Chapter 6
International Accounting Standards and Global
Convergence
Strategic Decision Point
Rules-based or principles-based standards? Rules-based
Detailed and complex standards Resulted in transaction manipulation Enlarged gap between managers and owners
Principles-based Reflects “true” underlying economic substance Provides increased protection for companies Makes comparability across companies difficult
Comparability of Accounting Information
International pressure exists for comparability, especially with MNEs
Different approaches to comparability Harmonization is more flexible Standardization suggests a state of
uniformity
Which groups are interested?
Governments Trade Unions Investors (including financial analysts) Bankers and lenders Accountants and Auditors
Pressures for Harmonization
Governments
Government involvement in accounting determination varies across the world
Do governments really use corporate reports? Information needed by governments is often too
extensive to include in the report Governments can demand whatever information
they need Information needs are extensive and confidential
These things suggest governments may not be important users of corporate reports
Is this a paradox? Explained by situations where governments might be
users
Government use of annual reports
Use reports, along with segmental information, to check performance of local subsidiaries of MNEs
Governments wish to monitor MNE operations as a whole
Governmental needs in differing departments can be accommodated by an annual report
Developing countries would have more information without bargaining for it with increased corporate disclosure
Governmental use of annual reports
Interest in extranational operations of MNEs
Intergovernmental organizations use this information for policy formulation (UN, EU).
Many governments desire increased bargaining power for information as members of intergovernmental organizations
Intergovernmental Organizations
United Nations 1976 study revealed lack of information 1979 – Working Group of Experts established
Emphasis on developing countries Have different interests from those of OECD and IFRS Major aim is international disclosure standards Intergovernmental Working Group of Experts on
International Standards of Accounting and Reporting (ISAR) established in 1983
Current issues deal with corporate governance Monitoring role in endorsing desirable standards UNCTAD – represented in
Standards Advisory Council of the IASB Advisory Panel of Small and Medium-sized Entities of the IASB
Intergovernmental Organizations
Organization for Economic Cooperation and Development (OECD) Represents industrialized nations Issued Guidelines for Multinational Enterprises
Aimed at strengthening confidence between MNEs and governments
Not required by law Guidelines are becoming more of a benchmark
Aim is to promote improvements in comparability and harmonization of standards
Intergovernmental Organizations – European Union
Involved in international harmonization of standards as part of company law harmonization
Goal is to promote European economic integration and development
No company should be at a disadvantage because of legal differences between countries
International Organizations – European Union
Interests of shareholders, lenders, suppliers, and other parties are protected
Directives in the EU have the force of law and must be ratified by member nations
Regulations become law without national ratification
Intergovernmental Organizations – European Union
Fourth Directive – approved in 1978 Requirements relate to
Disclosure Classification and presentation of information Methods of valuation
Compromise between European and Anglo-American systems
Contains detailed requirements for historical cost accounting with some flexibility
Intergovernmental Organizations – European Union
Fourth Directive Level of disclosure and transparency increased “true and fair view” concept adopted Does not adequately address
Foreign currency translation Leases and funds Cash flow statement
Intergovernmental Organizations – European Union
Seventh Directive – adopted in 1983 Control criteria other than ownership is applied on
an optional basis Requirements
Worldwide consolidations “Fair value” approach for assets purchased through
acquisitions Equity treatment of associated corporations Segmental disclosures of turnover by line of business
and geographical area Disclosure has been substantially improved
Intergovernmental Organizations – European Union
Additional Directives Eighth Directive – adopted in 1984
Deals with qualification and work of auditors Includes minimum educational requirements Encourages mobility of professional auditors
Proposed directive for employee disclosure was put aside due to MNE and government opposition Issues readdressed in Charter of Fundamental Social
Rights
Intergovernmental Organizations – European Union
Harmonization of stock exchange regulations and securities laws is also a prerogative Ensure investor access to sufficient information Promote capital market and stock exchanges
No plans for new directives “Mutual Recognition” approach was once
considered more effective IFRS adopted in 2005
Trade Unions and Employees
International Trade Union Confederations European Trade Unions Confederation International Confederation of Free Trade Unions World Confederation of Labor
Industry-specific trade unions Deal with individual MNEs
National Trade Unions Influence MNEs on a variety of levels
Information needs depend on contact with MNEs and purpose of information
Trade Unions and Employees
Power exists in the nation where they operate Unions have not grown beyond national boundaries
as MNEs have Trade union pronouncements are aimed at
establishing policies concerning MNEs Main concern centers on subsidiaries
Transfer pricing policies are a major concern MNE subsidiary transactions have received little attention
to date by regulatory bodies Information about the terms, conditions, scale,
security, and location of employment are of concern
Investors
Owners or potential owners of shares in the MNE parent corp. or a subsidiary
Interests are represented by international financial analyst organizations and IOSCO
Concerned with current lack of comparability Some want information approach rather than
a market approach to disclosure
Investors
International organizations ICCFAA and IOSCO
IOSCO - works for multilisting and international trading IOSCO is closely associated with the IASB
Want comparable information Interested in segmental information of MNEs Interested in consolidated results
Bankers and Lenders
Information needs are focused on financial positions, performance, and future prospects
Concerned with security of loans advanced Significant impact in France, Germany, Japan Have more direct access to required info International banks are involved in
harmonization and often require special financial reports (IFC, World Bank, etc.)
Accountants and Auditors
International Accounting Standards Board Formerly the IASC Governed by 14 board members Objectives
Propose international standards and promote their acceptance
Work toward improvement and harmonization of standards
Works for comparability of accounting standards
Accountants and Auditors
IASB Adopted 41 IAS standards, completed 5 new standards, and
revised 15 existing standards Achievements
Completed a core set of standards in 2000 as agreed with IOSCO for cross-board and national listings
Recent efforts are focused on EU compliance with IFRS in 2005 Endorsement by IOSCO was limited
Members of IOSCO are permitted to require reconciliation of certain items, supplementary information, and eliminate some options existing in IAS
Members will individually determine whether or not to endorse IFRS for cross-boarder listings
Figure 7.2: The IASB’s Governance Structure
Accountants and Auditors
IFRS and U.S. GAAP IASB and FASB are working toward similar
accounting standards FASB is researching international convergence
Objectives include Identify every substantive difference between U.S. GAAP
and IFRS Catalog those differences according to the strategy for
resolving them Recommend further agenda decisions to the Board to
further the objective of convergence with IFRS
Accountants and Auditors
IFRS and U.S. GAAP Benefits of convergence according to the FASB
Increased efficiency in capital markets by increased comparability and transparency from nation to nation
Reducing the administrative burden for MNEs by allowing only one set of financials to be prepared
Enable U.S. companies access to capital markets throughout the world without reconciling U.S. GAAP to IFRS
Accountants and Auditors
IFRS and U.S. GAAP Street, Nichols, and Gray (2000) suggest the gap
is narrowing Major differences are in the areas of
Property, plant and equipment revaluations Deferred taxes Goodwill Capitalized borrowing costs
SEC desires enforcement of international standards if they are in place
Accountants and Auditors
Rules versus Principles Recent scandals and aftermath perhaps show a
need for principle-based standards Sarbanes-Oxley requires the SEC to examine the
feasibility of principles-based standards Problems with principles-based standards
Guidance for application Comparability No guidance for complex transactions
Accountants and Auditors
Rules versus Principles Survey by Mike Ng (2004)
93% of companies surveyed reported that is was possible to apply rules-based standards but not reflect the economic substance of the transaction
Only 7% of companies surveyed believed principles-based standards would lead to a better reflection of economic reality
Results show that neither approach will ensure that companies report the economic reality of transactions
Accountants and Auditors
Noncompliance with IFRS is problematic IASI states that compliance means following IFRS and
each interpretation of IFRS Improper accounting treatment is not condoned by
explaining accounting treatments applied or by footnotes (paraphrase IASI).
Street and Gray (2000) found that only 775 of the companies in their sample stated they were fully compliant with IAS. International accounting firms are not supporting the
enforcement of IAS New structure of the IASB should help with compliance
Accountants and Auditors
International Federation of Accountants Sets international auditing guidelines Promotes international convergence of standards
International Auditing and Assurance Standards Board Independent body under the IFAC that creates
International Auditing Standards (ISA)
Accounting and Auditors
Reforms by the IFAC in cooperation with accounting firms, member bodies, regulators, and accounting organizations include: Establishment of the Public Interest Oversight Board to
oversee IFAC’s standard setting process Increased transparency with regard to IFAC governance
and international standard setting Public participation in the standard-setting process A more formal process of communicating with international
regulators
Accountants and Auditors
International Forum on Accountancy Development (IFAD) Created after the Asian financial crisis to aid developing nations Encourages conformity with IFRS Developed the International Financial Framework to aid in
improving standards within national financial frameworks Conducted a GAAP Convergence Survey (2002)
90% of countries surveyed plan to convert to IFRS Majority of countries surveyed plan to converge with IFRS by
establishing a government regulation or a standard-setting body Half of the countries surveyed see a barrier to convergence in the
complication of standards
Accountants and Auditors
International Association for Accounting Education and Research Promotes excellence in accounting education Contributes to development of international standards
The International Harmonization and Disclosure Debate
Some see harmonization and disclosure as a means to create a balance of power between MNEs and domestic corporations
More industrialized nations will not be totally supportive of increased regulation
Regional integration Long-term goal to remove market imperfections and
eliminate regulatory barriers (EU) Many countries are more concerned with protecting
their own business community at the expense of others
The International Harmonization and Disclosure Debate
Differences in reporting are due to differences in domestic needs
With domestic corporations, there is little concern for international standards
Natural accounting coordination will be a lengthy process according to research
Regional economic groupings (EU) and intergovernmental organizations (UN) will help
The International Harmonization and Disclosure Debate
Future developments will be centered on MNEs
May be less disclosure now in practice because of the complex nature of MNEs
National reporting requirements may limit disclosure