The concept of the reporting entity as outlined in SAC 1
The Statement of Accounting Concepts 1 (SAC 1) defines and explains the various concepts of a reporting entity such as the minimum required quality of financial reporting for an entity (Fay, 2009). The SAC 1 plays crucial roles in accounting by outlining the conditions under which an entity or economic entities can be identified as reporting entities; providing the criterion for determining appropriate classification methods; giving an overview of the purpose of reporting and; outlining the boundaries of a reporting entity (Rosen, 2001).
As far as the concept of minimum required quality of financial reporting is concerned, the SAC 1 provides that the reporting entity must prepare general purpose financial reports. These reports must at all times comply with SAC 1 and the universal principles of Accounting Standards(Fay, 2009). The SAC 1 does not put higher emphasis on the techniques used in accounting or the method a reporting entity uses to present its financial information. This is because the consideration for accounting techniques and method of presenting financial information are already included in Accounting Standards and provides important directions to reporting entities.
As outlined in SAC 1, a reporting entity can be defined based on the existing legislations and regulations that specify the entity that prepares the general purpose financial reports. In relation to this understanding, the concept of a reporting entity may include the legal entity concept and the broad concept. While the legal entity concept identifies the legislations applicable to a reporting entity in a private sector, the broad concept focuses on the accountability of elected and appointed representatives in a public sector. According to the legal entity concept, the SAC 1 requires private entities to report their financial information at their own convenient time. However, in the public sector where the SAC 1 applies the broad concept, the accent of accountability is widely applied among entities that do financial reporting and presentation (Rosen, 2001). Contrary to the legal entity concept, the broad concept is concerned with reporting and presenting results of individuals’ funds employed as representatives or officials in a public sector. Since there is always need for entities to remain accountable in their financial performance, the broad concept, which focuses on accountability of elected and appointed persons, has triggered the desires to prepare general purpose financial reports.
The relationship between the Corporations Act and AASB accounting standards
As a government agency, the AASB operates under the ASICA (Australian Securities and Investments Commission Act) of 2001 and performs statutory roles. These roles include developing conceptual frameworks that can be used to evaluate proposed accounting standards; making accounting standards according to the provisions of section 334 of the 2001 Corporations Act; formulating accounting standards for other economic functions and; participating in and contributing to the establishment of a single set of global accounting standards (Rosen, 2001).
From the statutory roles provided above, it is true that there are certain connections between Corporations Act and AASB accounting standards. The first connection is based on the understanding that CA promotes formulation or development of accounting standards that have global recognition. This means that Australian Accounting Standards are within the global framework and can be used to monitor financial performance of the economy. In their own frameworks, the CA and AASB accounting standards are known to advance or promote the objects of section 12 of the ASICA that focuses on reduction in the cost of capital, enhanced competition among Australian entities and maintenance of investors’ confidence in the country’s economy (Fay, 2009). Ideally, both CA and AABS accounting standards focus on the development and maintenance of high-quality financial reporting standards that can be used by entities to improve financial accountability and economic performances. This means that CA and AABS aim at including the Australian community in the global setting for improved accounting standards and financial reporting.
The company size test contained in Corporations Act is an alternative differential concept to the reporting entity outlined in SAC 1 used to specify or define the objective test based on the company’s size (Gospel, Pendleton & Vitols, 2014). According to the size test concept, there will be need for respective companies, particularly public corporations, to prepare financial reports, which would later be audited and lodged with ASICA. The most specific attribute of size test concept that makes it more preferable than the entity concept underlies the fact that the former classifies entities as either small or large proprietary companies and specifies the most required purpose of reporting (Gospel, Pendleton, &Vitols, 2014). For instance, the size test excludes small proprietary entities from external reporting purposes, which are different from the specifications of SAC 1 where the reporting is general for both the small and large companies. Within the frameworks of size test, the Corporations Act require small proprietary companies to maintain proper accounting records for future reporting, prepare accounts for examining internal management, and to meet the country’s taxation requirements (Axinn, Proger, Yoerg, American Bar Association & American Bar Association, 2001). On the other hand, the entity concept as outlined in SAC 1 focuses on accountability issues and ignores areas of internal control and taxation requirements.
Unlike the entity concept, the size test allows the authority to classify a proprietary based of certain criteria for the purposes of ensuring compliance with the accounting standards (Australia & CCH Australia Limited, 2011). The classification according to this concept is based on criteria like the company’s total revenues and any other entity the company controls, the company’s gross assets and the number of employees (American Bar Association, 2008). With such a classification criteria, it becomes possible to determine the company’s production capacity and maintain higher financial growth.
The application of size test requires proper calculation of revenues and gross assets, which must be according to Australian accounting standards. Even though this is a shared characteristic between size test and reporting entity concepts, the calculations according to the size test is operated on a more consolidated basis (American Bar Association, 2008). The size test concept requires that the calculations of revenues and gross assets be done even if the company is not a reporting entity contrary to the reporting entity concept where the calculations must be specific to the reporting entity.
While calculating the number of employees and their reporting funds, the size test takes into consideration part-time employees as an accurate measure of the proportion of full time employees. By recognizing part-time employees in the accounting process, the company gets the opportunity to include the financial contributions of every individual employed in the company. On the contrary, the reporting entity concept only considers the financial reports from administrative members and officials permanently employed in the company.
As much as the size test concept excludes small proprietary from preparing financial reports, the Corporation Act outlines specific conditions under which such companies can prepare financial reports (Axinn, Proger, Yoerg, American Bar Association & American Bar Association, 2001). The conditions provided in this context are categorical and differ from the factors considered for financial reporting under reporting entity concept. According to the size test concept, the small proprietary will be required to prepare its financial reports if and only if:
- The company’s shareholders holding a minimum of 5 percent of votes request the management to provide financial reports (Bureau of National Affairs, 2008). When such requests are being made, the size test require the shareholders to specify the means of reporting. Unlike in the case of reporting entity concept where the means of reporting accounting information is not specified, the size test recognizes three fundamental factors(Bureau of National Affairs, 2008). These include compliance with the accounting standards and principles, the use of director’s reports and application of generally accepted auditing techniques.
- The company, under the directives of ASICA, is required to prepare its financial reports and submit them for accrediting (Bureau of National Affairs., 2009). According to the size test concept, the directions given by the ASIC may only apply for a complete financial report or where the requirements to be complied with are specified. However, there is generalization of accounting requirements under the reporting entity concept, which makes it hard for the company to effectively prepare its financial reports (Bureau of National Affairs., 2009). In most cases, the financial reports prepared under entity concepts lack some of the most fundamental information that are necessary for analyzing economic conditions.
- During the reporting, the company was facing foreign controls for part or its entire accounting periods (Axinn, Proger, Yoerg, American Bar Association & American Bar Association, 2001). This is like a precaution taken through the size test when the management feels that the accounting period was not consolidated or lodged with the ASICA. Under this condition, the size test requires that the audited financial statement is lodged with the ASICA is the same manners as for large proprietary companies.
- The memorandum or article of association available for the company outlines preparation of financial statements as one of the management roles. In compliance with the size test, the provisions according to the company’s memorandum allows for financial auditing pursuant to borrowing agreement and loan repayment procedures (Axinn, Proger, Yoerg, American Bar Association & American Bar Association, 2001). The procedures followed in case of borrowing and loan repayment does not appear under reporting entity concept and limits applicability of other accounting elements.
In general, the discussions above highlight the kind of conflict that exists between the size tests of CA and reporting entity concept as used under SAC 1(Axinn, Proger, Yoerg, American Bar Association & American Bar Association, 2001). While the AASB accounting standards widely uses the SAC 1 reporting entity concepts, the CA does not use the reporting entity concept, but rather the more objective size test. Therefore, the information above answers the question as to whether the use of size test and its preference over reporting entity is justified (Gospel, Pendleton &Vitols, 2014).
American Bar Association. (2008). Model business corporation act: Official text with official comment and statutory cross-references, revised through December 2007. Chicago, Ill: Business Law Section.
Australia.,& CCH Australia Limited. (2011). Australian corporations & securities legislation 2011. North Ryde, N.S.W: CCH Australia.
Axinn, S. M. Proger, P. A., Yoerg, N., American Bar Association.,& American Bar Association. (2001). Interlocking directorates under Section 8 of the Clayton Act. Chicago, IL: American Bar Association, Section of Antitrust Law.
Bureau of National Affairs (Eds.). (2008). Corporate practice series. Washington, D.C.: Bureau of National Affairs.
Bureau of National Affairs. (2009). Securities regulation & law report. Washington: Bureau of National Affairs.
Fay, J. R. (Eds.). (2009). Accounting certification, educational, & reciprocity requirements: An international guide. Westport, Conn: Quorum.
Gospel, H. F., Pendleton, A., &Vitols, S. (2014). Financialization, new investment funds, and labour: An international comparison. Oxford: Oxford University Press.
Rosen, L. S. (2001). Financial accounting: A Canadian casebook with multiple-subject cases. Scarborough, Ont: Prentice-Hall of Canada.