Adoption of International Financial Reporting Standards

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Adoption of International Financial Reporting Standards (IFRS) in European Union

Introduction

International Financial Reporting Standards (IFRS) followed by International Accounting Standards Board (IASB) is a uniform format of financial coverage which has gained momentum globally and is a distinct reliable accounting model, which most likely will become predominant.

Carmona and Trombetta (2008) measured the logic and significances of the principles-based arrangement and proposed that the approach based on principles to the criteria and its internal tractability allows the appliance of IFRS to countries with various accounting customs and varying institutional circumstances. Moreover, they added that "the principles-based approach involves major changes in the expertise held by accountants and, hence, in their educational background, training programs and in the organizational and business models of accounting firms" (Salvador, and Trombetta 455-461).

Benefits

Adoption of IFRS - EU experience

According to Johnson (2007) "The European Union started their transition in 2002 and it ended in 2005. The experience of the European companies also brought on confusion and a burden on their companies, just like the United States is experiencing now. However, the main reason for the EU's confusion was mainly due to IASB's (International Accounting Standards Board) failure to finalize many of their rules. The EU's switch ended up going smoothly and successfully."

The adoption of IFRS in European Union constituted one of the biggest financial reporting alterations in current years and was debatable. The adoption of IFRS results in the use of a universal set of financial coverage standards within Europe, and between Europe and many other countries that require or apply IFRS.

Investors reacted positively to the switch over towards IFRS since they expected that application of IFRS would result in positive cash flow effects. The transmission included reduced contracting costs (Beatty et al. 1996) or decreased range for managerial rent removal connected to greater financial reporting clearness (Hope et al. 2006). Also the reaction on the part of the investors will be positive if they believe and feel that the movement towards IFRS would afford convergence benefits.

Barth et al. (1999) found that there was positive market results linked to convergence.[1] In the same way, Ashbaugh and Pincus (2001) found that earlier convergence efforts linking to IAS resulted in reductions in analyst estimates errors. Pae et al. (2007) discovered that firm values, shone in Tobin's Q, altered after the transition of EU rules meant to meet financial reporting, especially for firms with more agency costs.

Paul Boyle of the U.K. Financial Reporting Council stated that European Union's adoption of IFRS over the past three years was normally smooth, with a few exemptions. Actually several companies found Section 7 of IFRS covering the disclosure of financial instruments hard to construe. Some added as far as 250 pages to their annual report of financial particulars. "A man in one company advised me that I didn't have to read all 500 pages in their new annual report, that reading only 300 pages would give me a good idea of their industry. There are rumours that some annual reports in England have become so page-heavy that post office officials have balked at mailing them. Boyle says that the problem will be worked out with more experience" (Boyle, 2008).

The impact created by conversion to IFRS was much bigger and broader than expected. The EU experience states that it affects many areas beyond finance and includes human resources, business operations, IT, customers and external stakeholders. Furthermore, it can be learnt from the EU conversion that IFRS switchover will add considerable intricacy to a range of openings which firms currently pursue. These are mergers or acquisitions, expansion of global operations and new enterprise information systems implementation. IFRS renders companies with a major opening to attain broader transformational change and motor business gains beyond compliance.

The economic arguments for the adoption of IFRS are that it is being viewed by many as having very good quality and is sufficient for the task. Indeed there is some empirical research evidence which supports the belief that same standards of financial reporting globally will surely increase market liquidity, reduce transaction costs for capitalists, lessen cost of capital and finally facilitate international capital formation and flows. This is possible only and only due to the adoption of IFRS by firms (Barry, 2009).

It is true that IFRS conversion requires more human resource than may be available in the companies switching over. This creates without any doubt more job opportunities. It was found from the EU experience that the companies required additional staff to complete the project of switching over. And if larger organizations feel that resources can effortlessly be repositioned to meet demand will surely have to think again from the European experience. Normally, the bigger the company, the bigger the increase in human resource will be required. Human resources may facilitate in predicting resource needs and expand strategies to cover recruitment in key areas. From the EU experience it can be learnt that with the given present economy, harnessing staff deficits ahead of time is vital. Enrolling hired guns afterwards may turn out to be expensive and difficult as was experienced by EU.

The effect of IFRS on firms' info environment is not lucid ex ante. Actually IFRS is considered to set a high quality of standards which provides valuable information to investors (Ashbaugh and Pincus, 2001). Barth et al. [2008] found that firm' displayed quality increases, relative to local GAAP. Thus, this higher quality accounting management made reported earnings less piercing thereby improving analysts' prediction of accuracy and lowering the level of diffusion.

Switch over to IFRS in the EU has been quite successful and the main advantages gained are not only by the investors and other users of the final statements but some advantages are gained by the firms internally also.  IFRS reporting dynamically led to efficient management of the business. In reality IFRS harmonizes internal and external reporting since a single language of accountancy is being created and this is successful when it is applied all through a group's accounting processes. Thus it results in putting an end to the issues of interpretation linked to different accounting standards used in each country of operation.

Ernst & Young reexamined the 2005 financial statements of big EU companies that had switched over to IFRS. The firm also evaluated the level of consistency and equivalence among companies that ensued from IFRS acceptance and determined how operation measures founded on IFRS have been applied in market communications. The study conducted by Ernst & Young also reported that the 2005 switch over to IFRS was a reverberating success overall. The transition to IFRS demanded major alterations for all companies. The Ernst & Young study also established that the execution of IFRS has brought about importantly greater uniformity in accounting recognition and measurement, but the study at the same time states that there is still to go a long way before the full advantage of the switch over can be felt.

Conclusion

The acceptance of IFRS has without any doubt increased comparison of consolidated accounts as well as degrees of clarity for many companies. This was possible via elaborated section disclosures, accounting for unfunded pension responsibilities and the acknowledgement of differentials on balance sheets at fair value. In short the conversion to IFRS resulted in the following:

It was found that there was easier access to capital markets which lowered the cost of capital. Also processes adopted were centralized and standardized which had the ability to rationalize a disconnected financial reporting process with consistency in reporting. It also resulted in greater efficiency by making available the resources and efficient usage followed by reduced costs. Also there was improvement in internal controls which resulted in better financial info at the legal and amalgamated levels.

References

1. Ashbaugh, H. and M. Pincus. "Domestic Accounting Standards, International Accounting Standards, and the Predictability of Earnings." Journal of Accounting Research39 (2001): 417-434.

2. Barth, M. E., W. R. Landsman, and M. Lang. "International Accounting Standards and

Accounting Quality." Journal of Accounting Research 46 (2008): 467-498.

3. Barry, J. E. "The Economic Effects of IFRS, Investigating the Expected Benefits". The CPA Journal (2009):

4. Beatty, A., S. Chamberlain, and J. Magliolo. "An Empirical Analysis of the Economic

Implications of Fair Value Accounting for Investment Securities." Journal of Accounting and Economics22 (1996): 43-77. Print.

5. Hope, O., J. Jin, and T. Kang. "Empirical Evidence on Jurisdictions that Adopt IFRS."

Journal of International Accounting Research 5 (2006): 1-20.

6. Johnson, Sarah. "Could You Switch to IFRS in 3 Years?" On-line. (2007): Available from Internet, http://www.cfo.com/printable/

7. Kyle, A. "Continuous Auctions and Insider Trade", 1985, Econometrica, 1315-1335.

8. Pae, J., D. Thornton, and M. Welker. Agency Cost Reduction Associated with EU

Financial Reporting Reform. Working paper (2007): Queen's University.

9. Paul, Boyle, U.K. Financial Reporting Council (2008).

10.Salvador, Carmona, and Marco Trombetta. "On the Global Acceptance of IAS/IFRS Accounting Standards: The Logic and Implications of the Principles-Based System." Journal of Accounting and Public Policy. 27.6 (2008): 455-461. Print.

[1] Barth et al. (1999) shows that the net market effect of convergence is a function of two effects. The first is the direct informational effect, i.e., whether convergence increases or decreases accounting quality. The second is the expertise acquisition effect, i.e., whether investors become experts in foreign accounting, which depends on how costly it is to develop the expertise. Therefore, ex ante the net market effect of convergence is uncertain.

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