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	Table of Contents
p. 21 of 58 BACK | NEXT Purpose and Structure of the Toolkit Part One: Introduction and Overview Part Two: Preconditions and Infrastructure for Financial Sector Development I. Preconditions for Financial Sector Development II. Institutional and Market Infrastructure A. Insolvency B. Corporate Governance C. Financial Information D. Payment and Settlement E. Market Functioning Part Three: Financial Regulation and Supervision Part Four: Regional Financial Integration Part Five: ADB's Intervention in the Financial Sector Bibliography Glossary and List of Abbreviations Acknowledgements

Financial Sector Legal and Regulatory Toolkit : Part Two: Preconditions and Infrastructure for Financial Sector Development

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C. Financial Information

1. Accounting
2. Auditing
3. Credit Ratings and Credit Information Systems

Another precondition to efficient financial markets is perfect information. In the real world, perfect information does not exist; however, the better the information available, the better financial markets are able to function. As a result, information problems are among the most significant imperfections in financial markets; likewise, information costs are among the most significant transaction costs in financial markets. It has been noted that a central aspect of the global financial crisis has been lack of transparency on financial institutions, markets and products. As a result, much attention is being focused by the G-20 on issues relating to accounting, disclosure and credit ratings.

The legal and institutional framework can play a very important role in improving the quality of information available. Effective financial regulation and supervision and the legal infrastructure supporting financial transactions depend on the timely provision of financial information that is understandable and reliable. The development of both financial intermediaries and financial transactions hinges on reliable accounting and auditing standards. The differences in accounting practices among economies and regions, particularly in developing and transition economies, can vary tremendously and obscure the relative financial positions between economies, sectors, and companies in the same industries.

Accounting

The key actors in the development of internationally acceptable accounting standards are the International Accounting Standards Board (IASB) and the International Organization of Securities Commissions (IOSCO).

Formed initially in 1973 by agreement among the accounting bodies of ten industrialized countries, the IASC was renamed the IASB in 2001 and is working towards harmonizing and improving accounting principles.

The IASB's overall objectives are to formulate, publish, and promote international accounting standards (IAS) to be observed in the presentation of financial statements and to work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements. (IAS issued since 2001 have been named International Financial Reporting Standards (IFRS). These standards are not binding on nations or the IASB members themselves, and the IASB has no enforcement authority.

In the area of international accounting standards for financial reporting connected with stock exchange listings, the barriers created by the lack of a single financial language are especially significant to the process of international capital formation.

Following is a list of forty core standards, which can be grouped into five major categories:

1. General. General standards deal with
1. disclosure of accounting policies,
2. changes in accounting policies, and
3. information disclosed in financial statements.
2. Income statement. Core standards related to the income statement are addressed to
1. revenue recognition,
2. construction contracts,
3. production and purchase costs,
4. depreciation,
5. impairment,
6. taxes,
7. extraordinary items,
8. government grants,
9. retirement benefits,
10. other employee benefits,
11. research and development,
12. interest, and
13. hedging.
3. Balance sheet. Standards governing the balance sheet address
1. property, plant, and equipment;
2. leases;
3. inventories;
4. deferred taxes;
5. foreign currency;
6. investments;
7. financial instruments/off-balance sheet items;
8. joint ventures;
9. contingencies;
10. events occurring after the balance sheet date;
11. current assets and current liabilities;
12. business combinations (including goodwill); and
13. intangibles other than R&D and goodwill.
4. Cash flow statement. A single standard details cash flow statement contents.
5. Other relevant core standards. These cover
1. consolidated financial statements,
2. subsidiaries in hyperinflationary economies,
3. associates and equity accounting,
4. segment reporting,
5. interim reporting,
6. earnings per share,
7. related party disclosures,
8. discontinuing operations,
9. fundamental errors, and
10. changes in estimates.

The IASB core program has been approved by IOSCO, reviewed and largely recommended by the Basel Committee and included as one of the key standards for sound financial systems by the FSF. In addition, they have been accepted for international offerings and listings by a wide range of stock exchanges around the world.

The role of the IASB and their core standards is likely to increase. This increasing importance of the IASB and IAS is highlighted by the EU decision to adopt these standards for financial reporting by EU listed companies and the current discussion in the United States regarding greater acceptance of the use of IAS by foreign issuers.

IASB Founding Members Australia Canada France Germany Japan Mexico the Netherlands United Kingdom Ireland United States




IOSCO Members There are three categories of IOSCO members: ordinary, associate, and affiliate. Each ordinary member has one vote. The associate members have no vote and are not eligible for the Executive Committee; however, they are members of the Presidents' Committee. The affiliate members have no vote, are not eligible for the Executive Committee, and are not members of the Presidents' Committee. However, the affiliate members, which are SROs, are members of the SRO Consultative Committee. ADB is an affiliate member of IOSCO. Most of ADB's developing member countries have entities who are IOSCO members.

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Auditing

As with accounting standards, the key international initiatives have also been led by international financial organizations, in this case the International Federation of Accountants - International Auditing Practices Committee (IFAC).

The IFAC, organized in 1977, is an international organization of national accountancy organizations representing accountants. The IFAC organization includes, inter alia, the International Auditing Practices Committee (IAPC), which is charged with the responsibility of developing and issuing guidelines on generally accepted auditing practices and the content of audit reports.

The IFAC is charged with the responsibility of developing and issuing guidelines on generally accepted auditing practices and the content of audit reports.

Unlike the IASB, the IAPC has compiled and codified a complete set of International Standards on Auditing. The Standards are comprehensive and seem to be gaining greater acceptance. (Oliverio & Newman, 1997)

ISAs are broken down into nine categories:

1. General. General standards include an introductory preface, glossary of terms, and framework.
2. Responsibilities. Standards on responsibilities include objectives, terms of audit, quality control, fraud and error, and consideration of laws and regulations.
3. Planning. Standards on planning address planning generally, knowledge of the business, and materiality.
4. Internal Control. Standards on internal control cover risk assessments, computer information systems, and service organizations.
5. Audit Evidence. Standards cover a variety of issues on audit evidence.
6. Using Work of Others. Standards on use of the work of others, address the work of other auditors, internal audit, and experts.
7. Audit Conclusions and Reporting. Standards on audit conclusions and reporting cover the auditor's report, comparatives, and other information.
8. Specialized Areas. This addresses specialised areas, such as special purpose engagements, engagement for agreed procedures, and engagements to compile information.
9. International Auditing Practice Statements. This addresses a variety of issues such as interbank confirmations, microcomputers, databases, the relationship with bank supervisors, audit of small entities, audit of international commercial banks, communications with management, risk assessment and internal control in computer information systems, computer assisted audit techniques, and environmental matters.

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Credit Ratings and Credit Information Systems

Idealy, the development of credit rating systems and agencies serves similar functions in that they decrease the need for initial research and subsequent monitoring, thereby reducing the cost of credit and increasing lending and loan maturities. However, given the significant role played by credit rating agencies in the context of the current global financial crisis, many of these previously held assumptions are now being debated and in many cases rethought. IOSCO is taking a leading role in this process.

A 2003 study [ PDF ] analyzed this issue and found that

• the existence of private credit registries is associated with lower financing constraints and a higher share of bank financing, with special impact on small and medium sized enterprises;
• a stronger rule of law is associated with more effective private credit registries; and
• public credit registries (usually maintained by central banks for financial stability purposes) do not have the same, though may benefit younger firms and improve financial stability.

The only international standards to emerge so far in this area are from IOSCO, and these are

1. a set of principles regarding the activities of credit rating agencies [ PDF ] and
2. an optional code of conduct for credit rating agencies [ PDF ].

The IOSCO principles for the activities of credit rating agencies include four principles dealing with (i) quality and integrity of the rating process, (ii) independence and conflicts of interest, (iii) transparency and timeliness of ratings disclosure, and (iv) confidential information.

The Code of Conduct further develops the ideas in the Principles in the context of credit rating agency self-regulation. As such, the Code of Conduct is also divided into four areas:

1. Quality and integrity of the rating process. The first area includes sixteen requirements divided into three headings, namely, quality of the rating process (1-8), monitoring and updating (9-10), and integrity of the process (11-16).
2. Credit rating agency independence and avoidance of conflicts of interest. The second area includes sixteen requirements again divided into three headings: general (1-5), credit rating agency procedures and policies (6-10), and credit rating agency analyst and employee independence (11-16).
3. Credit rating agency responsibilities to the investing public and issuers. The third area includes eighteen requirements divided into two headings: transparency and timeliness of ratings disclosure (1-10), and the treatment of confidential information (11-18).
4. Disclosure of the Code of Conduct and communications with market participants. The fourth area only includes two requirements.

New standards in this area are currently being developed and are likely to emerge in the near future.

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