosing the qualification on the audit report. If a financially distressed corporate collapse subsequent to an unqualified opinion, the auditor is at a risk of being charged as guilt of nondisclosure of the fact.

On the other hand if the report is modified as to the validity of going concern assumption, it could hasten bankruptcy. Therefore the auditor must be skeptic of the work he performs.

Financial statements are prepared with the basic fundamental assumptions of accrual basis and going concern. Accordingly, with going concern assumption, assets and liabilities are recorded on the basis that the entity is able to realize its assets and discharge its liabilities in the normal course of the business. If the going-concern assumption fails, then the amount and classification of assets and liabilities in the balance sheet may need to be adjusted. Among other things, the going-concern assumption justifies the current and noncurrent classification within the balance sheet, the allocation of costs over period’s benefited, historical cost accounting.

Despite the fact that the auditor’s report is not a guarantee as to the future viability of the entity, it helps to establish the and credibility of the financial statements.

As pre the Sri Lanka Standard on Auditing when planning performing audit procedures and evaluating the results thereof, the auditor should consider the appropriateness of going concern assumption underlying the preparation of financial statements and any relevant disclosure. Consequently, the auditors’ attitude towards the financial evidence when forming the judgment of going concern assumption is a crucial factor.