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Chapter 03 - International Convergence of Financial Reporting

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CHAPTER 3

INTERNATIONAL CONVERGENCE

OF FINANCIAL REPORTING

Chapter NotesChapter 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 inaccounting 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.

HarmonizationA. 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 produceharmonization 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, andhence 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 accountingpersonnel to other countries.


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F. Allow for easy and cost effective adoption of high-quality standards by developingcountries and

G. Raise the quality level of accounting practices internationally.

Cons:

A. Considering the differences among countries in terms of socio-politico-economicsystems, it would be almost impossible to arrive at a set of accounting standards thatwould 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 ofstandards 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 settingo The IASCs main activity was the issuance of International Accounting Standards

(IASs), many of which allowed multiple options to accommodate existingaccounting practices in various countries.

B. 1988-1993

o

The IASC undertook a Comparability Project to eliminate most of the choices ofaccounting treatment permitted under IASs.C. 1993-2001

o The final phase in the work of the IASC began with the IOSCO agreement in 1993and ended with the creation of the IASB in 2001.

o The main activity during this phase was the development of a core set of 30international 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 approachA. The IASB was formed in 2001 to replace the IASC with the objective of developinga 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-timemembers serve as liaison with national standard setters. Technical competence is

the most important criterion for selection as a Board member.


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The first IASB chairman: Sir David TweedieD. 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).

E. International Financial Reporting Standards (IFRS) consist of IFRSs issued by theIASB, IASs issued by the IASC (and adopted by the IASB), and Interpretationsdeveloped by IFRIC.

F. As of March 2008, 41 IASs and 8 IFRSs had been issued, but only 30 IASs were

still in effect.

G. The IASB has a conceptual framework (Framework for the Preparation andPresentation of Financial Statements) that serves as the basis for developing IFRS.

The framework is similar to that of U.S. GAAP with less details.

H. 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 FASBo 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 accountingstandards

IFAC

Works to develop international standards of auditing, ethics, and education

Began International Forum on Accountancy Development (IFAD) to enhance theaccounting 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 twodirectives

Fourth Directive a set of comprehensive accounting rules built on the principle of atrue and fair view.


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Seventh Directive requires consolidated financial statements for company groups of acertain 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, forexample, 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 IFRSin 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 respectiveexchanges 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, FASBInterpretations)

Is designed to encourage professional judgment and discourage over-reliance on detailedrules

IASB Framework

TheFramework for the Preparation and Presentation of Financial Statementso 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 IFRSo 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 informationo Understandability should be understandable to people with reasonable financial

knowledge.

o Comparability allows for meaningful comparisons to financial statements ofprevious 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 StatementsThis 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 policieso 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 assumptionso Accrual basis/going concern/comparability.


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Structure and Content of Financial Statementso 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 IFRSo Restatement is the overriding principleo 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 Agreemento 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 forissues 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 betweenIFRS and U.S. GAAP.

o Convergence potential FASB assesses agenda items for possible cooperation withIASB.

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 self-

regulation

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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