International Accounting Standards Board (IASB) is previously been known as International Accounting Standards Committee (IASC) which is formed in 1973 and restructured in 2001. IASB is a committee with members of fourteen individuals which is twelve full time and two part-time members, the members are from nine different countries and their task is to work together in developing global accounting standards. The goal of IASB is to develop a set of high-quality, transparency, understandable and comparable global accounting standard that use to generate a financial statement which can be adopted worldwide. It also helps in removing barriers in investing between different nations and set up convergence of national accounting standard, such as IAS and IFRS. (IASB 2005:s2).
IFRS are standard which adopted by the International Accounting Standard Board. The standard that form IFRS are previously know as International Accounting Standard (IAS). (IFRS, Wikipedia). IFRS are expected to help in developing international financial reporting to be more transparency, comparability and in an investment patterns therefore, it is now widely accepted. (Eva K. Jermakowicz and Sylwia Gornik-Tomaszewski (2005). Furthermore, high quality accounting standards will help to provide credibility to the reported performance and also been seen as a compromise between the practicality implementation of the concept, as implementation of IFRS has imply a serious ramifications in financial statements. Hence, IASB strongly recommended that countries co-ordinated worldwide should adopt International Accounting Standard, as it brings transparency and uniformity to global business. These will bring confident to investor and help in creating economic partnership and growth.
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As mentioned by George Tsakumis, David R. Campbell Sr. and Timothy S. Doupnik, 2009 there are now approximately 100 countries who adopt IFRS as their accounting standard. These countries include the European Union, Australia, South Africa and also a number of countries which are economically important such as Japan and United States have plan to converge their national standard into IFRS.
IFRS often focusing in large capital market, capital market is market for securities which are debt and equity, this include of stock market and bond market. Capital markets of industrialize countries has been changing and developing in political economy. And capital market is the only area that develops internationalized economy (Simmons, Beth A. 1999). From the pass three decades, capital market is growing rapidly in economy and cross-border investment. This created more demand for investment opportunity therefore, more foreign investor will enters into the capital market. Besides this, larger economies will be more likely to achieve adequate liquidity due to it has larger firm to meet the minimum threshold. (Augusto de la Torre,Sergio L. Schmukler (2007)). Hence, IFRS focus mainly in capital market in order to increased comparability within the global capital market as capital market will have a different set of accounting standard due to different nation and needs of different user group. IFRS resulted in helping investor in understanding financial report in order to make decision.
Historically, financial reporting is varied in different economies and regulations from the different countries are differing greatly. Different needs of creditor and equity is also the cause of differences in financial reporting (Nobes and Parker, (1998). According to Doupnik and Salter legal system for accounting differences is classification of accounting system worldwide, legal system can be classified as common law or code law legal system (1995). Common law countries are usually known also as "Anglo-Saxon" countries which are common law based is Australia, Hong Kong, Malaysia, United Kingdom and etc. Financial statements in these countries are often presented in a "true and fair" way which is financial reporting are transparency with full disclosure to benefit the needs of the outside investor. The accounts also have separation between the financial and tax accounting. Common law countries often require high standard reporting and financial disclosure to generate more information to the public and support more large capital market. Common law system is offers stronger protections of the outside investor which brings in more investor to the equity market (La Porta et al. 1998) and emphasizes shareholders rights, therefore, shareholder itself have the ability to vote in establishing the rule and the conduction. Common law model would have the ability to support large capital market. This is due to its financial disclosure is transparent and it attracted more investor to invest.
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Countries which are code law based such as continental Europe, Japan and etc... are usually known as"continental and "macro-uniform". Code law countries' legal system is often relied on government regulatory agencies for most of their financing however, the requirements does not fit the accounting practice. Financial reporting in code law countries accounts often have a lower level of financial disclosure, it shows that code law's financial reporting is opaque when the collectivism is high and their financial reporting aim is to protect their creditor. Therefore, in result companies with a stronger protection in investor such as common law countries are supplied more conservatism than code law countries which have less protection in investor (Bushman and Piotroski, 2006). Countries which have protection for creditors will develop a large credit market however will have less participation in equity market Ali and Hwang (2000).
As a whole, common law countries often build in strong equity market, and debt becomes important in code law countries. (Thomas, Wayne B, 2004). Common law system is more preferable by accountants due to it is more efficient and like to be compromised. IFRS is rooted in common law countries however, many countries in code law system also adopted IFRS with involvement of their government in accounting rules. (Alan Rappeport, 2008). The rapid globalization recently had led to emerging economies countries accepting IFRS as a global accounting standard. Countries which have not adopted IFRS are also planning to adopt IFRS. As expected by IASC there will be more than 150 countries in 2011 at least converge with IFRS. Emerging economies countries such as Korea, Canada, Singapore, Malaysia and etc are adopting IFRS in the next few years. As recently in 2009, Japan and its companies approved the adopting of IFRS as soon as possible.
Japan intended to move toward IFRS is to help in maintaining its position among the global market. As seen as "accounting practices in Japan are the furthest removed from global norms," (Kyojiro Someya, 1996). Japan's accounting disclosure is different in path where it is important to raise capital from bank and, Japanese's financial reporting is seen as one of the country that provides less transparent financial statements. Bank debts in finance companies have result in causing lack of interest in shareholders and their needs. ( Benston et al 2006). Investors are now having more selection of opportunity to search for the world best portfolio for investment (E.N. Emenyonu and S.J. Gray, 2006). Therefore, Japan decide to change in term of they need harmonization with IFRS to raise capital in foreign market in order to provide an accounting standard that are familiar and trustable to the investor ( Benston et al 2006). Therefore this has urged Japan to consider convergence with IFRS. Large Japanese companies think that there is no reason for Japan no to adopt IFRS due to the benefits of IFRS such as reducing the barriers to have Japanese companies listed overseas, enlarge the international market, international status and international fund-raising of Japan. (Yao Jun, Chitoshi Koga ,2009) Besides this, Japan's financial reporting are responsible by two separate governments which is first half by Germany influence and second half by U.S idea. This reflected in Japan accounting standard as rule-based approach which contrasts with IFRS. Hence, completely converge to IFRS will help Japan to change into principle-based accounting and this approach will have greater impact on financial statements. Japanese financial report is not often seen as "true and fair" and transparency due to its historic emphasis on credit rather than investor, however, converging to IFRS did not reduce Japan's emphasis on debt-financing.
In addition, Canada also confirmed to adopt IFRS in 2011. In the world of globalization, adopting of IFRS will insulate Canada global capital market. Therefore, is essential for Canada to converge with IFRS to establish a financial reporting which is globally accepted. Besides this implementing IFRS manage to make financial reporting more transparent and understandable for user to improved decision making for investor. Canadian enterprise benefits from IFRS to attract more foreign investor and have better access to international capital and funding.
China a common law based country is the largest emerging economies which adopt and implemented fair value it accounting system. Barth (2007) commentated that fair value in IFRS is likely to increase. In 2006 the China government announced that Accounting Standards for Business Enterprise (ASBEs) is in line with International Financial reporting Standards (IFRS) therefore, there are changes needed to be made. The advantage from it is to increase transparency and enable economic growth as the previous system of China did not show a measurement of profit and loss this result in managers are difficult to determine whether the firm is earning profit or losing money. Sir David Tweedie suggested a four-legged stool for to increase the quality of the country's accounting standard. The first "leg" is adoption of IFRS's fair value and remaining legs are corporate governance, auditing and enforcement by regulatory authorities (Tweedie 2006b, p. 10). From the implementation of fair value China is able to attract foreign capital, list companies overseas and facilitate efficient capital market. Furthermore, if market for financial instrument is inactive, fair value and valuation will help to maximum use of market inputs. China is seen to grow rapidly and access to the WTO therefore, a reliable and transparent accounting system are need in China. Furthermore, the accounting standard which are applicable in previous are obsolete have replaced by Chinese Accounting Standards (CAS) to International Financial Reporting Standard (IFRS) to help in bringing china's accounting to be more harmonize. In additional, China is able to provide investor with insight into prevailing market value, to produce a financial statement which is transparent and to ensure the usefulness of financial reports.
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However, China had actually adopted, abandon and re-adopt the fair value accounting, this reflected that fair value is difficult to adopt in emerging economy due to lack of capital market that is functioning. In the early 1990s China's economy was growing fast but due to the usage of historical cost, huge unrealized investment gain is unreported. China then aware the problem arise by historical-based-cost and abandon historical cost and adopt fair value since fair value is used widely in international financial reporting and increasing support from standard setter such as IASB, FASB and major market regulator (SEC) (Barth, 1994). China intended to reform the fair value but this action was fail due to firm are taking advantage of fair value standard result in a series of scandals happened where two-third enterprise's financial statement were falsification. Hence, the fair value is needed to be revising and China has to setback the effort in fair value and international convergence. Finally, in 2006 China re-adopt fair value again as they need additional investment in the market and more listed overseas companies, so China seek to converge with IFRS (McCollum, 2006). The adaption of fair value has become China's rapid economic development. The CAS2007 has also converged with IFRS's fair value, fair value is used as disclosure requirement, and use as basis for cost allocation, assets, liabilities and revenue all are to be measured at fair value. Fair value accounting by IFRS is adopted quite extensively in China's CAS. Furthermore, is important for China to report their accounts to fair value as fair value is a global trend.
However, although fair values have give benefits in financial reporting but it also raise problem to the financial reporting as well. Fair value measurement is consists of three levels, this fair value hierarchy (FASB, 2005, p.5) is to help company in valuation of their assets and liabilities. Level 1 is quoted prices for asset and liabilities in active market if prices are not available then level 2 "quoted price for similar assets and liabilities in active market with appropriate with change" would be used(FASB, 2005, p.6). Level 3 estimates "require judgment in selection valuation techniques and relevant inputs". However, many companies have no experience in level three. In the early 2000, the collapse of companies are such as Enron and WorldCom, involve in accounting scandals, banking sectors are involve in credit crisis and this happens is because of inappropriate application of fair value and incorrect accounting standard. In 2001, Enron indicated that the financial statement of the company is seriously misleading it believe that Enron's using of level 3 fair value accounting play an important role. In the Enron case, Partnoy (2002, p. 327) stated that losses of Enron were hidden by misuse of fair value valuation of assets and liabilities were rigged to create false profit and loss entries. Enron extensively used level three and its first time using for energy contract. Indeed, problems are encountered from the companies when using third level estimates in their financial reports such as companies reporting revenue before earned, inventories are misreported and mispriced and expenditures are capitalized more than expenses. Enron's bankruptcy is due to managers used for level three to estimates internal and external accounting. This is because management uses judgment in valuation process for level-3 estimates in order to add concern about reliability when the market is inactive. However, this action is seen as management bias, this may result misstatement of earnings and equity capital. Fair value affects business in somehow companies are required to mark down their financial instrument at market prices and if prices are lower than original prices then this will lead to writes down on balance sheets excessive write-downs of overstated assets valuations have resulted in failure of a number of finance company
In 2002, the largest corporate accounting fraud happen was WorldCom. Major issue causing WorldCom failed is due to WorldCom used liberal accounting rules and writes down one quarter million of dollar in assets to make increase in the profit. According to the critics of the system many instrument could not calculate fair value due to many instrument does not have a liquid market therefore, fair value are often been estimate.
Besides this, the most recent problem of fair value is the credit crisis. The ongoing credit crises led to rise of criticism against use of fair value accounting. Hence, there is common theme for blaming crisis on the fair value accounting. Firstly, misleading of mark-to market objectives cause the current credit crisis to offshoot a highly speculative and credit reliance financial market ((Robin 2008). Recently been seen that banks included fair value to create profit during the performance of the company is worst and using huge write downs in asset for a major gain when their bond values are declining and this have worsen the credit crunch . From the unveiled huge write-down a tide of red ink are seen in the financial institutions. Bank also routinely overstated the fair value of their loan and investment. During the market inactive, bank will need to use assets values which is based on high volatile and the will cause a misleading picture to the investor. The miscalculation of fair value accounting is to design for the available market during valuation process (Gold et al 2007). However, such valuation process is guided by active market and adequate information. Another issue of valuation is by the banking crisis where markets are illiquid or close down this will leave the valuation uncertain. Crisis to bank are resulting from credit delinquencies, investor will loss confident due to the devaluation of assets. Hence, fair value valuation in inactive market are often been questioned. Due to the accounting scandals arise from fair value, countries such as China which have started to adopt fair value will loss confident in it and abandon the usage of fair value measurement.
Furthermore, countries will also loss their interest in adopting IASB because IASB also implement fair value. Hence, the problems of fair value have become challenges for IASB. Recently, in 2008 the chief executive of Axa, France largest insurer has launched an attack on IASB as being "accountable to no one (Sir David Tweedie). Two of the world's largest insurers Axa and AIG claimed those financial crises are due to the use of fair value accounting increased the market volatility. Axa recently unveiled a write-downs of £460m from the mortgage loan and a $11bn of profit in AIG were hit from writing-down fair value therefore, Axa's chief and AIG chief executive believe that fair value is the reason of financial crisis and they are questioning is fair value the right measurement system.
recently there are critics argue that fair value accounting could distort the market. This happen when the markets are not active, assets and liabilities do not have active market and therefore, prices are not available and valuations of asset are less reliable. In these circumstances, irrespective techniques are needed to develop the valuation models. However, this will effect in errors in valuation of specific instrument due to the use of inappropriate techniques and give rise to creating moral hazard problem. In additional, management uses judgment in valuation process is seen as a management bias because this action may result in misstatements of earnings. Besides these. Bath, Landsman and Wahlen(1995) stated that implementation of full fair value model for recognition of financial instrument at fair value could cause earning and regulatory more volatile than earning and regulatory based on historical cost. Profit and loss would be influenced by these market conditions hence, volatility might be exacerbated by investor's decision from short-term perspectives by the changes in accounting value.