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Each country using their own generally accepted accounting principles (GAAP) to report their financial statement so there are many accounting standards in the world. Nowadays, with the development of business globalization, an increasing number of companies do business in multiple countries. So the application of a single set of high quality globally accounting standards is more significant than ever. In this report I discuss the potential benefits and challenges of Global GAAP and the possibility of the adopting of IFRS especially the convergence of IFRS and US GAAP. I believe that the harmonization of reporting standards will benefit the world in the long run, but the adoption will not be achieved in short time.
Is Global GAAP desirable?
Why do countries adopt Global GAAP
Adopting a single set of high quality accepted accounting standards, the cost of information processing and auditing can be reduced. The preparers will not have to produce different reports according to different standards. The users of the financial reports in multinational companies can familiar with one set of accounting standards then lower the information costs. For the national government, accepting a set of accounting regulations can reduce the cost of setting national accounting regulations.
Transparency and comparability
In an increasingly integrated global economy, transparency and comparability are regarded as essential. (Bhimani, 2008) The adoption of a single set of standards increasing the quality of financial information and makes it easier for investors and other stakeholders to compare companies' performance across industry sectors and over large geographical distances. The companies could have more effective communication with investors and other international users of the accounts and increase the comparability with competitors both nationally and internationally. In order to enhancing the transparency of business information, a single set of high quality accounting standards is more informative and increasing the clarity and understandability of accounting reports. This could also result
3. Reducing the risks
With the financial reporting information disclosure becomes more reliable and effect the risk of investment will be reduced. Then the investors can reduce the likelihood of making poor decisions by less misunderstanding of different accounting system. The allocation of global capital resource could also be improved. The harmonization is one way to restore trust and provide investors more useful and reliable information. (Jopson, 2005) Companies benefit from the greater investor confidence and the restoring trust after financial crisis and scandals. It encouraging international flows of capital across national borders and increased the demand for share investment.
4.Benefits for national regulatory bodies
A single set of high quality accounting standards improved regulatory oversight and enforcement capacity on financial statement to ensure a high standard of financial disclosure, gives better ability to attract and monitor listings by foreign companies.
Limitations of Global GAAP
The environmental, institutional and cultural difference caused the variation of national accounting system. (David Alexander, 2011) " You can't have a single set of accounting standards for multiple forms of capitalism," said Martin Walker, professor of finance and accounting at Manchester University said in 2005. "Accounting has to reflect the economic, legal and political systems in which it is operating. Until those systems are the same, you can't standardize accounting."
As the majority user of Global GAAP, the multinational companies will have fewer opportunities to influence an international standard setter than a domestic one. Companies in different countries have different responds of business and economic environment. The diversity may not be presented by a single set of the global standard. The companies may face the high cost of changing standards and there is big uncertainty of the future of convergence. For small and medium-sized companies and the companies focus on national market the adoption is unnecessary and expensive.
For investors, the use of global standards, particularly in the early years of alternation, can cause confusion and may hides real differences of commercial activity.
For national government, the future of harmonization is unpredictable. Since the harmonization is more beneficial to countries where foreign trade is an important part of the economy, so some developing countries may be put at a competitive disadvantage. More powerful countries are more likely to be able to influence the setting of international standards through explicit lobbying and pressure tactics. (Sletten, 2009)Developing countries may not be able to influence global standards as much as developed countries.
Although there are limitations of Global GAAP currently, the globalization, development of capital market and constantly improvement of standards setting process could reduce or even eliminate those limitations. The Global GAAP is desirable.
Is Global GAAP feasible?
Adoption of IFRS in the world
The International Accounting Standards Board (IASB) was established in 2001 to develop a single set of high quality, understandable, enforceable and globally accepted International Financial Reporting Standards (IFRS). The first IFRS was issued in 2003, until January 2005, not only all listed companies within the EU and European Economic Area have to comply with IFRS, also Australian listed groups. Since then, nearly 70 countries have mandated IFRS for all listed companies. Further, about 23 countries have either mandated IFRS for some listed companies or allow listed companies to voluntarily adopt IFRS. However, as of 2007, at least 40 countries continue to require domestically developed accounting standards over IFRS, and this list includes some large economies like Brazil, Canada and China. (Sletten, 2009)
IFRS and US GAAP
The FASB have worked with the IASB to create a convergence between the national accounting standards and the international accounting standards since 2002.
The major differences between these two standards are the US GAAP is rule-based, while IFRS is principle-based. Rule-based standard are basically a list of detailed rules and mandatory, which could limit the judgment of accountants and protect them against litigation. However, the principles-based standards are just a simple set of key principles to ensure the quality of report. Then crucially depend on the professional judgment of accountants and auditors.
Prior to 2001, a central SEC concern had been that IASC standard were insufficient stringent and rigorous in communicating financial information relative to US GAAP, little reason for US GAAP to alter significantly in the face of initiatives in other countries to develop international accounting standard. (Bhimani, 2008) Nevertheless, the financial crisis of 2001-2001, the collapse of Enron and WorldCom the FASB noted that it is necessary to focus more on the principles in accounting standards. (FASB report, 2002). Because principles-based is more simpler and based on objectives so it could makes the standards more flexible with changing situations and harder to avoid. Its broad principles can be practical for a variety of circumstances. The growing complexities of corporate affairs have led financial reporting rulings to become more complex. (Sunder, 2002)The role of principles-based IFRS accounting had gained credibility in its ability to address some of the root causes of financial reporting crisis. (Bhimani, 2008)
In 2006 the IASB and the FASB (the boards) agreed on a Memorandum of Understanding (MoU) that identified the short-term and longer-term convergence projects that would bring the most significant improvements to IFRSs and US GAAP. The MoU was updated in 2008. Currently, most of short-term and several long-term projects have been completed or are close to completion. (Hans Hoogervorst, 2012) In 2008,the SEC also issued its prosed "roadmap" to convergence of IFRS.
Both FASB and IASB have Conceptual Frameworks. The IASB issued its 'Framework for the Preparation and Presentation of Financial Statements.' known as conceptual framework, which seeks to set and enforce standard for accounting procedures, and to set out the concepts that shape the preparation and presentation of financial statements for external users. (Whittington, 2008)
The Framework states the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. This information is vital for cash generation and delivery of profits to creditors and investors.
The Framework addresses the financial reporting including consolidated financial statements. To meet these common needs, financial statements are prepared and presented annually for a wide range of external users in an enterprise. Thus, it does not automatically apply to financial reports such as prospectuses and computations prepared for taxation purposes that are outside the scope of the Framework.
Stewardship contributes an important aspect to financial reporting, which should be reflected by precise acknowledgement in the objectives of financial reporting. Stewardship should be considered as a broader view than resources allocation as it emphases on both earlier performances and how the entity is positioned for the future.
In theory, the conceptual framework derived the development of accounting standards, avoided the situation of developing standards on a patchwork basis. Where a particular accounting problem is recognized as having emerged resources can then be channeled into standardizing accounting practice in that area. If there is a conflict of interest between user groups on which policies to choose, policies from a conceptual framework are less open to criticism that the standard-setting ones.
However, the financial statements are intended for a variety of users, and it is not certain that a single conceptual framework can be devised which will suit all users. There may be a need for a variety of accounting standards, to fulfill the diversity of user requirements and different purpose.
Whether a conceptual framework makes the task of preparing and then implementing standards easier than without a framework still unclear.
Challenges for IFRS adoption
Except the limitation of a single set of accounting standard I have mentioned before, currently, many challenges still exist for IFRS adoption. The biggest one is the training of accountants and auditors. Because IFRS is principle-based accounting standards, require more professional judgments to deal with the financial problem. The investors need to understand the variety of information even for the same circumstance as a result of different judgments. Firms not only have to train employees to prepare IFRS financial statements but inform analysts and investors of the changes of numbers shown on financial statements. (Hail, 2009) Therefore, preparing a team of IFRS educators for firms and investors is necessary and urgent if firms want to mandate to report under IFRS.
The adjustment to fair value under IFRS will have significant impact on financial statement especially the profits and net equity of companies. A study examined the annual reports of 175 companies in the UK, Italy and Ireland. The most significant change was in the UK where reported IFRS profits were 51% higher than those reported under UK GAAP and net equity was 35% lower compared to that reported under UK GAAP. (Wood, 2008) Higher profits influence the value of company's share price and increase the potential risk of misleading. Without an active market fair values are potentially misleading. "A market-to-model fair value is a prediction not an observation, it is based on assumptions and judgment about the future to a degree not generally appreciated." Said Ernst & Young (Jopson, 2005).
The enforceability of IFRS adoption is unclear. The IASB setting the standards but the application of those standards need an enforcement system to whenever possible prevent, and thereafter identify and correct, material errors or omissions. A stronger regulatory body to ensure the preparation and disclosure of information under IFRS is necessary. However, currently, there are two types of legal system, common law system and code law system. In common law situation accounting rules are not part of the law and code law countries the accounting standards are often embodied in the company law so in common law countries the degree of enforcement are much stricter than in code law countries. (David Alexander, 2011) The differences in legal system to have a uniform enforcement for IFRS is unrealistic at the moment rather a local regulatory should do more to enforce compliance.
The adopting of IFRS will greatly reduced the competition of financial reporting standards and granting IFRS a monopoly status. Potential deficiencies of a monopolistic standard are lack of innovation, slower reaction to market changes, and less motivation to provide best possible accounting standards for investors; however, unless countries are in the process of adopting a different set of standards, or at least willing to consider such an option, competition among standards will not take place at the country or regional level. (Hail, 2009)
Considering the development of globalization and the benefit of Global GAAP I believe that the convergence will be achieved eventually. But currently there are so many factors limit the development of adoption. The globally convergence will not be achieved in sort period.