Chapter 03 - International Convergence of Financial Reporting

CHAPTER 3 INTERNATIONAL CONVERGENCE OF FINANCIAL REPORTING Chapter Notes

Chapter Topics Harmonization and convergence Evolution of the International Accounting Standards Board (IASB) Other organizations involved in harmonization IASB framework and IFRS Use of and support for IFRS Principles-based vs. rules-based accounting Convergence of IAS and U.S. GAAP Harmonization and Convergence Harmonization o the process that reduces alternatives while retaining a high degree of flexibility in accounting practices o The efforts were lead by the International Accounting Standards Committee (IASC) since 1973 until 2001 Convergence o the adoption of one set of standards internationally. o This is the main objective of the International Accounting Standards Board (IASB) in 2001. Harmonization A. Harmonization allows for different standards in different countries as long as there are not logical conflicts. Standardization involves using the same standards in different countries. B. The objective of accounting harmonization is to have comparable financial statements from companies in different countries. C. Harmonization of regulations (de jure harmonization) does not necessarily produce harmonization of practices (de facto Harmonization), which is the optimal goal. Harmonization: The Pros and Cons Pros: A. Make financial statements of companies in different countries more comparable, and hence make it easier for investors to evaluate foreign firms. B. Simplify for MNCs the evaluation of possible foreign takeover targets. C. Reduce the financial reporting costs for MNCs to consolidate foreign D. Make it easier for companies to access foreign capital markets. E. Make it easier for MNCs and international accounting firms to transfer accounting personnel to other countries.

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F. Allow for easy and cost effective adoption of high-quality standards by developing countries and G. Raise the quality level of accounting practices internationally. Cons: A. Considering the differences among countries in terms of socio-politico-economic systems, it would be almost impossible to arrive at a set of accounting standards that would satisfy all of the parties involved. B. Nationalism international standards would be perceived as a set of standards developed to suit the requirements of other countries, and hence would not be received favorably. C. It is unnecessary to force all companies worldwide to follow a common set of rules. D. Todays global capital market has evolved without harmonized accounting standards. E. It would lead to a situation of standards overload. Harmonization by IASC: The International Accounting Standards Committee Was established in 1973 by professional accounting bodies in ten countries (Australia, Canada, France, Germany, Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States) Charged with the broad objective of formulating international accounting standards. A. 1973-1988 o Lowest common denominator approach to standard setting o The IASCs main activity was the issuance of International Accounting Standards (IASs), many of which allowed multiple options to accommodate existing accounting practices in various countries. B. 1988-1993 o The IASC undertook a Comparability Project to eliminate most of the choices of accounting treatment permitted under IASs. C. 1993-2001 o The final phase in the work of the IASC began with the IOSCO agreement in 1993 and ended with the creation of the IASB in 2001. o The main activity during this phase was the development of a core set of 30 international standards that could be endorsed by IOSCO for cross-listing purposes. Convergence by IASB: The International Accounting Standards Board Has the primary responsibility for international convergence of accounting standards. Highest common denominator approach A. The IASB was formed in 2001 to replace the IASC with the objective of developing a set of high quality accounting standards to be used through out the world. B. The IASB follows a due process procedure and uses a principles-based approach in developing international standards. C. The IASB has 14 members 12 full-time and 2 part-time. Seven full-time members serve as liaison with national standard setters. Technical competence is the most important criterion for selection as a Board member.

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D.

E.

F. G.

H.

The first IASB chairman: Sir David Tweedie In addition to the IASB itself, the other main components of international standard setting include the IASC Foundation and its Trustees, the International Financial Reporting Interpretations Committee (IFRIC), and the Standards Advisory Council (SAC). International Financial Reporting Standards (IFRS) consist of IFRSs issued by the IASB, IASs issued by the IASC (and adopted by the IASB), and Interpretations developed by IFRIC. As of March 2008, 41 IASs and 8 IFRSs had been issued, but only 30 IASs were still in effect. The IASB has a conceptual framework (Framework for the Preparation and Presentation of Financial Statements) that serves as the basis for developing IFRS. The framework is similar to that of U.S. GAAP with less details. The IASB also has issued guidelines for first time adopters of IFRS (IFRS 1).

Other organizations involved in harmonization efforts Association of South East Asian Nations (ASEAN) United Nations (UN) European Union (EU) International Organization of Securities Commissions (IOSCO) o IOSCO is essentially the international equivalent of the U.S. Securities and Exchange Commission (SEC). International Federation of Accountants (IFAC) o IFAC is similar, at the international level, to the American Institute of Certified Public Accountants (AICPA). IASB and FASB o IASB is essentially the international equivalent of FASB. IOSCO Works to achieve improved market regulation internationally Works to facilitate cross-border listings Advocates for the development and adoption of a single-set of high quality accounting standards IFAC Works to develop international standards of auditing, ethics, and education Began International Forum on Accountancy Development (IFAD) to enhance the accounting profession in emerging countries Started the Forum of Firms to raise global standards of accounting and auditing EU

Has worked to harmonize accounting standards within the EU, primarily by way of two directives Fourth Directive a set of comprehensive accounting rules built on the principle of a true and fair view.

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Seventh Directive requires consolidated financial statements for company groups of a certain size. The Committee of European Securities Regulators (CESR) issued Standard No. 1, Financial Information: Enforcement of Standards on Financial Information in Europe, in 2003. However, enforcement of IFRS is challenging in EU and it relies on the cooperation of member sates in adopting the standard.

Ways of adopting IFRS. A. Replace national GAAP with IFRS. B. Require parent companies to use IFRS in preparing consolidated financial statements. C. Require stock exchange listed companies to use IFRS in preparing consolidated financial statements. D. Require foreign companies listed on a domestic stock exchange to use IFRS. E. Require domestic companies listing on a foreign stock exchange to use IFRS. List of IFRS Adoptions by countries: listed vs. unlisted companies in a country http://www.iasplus.com/country/useias.htm http://www.pwc.com/us/en/issues/ifrs-reporting/country-adoption/index.jhtml
IFRS Adoption by Country Map

Concerns about adopting IFRS. A. They are too complicated for some companies. B. Using them as the basis for taxation could be a problem. C. Some IFRS, for example, those related to financial instruments and fair value accounting, are controversial. D. Guidance for first-time adopters is inadequate. E. In countries which do not have well-developed capital markets, and where the users are satisfied with the local standards, the adoption of IFRS would be of little benefit. F. There could be language translation issues. Use of IFRS Despite the difficulties, there is a worldwide trend towards convergence with or adoption of IFRS, as evidenced by: A. Support for the IASB structure and its highest common denominator approach. B. The IASBs initiatives to facilitate and enhance its role as a global standard-setter, for example, by issuing guidelines for first-time adopters, holding public round table forums, and having direct liaison with some national standard setters. C. Adoption by the EU public companies in the EU were required to begin using IFRS in 2005. D. The FASB/IASB convergence project (the so-called Norwalk agreement). E. IOSCO has endorsed IFRS for cross-listings. F. Many developing nations have adopted IFRS. G. Some countries disallow IFRS for domestic firms but allow foreign companies to use them. H. U.S. and Japan, for example will allow foreign countries listing on their respective exchanges to file financials prepared in accordance with IFRS without reconciliation to U.S. (in 2007) or Japanese GAAP.
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Principles-Based Approach to Accounting Standard Setting IASB attempts to follow a principles-based approach to standard setting. As such, accounting standards are grounded in the IASB Framework. Represents a contrast to a rules-based approach Attempts to limit additional accounting guidance (e.g., FASB, EITFs, FASB Interpretations) Is designed to encourage professional judgment and discourage over-reliance on detailed rules IASB Framework The Framework for the Preparation and Presentation of Financial Statements o Created to develop accounting standards systematically in 1989 and was reaffirmed by IASB in 2001. o Provides the basis for financial statements presented in accordance with IFRS o Similar to the relationship between U.S. GAAP financial statements and the FASB Conceptual Framework The objective and underlying assumptions of financial statements o Primary objective is to provide information useful to decision making. o Underlying assumptions include accrual-basis and going concern. Qualitative characteristics of information o Understandability should be understandable to people with reasonable financial knowledge. o Comparability allows for meaningful comparisons to financial statements of previous periods and other companies. o Relevance useful for making predictions and confirming existing expectations. o Reliability free from bias (neutral) and represents that which it claims to represent (representational faithfulness). Elements of Financial Statements o Definition assets, liabilities, and other financial statement elements are defined. o Recognition guidelines as to when to recognize revenues and expenses. o Measurement various bases are allowed: historical cost, current cost, realizable value, and present value. ` IAS 1: Presentation of Financial Statements This standard provides guidance in the following areas: Purpose of financial statements to provide decision-useful information. Components of financial statements balance sheet, statements of income, cash flows, changes in equity, and notes to the financial statements. Fair presentation the overriding principle of financial statement presentation. Accounting policies o Should be consistent with all IASB standards. o When specific guidance is lacking, use standards on similar issues, and definitions of the financial statement elements. Basic principles and assumptions o Accrual basis/going concern/comparability.
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Structure and Content of Financial Statements o Current/noncurrent. o Items to be included on face of financial statements. o Content of notes.

IFRS 1: First Time Adoptions of IFRS Provides guidance for first time adoption. Much used in 2005, particularly in EU. Requires compliance with all effective IFRS. o Preparation of opening IFRS balance sheet (i.e. 1/1/2004 for a 2005 IFRS F/S): Recognition, De-reorganization, Reclassification, Measurement o Reconciliation of Equity and Net Income from previous GAAP to IFRS o Restatement is the overriding principle o Allows exemptions (some optional and some mandatory) when costs deemed to outweigh benefits. IASB/FASB Convergence: The Norwalk Agreement Reached in 2002 Between the IASB and FASB To work toward accounting standards convergence FASBs key initiatives in the Norwalk Agreement o Joint projects boards will work together to address some issues (e.g., revenue recognition). o Short-term convergence to remove differences between IFRS and U.S. GAAP for issues where convergence is deemed most likely. o IASB liaison IASB member in residence at FASB. o Monitoring IASB projects FASB monitors IASB projects of most interest. o Convergence research project identification of all major differences between IFRS and U.S. GAAP. o Convergence potential FASB assesses agenda items for possible cooperation with IASB. Anglo-Saxon Accounting Countries include U.S., U.K., Canada, Australia and New Zealand Accounting systems not identical but share fundamental features: o Micro orientation (firm level) with emphasis on professional rules and selfregulation o Investor orientationprimary aim is efficient operation of capital markets (very transparent) o Less emphasis on prudence and measurement of taxable income or distributable incomesubstance over form

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