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The International Financial Reporting Standards (IFRS) are a set of rules in the field of accounting which will apply to companies worldwide. While the development of the IFRS provided an efficient and convenient procedure for financial reporting, further application of the IFRS revealed of several concerns raised by financial analysts. Before discussing the particular issues against the IFRS, it is important to trace the history and context by which the IFRS was created.
History of the IFRS
From the period of 1973 and 2000, the standards were released by the International Accounting Standards Committee (IASC). This committee was formed by accountancy bodies in different parts of the globe - Germany, Japan, United Kingdom, Australia, France, Mexico, Canada, Ireland, Netherlands and the United States. The standards were then referred to as the "International Accounting Standards" (IAS). By April of 2001, the responsibility for its issuance was transferred to the International Accounting Standards Board (IASB). Under the IASB, the rules were called the International Financial Reporting Standards (IFRS). Unlike its predecessor, the IASB is well managed, funded and more independent than the IASC.
With the onset of globalization, the European Union started requiring companies under its members states whose securities are included among EU regulated stock exchange to issue financial statements in compliance IFRS in 2005. The International Organization of Securities Commission (IOSCO) suggested to permit multinational issuers to apply 30 core standards to IOSCO members.
Providing statistical data to the clamor for the IFRS was the International Federation of Accountants (IFAC)'s survey. The survey reported that international financial reporting standards are crucial for the growth of economy. 55 percent of the respondents said adoption to the IFRS standards is highly important while 35 percent of the respondents indicated that the IFRS adoption is important.
Within the international community, the United States Securities and Exchange Commission (SEC) has been in the forefront of developing accounting standards which will serve as the reference for financial reporting of cross-border offerings.
Through an agreement between the Financial Accounting Standards Board (FASB) with the International Accounting Standards Board called the Norwalk Agreement, both bodies sought to create complementary accounting standards which can be applied in domestic as well as cross-border financial reporting. Succeeding memorandum of understanding included global standards for accounting as a strategic long term priority. SEC has been an active member of the FASB.
To summarize SEC's involvement in the development of the IFRS, the following timeline showed specific contributions and initiatives for the IFRS:
Between 1988 to 1997, SEC initiated international efforts to develop the IFRS. By the year 1997, SEC expressed the inconveniences and difficulties faced by issuers wanting to raise capital in different countries. The need to arrange various sets of financial statements to integrate and apply accounting requirements of each country raises the costs of compliance and even the inefficiencies of the process. SEC began expressing support for the Norwalk Agreement between the two important accounting bodies, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
In November of 2007, SEC voted to accept financial statements prepared by the foreign private issuers (based on the IFRS) without the reconciliation with the GAAP. In December of the same year, SEC provides a Concept Release which aims to seek input on the issue of permitting the US public companies to apply IFRS in their financial statements. During the following year the SEC began conceptualizing the possibility of proposing a rule that would implement an updated schedule of milestones for the IFRS eventual integration in the U.S.' companies. Similarly, the FASB and IASB committed to update the Norwalk Agreement to include a set of accounting standards which can fully operate by the year 2013. The said boards shall also address and resolve issues that may have hindered the adoption of the IFRS in the United States.
Another accounting body has also contributed to the development of the IFRS. With an approximately 340,000 members, the American Institute of Certified Public Accountants or AICPA was among the charter members of the IASB. Since that period, the AICPA has been leading the international efforts of convergence of financial reporting. The AICPA provides assistance on matters involving financial reporting to the IASC. AICPA is also developing the Code of Conduct's Rule 203 to acknowledge the IASB as an international accountancy standard setter. The updating of Rule 203 shall benefit the private companies and non-profit organizations by providing them with a choice if the IFRS is applicable in their particular situation.
The AICPA being an association is actively engaging its members on the issue of IFRS. Efforts to popularize the IFRS were initiated, including the continued education of AICPA members on the IFRS; ensuring that positions and statements of the AICPA is registered in an international scale; Collaborating with accounting educators and educational institutions for the teaching of the IFRS; and integrating questions on IFRS in the Uniform CPA Examination.
The development and adoption of the IFRS in the United States is bounded with the following timeline:
Formation of the International Accounting Standards Board (IASB) in 2001.
Issuance of the Norwalk Agreement by the IASB and FASB in 2002. It is in this period that the European Commission has expressed the necessity to adopt the IFRS by its state members for the 2005 financial statements.
By 2005, the Securities and Exchange Commission has released a roadmap permitting the filings for IFRS without GAP reconciliation by foreign companies by 2009.
In the following year (2006), the IASB and FASB agreed to conduct major joint projects.
By 2007, SEC has reported that the foreign filers in the country can file IFRS without the GAAP reconciliation. In the same year, SEC provided the option to foreign filers in the US to either adopt the IFRS or the GAAP.
SEC began considering a proposal for a timeline which will move the US public companies to IFRS in the year 2008. The governing council of the AICPA also considered amending the Code of Professional Conduct to permit the IASB as an accounting standard setter in the international community.
In 2009, the moratorium on the required application of new accounting standards as well as major amendments to current standards was ended by the IASB.
By 2011, Companies in three countries are expected to apply the IFRS - Canada, Japan and India.
The projected compliance of U.S. public companies to IFRS will be on the year 2013.
Advantages of the IFRS
Reducing Complexity in Financial Reporting
In comparing the IFRS and the US GAAP, the IFRS is less complex than the US GAAP. The former standards have increased the number of its pages since the years of its initial application. Given the principle-based structure of the IFRS, companies are expected to produce more convenient and easily comprehensible financial reports for investors and other players in the field. The IFRS also provides a certain guidance for interpretation which can facilitate the companies' application of the IFRS.
Increase Efficiency for Companies
The application of the IFRS is also expected to reduce the costs of hiring accountants knowledgeable in the US GAAP because of the global application of the IFRS. This will also increase the possible savings of companies through the decrease in maintaining a number of books while it lessens the costs and adjustments that financial experts must work on to compare and analyze financial concerns and conditions in different countries. The adaption of the IFRS may also lessen the percentage of errors in the translation aspect of financial information from the previous US GAAP to the IFRS.
Multinational companies and other players also vouch for the IFRS to be able to facilitate greater understanding and appreciation of opportunities. Companies with subsidiaries in varying jurisdictions can utilize a single accounting language for the entire company.
Financial professionals and companies are expected to be able to respond easily to the human capital needs of their subsidiaries across the globe.
Efficient Capital Allocations
The IFRS is expected to raise the capability of companies to generate capital in a various countries while simultaneously permitting investors efficient means to compare opportunities in the global community.
Alignment of the United States in the International community
IFRS is fast becoming a global norm. The IFRS adoption of the US shall enable the country to join the ranks of more than a hundred nations who have accepted the accounting standards.
Being that the IFRS is focused more on principles than the US GAAP, the IFRS will permit companies including auditors to concentrate less on strict adherence to the IFRS and instead focus more on issuing a statement of a company's evaluation of its economic realities for its activities.
Financial analysis is the science of assessing the viability of a business, how stable it is in the face of different challenges, and how capable it is in generating profits. Financial analysis is performed by professionals who make reports based on information primarily culled from the financial statements of businesses or groups. The findings in these reports are then presented to the heads of corporations who make corporate decisions that would affect company operations, investments, and acquisitions.
Oftentimes financial analysts' main concern deals with profitability or the ability of the company to generate income and deliver not only short-term and also long-term growth. The degree of profitability is usually determined by conducting a financial ratio of the income statement of the company. Financial analyst determines the solvency or ability of the company to pay its financial obligations to creditors and other third party entities in the long run; the liquidity of the company or the ability to ensure a positive cash flow in the light of paying off immediate obligations; and the stability of the company or its ability to remain operational in the long run without having to face large loses while conducting its business. In analyzing solvency and liquidity, a financial analyst makes use of data from the company's balance sheet, while for stability financial analyst makes use of both the company's financial statement and its balance sheet.
Based on the financial data gathered from the income statement, balance sheet, and other relevant information, the financial analyst will make a learned study about the company's past and future performance. The company's performance can also be determined by comparing the data from other companies in the same industry. This study is done by doing financial ratios and analyzing them either through horizontal and vertical analysis.
In horizontal analysis one will evaluate data from financial statements that has accumulated for a period of time. The purpose of horizontal analysis, also called as trend analysis, is to show a decrease or increase that has taken place and which can be expressed either as a numerical amount or as a percentage. If we use this in viewing ABF's performance what we could do is to track the increase in profit or sales in a period of about three or five years. This data can also be used as a performance indicator which could be compared to forecasts that could determine the performance of the company.
Vertical analysis on the other hand is a method of financial statement analysis wherein individual line items are compared to a baseline item. Oftentimes vertical analysis is used when comparing trends regarding the relative performance in the financial statement of any line items in the course of time. Another way to analyze trends affecting a company is through comparative analysis. In comparative analysis financial information from two or more periods in time is given and presented in two columns so that it would be easy to analyze.
Whatever method will be used in analyzing financial trends the fact is that financial analyst will always rely on the data contained in financial statements and balance sheets which are prepared and made by duly licensed professional accountants. The manner by which they will prepare the data can affect how the data will be read or analyzed.
That is why changes in accounting systems are important issues for the financial analyst. It is for this reason that certain questions are being raised regarding the standardization of accounting systems by adopting the International Financial Reporting Standards (IFRS) which, as was already mentioned in first part of this paper was developed by International Accounting Standards Board (IASB).
These questions manifest the challenges in institutionalizing the IFRS as a standard for accounting. The challenge is made clearer by the fact that for several years different organizations and countries have implemented their own set of accounting standards so the issue now is how to ensure the convergence of the systems and how will this convergence affect the work of financial analysts.
Let us consider these issues separately. First of all, to understand the differences between the IFRS with other existing standards let us use as point of comparison the US GAAP system and how it works in different areas or criteria compared to the IFRS.
In terms of approach to financial reporting the IFRS is more principle based in that it just presents a workable general framework that will guide financial entities and governments in making their financial reports. Compared to the IFRS the US GAAP financial reporting system has a more rigid approach being a rules based system. In actual practice this means that in doing a financial report the entities concerned must strictly use only the variables set forth by the rules of the US GAAP.
The IFRS and the US GAAP system also differs in measuring different variables such as the date for measuring share-based payments to non-employees, use of historical volatility or industry index measurement for non-public entities, modification of an award, share based payments and its classification in the balance sheet, marketable equity, measuring minority interest, purchase in process in research and development, determining acquisition costs, rights and obligations under insurance contracts, determining embedded derivatives in insurance contracts, defining what constitutes discontinued operation, defining how to determine a discontinued operation-continuing involvement and when to present discontinued operations, what should be included when disclosing non-current assets, disclosure of measure of liabilities, basis of identifying operating segments, how to present financial statements, etc.
These variables are often addressed differently by the IFRS compared to the US GAAP and these changes affect not only the financial statement of the company but how the financial status of the company is seen and perceived based on the data included or not included in the new IFRS standard.
For example on the question of measuring minority interest, the approach of the old US GAAP system is to include it in the financial report by measuring it at fair value but only if the minority interest of the company being reviewed passes the standards for consolidation determined by the risk and rewards model. If it does not meet this requirement then it is often recorded not independently but in proportion to the historical cost. While in the IFRS this is automatically considered as the minorities share at fair values. The approach is not a trivial thing but changes how minority shares are often viewed in old accounting systems.
Another significant change in the IFRS compared to the US GAAP is its definition of what constitutes a discontinued operation. Generally a discontinued operation occurs when an operation of a business is discontinued because it was already sold, it was abandoned, or it was disposed of. Current accounting rules states that when reporting discontinued operations it should be reported separately in the income statement from continuing operations. Accounting rules also state that anything that is gained or was lost because of the disposal of a separate but very important line of the business or a type of customer should be reported along with the results of the operations of a segment that was discontinued.
Under the US GAAP system discontinued operations is defined as any component which may constitute a segment in operation, a unit that reports to the main company or it can be a subsidiary or any group that provides an asset to the company. While under the IFRS only a major component of the company and a significant geographical unit can be considered as part of discontinued operations.
Also under the old US GAAP system the presentation of discontinued operations requires that it reports pre-tax and post-tax deductions in the income statement. While in the IFRS the discontinued operation figures considers only the post-tax income or loss. This means that the two systems would come up with a different base figure because it computes different variables in connection to defining the numerical value of a discontinued operation.
These differences show how changing the financial reporting system into a singular standard such as the IFRS would entail substantial adjustments to the existing systems. In recognition of this measures have been instituted to ensure compliance to the IFRS standard. To prepare for this, transitional measures must be implemented. First of all training and education for stakeholders such as investors, accountants and other people involved in preparing and using financial statements. This would mean the inclusion of the IFRS standards in the curricula of universities, and adjusting the examinations given for the CPA to gauge the level of understanding in relation to the IFRS. Businesses should also put in place new software programs and adjust the process of reporting to show that they are following the new IFRS system. In concrete terms this means changing both the requirements for enforcing internal control, and the system for data gathering which currently is in line with the US GAAP. Requirements for oversight and disclosure must also be adjusted to put emphasis on the principles of international cooperation and coordination.
Institutional and individual investors and creditors must also be familiarized with the way financial reports are written based on the IFRS. This would mean modifying the existing rules in relation to lending agreements so as to allow reporting under the IFRS. And lastly, even the representatives of the legal system from lawyers, judges and legislators would need to discuss issues related to taxation and the application of legal measures.
Based on what is stated above one can see that implementation of a universal standard for financial reporting effects different aspects of the economic life of society. From taxation to banking and rules regarding corporations, the fact is IFRS is more than just a guide to financial reporting it is essentially a new way to conduct financial transactions and as such it also changes how financial developments are viewed and analyzed.
Proponents of the IFRS states that implementing it is necessary in order for corporations, governments, and other financial entities and institutions are empowered to face the changing economic landscape brought about by an increasingly global economy. According to the adherents of IFRS its implementation will help companies to increase their ability for capital growth in multiple areas of jurisdiction around the globe while allowing a more efficient means of comparing global opportunities for investments. The IFRS will also allow strengthening the alignment of individual countries with an integrated global economy. This is especial true because the IFRS is fast becoming the norm in terms of standards in financial reporting.
The IFRS is also being touted by its adherents as a means to protect the competitiveness of a national market because it will make investing cross-border easier because of the integration into one global market using the IFRS. The IFRS would also institute a more transparent accounting system that will not dwell too much on detailed requirements but on providing a clear picture of the business entity's appraisal of economic realities in relation to its business activities. The IFRS would also reduce and simplify financial reporting by doing away with long, complex and highly technical reports, and replacing it with a shorter report that focuses more on presenting the economic purpose of the business activities of the company. By putting in place a universal standard in financial reporting, the IFRS would also cut the cost of companies operating globally because they will be able to hire cheaper local accountants who also have knowledge of the IFRS system. It will also cut the cost associated with maintaining a multiple set of books and it will ensure efficiency because it will reduce the occurrence of errors which accompanies translation of financial information from the IFRS to other systems that are currently in place.
For its adherents, the IFRS is the future of financial reporting and global economic progress. Simply put the IFRS is beneficial for investors because it will institutionalize a financial reporting system that is more accurate and comprehensive, and by doing so it will change the way trade and commerce is conducted. However not everyone agrees about the positive effects that changing to the IFRS will bring some are critical that instead of growth the IFRS might have an effect on how financial analysis will be conducted.
The convergence and adoption of the IFRS resulted to a number of differing views on the benefits of uniform financial standards. The following issues were among the concerns raised:
Structure of the IASB governance
For the IFRS to be truly effective, the governing body must be efficient in its governance. The IASB must have a stable funding structure, expert individuals as well as an efficient governance structure to be able to guarantee that procedure for the standard setting will not be tainted with external influences of companies and other constituents. The IASC has taken steps to ensure its public accountability by forming a monitoring board in January 2009 while ensuring that the standard setting process remains independent. The monitoring board included the United States SEC.
Consistency in the IFRS adoption and regulatory review
To be able to fully obtain the benefits of the IFRS, nations must be able to adopt the said reporting standards. It is also similarly important that the IFRS is applied in a consistent manner which can be done through a mechanism that will review the auditing principles, practices and standards. In time the global regulatory review must be improved particularly on its coordination to be able to adjust to the said developments.
Discontinuing US GAAP
Players in the market have reportedly recognized the value of global accounting standards. However, there are also a number of players who have valued the US GAAP and have been concerned over the adoption of the new IFRS against the US GAAP which has already been widely adopted across the globe.
Several differences between the IFRS and US GAAP are evident. For contingencies, the IFRS uses a different probability threshold and measurement objective. The Last In First Out principle as an inventory costing method is not allowed under the IFRS. Unlike the US GAA which uses a two-step method, the IFRS utilizes a single step method for impairment write-downs. The IFRS also does not allow debt covenant violations curing after year-end. Revenue recognition under the IFRS is less extensive compared to the US GAAP.
Non-compliance with the standards
The issue of 100% compliance to the IFRS of countries worldwide may not be able to reach 100 percent compliant. Some countries reserve the right to adapt selectively or modify standards beyond their national interest. This may lead to further incompatibility which ironically is the problem that the IFRS wanted to resolve.
Structural changes in the United States
The full transition to the IFRS of the US companies shall need a considerable investment from players in the capitalist market. Training and education for accountants, auditors and investors are needed to educate and prepare them for the IFRS. Necessary adjustments and changes in the academe is also needed in particular, the possible integration of the IFRS in the curriculum and CPA exam. Companies must also be prepared for the eventual application of the IFRS through updating systems and software platforms to include the IFRS requirements. Internal control requirements must also be updated including data gathering systems. Individual and institutional investors and lenders must familiarize themselves with the IFRS particularly the financial reports. For the legal system, lawyers, judges and even lawmakers must also be knowledgeable on the IFRS in particular the tax issues and other related laws.