International Financial Reporting Convergence

International Harmonization of Accounting Standards

• The evolution of the IASC and IASB illustrates how international accounting standard-setting has been in the private sector, supported by accounting bodies, standard-setters, capital market regulators, government authorities, and financial statement preparers/users.
• Harmonization allows different countries to maintain varied standards, provided they do not conflict, differing from standardization.
• Standardization means eliminating alternatives in accounting for economic transactions whereas Harmonization reduces alternatives while maintaining flexibility in accounting practices.

Considerations for Accounting Harmonization

• Accounting harmonization involves either regulations/standards (formal) or practices (material), aiming for international harmonization.
• Harmonization can be hindered by audit quality, enforcement mechanisms, culture, legal requirements, and socioeconomic/political systems.

Harmonization Efforts via IASC

• The IASC, established in 1973, intended to formulate "international accounting standards."
• It was funded by member bodies, multinational companies, financial institutions, accounting firms, and IASC publication sales.

Three Phases of IASC's Work

• Lowest-Common-Denominator Approach (1973-1988): Issued 26 generic IAS, many allowing multiple options, accommodating existing practices and introducing little comparability across countries.
• The Comparability Project (1989-1993): Published the Framework which led to the elimination of most accounting treatment choices and 10 revised IAS were approved in 1993.
• IOSCO Agreement (1993-2001): Led to the creation of the IASB.

Creation of the IASB

• The IASC proposed a revised structure and process for developing international accounting standards, leading to the IASB's creation.
• Recommendations balanced geographic representativeness with technical competence and independence.
• The IASB formation in 2001 shifted focus from harmonization to convergence and global standard-setting, marking a new era in international financial reporting.

Structure of the IASB

• The IASB operates under the IFRS Foundation, an independent entity.
• The IASB's structure includes the IASB itself, the IFRS Foundation (IFRSF), the Monitoring Board, and the IFRS Interpretations Committee (IFRSIC).

Monitoring Board

• Its members include the European Commission, the Growth and Emerging Markets Committee of IOSCO, the U.S. SEC, and securities regulators from Brazil, Japan, China, and South Korea.
• The Monitoring Board enhances the public accountability of the IASC Foundation, participates in trustee nominations and approvals, and oversees IASB activities (agenda-setting) to improve financial reporting accuracy and investor protection.

Trustees of the IFRS Foundation

• There are 22 trustees that represent different geographical areas, including auditors, preparers, users, academics, and public officials.

Responsibilities of the Trustees

• Trustees appoint IASB members and establish their service contracts and performance criteria.
• They appoint members to the International Financial Reporting Interpretations Committee and the IFRS Advisory Council.
• They conduct annual reviews of the IASC Foundation and the IASB strategy and its effectiveness, including the IASB's agenda.
• They approve the IFRS Foundation’s annual budget and determine its funding basis.
• They review broad strategic issues affecting accounting standards, promote the IASC Foundation, as well as review compliance with operating procedures and consultative arrangements.
• They approve amendments to the constitution, consulting with the IFRS Advisory Council and publishing Exposure Drafts for public comment.
• Trustees exercise all powers of the IFRS Foundation, excluding those reserved for the IASB, the IFRS Interpretations Committee, and the IFRS Advisory Council.
• They foster and review the development of educational programs and materials.

International Accounting Standards Board

• The IASB is responsible for setting IFRS standards.
• They develop and issue IFRS and Exposure Drafts and approve interpretations developed by the IFRIC.
• The Board includes 14 members (11 full-time, up to 3 part-time), selected based on professional competence and experience.
• The board consists of four members from the Asia/Oceania region, four from Europe, four from the Americas, one from Africa, and one member is appointed from any area to maintain geographical balance.

IFRS Advisory Council

• This council provides a forum for organizations and individuals interested in international financial reporting.
• They advise the IASB on priorities and inform the IASB of the views of the Council members on major standard-setting projects.
• About 40 members serve three-year terms.

IFRS Interpretations Committee

• There are 14 Committee members, appointed by the Trustees for three-year terms.
• They interpret IFRS application and provide guidance on issues not specifically addressed in IFRS or IAS.
• The Committee publishes Draft Interpretations for public comment and considers their comments before finalizing an interpretation, as well as obtaining Board approval for final interpretations.

International Sustainability Standards Board

• This is a deliberative body that develops and issues globally accepted standards for sustainability reporting.

From Harmonization to Convergence of Financial Reporting Standards

• The IASB shifted from being a harmonizer to a global standard-setter.
• Convergence can mean enforcing a single set of standards, diminishing differences, or a core set of common standards with varying interpretations.

Three Approaches to Convergence

• Merge all standard-setting bodies into a unified global body *optimal, but difficult.
• Recognize each standard-setting body as the sole authority in its jurisdiction *discretion superior to uniformity
• Recognize that a national standard-setting body can coexist with international coordination bodies

Goal/Strategy of the IASB

• The main goal is to achieve international convergence with its standards in order to develop a high-quality set of standards for international financial reporting (global standard-setting).
• Strategy is to identify the best standards worldwide and build a body of accounting standards that constitutes the highest common denominator of financial reporting.

Major Concerns in Achieving IFRS Convergence

• Complicated nature of particular standards, especially those related to financial instruments and fair value accounting.
• IFRS as a basis for taxation may be problematic for countries with tax-driven national accounting regimes.
• Disagreement with certain significant IFRS, especially those related to financial statements and fair value accounting.
• Insufficient guidance on its first-time application.
• Little benefit for countries with limited capital markets.
• Investor/user satisfaction with national accounting standards.
• IFRS language translation difficulties.

Other Harmonization Efforts

• Several international organizations have been involved in harmonization efforts:
  • Regional: EU, Association of Southeast Asian Nations
  • Worldwide: UN
  • Other organizations: IOSCO

International Organization of Securities Commissions (IOSCO)

• It facilitates cross-border securities offerings and listings and has advocated for the adoption of high-quality accounting standards for cross-border listings.

International Federation of Accountants (IFAC)

• IFAC has 160 member bodies and associates in 135 countries.
• It establishes and promotes adherence to high-quality professional standards on auditing, ethics, education, and training.
• In 1999, IFAC launched IFAD to enhance the accounting capacity and capabilities in developing and emerging nations.
• Membership includes WB, IMF, Asian Development Bank, IOSCO, IASB, SEC, and large accounting firms.
• The primary aim of that forum is to promote transparent financial reporting, duly audited to high standards by a strong accounting and auditing profession.

International Forum on Accounting Development (IFAD)

• It promotes transparent financial reporting and accounting responsibility to support the public interest.
• It focuses to accounting/auditing needs of developing countries.

Goal of IFAD

• Cooperation between governments, accountancy and other professions, international financial institutions, regulators, standard-setters, capital providers, and issuers of financial statements.

European Union

• Its aim was to create a unified business environment, through:
  • Harmonization of company laws and taxation.
  • Promotion of full freedom in the movement of goods and labor between member countries.
  • Creation of a community capital market.

Arguments for Convergence

• Facilitate better comparability of financial statements, which allows for easier evaluation of potential investments in foreign securities and to take advantage of the risk reduction possible through international diversification.
• Facilitate international mergers and acquisitions.
• Reduce investor uncertainty and the cost of capital.
• Simplify auditing
• Easy transfer of accounting staff internationally.
• Raise the quality level of accounting practices internationally, increase the credibility of financial information, and enable developing countries to adopt ready-made, high-quality standards with minimal cost and effort.

Arguments Against Convergence

• Significant differences in existing standards (enormous political cost of eliminating differences).
• Difficulties in arriving at universally-accepted principles due to nationalism and traditions.
• A need for common standards is not universally accepted (well-developed global capital market already exists).
• Standards overload because some enterprises might comply with a non-relevant set of standards.
• Necessary differences in accounting across countries due to differing environmental influences.

A Principles-Based Approach to International Financial Reporting Standards

• The IASB follows a principles-based approach to standard-setting, meaning it relies on high-level, broadly stated principles rather than detailed, prescriptive rules
• Standards here establish general principles for recognition, measurements, and reporting requirements for transactions, limiting guidance and encouraging professional judgment in applying general principles to entities or industries.

IASB Conceptual Framework

• The purpose of this Framework is to assist the IASB in developing future standards and revising existing standards; it will result in a set of financial statements useful for making investment decisions.

Potential Users of Financial Statements

• Investors, creditors, employees, suppliers, customers, governmental agencies, and the general public.

Framework deals with

• 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.

Objective of Financial Statements and Underlying Assumptions

• The primary objective is to provide information useful for decision-making.
• Financial statements must be prepared on an accrual basis and the enterprise must be considered a going concern.

Qualitative Characteristics of Financial Statements

• Understandability, relevance, reliability (neutrality and faithful representation), and comparability.

Elements of Financial Statements: Definition, Recognition and Measurement

• Assets: Resources controlled by the enterprise which will provide future economic benefits, and are only recognized when probable economic benefits will come.
• Liabilities: Present obligations arising from past events to be settled through an outflow of resources, and are recognized when a probable outflow will occur.
• Income: Increases in equity other than from transactions with owners, and recognized when the increase in an asset or decrease in a liability can be measured reliably.
  • Expenses: Part of income that decreases in equity, recognized when the related decrease in assets or increase in liabilities can be measured reliably.
  • Revenues: Part of income that increases in equity.
• Equity: Assets - Liabilities.

Concepts of Capital Maintenance

• Financial Capital Maintenance: historical cost.
• Physical Capital Maintenance: current cost.

Presentation of Financial Statements (IAS 1/IFRS 1)

• Provides guidance on the purpose of financial statements (to provide information for decision-making) and components of financial statements (balance sheet, income statement, statement of cash flows, statement of changes in equity, and notes).
• The principle of fair presentation dictates that financial statements shall present fairly the financial position, financial performance, and cash flows of an entity.
• Accounting policies shall be in compliance with all IASB standards and applicable interpretations.

Basic Principles and Assumptions

• Accrual basis: accruals are amounts of money that have been earned or spent, but not yet paid.
• Going-concern assumption: the company is financially stable enough to meet its obligations and continue its business for the foreseeable future.
• Consistency/Comparability: Continuity of accounting principles.
• No offsetting of assets/liabilities/revenues/expenses: not netting.

Structure and Content of Financial Statements

• Current and noncurrent distinction of assets and liabilities.
• Items to be on the face of financial statements.
• Items to be disclosed in the notes.

Adoption of IFRS

• IFRS can be adopted in different ways, including replacing national GAAP for all companies, consolidated entities preparing group-level financial statements, stock exchange-listed companies, foreign companies listing on domestic stock exchanges, and domestic companies that list on foreign stock exchanges.

IFRS in the European Union

• In 2002, the EU issued a directive requiring domestic-listed companies to use IFRS for consolidated accounts as of 2005.

Objectives of the EU directive

• Improve the quality of corporate financial reporting.
• Increase comparability and transparency.
• Promote the development of a single capital market in Europe.

IFRS in Other Countries

• China and India: Maintain domestic accounting standards (national GAAP) but have undertaken convergence initiatives to align with IFRS.
• Japan: Japanese GAAP differs materially from IFRS, though companies can receive permission for other GAAP-U.S. or IFRS.
• United States: In 1996, the U.S. SEC announced three criteria for cross-listing. In 2002, as part of the Norwalk Agreement, the IASB and FASB pledged to make their existing financial reporting standards fully compatible as soon as practicable, and to coordinate their work to ensure that comparability is maintained.

The Great Financial Crisis

• The Financial Crisis Advisory Group (FCAG) addressed effective financial reporting, limitations of financial reporting, convergence of accounting standards, and standard-setting independence and accountability.

FASB/IASB Fair Value Measurement Project

• The FASB and IASB developed a consistent and converged framework for measuring and disclosing fair value in financial reporting.
• Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

IFRS for SMEs

• Expensing all R&D expenditures versus capitalizing the development costs.
• Requiring the equity method for all investments in associates (affiliates) and joint ventures.