This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
The world has seen tremendous changes of late. The boundaries are shrinking and investments are being made across continents. Businesses are not being limited to a specific country but instead they are operating in various countries, acquiring firms through Mergers and Acquisitions and also operating under various jurisdictions. Financial reporting forms a major part for the companies. As we see a huge variety and complexity of transactions and the forecasting, estimating and the assumptions a company has to make when presenting its financial statements, they can take any form if reporting standards doesn't exist. Every country has their own set of reporting standards. Globalization has given rise to a standardized format of financial reporting in the form of International financial Reporting Standards (IFRS).
IFRS and its goals
IFRS are the standards adopted by International Accounting Standards Board (IASB). IASB is the independent standards setting body based in London, England. It has 15 members from various countries, diverse backgrounds and with immense experience who are responsible for the development, publication and reviewing of standards. The idea of having a common set of standards across the globe started in 1973 when International Accounting Standards committee was setup with collective efforts of few countries. This committee came up with International Accounting Standards (IAS) and this laid the foundation by promoting for the use and application of these common set of standards. In 2001, this committee was replaced by IASB and the IAS was replaced by IFRS. Gradually these standards were adopted by over 15000 companies and also by over a hundred countries. The two accepted standards internationally are IFRS and US Generally Accepted Accounting Principles (GAAP). Financial Accounting Standards Board is the standards setting body for US GAAP. In the current scenario of globalization these two boards are working towards convergence into IFRS. IASB was formed on four stated goals. Develop global accounting standards requiring transparency, comparability and high quality in financial statements. Promote the use of global accounting standards. Account for the needs of emerging markets and small firms when implementing global accounting standards. Achieve convergence between various national accounting standards and global accounting standards. In line with these goals and also to have financial information that is consistent, comparable and understandable, these standards took a principle based approach.
Global Relevance of Principle based approach
Principle based approach gives a conceptual view instead of providing a rigorous set of rules to be followed. This approach gives the accountants to take their decision based on the principles provided. In a rules based approach the standards become longer and complex. There would be rules to address many contingencies. With the number of rules increasing the accountants always find a way to circumvent the rules for the financial reporting. This leads to many scandals. In this age of globalization, there are many institutions and other investors investing in a particular firm. If the firm choose to circumvent the rules and show cooked up results and then finally declare insolvency, the repercussion would be felt in a very big way as everyone are connected to each other after globalization. IFRS being a principle based approach gives the accountants to use their judgments. Though there are rules even in IRFS, the intent is not to provide guidance for every possible situation. These standards just show us as to how to reach the destination instead of giving every direction to reach the destination. On the flipside, there are certain areas when a principle based approach like IFRS becomes ambiguous. For example, in the case of lease accounting it becomes really difficult to consider it as capital or not, also interest income and dividend income to consider them as operating cash flow or not. With such and many more ambiguous cases arising, the accountants would prefer a rule based system like US GAAP or GAAP of their nation.
The ideas on which the IASB bases its standards are expressed in the IFRS "Framework for the preparation and Presentation of Financial Statements" that the organization adopted when it was formed in 2001. This framework details the qualitative characteristics of financial statements and specifies the required reporting elements. IFRS framework gives the qualities required for financial statements as being understandable, relevant, reliable and comparable. The importance of this framework is to provide foundation for the investors and policy makers to take a better economic decision and also to provide financial status of the company to the stakeholders.
Global Relevance of IFRS
In this age of globalization when we look at a global common standard like IFRS, we find numerous advantages. With so many exchanges gaining importance in this moment, many companies are trying to get listed in these exchanges. With a different GAAP followed by the company and to change to the required GAAP and then get listed is a tedious process and this involves huge costs to the company. If a common international standard is accepted everywhere then the company can cut down on these costs. For example, companies trying to get listed in NASDAQ have to comply with the requirement of Securities and Exchange Commission (SEC) and so the company has to show the financial reports in US GAAP. With so many reports and many more differences in the ratios, this could lead to cost issue for company and also confusion in the minds of investors looking at reports done in two different GAAPs. If IFRS is accepted in every country, this changing report wouldn't be there. Every year billions of dollars are being invested in companies situated in different countries. These investments are to be made with rigorous analysis and also looking at the various activities of the company.
For this purpose the investors look through the financial statements and also compare with the companies operating in the same sector and are situated in a different country. If the reports of these companies are made according to different standards then the comparisons would not yield the actual outcome. So, to compare 'apples with apples' one needs the reports to be made according to same standards and this is where IFRS would be of so much relevance in the current scenario.
The corporates from developing countries also could raise their reputation and could be compared with their peers in developed countries and this comparison would be done on the basis of a similar platform, i.e., IFRS. IFRS advocates the use of fair value method where the assets and liabilities are to be shown on the mark-to-market value instead of the amortized cost. The unrealized losses and gains would come into picture while reporting the value of the assets. Here lies the ambiguity. IFRS experts claim that the company incurring huge losses will have to reflect them as mark to market in their report. This will give a lot of clarity to the investors as to what the company's real situation is. There will be a huge change in the ratios to the ratios that will be calculated by the historical cost value method. But then if there is a huge unrealized gain then this could be highlighted by the company and could be used to gain unfair advantage. This is the major critic about the fair value system. Investors with little knowledge about these new standards across the globe could be misled by such an act. Moreover the tax policies and the dividend distribution would be primarily affected by this fair value method.
In the era of financial innovations there are so many hybrid instruments that are being designed. If we have a standard that is rule based, it becomes utmost difficult to report about the hybrid products. Globalization is paving way to bring a set of standards to cater to such innovations. These international standards guide the companies to report them basing on the experts judgments. There will be healthy competition as there will be a common level playing field for the companies. After the advent of WTO and subsequently trade extending freely beyond the borders of a country, there will be revenues coming from various places and the company would be operating under various tax laws. A common reporting standard would reduce the cost for a company as it has to make report for various exchanges and tax departments. On the macroeconomic front, adopting a common platform of reporting standards is going to help the economies of the countries also. IFRS would be benefitting the capital markets and this in turn would be adding value to the economy.
The biggest challenge involves convincing the developed nations to implement such an international standard and which would lead to the reduction of dominance by these countries. Even now if we see, it is more of the developing countries that have used these standards. Certain companies don't want to incur additional costs and doesn't want to convert to IFRS given a choice. Such issues could be major hindrances for making IFRS a globally relevant and important standard.