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Over the last years, the International Accounting Standards Board (IASB) and the Financial Accounting Standard Board (FASB) are working on the establishment of a set of international accountings standard to reduce variation in accounting practice and introduce a degree of uniformity into financial reporting which will lead to a better comparability between companies and thus, will increase the degree of confident in the market.
In 2005, the implementation of the International Financial Reporting Standards (IFRS), created by the International Accounting Standards Board (IASB), for all companies listed on all stock exchanges in the European Union (EU) brings a main change in the valuation of assets. Indeed, IFRS constrains these companies to apply the Fair Value Accounting (FVA) techniques to assess the value of an increasing variety of assets. The IASB defines the Fair Value as being "â€¦ the amount for which an asset or liability could be exchanged between knowledgeable, willing parties in an arm's length transaction". (IASB 1999-IAS19, foreword, Perry and Nölke, 2006)
The major issue with this valuation technique concerns the IAS 39, dealing with recognition and measurement of financial instruments (substantially revised in 2003). For companies that invest, borrow or use derivatives significantly raises the standard larger than any previous standard in all areas of accounting. For early adopters, the standard changes the way they account for their financial instruments and it involves significant changes in systems, procedures and documentation. Some changes in IAS 39 affect preparers of accounts under IFRS, in areas such as the classification of assets, derecognition and other key areas. (FocusIfrs.com)
These changes impact the balance sheets of financial institution which are more sensitive to the fluctuation in the fair price. Furthermore, the Global Crisis highlighted this delicate question of the fair valuation of financial instrument as political bodies seems to think that it has contributed to increase the consequences of the crisis on banks, financial markets and the overall economy (Bengtsson, 2011 and Walliser, 2012).
The dissertation is not aimed to study which evaluation method is the best in the public's interest but to make an overview of different theories of accounting regulation in a global context with a focus on the IASB.
In order to be able to identify these different theories, this literature review will discuss the previous research paper on this subject. The first part focuses on the creation of a single set of accounting standards while the second one is about the controversial concept of fair valuation of financial instrument.
The creation of a single set of accounting standards
Why the European Union want a single set of accounting standards
According to Thorell and Whittighon (1994) financial accounting is a tool of communication between the company and the rest of the world. However, financial accounting is regulated by different rules in accordance with the country where they come from. Each country has its own National Accounting Standards and they differ from one country to another, creating some difficulties for investors and companies who are operating internationally and/or have shares that are traded on financial markets and who have to satisfy the information needs for investors in different countries.
Nowadays, a number of factors have conducted to the need of a common set of accounting standards. Carmona and Trombetta (2008), referring to other studies (Flower, 2004 and Ball, 2006) gave some examples like the political integration (especially in the European Union) or the globalization of financial markets. Akman (2011) added that the increase in cross country capital transfers and foreign direct investments evolved the necessity of eliminating or minimizing the differences in accounting standards to enhance comparable financial information globally. A common set of accounting standards would also allow a free flow of financial information required for the conception of a common market which would permit a free mobility of capital, labour and enterprise, as well as trade, across the borders between member countries. The idea of a common market is a fundamental objective of the European Union and, as well as the worldwide integration of the financial markets or example, they are the forces that encourage the development of a single set of accounting standards throughout the world. (Thorell and Whittighon, 1994 and Hopwood, 1994)
As a result of such developments, several institutions have emerged:
the International Accounting Standards Board (IASB),
the Financial Accounting Standards Board (FASB),
the OECD Working Group on Accounting Standards,
the UN Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting,
the EU's Accounting Advisory Forum,
the International Federation of Accountants (IFAC),
the International Organization of Securities Commissions (IOSCO),
the Federation des Experts Comptables Europeens (FEE)
There also are other regional and international regulatory, occupational and pressure groups that have been created in order to harmonized the accounting standards. They all have different interests and a very active politic movement has emerged between them. (Hopwood, 1994) The fact that political organizations are involved in the creation process is not surprising because they all want to keep their own accounting standard and this is the reason why the decision of the European Union (EU) to give the responsibility of creating a single set of accounting standards to a private body on which the EU does not have control is unforeseen. (Chiapello and Medjad, 2009) However, Perry and Nölke (2006) explain the choice of the EU to subcontract the creation of the accounting standards by the fact that the EU did not want to comply with the FASB and thus, conceding control of the accounting regulation to a US standard setter.
In their study, Chiapello and Medjad (2009) examine the possible reasons why the EU gave such a responsibility to a private body. First, it appears that there was no other option as the EU's members were not able to agree on a common accounting system. The IASB was the only viable option because their standards could be applied as "Global private standards" and not as "Foreign private standards" which is more acceptable for the host country. Moreover, unlike standards created by governmental agencies, IASB/IFRS standards are expected to better reflect markets' and societies' concerns. The rational and lower cost of this option seems to be another reason to explain the outsourcing of the creation of a single set of accounting standards to a single private agency (Chua and Taylor, 2008). Indeed, the IASB standards are considered to be "soft-law" (Non-mandatory principles that may have practical effects) and thus, could allow the EU to save money by stepping back and by letting the IASB creates internationally recognised standards without having to pay anything (Chiapello & Medjad, 2009).
Nevertheless, such outsourcing must also be perceived to be legitimate and, because they have three characteristics required of a technology for global governance (e.g. sponsorship by powerful interest groups/regulators, internationality and plasticity) (Chiapello & Medjad, 2009), and because it is the successor of the IASC (Whittington, 2008), the IASB can be considered legitimate. However, Chua and Taylor (2008) also said that transferring the accounting standard setting process to an organization outside national boundaries may be a means of eliminating what many in the regulatory and political setting may see as a ''messy" process at the national level. One the other hand, Walker (2010) adds that a common set of accounting standards could prevent the creation of a better way to regulate the financial markets and the accounting practices. His paper argue that the different actors in the accounting world disagree on what make a good accounting and reveal that the main disagreement concerns the accounting concepts (i.e. scope, objectives and means to achieve the objectives of financial reporting).
The fact that the SEC (The United States Securities and Exchange Commission) allows foreign companies reporting under IFRS to avoid providing reconciliation with US GAAP could be a sign of a possible convergence between the IASB and the FASB. Furthermore, the two organisations create standards on a common base and align their agendas. In the future, the SEC may also allow domestic US listed companies to comply with the IFRS norms instead of the US GAAP (Whittington 2008). However, in their research, Chua and Taylor (2008) found that it is very unlikely to see these two accounting standards co-exist and that the decision of the SEC may, actually, delay the convergence of these two standards setter as well as the creation of a single set of accounting standards by a unique international standard setter.
Notice that the recognition of the IFRS in the EU has raised several issues. The main one concerns the IAS39 on the valuation of the Financial Instrument (Fair Value Accounting (FVA) versus Historical Cost Accounting) and the second one is about the governance and accountability of the IASB. influence of the Anglo-Saxon Accounting on the creation of the standards. Indeed, the EU bodies (the Commission and the Parliament) would like to increase their control over the IASB to avoid a too large influence of the Anglo-Saxon Accounting on the standards creation and thus avoid the dominance of the English-speaking countries accounting policies. The decision of the SEC has exacerbated the fear of the EU on the convergence between the IASB and the FASB. (Bengtsson, 2011 and Whittington, 2008)
The impacts of the mandatory adoption of the IFRS in EU after 2005
In 2005, the European Union made the accounting standards created by the IASB mandatory for the listed companies. This was aim to facilitate the comparison between European companies. However, some authors examined the real impact of this mandatory adoption on the quality of disclosures and of the harmonization of accounting practices.
In their study, Carmona and Trombetta (2008) states that, due to their nature, the accounting standards do not necessarily change the reporting practices. Indeed, the IAS/IFRS standards, as well as the Generally Accepted Accounting Principles (GAAP), are "principle-based instead of "rules-based". It gives a certain level of flexibility as it provides key objectives and guidelines that inform transactions and economic events. In the case of the IASB, the "principles-based" allows firms to interpret and adapt the standards to their own accounting practices, enable a quick development and application of these norms throughout the world. However, it is important to notice that a lack of rules can also lead to unreliable and inconsistent information, making the comparison between companies difficult (Nelson, 2003). Carmona and Trombetta (2008) thus noticed that companies use the flexibility offers by the "principles-based" standards to keep their accounting policies. They also found that the adoption of the IAS/IFRS norms did not lead to a complete uniformity of accounting treatments. On the other hand, they observed that the quality in voluntary disclosures has improved while it is not always the case after 2005.
Conversely, Akman (2011) investigated to know if the use of IFRS eliminates the impact of cultural dimensions on the financial disclosure because the countries share the same set of standards. The study uses a sample of 498 firm-year observations from six countries for the period between 2004 and 2006 and shown that culture still plays a role in the financial disclosure levels of companies even after the adoption of IFRS, although the level of disclosure increases in all countries examined following the adoption of IFRS. By stating that, even after applying the IFRS norms, companies are taking advantage of its flexibility to retain existing accounting policies, Carmona and Trombetta (2008) and Akman (2011) came to the same conclusion: the use of the same accounting standards does not completely eliminate the differences in disclosure and companies continue to disclose information in accordance with their cultural background.
Ultimately, the change in the accounting standards influences in a certain way the governance of a company because they format the company's view (level of profit, debt ratio equity, turnover etc...) by the rest of the world and thus, influence the company's strategy. The change in standards could be seen as a chance to evaluate in which way the accounting policies influence a company's governance and how the recording of the economics transactions could impact on the practices of companies. (Chiapello, 2005)
The concept of fair valuation of financial instrument
The Fair Value Accounting
The accounting standards harmonization is in line with the Anglo-Saxon accounting policies. Indeed, the IASB admit that the shareholder perspective is favored. However, this mode of governance does not take into account of the sustainable development as it is generally known and despite the ONU's recommendations to take into account the general interest, it appears unlikely that the majority of the shareholders will follow these incentives. Now the accounting standards are no longer in the service of economic development based on the production of goods and services; they are currently supposed to serve the extreme rapidity of movement of capital. This purpose will lead to balance sheets as volatile as financial markets and make cohabitated values of actual transactions, estimated market values and expected values resulting from calculations based on mathematical models for random discount rate (Capron, 2006).
The adoption of an Anglo-Saxon accounting also leads to the use of the Fair Value Accounting (FVA) techniques which is opposed to a more traditional accounting method (e.g. In France or in Germany) where the valuation at the Historical Cost Accounting is preferred. The IASB defines the Fair Value as being "â€¦ the amount for which an asset or liability could be exchanged between knowledgeable, willing parties in an arm's length transaction". (IASB 1999-IAS19, foreword, Perry and Nölke, 2006) and unlike historical cost, FVA eliminates the direct link between the price paid by the firm for an asset and the value attributed to this asset in the firm's statement. In addition, FVA favoured the shareholders and enable companies to show the profits very quickly as a good financial performance increases the market value of the firms (Perry and Nölke, 2006). In contrast, the French accounting policy, as well as the German one, preferred the prudence and is focused on the creditors rather than on the shareholders. Indeed, profits are show only when they are certain, enabling creditors to know, not the financial value of a company taking into account financial forecast, but if the company is capable to settle her liabilities (Chiapello, 2005; Perry and Nölke, 2006; Chiapello and Medjad, 2009).
Bernstein (2002, foreword, Perry and Nölke, 2006) says that the choice between historic cost and FVA is equivalent to a choice between economic reality and comparability. While FVA accounts might better reflect current economic reality and might theoretically have more predictive power, the number of complex and subjective considerations that is required to produce an FVA financial statement leads to incomparable results between different time periods or between different firms.
By taking into account the potential gains; the new system takes the risk to record and to allocate gains that are not certain and which may have not been evaluated properly (the estimation is made today by the market, or by an auditor influencing the market but is not necessarily validated by a transaction). This practice can lead to a suspicious market vis-à-vis of a company value while the IASB would like to reinforce the investors' confidence. This unexpected consequence has raised a number of reaction and in particular in the banking sector. Indeed, with 39 (dealing with recognition and measurement of financial instruments), the IASB favours the speculation on the financial instrument while bankers use them in order to protect themselves in the long-term (French bankers have been officially supported by the President Jacque Chirac against the application of the IAS 39). After negotiations, they finally obtained a very controlled exemption (Capron, 2006).
IAS 39 and the Fair Valuation of financial instruments
The application of the fair valuation of financial instrument impacts the balance sheets of financial institution, making them more sensitive to the fluctuation in the fair price. Indeed if a mark-to-market price is higher than the historical cost then it leads to write-ups of assets and vice versa. In other words, the application of fair value could amplify the rise in stock prices in periods of rising market and downward movements in the decline phase of the stock. Furthermore, the Global Crisis highlighted this delicate question of the fair valuation of financial instrument as political bodies seems to think that it was one of the factor that aggravated the propagation and the intensity of the crisis on banks, financial markets and the overall economy (Bengtsson, 2011 and Walliser, 2012).
The appliance of the Fair Value Accounting is a common point between the IASB and the FASB. They both believe that this method is superior to historic cost. In their research, Perry and Nölke (2006) found out that FVA accounting standards are expected to increase management efficiency and reduce the principal agent conflict. FVA is also supposed to reduce the accounting manipulation and the information asymmetry between managers and shareholders (Walliser, 2012). However, the combined use of the Balance Sheet Approach and the FVA can increase the volatility of profits caused by the re-measurement of assets values. (Bernstein, 2002, foreword, Perry and Nölke, 2006)
For countries such as France and Germany, in particular, this production of accounting standards by a non-governmental organization is a cultural revolution and open the door to a considerable volume of critical literature emanating from France (Raffournier, 2007 foreword Chiapello and Medjad, 2009). While the independence of the IASB was the condition for the EU's adoption of IFRS, a repoliticalization of accounting standard setting can be observed as it seemed to be necessary in order to avoid a new crisis. The IASB independence has been sacrificed it in order to reinstall a financial stability and to help the banks. (Bengtsson, 2011)
In his paper, Bengtsson (2011) presents different views that have been taken about the implication of the fair valuation during the crisis. The first group considers that FVA contributed to losses recorded by financial institutions and other firms. Even if little evidence has been found concerning the implication of the FVA, some authors think that this valuation method put pressure on the balance sheets of financial institutions, leading some banks to sell assets at depressed prices to avoid breaching capital requirements and thus causing losses on the other banks' balance sheets (Allen and Carletti, 2007; Appelbaum, 2009; Jones, 2009 foreword Bengtsson, 2011). Alternatively, the other group believe that FVA allows the assessment of the true position of financial institutions, increasing the transparency of the valuation (Turner, 2008; Veron, 2008 foreword Bengtsson, 2011), allowing then investors and others markets' actors to distinguish between distressed and healthy financial institution and therefore, to slow the progression of the crisis.
While the implementation of the IFRS after 2005 should have reduce variation in accounting practice and introduce a degree of uniformity into financial reporting which will lead to a better comparability between companies and thus, will increase the degree of confident in the market, some authors (e.g. Carmona and Trombetta, 2008, Akman, 2011) shown that a country culture still play a role in the application of the IFRS and that the use of the same accounting standards does not completely eliminate the differences in disclosure.
With the support of the EU, the diffusion of the IFRS has been relatively fast, bringing significant changes in some fundamental features of the accounting policies. The main and the most controversy change concerns the fair valuation of the financial instruments framed by the IAS 39 (recognition and measurement of financial instruments). With the Anglo-Saxon orientation of the IASB, IAS 39 brings the concept of Fair Value Accounting (FVA) techniques to assess the value of an increasing variety of assets which increase the sensitivity of financial institutions' balance sheet to the fluctuation in the fair prices, and thus to the volatility of financial markets. The Global Crisis also highlighted the possible issues raised by the use of the fair valuation of financial instrument as political bodies seems to think that it has contributed to increase the consequences of the crisis on banks, financial markets and the overall economy.
The lack of details and the large interpretation opportunities of the IFRS can lead to new fraudulent practices, motivated by the profit-seeking throughout the financial speculation. The focus of the IASB on the shareholders views leads to a change in the company's governance where they need now to focus their decisions on the shareholders wealth maximisation instead of taking into account the general interest. The efforts in recent years to improve reporting to third parties may be delayed or nullified by an accounting system turned to another purpose: the promotion of the financial speculation.