For several decades, global organisations such as the European Union (EU), International Organisation of Securities Commission (IOSCO) and the International Accounting Standards Commission (IASC) have supported international efforts to harmonize financial accounting standards and reporting(James, 2009). To some extent, the EU gave global convergence a kick-start when they made it compulsory for EU companies listed on an EU exchange prepare their consolidated accounts after Jan 2005, under IFRS (Gill and Rosen, 2007). In 2001, the IASC reorganized and the IASB was created. Harmonization efforts thereby shifted to globalization and in 2002, the FASB and IASB signed what is commonly referred to as the “Norwalk Agreement”, in which the two standard setting organisations agreed to work together to develop a high quality single set of accounting standard that would be used internationally for domestic and cross border financial reporting. It was agreed that to achieve this goal, they would eliminate existing differences between US GAAP and IFRS and coordinate their efforts on future standard setting projects. As a result of this, they are now compatible in many areas even though some significant differences still exist such as LIFO inventory cost valuation which is widely used in the US but is specifically prohibited under IFRS. Others like presentation, pre-operating and pre-opening costs, borrowing costs and fair value (Gill and Rosen, 2007) exist and have to be reconciled if a global set of standards are to emerge (FASB, 2002).
POTENTIAL ADVANTAGES AND DISADVANTAGES ARISNG FROM ONE SET OF GLOBAL ACCOUNTING STANDARDS
Having a single set of global accounting standards has its benefits. Firstly, a single set of high quality globally accepted financial accounting standard tends to serve the financial users better and would likely lead to the greatest comparability between companies (James, 2009). The SEC identifies comparability of financial information to investors as a key benefit. Firms choose to adopt IFRS in order to increase opportunities such as increasing the number of global customers and suppliers. US companies want to investigate the financial strength of these customers when establishing long term relationships and these can be facilitated through the use of one reporting standard
Secondly, academic research suggests that investors prefer to invest in companies that use familiar standards. Firms that engage in international activities would benefit from convergence and are more likely to voluntarily adopt IFRS if they have more international interactions (Bradshaw et al., 2010).
Furthermore, voluntary adoption of IAS reduces the tendency for investors to over invest in domestic stock and under invest in foreign stocks. This could suggest that foreign investment decisions are related to conformity of accounting methods with domestic accounting standards. US Companies will therefore benefit from convergence of US GAAP and IFRS given that IFRS has over 100 countries adopting to it , thereby increasing foreign investment (Bradshaw et al., 2010).
One set of global accounting standards would lead firms to exhibit less earnings management, more timely, less recognition and more value relevant information. There would be improvement in accounting quality and also increased liquidity in markets because IFRS is considered a higher quality set of standards as evidenced by lower information asymmetry and greater liquidity (Bradshaw et al., 2010).
Lastly, it allows US issuers’ greater opportunity to compete in global capital markets. “Replacing the competing and often contradictory standards would improve investor confidence, allow investors draw better conclusions and simplify the process and cut costs for issuers” (Gill and Rosen, 2007).
However, having only one set of global accounting standards has its demerits. Adopting IFRS when material differences exist at both conceptual and magnitude level could pose great costs and can be detrimental to investors(Bradshaw et al., 2010). For smaller companies, challenges will arise when their clients are acquired by foreign owners wanting to file under IFRS and this will be due to the firms not being prepared for the change because they don’t have the same resources as the big firms(Rahr et al., 2010).
Secondly, transition is costly and time consuming especially for public accounting firms due to initial education and software modifications which will require time and money to compute when transition to IFRS takes place. Fees for advising companies by CPAs would be substantial (Rahr et al., 2010).
Furthermore, it can lead to users of financial statements claiming that preparers claim that they used standards that are not reliable and that they don’t have sufficient knowledge of IFRS, leading to litigation issues (Rahr et al., 2010).
Lastly, US colleges and universities don’t appear to be equipped to teach IFRS at a level necessary for near-term adoption of standards (Bradshaw et al., 2010).
WOULD ONE SET OF GLOBAL STANDARDS BE APPROPRIATE FOR ALL COUNTRIES?
Though having one set of accounting standards have their benefits, it may be naÃ¯ve to think that adopting one set of standards for all countries. Skills transferred from Anglo-American countries to developing countries may network because they are culturally irrelevant or dysfunctional in these developing countries (Perera 1989, Cited in Deegan 2001).
Also, the IASC standards are strongly influenced by Anglo- American accounting models and thus tend to reflect the circumstances and patterns of thinking in a group of countries. They are likely to have problems of relevance in countries with different cultural environments from Anglo American countries (Craig Deegan, 2001).
Lastly, efforts towards assisting countries, particularly the developing countries by providing them with a mechanism to use western style accounting systems may cause harm because UK professional bodies don’t make concessions to overseas students and insist on a set of knowledge known to UK practice and are irrelevant and harmful if applied in the wrong way (Seminar note).
ADVANTAGES AND DISADVANTAGES OF A PRINCIPLE BASED APPROACH AND RULES BASED APPROACH FOR REGULATION OF FINANCIAL REPORTING.
IFRS are generally principle based standards while the US GAAP is more rules based. They differ on a number of points and can affect an entity’s reported results(Gill and Rosen, 2007). The rules based approach has been under fire of late due largely to the Enron Corporation failure whereby Arthur Anderson was seen as designing client-originated financial instruments that met the technical requirements of GAAP while violating the intent (Benston et al., 2006). The Sarbanes-Oxley Act of 2002 (SOX) was then issued to improve financial reporting and protect investors and it requires that the SEC conduct a study on the adoption of a principles based set of accounting standards (James, 2009).
Principle based approach encourage the use of professional judgement with a focus on what is right and not what is in the rules and thus discourages financial engineering. They have a better ability to cope with the speed of change of environment and they are also less voluminous and easier to understand as they provide latitude to financial statement preparers and are easier to conform with international standards(Moneywatch.com, 2002).
However, the flexibility of principle-based approach leads to professional judgement calls when financial statements and audits are prepared and this could lead to financial restatements and increased litigation if the users disagree with the CPA’s judgment. They can also be a significant loss of comparability among reporting entities because preparers and auditors are required to exercise judgement in accounting for transactions (Benston et al., 2006).
The Rules based Approach are developed to meet demands of major constituents like management and auditors who want a clear answer to every perceivable accounting issue and this protects accountants from criticisms and lawsuits (Benston et al., 2006).
There is also less need for explanation in financial statements and less room for interpretation which results in less complex and more transparent financial statements and it reduces problems in countries such as the US characterized by a litigious environment and dominated by a very legalistic framework as the rules are stated clearly (Benston et al., 2006).
However, they are too voluminous as it comprises of over 2000 separate pronouncements which are several hundred pages long and issued in various forms and formats by numerous bodies (Gill and Rosen, 2007).
Secondly, because of its detailed regulations, application of rules-based approach has led to a lack of transparency regarding matters like revenue recognition derivatives, off-balance sheet finance and the likes (Elliot and Elliot, 2006).
Lastly, rules can become useless or dysfunctional when the economic environment changes or if managers create innovative transactions (Benston et al., 2006).
Convergence of IFRS and the US GAAP is in the best interest of US companies in the long run if it provides greater comparability and yields equal or higher quality standards. They both represent a high quality set of accounting standards in terms of mitigating information asymmetry and providing information important for valuation. However, it’s unclear whether IFRS provides equivalent financial reporting quality relative to US GAAP(Bradshaw et al., 2010).
The Published Financial Statement Accounting Essay
Annual report and accounts consists of different elements. A financial statement contains the financial information which is communicated to various users depending on their needs. The users can be internal or external users. The importance of this information varies, depending on the needs of specific users but according to the framework, the publication of financial information serves to reflect and to provide a clear image of the financial situation and performance of the entity which will help them to make a financial decision. Thomas and Marie (2012, 55). Users need financial information to assess the way the company uses its liquidity to fund its operations and investment, to be informed about its financial position and the nature of its resources for daily transactions, to estimate or predict the circumstances that may affect them, to be informed about the extent to which the company follows the laws and regulations. Usually the performance information is represented on the income statement, the financial situation is represented on the balance sheet, and the information about changes in financial position is supplied in the notes to financial statements.
Financial statements are the principal means of communicating financial information to various users. The framework defines seven essential users (Jill and Roger, 2007) but in contrast, Peter and Eddie (2002p 3) state that there are internal and external users who already have a relationship with the firm in economic terms or those who are interested in a future relationship.
Starting with managers, Petter and Eddie (2002.3) noted that managers need information to assist them to make the decision and adopt and strategy of planning for the future. Furthermore, the manager who has been put in charge of presenting financial statements also needs this information to be sure that the management style, strategy and planning adopted are beneficial to the financial performance of the company.
The conceptual framework states that the employees are principally interested in the type of information which permits them of having a clear idea about the stability and the performance of the company that they work for (Thomas and Ward,56 2012). Employees need information in order to ensure the stability of their jobs in the future, and to measure their ability to determine if there is a chance of getting a higher pay or promotion, and other benefits.
The Investors need information about management policy, performance, stability and financial position of the company as well as to assess the risk and benefits provided by the investment in order to make a decision. Also, they need information to help them choose the proper time for transactions like buying and selling. Thomas and Ward (2012:56)
Lenders are always taking risks which is why they choose the contract with lowest risk the framework noted that “they are interested in information about performance and economic stability of the company, and also the information about the situation of liquidity available in the present and the future, in order to ensure whether the borrower is able to meet the deadlines for the payment of their loans and the interest. (Thomas and Ward, 2012:57).
Regarding suppliers and other creditors, Thomas and Maries said that giving a loan and outputting goods without immediate payment is the same. This is the reason, they will be interested in the information that will help them at the beginning to decide whether to engage with company or not, and also to study the duration and the amount of credit to offer. According to the framework, suppliers and other creditors are interested in information that enable them to know whether they will be repaid at due date. Yet Suppliers and others creditors are interested in engaging with the enterprise for a shorter period compared to lenders who are concerned about liquidity position and the supplier seeks to know if there is a growth within the company and compare it with these production capacities.
Jill and Roger (200741) states that the customers are interested in the information that enable them to evaluate the performance and ability of the company to continue its business and to know their capacity to meet the requirements of quality, the quantity and time to provide goods and services depending on customer needs.
Governments and their agencies are composed by the tax authorities, financial and organization like central bank that has authority of control and regulations. Principally, the information is used as basis for calculating dues and taxes that the company has to pay. It has noted that the government and their agencies are interested in information about profitability and how it is distributed, with the aim of determining the tax policy, as they need information on the conduct of activities of entities to adjust them. (Thomas and Ward, 582012)
The public is also interested in information about the performance of the company in order to define the level at which the company is progressing and its impact on economic development and social environment.
To ensure that the information is useful to users for decision making, four qualitative characteristics need to be present in the information. Understandability – the user must understand the information directly but should have basic knowledge of accounting and the economy. Relevance – information must meet the needs of users in order for them to make decisions and enable them to compare the events of different periods. Reliability – information must be reliable to give a real image of transactions and other operations. Comparability – the information has to be available for comparison over time to determine the situation and the economic performance. (Jill and Hussey, 422007)
It is true that the financial information addresses different user groups under standard characteristics, but it still has limitations on the usefulness of the information. The financial statement is based on historical costs. That is to say it is only monetary operations but the declaration is not correct. Also, with regards to the intangible assets there is no possibility of measuring the values of all of them in the sector of accounting.
For instance, human resources are also ignored in most financial statements, and the brand value of the company is not on the statements either. Inflation is not included in the present value and all the information are based on estimates, so there is no real value on which the user can rely on. The financial statement does not take into consideration any anticipated financial condition that can happen in the industry and market which might affect the performance of the company and the decision taken by the different users of the financial statement which contains only financial information and ignores the non-financial information which is not sufficient for certain users as the case of public and employees. In contrast, investors are more concerned than other users by information presented in the financial statement.
To conclude, the company is obliged to communicate the information under financial quality standards that are useful to different users, which are a total of eight. They are; managers, investors, customers, suppliers and other creditors, employees, lenders, government, and the general public. The objective of this information is to reflect the performance, position and stability of the company for the user to make a good decision. Despite the quality and control, the rest information is still not reliable and useful for certain users to make a decision.