Question:
Discuss the international accounting standards and the conceptual framework: financial reporting.
Answer:
International Accounting Standards
Introduction:
Accounting standards are authoritative statements aimed at narrowing the areas of difference and varieties in accounting practices. The foundation of a strong financial accounting reporting architecture has been a long-lasting desire for professional bodies of accountancy, regulators, academics (Albu, Albu and Alexander 2014). This standpoint is reinforced by the fact that economic and political forces conceptually frame accounting. In the past, there were many countries developed and followed its own unique accounting standards. The main differences in measurement of accounting and reporting procedures of various countries were making it difficult to compare and evaluate financial information of companies from different countries (Angeloni 2016). In this way, the literature and the international accounting reality identifies the existence and manifestation of a process of bringing the national system of accounting to a common direction and developing a uniform system of financial reporting. However, the problems created by the divergence in accounting standards, mainly in the economic integration of the global business field, are so enormous that the pressure of global convergence of accounting standard is escalating (Arnold 2012).
This report will try to enhance the understanding of the market participants about harmonisation and convergence of financial reporting standards. The European perspective will evaluate the adoption process of IFRSs and critical analysis will take place, which will help the practitioners to use the new conceptual framework for financial reporting.
Harmonisation v Convergence:
There is a fundamental dissimilarity between harmonization and Convergence. In spite of knowing, the fact that IFRS are gradually becoming the need of the hour across the world and given aggressive attempts by companies in globalising their operations, some confusion still prevails over the differences between the adoption of harmonization and convergence attempts of accounting standards. Initially, FASB tried to minimize the differences between accounting standards through adopting harmonization approach for reporting purpose (Ball, Li and Shivakumar 2015).With this effort, the IASB shifted their focus from harmonization to convergence later in 1990s. Here, the focus of the convergence was to set a common platform for IFRS and US where single set of standards were used for financial reporting purpose. This allows companies to communicate better with their strategy to shareholders. However, the main issue, increasingly debated in the process of convergence, is that the convergence is expected to solve the inefficient reconciliation barrier that prevents foreign organisations from accessing local markets.
The benefits of convergence of accounting standards would be lower transaction costs for preparers of financial reports, since they would be able to comply with a single set of standards, instead of multiple sets. However, the Securities and Exchange Commission has long been hesitant to endorse convergence for financial reporting purpose. Firms are not like to use convergence of financial recordings because a huge costs is associated with this conversion procedure.
According to the IASB, the main difference between the GAAP and IFRS is the approach each takes to the standards. The focus of the harmonization was to mitigate the differences between accounting standards (Bohusova and Nerudova 2015). For example, GAAP and IFRS have a great deal of differences in the areas like valuations of inventory methods, depreciation rules and many more (Erb and Pelger 2015). Many national principle setting bodies now have the strategy of harmonization of IFRS. For example, the Accounting Standards Board has ensured that there can be no case for maintaining differences between the principles underlying UK and International Accounting Standards. Therefore, a national perspective of harmonization of reporting standards is the main objective of the term of harmonization whereas the convergence of financial standards identifies the cross-border differences between IFRS and GAAP (Tschopp and Huefner 2015). In convergence, the prime objective is to make a single set of standards which would be applied anywhere in the world. It means the perspective of international convergence is quite broader, by which those countries are also covered up who does not follow IFRS, like Japan and China (Bohusova and Svoboda 2015). However, the harmonization of accounting standards is directly connected with towards the convergence of GAAP and IFRS, which is the International Financial Reporting Requirements.
Advantages of Harmonisation:
Universal accounting Standards provides many added benefits towards the international economy.
Comparability: Harmonisation strives to increase the level of comparisons between different financial standards by setting limits on the alternative accounting treatments allowed for similar transactions (Yu and Wahid 2014). Investors and analysts can also compare the financial statements of global corporations since all companies adheres same set of principles for accounting. In addition, reliability of financial statements is also increased because the stakeholders are able to evaluate the financial performance of the firm based on the standards, which is known to them.
Decrease the reporting costs: Corporations invest huge money for financial reporting. Multinationals operates in different countries following different accounting standards and normally repeats the entire process for consolidation (Wang 2014). Following harmonized financial reporting standards, global corporations can reduce their operational costs because there is a requirement to prepare only one report for consolidation purpose. Additionally, it also enables an organized review. It helps organisation to evaluate the financial performances of overseas associates and subsidiaries.
Disadvantages of Harmonisation:
Differences in culture: IASB failed to maintain accountability at following the accounting standards in harmonized manner because social, cultural and political differences between countries are relevant for reporting purpose and corporations face many difficulties to translate such harmonized standards into the domestic language and used inconsistency (Green 2012).
Global enforcement: The suitable application of harmonized accounting standards completely depends on the individual government’s acceptability (Pelger 2015). In the year of 2008, for instance, the French Authority permits the Bank Society General to move the corresponding losses from 2008 to 2007 for presenting better financial position at the end of 2008. Therefore, harmonization in accounting standards provoked global disagreements in accounting practices.
The adoption of IFRS in the EU:
The European Union is one of the major users of IFRS in terms of market capitalisation. Since the year of 2005, the compliance with IAS is compulsory in the EU for the consolidation accounts of corporations with securities traded on the regulated market (Biondi 2014). However, there are many other countries who wants or waiting for application of IFRS in their business practices. Those companies in UK who do not use IAS need to apply the principles of UK GAAP.
National GAAP convergence with IAS is already practiced in UK (Tan 2015). Here, UK corporations are mainly focussed on maintaining consistency between IAS and UK standards. It is important for better understanding of financial reporting. This approach is significant for those UK organisations who would like to prepare their financial standards under the UK standards, but who also wish to ensure consistency with IAS in their statements (Christensen et al. 2015) As a result, the number of companies using IFRS for their reporting has remarkable increased since 2005. Approximately 8000 European companies filed their consolidated accounts using IAS. However, the Exchange Commission has not been approved to use of certain IAS standards by any UK companies like certain section of IAS 39 Instruments of Financial. The EC endorsed all the standards of IFRS except IAS 39 and IAS 32. Initially, there was a huge controversy raised when the EC endorsed the “curve out” version of IAS 39 in UK (Petaibanlue, Walker and Lee 2015). It established as a temporary option, which was differed from the rest of the world. Many researchers and analysts opposed the regulation at that time and the impact of IFRS has remained controversial since its adoption in the EU.
There are many practitioners in EU who would like to accept the implementation of IFRS as issued by the IASB, into their financial reporting purpose, but they are not reluctant in adoption of modified standards (Domil et al. 2015). According to Biondi (2014), it is not clear how investors in European firms would accept the changes in financial reporting. On the contrary, the recent marker research examines that investors in European corporations would react favourably towards the adoption of IFRS for resulting higher quality of accounting information (Crawford and Power 2015). It would also anticipate that issues may be reduced relating to information asymmetry between investors and corporations. Furthermore, researchers also might have believed that investors may be benefited with the convergence of accounting principles, such as lowering the cost of comparison of the financial performance of organisations. Apart from the discussion of investors’ perspective, modern researchers cover mandatory IFRS adoptions in the EU. It is observed from the study that overall convergence is beneficial for organisations, helps in transparency, market liquidity, efficiency of corporate investment and global capital flows (Christensen et al. 2015). However, researchers find it difficult to incorporate unpromising data such as essential changes made by other institutions, which directly affects in mandatory implementation of IFRS in the EU (Crawford et al. 2014). In addition, it has also been evaluated that benefits of IFRS were erratically distributed among various corporations and different countries due to have structural differences in the pattern of institutions.
Researchers find several aspects regarding the IFRS implementation in the EU. For example, the link between financial reporting and other institutions in the EU require further exploration which would have a direct effect in the capital market of the EU. The above findings suggest that the effects of adoption of IFRS have controversial effects in the EU. Although this study highlighted about the benefits, which may be achieved by the policy makers after accepting the adoption procedures of IFRS along with the details of what needs to be done in future.
The Conceptual Framework: Financial Reporting
Introduction:
The IFRS Framework describes the theoretical concepts, which are used in preparation and presentation of financial statements for external users. The major purpose of this is to resolving accounting issues and provides a guideline to the Board for future prospects of IFRSs (Barth, Nobes and Tarca 2015). The IFRS Conceptual Framework addresses a statement of principles for financial reporting.
Fundamental Qualitative Characteristics:
Financial information presented in financial statements requires some key qualities, which make it useful for the users. “IASB Conceptual Framework” segregates these into fundamental and enhancing qualitative characteristics. The characteristics are useful for financial reporting which identifies the types of information likely to be used for decision making in financial reporting purpose (Dichev 2015). There are three fundamental qualitative characteristics: Relevance and Faithful representation, and Materiality.
Relevance: Financial information is useful if such data is used for user’s decision-making process. Such information may have predicted value, confirmatory value or both. Both values of financial information are interrelated.
Faithful representation: The primary characteristics of financial information must represent the faithful data while preparing the financial statements. Such data seeks to ensure a plenty of underlying characteristics like neutrality, freedom from error and complete information (Erb and Pelger 2015). Therefore, the financial information is considered to be useful if it must follow both relevant and faithfully representation.
Materiality: Materiality ensures that financial information must have an entity-specific, which is expected to affect the decisions of users. All the items of financial information must relate with the individual entity’s financial report of a specific period.
Qualitative Characteristics for enhancement of financial suitability:
Apart from fundamental characteristics, the enhancing qualitative features like Verifiability, Comparability, Understand ability and Timeliness must be maintained that which will increase the usefulness of the financial information in reporting purpose.
Verifiability: Verifiability is all about the recognising information, which needs to communicate the fundamental economics of the firm’s business. Verifiability means of examining of a particular depiction that consists with different observer’s knowledge, although it is not essentially proves its authenticity (Gordon et al. 2015).
Comparability: Comparability of financial information with other individual entities is an important qualitative characteristic. Information about reporting entity must be compared with similar information of other entities in a specified period. It is helpful information of firms and the investors to evaluate the future condition of the business.
Ability of Understanding: Financial information must ensure its ability to understand by the users. The information must be presented clearly and concisely (Teixeira 2015). It may be classified, characterised for enhancing the better representation for users. For example, the deferred revenue expenditure is a kind of expenditure, which is an anticipated expense likely to be incurred in the coming years. This disclosure must be clearly specified into the financial statements for better understanding to users. It is a well-known fact that reports are organized for practitioners who have a sound knowledge of economics and a particular business. This information is useful for those who can analyse and evaluate such information with diligence and full integrity. Therefore, the level of understanding of financial information is an essential part of the financial framework for reporting purpose.
Timeliness: Disclosure of financial information must not be excessively delayed. The information will be useful, if it maintains the timeliness at the time of presenting the financial reports. For example, the five-year’s back financial data of a reporting entity is irrelevant for analysing the recent performance of the company.
Conclusion:
The first portion of the study investigates the usefulness of harmonization and convergence of accounting standards. Both advantages and disadvantages of harmonized accounting standards are evaluated in the report. Furthermore, the adoption of IAS in the EU is also incorporated into the analysis of the perception of firms and investors in the UK market. The prospects of IFRS adoption is however, a controversial issue in the EU.
In the second part of the report, the report discussed the Conceptual Framework for financial reporting which was prescribed by IASB. This framework provides a proper guideline to the Board in developing future IFRS. IASB classified this Conceptual Framework into the “fundamental qualitative characteristics” and “enhancing qualitative characteristics”. Here the financial framework considers the nature of the financial information by analysing the characteristics of comparability, verifiability, and materiality and so on. All characteristics of financial information must be incorporated for making it more useful for the financial users.
References:
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