IFRS: A Strategic Initiative

IFRS: A Strategic Initiative

International Financial Reporting Standards or IFRS are a set of high quality globally acceptable accounting standards formed by the IFRS Foundation for ensuring accountability in the financial statements of the companies. This makes easy to compare the financial performances of the companies from all over the world. The main purpose of IFRS Standards is to encourage transparency, accountability and efficiency in the financial markets for protecting the interests of the stakeholders of the companies (IFRS, 2018a). These accounting standards also help to foster economic growth and financial stability in the country. IFRS brings transparency in the financial information of the companies by making investors aware of the economic decisions that will be taken by them. Accountability can be achieved by reducing the gap in the information between the investors and the management of the company. The adoptability of a single accounting standard helps in identifying the risks and returns associated with an investment. The IFRS foundation which forms the basic principles  is based on three-tier structure; public accountability ensured by the monitoring board consisting of the capital market authorities, governance ensured by the trustees of the IFRS Foundation and independent standard setting ensured by the International Accounting Standards Board and IFRS interpretations committee (IFRS, 2018b).

Emergence of IFRS

Globalization in the world has led to free flow of capital between different countries and cross-border transactions in order to benefit from the global trade. One third of all the financial transactions now take place across borders which are expected to grow even more in the future (IFRS, 2018c). Thus maintaining a global set of standards has been important to ensure transparency and accountability in the transactions that are taking place throughout the world. Investors are always keen on finding new investment opportunities across the world and diversifying the risks associated with them. Companies on the other hand, intend to raise capital through international transactions and expand their business by developing subsidiaries in various countries. These cross-border activities were difficult to be carried out in the past as different national accounting standards existed in different countries. This resulted in increasing costs, complexity and risk for both the parties who were involved in the international transactions (IFRS, 2018c). The difference in the accounting standards led to ambiguity in the financial statements and consequently confused the investors and others who were responsible in making economic decisions based on those statements. The application of national accounting standards also meant that items were valued based on different accounting methods; thus small changes in requirements had major impacts on the financial performances of the companies (IFRS, 2018c). These issues were expected to be resolved by setting high quality globally acceptable accounting standards known as IFRS.

IFRS has been initiated to maintain a universal financial reporting infrastructure, to motivate beneficiaries for generating sound business, to make fair presentation of financial statements and to maintain higher transparency in the financial information. Some of the reasons for creating these international accounting standards are (Ashok, 2014):

It helps in the comparison of financial performances of different business entities,

It is the reporting standards of all the companies registered in the world stock exchanges,

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The universally accepted principles also help in effective communication with the stockholders of the companies, thus reducing inventory uncertainty and risk and increasing the market efficiency,

It enables cross-border trading in securities by bringing transparency in the transactions,

IFRS also enhances the quality and flow of information within the organizations thus enabling the managers to make effective and timely business decisions,

IFRS also improves the strategic business decisions and helps in reducing costs in long run,

The universal acceptance of the accounting standards helps in building new relationships with customers and investors across borders,

The cost of borrowing for the companies is also reduced as their financial positions with credit rating agencies are improved,

IFRS also helps the lenders in anticipating risks of lending fund to the companies.

Comparison with Initial Accounting Standards

SATTA or Statement of accounting Theory and Theory Acceptance was an approach formulated by a committee of the American Accounting Association (AAA) in 1977. The three basic principles put forward by this approach were; the classical models, the decision usefulness approach and the information economics model (Holthausen, 2009). The classical model emphasizes on the identification of best possible ways of generating income and wealth for an organization. The decision usefulness approach aims at providing timely information that are essential for taking crucial decisions. The information economics model views accounting information of an organization as one of its most important resources which has demand and supply as that of goods and services. This approach mainly provides solutions for solving financial accounting information. It mainly deals with the accounting information of an organization and ensures its transparency and accountability within that organization. IFRS on the other hand are the universal accounting standards that are effective for all the companies registered under the global stock exchanges. IFRS is a much broader concept that covers the important organizations of the world.

ASOBAT or A Statement of Basic Accounting Theory developed by AAA emphasized on the needs of users of accounting information (Holthausen, 2009). It defined accounting as the process of accumulating, analyzing and providing economic information to the users of such information in order to help them in making accounting decisions. The four basic principles of accounting under ASOBAT are; relevance which provides information that are useful for making decisions, verifiability which measures to what extent the consensus has been reached in the different statistical measures, freedom from bias which ensures unbiased and fair preparation of the financial statements and quantifiability, which refers to the capability of being measured in quantity.  ASOBAT, though a better measure than SATTA, it could not live up to the expectations of protecting the rights of the investors and shareholders.

The Conceptual Framework is a set of accounting principles formed by the Financial Accounting Standards Board (FASB) for comprehending the underlying concepts in financial reporting (FASB, 2018). This framework provides guidelines about which transactions or events should be accounted and the process of recognizing, measuring, summarizing and reporting them in the books of accounts. It does not intend to form new accounting standards but develop the existing ones. It forms the basis for discussing common accounting problems by asking the right questions, restricting the areas of conflicts arising in accounting judgments and discretion and ultimately imposing an overall discipline of carrying out the accounting decisions. This principle is also limited to providing solutions for only the accounting problems and not the financial statements of the companies.

IFRS and GAAP

IFRS Standards help in the preparation of financial statements of the companies and thereby provide useful information to the investors, shareholders, customers and other users. It also identifies the financial position, profitability and liquidity of a company to help the users in taking economic decisions. GAAP or Generally Accepted Accounting Principles are the principles or procedures issued by the Financial Accounting Standard Board for recording, summarizing and reporting of the financial data.

GAAP are the standard guidelines for financial accounting that are used in the United States, while IFRS standards are used globally for enabling smooth running of international trade. GAAP provides rules for treating large number of transactions whereas IFRS provides the guidelines that are to be followed in preparing the financial statements (Tyson, 2011).In GAAP, last in first out method of inventory is followed which leads to low level of reported  income as the actual inventory levels cannot be depicted. On the other hand, IFRS Standards strictly follows the first-in first-out and weighted average methods for measuring the levels of inventory. GAAP requires writing the value of the inventory based on its market value and does not reflect the changes taking place in the market value. In IFRS, the values of the inventory can be reversed according to the changes in the market value and thus is a more flexible concept than GAAP. The concept undertaken by IFRS for capitalizing and amortizing the development costs over multiple periods is not present in GAAP. The latter concept requires all the development costs to be charged as expenses as and when they are incurred by a company. The going concern concept is not prevalent in US GAAP framework, whereas IFRS emphasizes both accruing and going concern concepts of a business (Tyson, 2011). IFRS has focused on transparency, accountability and efficiency in preparing the financial statements of companies thus helping in international business. GAAP on the other hand ensures mainly relevance and reliability in the financial statements giving less importance to the comparability.

Despite the differences between GAAP and IFRS, the conceptual frameworks of both these guiding principles refer to the effective use of accounting objectives and characteristics. Both of these principles provide guidelines for preparing the three financial statements; income statement, cash flow statement and balance sheet of the company. They follow the accruing concept which requires recognizing the revenue only after it is realized or being capable of realized. The two concepts are formed to protect the rights and interests of the stakeholders of the companies.

Strategic Effects of IFRS

Securities and Exchange Commission (SEC) is the regulator of public capital markets in the United States. The agency is responsible for prescribing the format and content of the financial statements filed with it (Cherry & Schwartz, 2013). The issues in IFRS that are addressed by SEC are the effective implementation of the IFRS standards worldwide, independence of the standards, transition issues, educating the investors, impact on the environment, impact on the issuers and knowledge of the human capital. The adoption of IFRS Standards led to the increase in the quality of valuation in the equity markets thereby reducing the risk for the investors as the financial information are more accurately provided. The small investors in the capital markets are benefitted through the uniform standards as they are able to compete effectively with the professionals in the market. Large organizations which have huge databases are able to reduce their cost of processing financial information as the differences in the accounting standards are eliminated. This in turn will increase the market efficiency and benefit the investors of the capital market. The reduction in differences of the accounting standards has also helped in removing barriers in the international acquisitions and divestitures. The increase in the quality of financial information due to these universal standards has led to the reduction in the firms’ costs of equity capital, thus increasing their share prices in the market and making more investments (Gornik-Tomaszewski & Showerman, 2010). The managers are also encouraged to act in the interest of the shareholders for the increased transparency in the financial statements.

Companies across the world have differences in their strategy, investment policy, financial policy, technology, industry, size, structure, geographical background, government regulations and socio-economic conditions (Gornik-Tomaszewski & Showerman, 2010). Thus the ways they use their capital and run the labor and product markets are also quite different from each other. This makes it quite difficult to implement universally accepted principles throughout the world. Furthermore, using accounting choices based on uniform standards may not prove to be fruitful in case of unexpected and uncertain situations. Change in any new method includes training and education of the employees who are responsible for preparing the financial statements (Gornik-Tomaszewski & Showerman, 2010). Thus this will increase the costs of adoption of the IFRS principles. The adoption of these principles also possesses political and economic threats to the country if they are not effectively implemented.

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Challenges of Implementation

Some of the major challenges faced in adopting and implementing IFRS Standards are:

International Convergence– It is difficult to estimate the extent of adoption of the universal accounting standards that leads to the international convergence. There is absolute definition for adoption that can be treated as the measure of progress towards the international convergence of the accounting principles. It may differ across the different borders which ultimately leads to the time lag in adoption in various under developed countries. Furthermore, the national standards may not be in full accordance with the international standards thus creating a confusion in the compliance of the financial statements with that of IFRS Standards (Willmore, 2015).

Translations of International Standards- The language barriers across the different countries make it difficult to translate the standards of IFRS and implement them accordingly. Some of the issues in this sector were that the use of complex sentences which made translation difficult, the inconsistent use of terminology, use of the similar words for describing different concepts and the use of such terminologies which cannot be translated (Christensen, Hail,& Leuz, 2013).

Complex Structure– The complexity in the structure of the international standards made it difficult to be adopted and implemented. The international accounting standards formulated for audit risk, fraud and quality control were pointed out as the main issues in the structure (Willmore, 2015). They also neglected the fact that many countries had to adopt the international standards on the basis of their country’s laws and regulations.

Knowledge Shortfall– The increasing challenges of global issues, transactions and financial products require the accounting professional to have adequate knowledge in order to deal with them (Christensen, Hail,& Leuz, 2013). Thus, education and training were needed to increase the knowledge of the users of the international standards so that they develop the specific skills to apply them.

Challenges of SME– The small and medium sized enterprises in many countries need to prepare their financial statements according to the national standards in accordance with the generally accepted accounting principles set by the laws and regulations (Samujh & Devi, 2015). These information are filed with the government and are available to the public, investors, creditors, suppliers and many other; thus implementation of international standards becomes difficult for them.  

Endorsement of IFRS– Inadequate involvement and acceptance of the international standards have also made it difficult to be implemented in the countries. 

Adoption and implementation of international standards can be achieved with full participation from the board of directors, management, auditors, employees, regulators and other participants who are responsible for the process of financial reporting in a company.

Impact of IFRS on US Accounting Standards

IFRS adoption has affected the financial reporting process of the public firms in US along with its auditing, taxation and consulting functions. The impact had been huge on the small accounting firms due to the scarcity of resources for adopting the international standards. The IFRS though not fully adopted by US, the staff of SEC office explored various ways of incorporating a set of high-quality global accounting standards (PWC, 2018). The country plans to discuss about the implementation of IFRS though the public firms may continue following the GAAP principles of US (PWC, 2018). The SEC chief had expressed his views on eliminating the differences in the standards established by FASB and IASB by following the footsteps of IFRS Standards. IFRS has been prevalent in various big and small US companies for cross-border mergers and acquisitions, subsidiaries present in foreign countries and the presence of non-US stakeholders in the companies. The subsidiaries have been asked to prepare financial statements on the basis of both the accounting standards. Though the IFRS standards have not been fully implemented in the country, the adoption of certain guidelines and principles has led to the increase in international business. The transparency and accountability have increased in the accounting information and financial statements resulting in gaining confidence of the investors (Weiss, 2011). US companies are always looking for global opportunities to expand their business internationally, thus adopting IFRS Standards has proved to be beneficial for them. Huge amount of US capital have been invested in foreign markets where IFRS standards are predominant. Thus, the country needs to formulate the international standards for sustaining in the market.

Conclusion

IFRS Standards aim at bringing transparency, accountability and efficiency in preparation of the financial statements which consequently helps in protecting the rights and interests of the investors. The transparency helps in comparing the financial information of companies across borders, which in turn enables the investors to take useful decisions. Accountability and efficiency on the other hand enrich the quality of information provided to the various users and encourage the investors to make new investments. Adopting such international standards require costs and efforts on part of both the organizations and the government. Changes need to be done in the systems and procedures of the accounting transactions and financial information. This is turn must be carefully analyzed by the investors and other users to identify the information relevant to fulfilling their purposes. Furthermore, changes must be made in the securities markets by its regulators and other accounting professionals to bring compliance with the change in the accounting standards. Thus, it can be said that the implementation of IFRS Standards proves to be beneficial to the advent of globalization in the world.