Discussion 8 - IFRS vs GAAP

International Convergence of Financial Reporting

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Learning Objectives

Explain the meaning of convergence

Identify the arguments for and against international convergence of financial reporting standards

Discuss major harmonization efforts under the IASC

Explain the principles-based approach used by the IASB in setting accounting standards

Describe the support for, and the use of, IFRS across countries

Examine the issues related to international convergence of financial reporting standards

Describe the progress made with regard to IASB/FASB convergence project

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International Accounting Standard-setting

Evolution of IASC and IASB shows international accounting standard-setting in the private sector:

With the support of the accounting bodies, standard-setters, capital market regulators, government authorities, and financial statement preparers

Harmonization allows countries to have different standards as long as they do not conflict

Accounting harmonization considered in two ways

Harmonization of accounting regulations or standards

Harmonization of accounting practices

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International Accounting Standard-setting

Other factors leading to noncomparable accounting numbers despite similar accounting standards

Quality of audits

Enforcement mechanisms

Culture

Legal requirements

Socioeconomic and political systems

International convergence of accounting standards refers to both a goal and the process adopted to achieve it

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Harmonization and Convergence

Harmonization

Reduction of alternatives while maintaining a high degree of flexibility in accounting practices

Convergence

Enforcement of single set of accepted standards by several regulatory bodies

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Harmonization

Can be considered in two ways

Harmonization of accounting regulations and standards

Harmonization of accounting practice

Ultimate goal of international harmonization efforts

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

Different from standardization

Standardization involves using the same standards in different countries

Allows for different standards in different countries as long as they do not conflict

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Harmonization Efforts

Several organizations were involved at global and regional levels

International Organization of Securities Commissions (IOSCO)

International Federation of Accountants (IFAC)

European Union (EU)

International Forum on Accountancy Development (IFAD)

International Accounting Standards Committee(IASC)

International Accounting Standard Board (IASB)

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International Organization of Securities Commissions (IOSCO)

Established in 1974

Initially limited its membership to regulatory agencies in America

Opened membership to agencies in other parts of the world in 1986

Aims at ensuring a better regulation of markets on both domestic and international levels

Works to facilitate cross-border securities offering and listings by multinational issuers

Advocates the adoption of a set of high-quality accounting standards

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International Federation of Accountants (IFAC)

Established in October1977 at 11th World Congress of Accountants in Munich

Promotes adherence to high-quality professional standards of auditing, ethics, education, and training

Launched International Forum on Accountancy Development (IFAD) to

Enhance the accounting profession in emerging nations

Promote transparent financial reporting

Established the Forum of Firms with an aim of

Protecting the interests of cross-border investors

Promoting international flows of capital

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European Union (EU)

Founded in March 1957 with the signing of the Treaty of Rome by six European nations

Issued two directives aimed at harmonizing accounting

Fourth Directive: Dealt with valuation rules, disclosure requirements, and the format of financial statements

Established the true and fair view principle

Provided considerable flexibility

Allowed countries to choose from among acceptable alternatives

Opened the door for noncomparability in financial statements

Seventh Directive: Dealt with consolidated financial statements

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European Union (EU)

Directives helped reduce differences in financial statements

Complete comparability was not achieved

European Commission decided not to issue additional accounting directives

Associated itself with efforts undertaken by the IASC toward a broader international harmonization of accounting standards

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International Accounting Standards Committee (IASC)

Established in 1973 by leading professional accounting bodies in 10 countries

Broad objective of formulating international accounting standards

Harmonization efforts evolved in three main phases

Lowest-common-denominator approach

Issuance of 26 generic International Accounting Standards

Comparability project

Publication of Framework for the Preparation and Presentation of Financial Statements

Comparability of Financial Statements Project

IOSCO agreement

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International Accounting Standards Board (IASB)

Replaced IASC in 2001

IFRS Foundation appoints board of 16 members

13 full and 3 part-time

Board approves standards, exposure drafts, and interpretations

Shift in emphasis from harmonization to global standard-setting or convergence

Main aim is to develop a set of high-quality financial reporting standards for global use

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Arguments for Convergence

Facilitate better comparability of financial statements

Easier evaluation of companies

Facilitate international mergers and acquisitions

Reduce financial reporting costs

Cross-listing would allow access to less expensive capital

Reduce investor uncertainty and the cost of capital

Reduce cost of preparing worldwide consolidated financial statements

Simplify auditing

Easy transfer of accounting staff internationally

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Arguments for Convergence

Raise the quality level of accounting practices internationally

Increase credibility of financial information

Enable developing countries to adopt a ready-made set of high-quality standards with minimum cost and effort

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Arguments against Convergence

Significant differences in existing standards

Enormous political cost of eliminating differences

Nationalism and traditions

Arriving at universally accepted principles is difficult

Need for common standards is not universally accepted

Well-developed global capital market exists already

May cause standards overload

Differences in accounting across countries might be necessary

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Principles-Based Approach to International Financial Reporting Standards

IASB follows a principles-based approach to standard setting vs a rules-based approach

Standards establish general principles for recognition, measurements, and reporting requirements for transactions

Limits guidance and encourages professional judgment in applying general principles to entities or industries

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IASB Framework

Created to develop accounting standards systematically

Framework for Preparation and Presentation of Financial Statement adopted by IASB in 2001 from IASC

Scope of Framework

Objective of financial statements and underlying assumptions (i.e., accrual basis accounting and going-concern assumption)

Qualitative characteristics that affect the usefulness of financial statements

Definition, recognition, and measurement of the financial statements elements

Concepts of capital and capital maintenance

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Qualitative Characteristics of Financial Statements

Understandability: Understandable to people with reasonable financial knowledge

Relevance: Useful for making predictions and confirming existing expectations

Affected by nature and materiality of information

Reliability: Neutral and represents faithfully what it purports to

Reflecting items based on economic substance rather than their legal form

Comparabilty

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Use of IFRS

Evidence of support for IFRS

Adoption by the EU – public companies in the EU were required to begin using IFRS in 2005

IOSCO has endorsed IFRS for cross-listings

IFAC G20 accountancy summit in July 2009 issued renewed mandate for adoption of global accounting standards

Latest IFAC Global Leadership Survey—emphasized that investors and consumers deserve simpler and more useful information

Adoption of IFRS in 2011: Japan, Canada, India, Brazil and Korea

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IASB/FASB Convergence

IASB’s and FASB’s key initiatives in the Norwalk Agreement in 2002

Joint projects – boards work jointly to address issues (e.g., revenue recognition)

Short-term convergence –remove differences between IFRS and U.S. GAAP for issues where convergence is deemed most likely

IASB liaison – IASB member in residence at FASB

Monitoring IASB projects – FASB monitors IASB projects of most interest

Convergence research project – identification of all major differences between IFRS and U.S. GAAP

Convergence potential – FASB assesses agenda items for possible cooperation with IASB

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