Chapter 2International Harmonization of Financial Reporting

What is harmonization?

Harmonization -- the process of increasing the level of agreement in accounting standards and practices between countries.

Harmonization is not the same as standardization whereas standardization implies the elimination of alternatives in

accounting for economic transaction and other events , Harmonization refers to reduction of alternatives while retaining a high degree of flexibility in accounting practices, so harmonization allows different countries to have different standards as long as the standards do not conflict. The two “levels” of Harmonization

Harmonization in accounting standards, which is increased agreement in accounting rules.

Harmonization in practice, which is increased agreement in actual accounting practices.

Harmonization in standards may or may not result in harmonization in practice.

Arguments for and against Harmonization Arguments for Harmonization :-

Proponents of accounting harmonization argue that :- Harmonization expedite the integration of global capital

markets and make easier the cross-listing of securities because of the comparability of Financial statements.

Harmonization facilitate international mergers and acquisitions. Harmonization reduce investor uncertainty and the cost of

capital. Harmonization reduce financial reporting costs. Harmonization allow for easy adoption of high-quality

standards by developing countries. Arguments for Harmonization :-

Proponents of accounting harmonization argue that its not necessary to force all companies world wide to follow comment set of standards. Significant differences in standards currently exist . The political cost of eliminating differences.

Overcoming “Nationalism” and traditions. Perhaps it will not provide significant benefits. Will cause “Standards Overload” for some firms. Diverse standards for diverse places is acceptable.

Harmonization EffortsOrganizations involved

Association of South East Asian Nations (ASEAN). United Nations (UN) / European Union (EU). International Organization of Securities Commissions (IOSCO). International Federation of Accountants (IFAC). IASB and FASB.

International Organization of Securities Commissions (IOSCO).See web site http://www.iosco.org Established in 1974, International Organization of Securities Commissions IOSCO today IOSCO is the leading organization for securities regulators around the world , with about 135 ordinary, associate, and affiliate members from about 100 countries , and aims among other things to : Achieve improved market regulation internationally. Facilitate cross-border listings. Advocates for the development and adoption of a single-set of high

quality accounting standards.

International Federation of Accountants (IFAC).See web site http://ifac.orgFormed in 1977, International Federation of Accountants (IFAC) aims to develop international standards of auditing, ethics, education, and training , In pursuing these goals IFAC has contributed to the harmonization process in many ways as : Began International Forum on Accountancy Development (IFAD)

to enhance the accounting profession in emerging countries. That was in response to criticism from the world bank after the Asian financial crises that the accounting profession was not doing enough to enhance the accounting capacity capabilities in emerging countries .

Started the Forum of Firms to raise global standards of accounting and auditing (Details at www.ifad.org).

EU European Union :See web site http://europa.eu/index_en.htm The European Union EU was the EU was established by the Treaty of Maastricht on November 1993 upon the foundations of the pre-existing European Economic Community, founded in March 1957 with the signing of the Treaty of Rome by sex European nations (Belgium, France, Germany, Italy, Luxemburg, and the Netherlands), and now EU Comprising 27 member states .

The European Union EU Has worked to harmonize accounting standards within the EU, primarily by way of two directives, EU directives possess the force of law . Fourth Directive 1978

a set of comprehensive accounting rules covering the content of annual financial statements, their methods of presentation and measurement and disclosure. The Fourth Directive built on the principle of a “true and fair view.” Seventh Directive 1983

requires consolidated financial statements for company groups of a certain size.

International Accounting Standard Board (IASB) International Accounting Standard Board was created in 2001 to

replace the predecessor, the IASC (International Accounting Standards Committee).

IASC was established in 1973 by an agreement of the leading accounting profession bodies in 10 countries (the United States of America, Australia, Canada, France, Germany, Japan, Mexico, Netherlands, United Kingdom and Ireland ).

The IASC harmonization effort from 1973 to 2001 evolved in several phases, the initial phase was the issuance of 26 IASs, the approach was lowest-common-denominator, so many of these standards allowed multiple options.

IASB works toward harmonization of international accounting standards.

The mission of IASB is to develop, in the public interest, a single set of high quality, understandable and international financial reporting standards (IFRSs) for general purpose financial statements.

International Accounting Standard Board Comprised of 14 members (12 full, 2 part-time).

7 members of 12 full time must have a formal liaison responsibility with a national board.

Standard development process is open and Standards are principles-based.

Since establishment of IASB, focus is on global standard-setting rather than harmonization per se.

IASB – Major InitiativesComparability Project

Begun in 1989, which can be described as the second phase of the IASCs effort (The third phase was the Framework for the Preparation and Presentation of Financial Statements).

The comparability of financial statement Project aims at eliminate most of choices of accounting treatment currently primeted under IASs.

Comprehensive review of existing IAS , and as areult many of IASs were revised In order to increase rigor of IAS.

IOSCO Agreement The final Phase IASC work to harmonization . Begun in 1993 and ended with the creation of IASB in 2001 The main activity during this period was establishment of a core set

of 30 accounting standards could be endorsed by IOSCO for cross-listing .

Standards agreed upon by IOSCO and IASC.

IASB – Revised StructureThe restructured IASB is overseen by the IASC Foundation which also oversees: The International Financial Reporting Interpretations

Committee (IFRIC). The Standards Advisory Council (SAC). Also, IFRSs are subject to due process and the IASC

Foundation now periodically reviews its constitution.

IASB Perspective IASB attempts to follow a Principles-Based approach to standard

setting. As such accounting standards are grounded in the IASB

Framework.

A Principles-Based approach 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 and IFRSs

IASB Framework (more details required in single file about Framework).

The most important phase of harmonization activity is releasing Framework for the Preparation and Presentation of Financial Statements. The objective and underlying assumptions of financial statements. Qualitative characteristics of information. Definition, recognition, and measurement of elements in financial

statements. Concepts of capital maintenance. Possesses objective and underlying assumptions of financial

statements. Primary objective is to provide information useful to decision

making. Underlying assumptions include accrual-basis and going concern.

Qualitative characteristics of information

Understandability – should be understandable to people with reasonable financial knowledge. Comparability – allows for meaningful comparisons to financial statements of previous periods and other companies. Relevance – useful for making predictions and confirming existing expectations. Reliability – free from bias (neutral) and represents that which it claims to represent (representational faithfulness).

Definition – assets, liabilities, and other financial statement elements are defined. Recognition – guidelines as to when to recognize revenues and expenses. Measurement – various bases are allowed, historical cost, current cost, realizable value, and present value.

Financial capital maintenance One approach to income measurement. Net income represents the increase in net financial assets, excluding owner transactions. The approach in U.S. GAAP.

Physical capital maintenance Another approach to income measurement. Net income represents increase in physical productive capacity.

Excluding owner transactions. Requires current costs for measurement of certain physical assets.

Presentation of Financial Statements (IAS 1)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 Should be consistent with all IASB standards. When specific guidance is lacking, use standards on similar issues, and definitions of the financial statement elements.

Basic principles and assumptions Reiteration of underlying assumptions. Accrual basis/going concern/comparability.

Structure and Content of Financial Statements Provides information on presentation format: Current/noncurrent. Items to be included on face of financial statements. Content of notes.

First Time Adoptions of IFRSs (IFRS 1) Provides guidance for first time adoption. Much used in 2005, particularly in EU. Requires compliance with all effective IFRSs. Allows exemptions when costs deemed to outweigh benefits.

Use of IFRSsEvidence of support for IFRSs

Adoption by the EU – public companies in the EU were required to begin using IFRSs in 2005. IOSCO has endorsed IFRSs for cross-listings. Many developing nations have adopted IFRSs. Some countries disallow IFRSs for domestic firms but allow foreign companies to use them. U.S. is a major exception, does not allow use of IFRSs.

IASB/FASB ConvergenceThe Norwalk Agreement

Reached in 2002 Between the IASB and FASB. Is a promise of cooperation in standard-setting between the

International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).

IASB and FASB pledged to use there best effort to1. make there existing financial reporting standards fully compatible

as soon as practicable .2. to coordinate there work program to ensure that once achieved

compatibility is maintained The Agreement Represents a significant step To work toward

accounting standards convergence to achieve international harmonization..

IASB/FASB Convergence

The key initiatives in the Norwalk Agreement was 6 projects 1. Joint projects – boards will work together to address some issues

(e.g., revenue recognition).2. Short-term convergence – the tow board agreed to undertake Short-

term project to remove differences between IFRSs and U.S. GAAP for issues where convergence is deemed most likely.

3. IASB liaison – IASB member in residence at FASB.4. Monitoring IASB projects – FASB monitors IASB projects of most

interest.5. Convergence research project – identification of all major differences

between IFRSs and U.S. GAAP.6. Convergence potential – FASB assesses agenda items for possible

cooperation with IASB.