As a result, it is very difficult for accounts to be read accurately and to make suitable financial decisions on investment by entities from other jurisdictions. Comparing performances and consolidating accounts without at least a degree of international harmonisation would prove very difficult, if not impossible.
The Importance of Harmonisation As a result of the problems mentioned above, a uniform set of International Financial Reporting Standards (IFRS) have been developed with the view to mitigating or, in some cases, eliminating divergences in the way that accounts are reported in different jurisdictions. It is recognised that a blanket standardisation is simply impossible; countries need the flexibility and freedom to allow influences from their own social and economic backgrounds to come into play. For this reason, a process of harmonisation has been established.
By having a guideline for the ways in which companies from different countries must deal with certain corporate issues, it makes the position of managers and investors much easier. Having a foundation of standards allows allocation choices in terms of resources and time to be made across jurisdictions. In order to do this, a like for like comparison must be possible and this can only be achieved with a degree of harmonisation.
In particular, the area of taxation has gained a great deal of attention from international accounting standard setters. For example, Financial Reporting Standard 19 states how a company should deal with deferred taxation situations, i.e. where the point of realising the asset and the corresponding liability are different and how this can be accounted for in the company accounts. By ensuring companies across the globe are broadly following the same principles, it is much easier to ascertain the true financial position of the company in question.
The International Accounting Standards Board The International Accounting Standards Board (IASB) is a wide group of people who are independent and are involved in the development and management of the International Financial Reporting Standards. The work of the IASB is supervised by the International Accounting Standards Committee and has additional support from external advisory committees.
In total, there are fourteen board members, representing nine different countries, thus ensuring geographical diversity and representation during the standard setting process. The main work of the IASB is to work with the various different national accounting standard setters in a bid to ensure that there is a worldwide convergence of accounting standards being put in place. As mentioned previously, the aim is not to force nations into following one set of distinct rules, but rather to encourage a union of standards.
The work of the IASB has been widely recognised, with more than 100 countries across the world either requiring or at least allowing the use of international accounting standards. This substantially increases the freedom of trade and investment on an international scale. International companies are able to ensure that consolidated accounts are prepared to produce useful and accurate accounts of the way in which the company is performing. This ability to draw accurate comparison is vital for the truly international scope of modern business.
Structure and Processes of the IASB Gaining harmonisation and convergence of accounting standards is clearly an important and useful element of international business. Achieving this is, however, a particularly difficult task. No international financial reporting standard can be passed and agreed on without the due process being followed. International agreement is vital, if such convergence is going to be efficiently attained across the globe.
The process is carried out in six stages, each of which is open to debate and is overseen by the executive committees. Firstly, the agenda is set. During this process, the IASB will look at the issue being raised, the current approaches being taken by the various different countries and the realistic possibility of achieving greater harmonisation. On the assumption that further harmonisation is thought possible, the IASB will then consider and set out the scope of the international standard that is envisaged.
Secondly, the project of establishing the accounting standard is planned fully to ensure the maximum possible buy-in from the various countries. Crucially, at this point, the IASB will decide if it is going to act alone in establishing the standard or whether it requires the assistance of other standard setting bodies.
Thirdly, once the project is fully understood, a discussion paper is published. This will state the issues as the IASB sees it and the possible solutions that exist for the problem. This is absolutely crucial. The work of the IASB relies almost entirely upon the agreement of the participating countries and, therefore, opening the discussion up to these countries is vital.
Fourthly, once the discussion stage has been duly undertaken, an exposure draft is issued with details of the proposed solution. This is essential as it will be at this point that many countries will raise objections or make further suggestions.
Fifthly, all of these processes are put together and the standard itself is drafted and published. It takes into account all comments and issues raised during the discussion paper and exposure draft.
Finally, after the standard has been issued, the IASB will review the uptake and the way it has been applied by the various countries. It may be that further amendments or new standards are needed and the process will then restart.
The entire process is based on discussion and co-operation, which is vital if any form of harmonisation can be truly efficient.
Challenges to Harmonisation Harmonisation is clearly beneficial for international trade and businesses. However, such large scale convergence is going to be difficult to manage and achieve; firstly, as the standards have to be incorporated into the national standards set by every individual country. This requires the relevant countries to be on board and prepared to support the various international standards being developed. Naturally, the support that is being shown for this is different between the various countries, with the more affluent countries being able to comply more readily because of their advanced accounting structure.
Secondly, the changing of the way in which accounts are presented is not always a quick or cheap process, which can cause difficulties for some smaller companies. In some cases, the adoption of certain international standards will result in the reported profits of the company falsely appearing substantially lower than the previous year. For this reason, some companies will naturally be slower or more hesitant to adopt the new standards. Where there is resistance, the IASB does not have the power or teeth to enforce the standards. This lack of ability to enforce can ultimately make the process of ensuring total international harmonisation extremely difficult and potentially impossible.
Conclusions The IASB plays an absolutely vital role in the move towards gaining an internationally harmonised set of accounting standards. All of the work undertaken by the IASB is mindful of the need to achieve co-operation between all countries and, as such, has been structured in the way that it establishes standards through the process of discussion and explanatory documents, encouraging the accession of all relevant parties, at every step of the way. In doing so, the chances of international harmonisation are much greater and this will bring with it all of the benefits of internationally usable accounts.
Bibliography Bazaz, Mohammed S., International Accounting: A Global Perspective, Issues in Accounting Education, Vol. 20, 2005
Collins, Katherine, International Accounting Rate Reform: The Role of International Organizations and Implications for Developing Countries, Law and Policy in International Business, Vol. 31, 2000
Fleming, Peter D., The Growing Importance of International Accounting Standards; Arthur R. Wyatt, Chairman of the International Accounting Standards Committee, Heralds International Harmonization, Journal of Accountancy, Vol. 172, 1991
Gornik-Tomaszewski, Sylwia, Mccarthy, Irene N., Cooperation between FASB and IASB to Achieve Convergence of Accounting Standards, Review of Business, Vol. 24, 2003
Heely, James A., Nersesian, Roy L. Global Management Accounting: A Guide for Executives of International Corporations, Quorum Books, 1993
Holmes, Geoffrey Andrew, Sugden, Alan, Holmes, Geoffrey, Gee, Paul, Interpreting Company Reports and Accounts, Pearson Education, 2004
Larson, Robert K., An Empirical Investigation of the Relationships between International Accounting Standards, Equity Markets and Economic Growth in Developing Countries, Journal of International Business Studies, Vol. 25, 1994
Nobes, Christopher, Parker, Robert, Comparative International Accounting, Pearson Education, 2006
Rider, Barry, in Villiers, Charlotte (ed.), Corporate Reporting and Company Law, Cambridge University Press, 2006
Rodgers, Paul, International Accounting Standards: From UK Standards to IAS, an Accelerated Route to Understanding the Key Principles of International Accounting Rules, Butterworth-Heinemann, 2007
Sale, J. Timothy, Salter, Stephen B, Sharp, David J., Advances in International Accounting, Elsevier, 2004
Schipper, Katherine, Principles-Based Accounting Standards, Accounting Horizons, Vol. 17, 2003
Schwartz, Donald, The Future of Financial Accounting: Universal Standards, Journal of Accountancy, Vol. 181, 1996
van Greuning, Hennie, Koen, Marius, International Accounting Standards: A Practical Guide, World Bank Publications, 2001
 Holmes, Geoffrey Andrew, Sugden, Alan, Holmes, Geoffrey, Gee, Paul, Interpreting Company Reports and Accounts, Pearson Education, 2004
 van Greuning, Hennie, Koen, Marius, International Accounting Standards: A Practical Guide, World Bank Publications, 2001
 Collins, Katherine, International Accounting Rate Reform: The Role of International Organizations and Implications for Developing Countries, Law and Policy in International Business, Vol. 31, 2000
 Rider, Barry in, Villiers, Charlotte (ed.), Corporate Reporting and Company Law, Cambridge University Press, 2006
 Rodgers, Paul, International Accounting Standards: From UK Standards to IAS, an Accelerated Route to Understanding the Key Principles of International Accounting Rules, Butterworth-Heinemann, 2007
Marginal and Absorption Costing for Financial Statements
This paper aims at looking at how income statements are prepared using marginal and absorption costing. The absorption costing method charges all direct costs to the product costs as well as a share of indirect costs. The indirect costs are charged to products using a single overhead absorption rate which is calculated by dividing the total cost centre overhead to the total volume of budgeted production. (ACCA, 2006; Drury, 2006; Blocker et al., 2005). On the other hand under marginal costing, only variable costs are charged to cost units. Fixed costs are written off the profit and loss account as period costs. (Drury, 2006; Blocker et al., 2005). Sections a) and b) below show the marginal and absorption costing income statements respectively for H Ltd that manufactures and sells a single product during the years ending 2006 and 2007. It is assumed that the company uses the first-in-first-out (FIFO) method for valuing inventories. In addition it is assumed that the company employs a single overhead absorption rate each year based on budgeted units and actual units exactly equalled budgeted units for both years. Workings are shown the attached excel file.
H Ltd Income Statement (Marginal Costing)
Cost of Sales:
Production cost (W1, W2)
Variable Marketing and Admin
Cost of Goods available for sale
Ending inventory (W3, W4)
Less Fixed costs
Marketing and Admin
H Ltd Income Statement (Absorption Costing)
Cost of Sales
Production Cost (W5, W6)
Ending Inventory (W7, W8)
Marketing and Admin Expenses
Reconciliation of net income under absorption and Marginal Costing.
Absorption operating profit
Less Fixed overhead cost in ending inventory (W9)
Marginal Costing net income
Under marginal costing inventory of finished goods as well as work in progress is valued at variable costs only. On the contrary, absorption costing values stocks of inventory of finished goods and work in progress at both variable costs and an absorbed amount for fixed production overheads. (ACCA, 2006; Lucy, 2002). In the case of H Ltd, under marginal costing, only variable costs are included in the ending inventory figure. This results in a profit figure of £400,000. On the other hand absorption costing includes additional £200,000 as fixed overhead in the ending inventory for 2006. As a result absorption operating profit is overstated by £200,000 in 2006. In like manner, the absorption profit under absorption costing is overstated by £140,000 due to an inclusion of £140,000 of fixed overhead cost in the ending inventory figure for 2007. To reconcile the profit under absorption costing and marginal costing, we may either subtract the fixed overhead included in ending inventory from the absorption cost operating profit to arrive at the marginal cost operating profit or add the fixed overhead costs in ending inventory to the marginal cost operating profit to arrive at the absorption cost operating profit.
Stock build-ups may result from using absorption costing for performance measurement purposes because inventory is valued at both fixed and variable costs. Firstly, profit is overstated. In fact absorption costing enables income manipulation because when inventory increases fixed costs in the current year can be deferred to latter years and as such current net income is overstated which in effect results in financial statements that do not present fairly and as such affect users’ decisions on the financial statements. Secondly, maintaining high levels of inventory may result in obsolescence and as such declines in future profitability resulting from the loss in value of the inventory. (Blocher et al., 2005; Storey, 2002).
Advantages of Absorption Costing and Marginal Costing
According to ACCA (2006) the following arguments have been advanced for using absorption costing:
It is necessary to include fixed overhead in stock values for financial statements. This is because routine cost accounting using absorption costing produces stock values which include a share of fixed overhead. Based on this argument, financial statements prepared using absorption costing present a true and faithful representation of the actual results of operation of the company.
For a small jobbing business, overhead allotment is the only practicable way of obtaining job costs for estimating and profit analysis.
Analysis of under/over-absorbed overhead is useful to identify inefficient utilisation of production resources.
ACCA (2006) also identifies a number of arguments in favour of marginal costing. Preparation of routine cost accounting statements using marginal costing is considered more informative to management for the following reasons:
Contribution per unit represents a direct measure of how profit and volume relate. Profit per unit is a misleading figure.
Build-up or run-down of stocks of finished goods will distort comparison of operating profit statements. In the case of closing inventory, the inventory is valued only at the variable cost per unit. This makes the profit under a situation where there is closing inventory to be the same as the case when there is no closing inventory thereby enabling the comparison of operating profit statements over time.
Unlike under absorption costing, marginal costing avoids the arbitrary apportionment of fixed costs, which in turn result in misleading product cost comparisons.
Bibliography ACCA (2006). Paper 2.4 Financial Management and Control: Study Text 2006/2007. www.kaplanfoulslynch.com
Blocher, E., Chen, K., Cokins, G., Lin, T. (2005). Cost Management A Strategic Emphasis. 3rd Edition McGraw Hill.
Drury, C. (2004). Management and Cost Accounting. 6th Edition. Thomson Learning, London.
Lucy, T (2002), Costing, 6th ed., Continuum.
Storey, P (2002), Introduction to Cost and Management Accounting, Palgrave Macmillan