Chapter 3: 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 proposed changes to the IASB’s Framework
• Discuss the IASB’s Standards related to the first-time adoption of IFRS and the presentation of financial statements
• Describe the support for, and the use of, IFRS across countries

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Learning Objectives

• Examine the issues related to international convergence of financial reporting standards
• Describe the progress made with regard to IASB/FASB convergence project
• Explain the meaning of “Anglo-Saxon” accounting

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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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Arguments for Convergence

• Facilitate better comparability of financial statements
• Easier evaluation of companies
• Facilitate international mergers and acquisitions
• Reduce financial reporting costs
• Cost-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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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 Forum on Accountancy Development (IFAD)

• Mission was to improve the market security and transparency, and financial stability on a global basis
• Assists in defining expectations from accountancy profession
• Encourages governments to focus on the needs of developing economies in transition
• Harness funds and expertise to build accounting and auditing capacity in developing countries

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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 mail 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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EXHIBIT 3.2—The Structure of the IASB

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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
• 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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Proposed Changes to existing frameworks by IASB and FASB

• IASB and FASB will work on existing frameworks to provide basis for developing future standards by boards
• Phases of project
• Objectives and qualitative characteristics
• Elements and recognition
• Measurement
• Reporting entity
• Presentation and disclosure
• Purpose and status
• Application to not-for-profits
• Finalization

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Elements of Financial Statements

• 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

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The Norwalk Agreement

• Proposed Changes as per the discussion paper published jointly by two boards:
• Decision-useful objective encompassing information relevant to assessing stewardship
• Stakeholder approach (vs. U.S. framework of shareholder approach) — users other than capital providers explicitly acknowledged
• Asset of an entity would be present economic resource to which, through an enforceable right or other means, entity has access or can limit others’ access
• Emphasis on principle and guidance development for fair value measurements in IFRS—exit price as measurement base, or, if not—develop additional guidance

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Presentation of Financial Statements (IAS 1)

• Single standard providing guidelines for the presentation of financial statements
• Guidance areas
• Purpose of financial statements
• Components of financial statements
• Overriding principle of fair presentation
• Requires the faithful representation of the effects of transactions and events
• 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

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Presentation of Financial Statements (IAS 1)

• Basic principles and assumptions
• Adds to the guidance provided in the Framework
• Immaterial items should be aggregated
• Assets and liabilities, and income and expenses should not be offset
• Structure and content of financial statements
• Current/noncurrent
• Items to be included on face of financial statements
• Items to be disclosed in the notes

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First Time Adoptions of IFRS (IFRS 1)

• Provides guidance to companies that are adopting IFRS for the first time
• Requires compliance with all effective IFRS at the reporting date of an entity’s first IFRS financial statements
• Allows exemptions when costs outweigh benefits

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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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International Convergence Issues

• The complicated nature of standards such as financial instruments and fair value accounting
• The tax-driven nature of the national accounting regime
• Disagreement with significant IFRS, such as financial statements and fair value accounting
• Insufficient guidance on first time application of IFRS
• Limited capital markets are less beneficial
• Investor satisfaction with national accounting standards
• IFRS difficulties in language translation

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IASB/FASB Convergence

• The Norwalk Agreement reached in 2002 between the IASB and FASB pledged
• For compatible financial reporting standards
• Proper coordination of work program to maintain compatibility

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IASB/FASB Convergence

• IASB’s and FASB’s key initiatives in the Norwalk Agreement
• 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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IASB/FASB Convergence

• Following global financial crisis both groups formed Financial Crisis Advisory Group (FCAG)
• July 2009 FCAG report addresses:
• Effective financial reporting
• Limitations of financial reporting
• Convergence of accounting standards
• Standard-setting independence and accountability

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Anglo-Saxon Accounting

• Accounting systems prevalent in English-speaking countries including U.S., U.K., Canada, Australia and New Zealand
• Fundamental features:
• Micro orientation (firm level) with emphasis on professional rules and self-regulation
• Investor orientation
• Primary aim is efficient operation of capital markets
• Very transparent
• Less emphasis on prudence and measurement of taxable income or distributable income
• Substance over form

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End of Chapter 3

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