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Sample International Accounting Standards (IFRS) Verses National Accounting Standards (GAAP)

1.0 Introduction

The debate regarding the effectiveness of applying international accounting standards such as International Financial Reporting Standards (IFRS) over Generally Accepted Accounting Principles (GAAP) has been of an a great magnitude of over the years, fuelled by the effects of globalization. The IFRS, initially known as International Accounting Standards (IAS), was first issued in 2003 by the International Accounting Standards Board (IASB) (Ramanna and Sletten 2009). The main aim of IFRS was to unite accounting across the EU, which consisted of approximately 19 countries that time. The applicability of the IFRS got recognition globally, with about 70 countries by the end of 2009 evidenced to have adopted the IFRS (Ramanna and Sletten 2009). However, despite of their associated benefits, some large economies such as Japan, USA, Brazil, Canada, India, China and Japan continue to use domestically developed accounting in place of IFRS. This paper provides a comprehensive analysis of the relevance of adopting international accounting standards (IFRS) and its associated criticisms. However, before the actual analysis, the author presents a brief summary of the nature, scope, features, assumptions and requirement of IFRS for clarity purposes.

2.0 The Nature, Scope, Characteristics, Assumptions and Requirements of IFRS

Fundamentally, IFRS are designed to act as a common worldwide language for business affairs in order to facilitate the understandability and comparability of company accounts across international boundaries. The IFRS are built on three key assumptions.  The first assumption-going concern- is based on the postulation that a business entity will continue to be in operation for an infinite future (Epstein and Jermakowicz 2010). The second assumption states that the accounting figures (reported) will be based on a stable measuring unit. Moreover, the IFRS assumes that the preparation and reporting of company accounts is based on the assumption of constant purchasing power units.

Under the context of IFRS, the quality of a company’s financial statement is weighted against two primary features: materiality and faithful representation, and four secondarily (enhancing) characteristics, which include timeliness, comparability, verifiability and understandability. According to article 10 of the IAS 1 (IFRS), a company is obligated to provide five elements in its financial statements. The first element is the Statement of Financial Position consisting of details on the company’s assets, liability and equity.  The second element (Statement of Comprehensive Income) should detail the company’s revenues and expenses, which should be measured in monetary (nominal) terms under the historical cost concept. Other elements include the Statement of Cash Flows, statement of Changes in Equity, and Notes to Financial Statements.

3.0 Argument for and against the use of international financial accounting standards

The application of global accounting standards has received a number of both supports and criticisms over the past years.

3.1 Argument in Support

The adoption of the international accounting standards (IFRS) has been supported in many countries for a number of valuable reasons. Generally, the benefits associated with the adoption of IFRS ranges from economic value, political value to synchronization (network) value benefits. However, due to the presence of other support arguments that do not fall in any of these segments, the author has found it convenient not to base any of the inherent benefits in any on the underlying segments.  First, the proponents of IFRS can help a company to minimize the costs associated with information processing and auditing, particularly to the participants of capital markets (Barth 2007; 2008). Financial analysts argue that if informational costs are reduced with the adoption of IFRS, foreign investors will be encouraged to invest in the country thus boosting an economy’s level of foreign capital and trade. This argument is based on the factor that in the absence of IFRS, foreign investors will incur information costs in familiarizing themselves with domestic accounting practices. Such costs are said to greatly influence their investment destination country (Ramanna and Sletten 2009). In the absence of IFRS, financial analysts argue that investors may be faced with the information symmetry, which may result to investment risks attributable to adverse selection (unobservable private information) and moral hazard.

In addition, it has been argued that the adoption of IFRSs increases the understandability of a company’s financial statements to different users over to the use of local accounting standards such GAAP. With the effects of globalization, particularly the removal (relaxation) of trade liberalization, individuals do conduct businesses globally. This can be evidenced in UAE when the adoption of IFRS led to the establishment of ‘free trade’ zones, later the ‘free trade’ agreements, which enabled foreign firms to have access to tax-free reports coupled with considerably lower employment costs and significantly fewer regulatory requirements. Ideally, if you invest in different companies globally with distinct domestic accounting practices, it will harsh for you to comprehend each company’s accounting practices without the application of a common accounting standard (IFRS). Analysts, further, argue that with the international acceptance and understanding of IFRS, companies will be at a position to stay competitive and suppress global challenges arising from globalization of markets.

Another argument if support of IFRS is based on their underlying relative ease of comparability. Albrecht (2008) asserts that the adoption of IFRS helps companies, the public and investors to internationally compare financial easier. Comparability enhances consistency of the financial statements. Consider a multinational company having its operations in different countries with different national accounting. Will there be consistence in the financial reports from each subsidiary? In this case, it will be difficult to assess how the company is performing in different geographical (national) locations whose accounting practices are diverse. It has been argued that the requirements for companies to adopt a globalized set of accounting standards have an effect of ensuring trustworthy, reliable financial information regarding various corporate.

Moreover, since at the end of each financial year multinational companies are required to consolidate their financial statement across all nations, it will be difficult if each of its branches (in different countries) adopt its own national accounting standards over the application of a common international accounting practices (IFRS). IFRS enhances cross sectional comparison, that is, without the use of one set of accounting practices, it will be very difficult, in fact impractical, for a company to gauge its financial performance against that of its competitors in the same industry (Irvine and Lucas 2006). For example, assuming that the HP Company Ltd uses IFRS while Apple Company utilizes GAAP, then an investor may not correctively compare which of the two companies in the technology industry to invest in. According to Christopher Cox, the chairperson of SEC, IRFS provides a worldwide language of transparency and disclosure, which is the ultimate goal of global investors who seek to comparable financial data (information) in order to make rational investment decisions (Albrecht 2008).

The adoption of international over domestic accounting has also been supported for cost reasons. Analysts argue the cost minimization benefits (efficiency and costs savings) of IFRS are more prominent in multinational enterprises (MNEs) such as Toyota Motor Corporation, Coca Cola Company, Nestle, British Airways, among others. The use of IFRS is likely to strengthen its position to negotiate with financial (credit) institutions thus sinking its cost of borrowing, given the positive effects of IFRS on a company’s credit ratings. For a multinational corporation such as British Airways, the adoption of IFRS has spearheaded its ease of initiating valuable alliances, implementing cost-national acquisitions, and structuring collaboration agreements with foreign entities. According to Chand (2005), with the adoption of IFRS, multinational corporations have no further obligation to more than one set of account for distinct national jurisdictions.

Sources, further, reveals that the adoption of IFRS will help companies increase the hope for a higher level of capital mobility at a minimal cost (Irvine and Lucas 2006). Capital mobility refers to the ability of the company (private) funds to move across national boundaries with the aim of pursuing higher returns. This implies that multinational companies, which utilize IFRS in preparing and reporting its financial statements, have potential to improve their profitability positions by varying the capital investments in different nations. Irvine and Lucas (2006), further, postulate that the use of IFRS will result to efficiency allocation of resource among companies, which in turn facilitates productivity and profitability of a business enterprise. This argument can be linked the low nature of information costs attributed to the use of IFRS, discussed earlier.

3.2 Arguments Against

Despite of the benefits associated with the use of IFRSs, the standards have been received a number of criticisms over the past years, most of which can broadly be linked to the issues of uncertainty, conversion costs, diversity, lack of enforcement, among others. Before we into a conclusion of whether or not it is rational to for companies to adopt international accounting standards (IFRSs) in place of local accounting standards, it will be crucial for us to comprehensively understand the key arguments against its adoption, which are available of the critic’s desk.  First, it has been argued that the direct cost of converting a company’s accounting practices to IFRS may be considerably high (assuming the company had been using GAAP or any other local accounting practices). These costs are likely to take the form of employee training, buying and installation of new accounting systems, among other costs. Proponents argue that there is no evidence that adopting IFRS will minimize the cost of capital far much less to cover the humongous costs that might have been incurred by the company during conversion.

Second, there is evidence that indicate IFRS as being of less quality than local accounting standards like GAAP. For example, a comparative research conducted by FASB on the similarities between US’s GAAP and the IFRS in 1999 (essentially referred to IAS that time) revealed IFRS to be of lower quality than GAAP. Since then, not much has been done to improve the quality of the IFRS. Therefore, it may be difficult- as there is no evidence- to conceive someone that (maybe) currently the IFRS is far better than GAAP. In fact, another research by Teri Yohn of Indiana University arrived at the same results that GAAP might be as good as or even better than the IFRS. The research had found investors to prefer GAAP to IFRS.

Despite of the so-called ‘understandability benefits’ that have been attributed to the use of IFRS over the recent past, the proponents of the use of IFRS argue that underlying core principle associated with such standards is amorphous, undocumented and vacuous. Another key criticism in connected with international accounting standards is the possible environment of uncertainty that may arise. According to Albrecht (2008), the adoption of IFRS may create an atmosphere uncertainty, particularly in the evaluation of accounting standards. This is because; the international accounting standards (IFRS) authorize managers to exercise their individual judgment when making decisions on what to report in a company’s financial statements. It has been argued that this ‘excess freedom’ may result to possible errors (arising from say personal biasness) in repotting the financial statements of a firm. Such errors may make investors, shareholder, and even the general public to lose confidence in the financial statements. With the uncertainty in a company’s financial statements, there are chances for such companies to lose their credit position as weighted by relevant credit or financial institutions, which is a significant component of their debt financing through loans.

IFRS, unlike other local accounting standards have been criticized of lacking appropriate degree of enforcement by the relevant bodies. Although the International Accounting Standards Board oversees the enforcement of the IFRS, proponents of these accounting standards argue that the enforcement of IFRS is not adequately supervised as compared with the enforcement of local accounting standards, which are under the supervision of several organizations such as Securities and Exchange Commission (for the case of US). Some literature postulates that the use of international accounting standards may make the comparison of financial statement more difficult (Albrecht 2008). This argument is based on the fact that many companies different countries, though claimed to have complied with the IFRS, retains the right to modify those accounting standards. The implication, here, is that not all companies will completely switch their accounting systems to be in line with IFRS. This amounts to a condition of incomparability, which is one of the key issues that the IFRS claims to address.

Another problem with international accounting standards can be founded on its ease of implementation. Proponents of these standards argue that it is difficult, rather impractical, for companies in developing countries to adopt international accounting standards like IFRS.  It has been argued that the accounting practices and policies applied in some developing countries, to some extent, reflects the individual values, culture and the beliefs of those countries. A practice example can be traced back to the adoption of IFRS in the UAE countries and other GCC countries. In an effort to integrate the IFRS to the accounting systems of firms in such countries to suit the requirement of domestic businesses, the Chairperson of the GCC Accounting and Auditing Organization, Al Rashed, identified a number of deficiencies. It was argued that with the adopting of the IFRS, the GCC countries’ culture and belief would have been locked out. This implies that a company wishing to adopt the IFRS, in those countries, is to likely crash with cultural practices, individual values and beliefs (Irvine and Lucas 2006). This crash can be evidenced in Papua New Guinea and Fiji, where the motive to harmonization of financial reporting through the application of IFRS failed, since the process was driven by capital markets at the expense of local culture (Chand 2005). Moreover, the high-level of non-conformity with the IFRS by companies in Kuwait can be associated with lack of proper attention to amend to suit the economy’s economic infrastructure and legal structures. Further, in Bangladesh, companies are required to design and only use those accounting standards, which are consistent with the country’s Company Act (Mir and Rahaman 2005). In such situations, the applicability of international accounting standards may be insignificant. Other challenges identified with the implementation of IFRS in developing countries have been associated with a culture of low level of suffrage (accountability of voters), inadequate regulation (or in some regions no regulation), and fraud.

4.0 Conclusion

Based on the above discussion and other social, political and economic considerations- assuming appropriate relevant  cultural adoption measures will be implemented by institutions concerned- the adoption of the international accounting standards will yield more benefits than costs, if we based our argument on cost benefit analysis (CBA). In other words, if there will be one international accounting language, assuming minor adjustments in particular countries, companies, governments, investors, and the public will be at a position to understand,  and make appropriate comparisons. Therefore, it can rationally be argued from a professional accountant point of view that the switch from the utilization of local accounting standards: GAAP (for companies that apply them) to the adoption of international accounting standards (IFRS) will be essential if not vital.

Reference List

Albrecht, D. , 2008. Why Switch to IFRS from GAAP? [Online]. Available at: <http://profalbrecht.wordpress.com/2008/12/20/why-switch-to-ifrs-from-gaap/ > [Accessed 28 November 2012]

Barth, M.E., 2007. Research, standard setting, and global financial reporting. Hanover, MA: New Publishers.

Barth, M.E., 2008. Global financial reporting: Implications for U.S. Academics. The Accounting Review 83, p. 1159-1179.

Chand, P., 2005. Impetus to the success of harmonization: the case of South Pacific Island Nations. Critical Perspectives on Accounting, p. 209 – 226.

Epstein, B. J. and Jermakowicz, E. K., 2010. Wiley IFRS 2010: Interpretation and application of international financial reporting standards. Hoboken, N.J: Wiley.

Irvine, H. and Lucas, N., 2005. The rationale and impact of the adoption of international financial reporting standards: the case of the United Arab Emirates. [pdf]. Available at: < http://eprints.qut.edu.au/13041/1/13041.pdf > [Accessed 28 November 2012]

Mir, M. Z. and Rahaman, A. S., 2005. The adoption of international accounting standards in Bangladesh. Accounting, Auditing & Accountability Journal, 18 (6), p. 816 – 841.

Ramanna, K. and Sletten, E., 2009. Why do countries adopt International Financial Reporting Standards? [pdf]. Available at: < www.hbs.edu/faculty/Pages/download.aspx?name=09-102.pdf > [Accessed 28 November 2012]

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