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This assignment within corporate reporting has given the author the opportunity to choose two areas of research to study. The first question that has been chosen will cover the International Accounting Standards Board (IASB), partial replacement of IAS 27 Consolidated and Separate Financial Statements with IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosure of Interests in Other Entities. Within the first question the author will aim to analyse why the IASB felt that IAS 27 was required to be replaced and the major differences between IAS 27 and the new IFRS 10 and IFRS 12.
two is centred on the focus of the IASB to develop a set of global accounting standards and there support to join together national standards and international standards. This paper will identify national differences within financial reporting and explore the types of international accounting harmonisation including the methods that are used to measure it. Research will also be conducted on the convergence between international standards and US GAAP project being applied by the IASB, in particular the pro's and con's of international accounting harmonisation.
Differences between IAS 27 and both IFRS 10 and IFRS 12
Ability to direct the investee's relevant activities:
The existing IAS 27 in defining control refers to the power to govern an investee's operating and financial policies. IFRS 10 has introduced the model of relevant activities this is much broader than the reference to operating and financial policies within IAS 27. The concept of relevant activities is largely significant to the activities of the investee and can affect the investee's returns.
The relevant activities of an entity may change over time; and preparers will need to reconsider their assessment when facts and circumstances change. New requirements to assess control will require preparers to identify the relevant activities of an investee in order to determine whether they have the ability to direct them.
Identification of relevant activities can be challenging and may require prepares to apply judgement, in particular to investees which are structured entities (as defined in IFRS 12), or to circumstances when several investors have the ability to direct different relevant activities. IFRS 12 defines a structured entity which has been designed so that voting or similar rights are not the foremost factor in deciding who controls the entity.
De facto control:
IAS 27 provided inadequate guidance on de facto control, which has as led to diversity in practice. It has been uncertain if a reporting entity should follow a precise focus on voting and other contractual rights or use a broader approach in relation to direct activities through the rights it holds for assessing control.
IFRS 10 maintains that an investor can have control over an investee without owning more than half of the investees voting rights, an example would be a contractual arrangement between other vote holders and the investor.
Substantive right under IFRs 10 is considered in determining whether an entity controls the investee. The factors in determining whether a right is substantive include the existence of any barriers that prevent the holder from exercising their rights and the ability of a number of parties to exercise their rights collectively.
De facto control existence is determined using a two step approach; preparers should first consider the size of their holding of voting rights relative to the size and dispersion of the holding of other vote holders and should then secondly test for existence of other contractual arrangements.
When the factors of the two step approach appear to be inconclusive in determining de facto control, preparers should then consider the following information: voting patterns at previous shareholder meetings, evidence of power, any special relationships with the investee and the level of their exposure to the investee's returns.
Potential voting rights:
Potential voting rights within IAS 27 are included in the assessment of control only if they are currently exercisable. Within IFRS 10 the potential voting rights are seen as substantive in nature and the exercisable principle in IAS 27 has been removed. Subsequent current
potential voting rights may not be considered substantive, in assessing such rights the market condition and the entity's intention would have to be considered, while under IAS 27 these issues were not taken into account.
IAS 27 does not provide guidance on how to assess whether an investor with decision making rights is acting as a principal or an agent on the behalf of others. IFRS 10 has introduced the theory of delegated power and provides guidance regarding the determination of whether a decision maker acts as a principal or an agent. The standard uses the link between power and returns and clarifies that in order to control an investee both elements will be required.
In assessing agency relationships, preparers would first need to consider a range of factors, including whether any single party holds substantial rights to remove the decision maker without cause.
Other potential factors to be considered include:
Scope of the decision-making authority
Rights held by other parties
The decision maker's exposure to variability of returns
IFRS 10 introduces a single control model that is applied to all investees, referred to as SPEs in SIC-12 in which voting rights are not relevant in assessing control. The new standard requires an investor to meet the three elements of the control definition, the ability to direct its relevant activities, have exposure or rights to variable returns and the ability to affect those returns..
IAS 27 contains limited disclosure requirements for consolidated entities and no disclosure requirements for unconsolidated structured entities. IFRS 12 has expanded the disclosure requirements which have given the preparers flexibility to adapt their individual disclosures to meet there objectives and a single disclosure standard for entities with special relationships with other entities, including joint ventures and subsidiaries.
Disclosure of interest in other entities:
IAS 27 failed to provide disclosure requirements for unconsolidated structured entities. IFRS 12 has a defined structure so that an entity has voting or similar rights which are not the main factors in deciding who controls the entity. E.g. include asset backed financing, securitisation vehicles and certain investment funds.
Why IASB have issued IFRS 10 & IFRS 12
The IASB in 2003 commenced a consolidation project aimed to focus on divergence in practice when applying IAS 27 as a result of this project IFRS 10 and IFRS 12 have been issued. IFRS 10 and IAS 27 were required to consolidate all controlled entities and during the period of development of IFRS 10 the IASB have provided an exception to consolidation for 'investment entities'.
Relevant issues addressed include the measurement of subsidiaries of investment entities at fair value provides more relevant information than consolidating those subsidiaries and that consolidating the subsidiaries of investment entities makes it complicated to assess the value of their investments. Preparers of financial statements also stated that preparing consolidated information for investment entities was costly, time-consuming and provided little benefit.
IFRS 10 permits or requires fair value measurement for most investments, previously within IAS 27 investments in subsidiaries were required to be consolidated and could not be measured at fair value and as a result an investment entity with no subsidiaries was able to present all of its investments at fair value. The introduction to consolidation improves comparability both within an investment entity's financial statements and between investment entities' financial statements.
The introduction of IFRS 10 and IFRS 12 was carried out in cooperation with the FASB with the aim of achieving alignment between IFRS and US GAAP.
Costs and benefits of adopting the new IFRS 10 & IFRS 12
The initial assessment of IFRS 10 and IFRS 12 is that they will both bring important and sustained improvements to financial reporting. Expected revision of 'definition of control' will lead to a more consistent and appropriate consolidation decisions. The new disclosures will also improve significantly the ability of users to understand and assess the risks of an entity in relation to a special purpose or structured entity.
Cost and benefits for Preparers:
The Amendments will result in significant cost savings for investment entities (preparers), because they will no longer need to perform the consolidation procedures and account for the underlying net assets of their subsidiaries on a line-by-line basis
Preparers will facilitate understanding in communication with users and improve information in regard to the fair values of the investments of investment entities, and benefit preparers
Amendments can be applied retrospectively with transitional relief which is consistent with the transition requirements in IFRS 10 as amended in June 2012. This will reduce the burden for affected preparers on primary application
Non-investment entity parents will not be permitted to retain the fair value accounting applied by its investment entity subsidiaries. These entities may incur some extra cost by having two different measurement bases of accounting but the cost is not expected to be significant
Cost and benefits for users:
Amendments have been introduced that as provided users with information about the fair value of an investment entity's investments in subsidiaries and the way in which the fair value is measured. This information should reduce the cost of analysis and improve the comparability and relevance of information provided
Transition relief on consolidation may result in less information for users on initial adoption and increased one off costs for users
Consistent measurement basis at fair value for investments in subsidiaries of investment entities, in their separate financial statements
The cost for preparers will be most significant at transition when they will need to reassess their relationships with certain entities to determine if they control the investee and in meeting the new disclosure requirements. The current opinion in relation to the new standards is that the important improvements in terms of comparability and transparency will outweigh the costs in the long term.
Reasons for national differences in financial reporting
Entities worldwide prepare financial statements with the same objective in mind, to design a set of financial statements that can be the basis for a user to make economic investment decisions.
National jurisdiction may vary to take account of the local environment in which entities operate and as a result the same business transaction are accounted for in different ways for example within the UK compared to the USA or Japan.
Factors that influence variations in national practices:
Legal systems operation
Different political systems-'The level of central government control'
Different capital markets
Variation in the type and scale of economic activity, from developing economies to industrialised economies
Degree of international influence and directness of an economy
Stability of the economy and inflation rates
Influence of the accounting profession
National differences in corporate governance structures and practices
E.g. of inconsistent national financial reporting is that of a German car manufacturer. In 1993 Daimler-Benz obtained a listing of its shares in the USA and submitted its report under both USA accounting practices (GAAP) and German GAAP for that year.
The company reported a loss of $1 billion under US GAAP, while at the same time reported a profit of $370 million under its own domestic German GAAP. The disparity was because of the different accounting practices being used by different countries. Such significant differences can undermine the usefulness of financial statements.
Explain the meaning and types of international accounting harmonization
Harmonization as opposed to standardization has the meaning of reconciliation its term is a practical approach to reconcile rather than to standardise, especially if it relates to accounting standardization procedures owned by one country that should be applied by other countries. Harmonization is currently playing an important part in producing improved communication on financial information that can be interpreted and understood internationally.
The definition of harmonization is considered more realistic and more likely to be accepted rather than standardisation, each country also as its own set of rules and philosophies with the aim of control of its accounting standards.
Implementation of complete or limited harmonization between national GAAP and IFRS is a decision that requires particular attention to the situation of SMEs, thereby ensuring that there are at least no contradictions between them both. The relationship between national GAAP and Income Tax Law and Company Law should play a major role within this decision.
Qualitative characteristics of accounting information have an important requirement to be compared in the world of international trade and investment. The standardisation of international accounting standards to obtain full comparability is broadly accepted internationally but there is the existence of certain factors in a country that are still needed to make the national accounting standards applicable within a country. For e.g. within Indonesia there is a (FASAC) Financial Accounting Standards Accounting for Cooperatives but this standard is not required within the United States which indicates the difficulty in creating a standardised international accounting concept.
Harmonization can also be interpreted as a group of countries that agree on an accounting standard that is similar, but if implementation fails to take place then the standard should be disclosed and reconciled with mutually agreed standards. Institutions that are active in the business harmonization of accounting standards include the OECD (Organization for Economic Cooperation and Development) and the United Nations.
Types of Harmonization of accounting include:
Harmonization of accounting standards in relation to reporting and assessment of reports
Harmonization of corporate disclosures made public on the stock associated with listings on the stock exchange
Harmonization of auditing standards
Creation of an understanding of the presentation of information within parent companies and subsidiaries or vice versa
Information prejudice would be unlikely to occur
Measurement of international accounting harmonization
There are currently two approaches to measure accounting harmonization an index-based techniques and statistical modelling.
The index-based method measures a view of harmony which is different from that adopted in the statistical modelling of the harmonization process. The concept of harmony underpinning indices is based on uniformity whereby maximum harmony is achieved when all firms adopt the same accounting treatment. This technique is seen as simplistic and has been criticized because it ignores the possibility of companies operating under diverse conditions and the use of different treatment for the various items on a financial statement.
Comparability of financial statement items does depend on the use of the accounting method that a company feels is appropriate to its operating conditions, for e.g. (FIFO ) First in First Out method when accounting for physical inventory movements and (LIFO) Last in Last Out will give dramatically different results within their accounting methods.
Convergence project between US GAAP and international standards
The International Accounting Standards Board (IASB) and Financial Accounting Standard Board (FASB) are the most significant organizations within the financial reporting regulation setters. Both organizations acknowledged that for international capital markets to function appropriately a single set of quality accounting standards were required to exist for listed companies.
The main difference between US GAAP and IFRSs is in the area of the general approach. The IFRSs are based on basic accounting principles with limited application guidance, US GAAPs are based especially on rules with specific application guidance.
Advantages of IASB international convergence
Investor understanding and confidence is improved.
Investor decision making is improved.
Capital is allocated more efficiently around the world.
Financial risk and cost of capital are reduced.
Strategic decision making in mergers and acquisition is improved.
Criticisms of IASB international standards
Solution is too simple for such a complex problem.
Strips accounting of its flexibility to adapt to different situations.
Challenges national sovereignty.
A tactic of large accounting firms to expand their market share.
May create standards overload.
Reconciliation and mutual recognition
Financial statements based on home GAAP, but net income and stockholders' equity reconciled to another GAAP.
This is the SEC requirement for foreign filers.
Less costly than preparing complete financial statements based on another GAAP.
Mutual recognition (reciprocity)
Jurisdictions accept financial statements based on each other's GAAP.
Does not improve comparability.
Can create an unlevel playing field.
Arguments on both sides have merit.
But convergence and international standards are a reality.
The role of the IASB is to develop world-wide accepted Accounting Standards with the purpose to formulate the standards and to promote its global use and acceptance. The IASB has achieved important accomplishments in the comparability of financial statements and the achievements of the IASB (regulation of the EU, agreement between FASB and IASB) has been a major breakthrough in the international harmonization process.
Therefore the role of the IASB is within the future a very important one with the main objective to continue to assist in the development of an improved common conceptual framework that provides a sound foundation for the developing future accounting standards.