What are the practical implications of implementing the International Financial Reporting Standards


The dynamic world of today, which is constantly changing withholds a challenge to adjust and accommodate those forces and factors over which we have little or no control. To begin with, globalization is the biggest challenge and phenomena to tackle. Globalization of the capital markets and the spread of free trade worldwide have enormous implications on all organizations and individuals as the capital now moves more freely across national borders, including both labor and cash flow.

Therefore the need for complete information is even greater at a time like this due to the increase in trade and investments in stocks and financial markets within and across borders. The need of investor to weigh opportunities of disparate nature is greater than ever, for which a standard reporting system for investors to view before making an investment is need of the hour. So, for harmonized standards worldwide it is being actively worked upon and pursued by Financial Accounting Standard Board (FASB), SEC and the IAS committee to bring complete and as much information about an organization as possible for the wider interest.

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Since the past three decades, an increasing amount of attention has been given to the activities of the International Accounting Standards Committee (IASC)1 and the International Organization of Securities Commissioners (IOSCO) (Financial Analysts Journal, Vol. 48, No. 6, 1992, pp. 21-2).

As mentioned earlier, a high quality reporting framework is required which provides comparable, reliable and transparent information to ensure fair, liquid and efficient capital markets worldwide. So the Securities and Exchange Commission (SEC), keeping in mind the interests of investors, lenders and other organizations which are becoming increasingly global, has also increased its involvement in various forums to develop a globally accepted standard of financial reporting framework.

However, with the implementation of SEC's Electronic Data Gathering and Retrieval (EDGAR) system, the financial analysis will require more emphasis than ever before on recognition and measurement in financial reports so that we may be assured that the contents of data bases are both complete and comparable (Holger Daske et al, 2008).

As the evolution of International reporting standards is happening, there is a massive and growing academic literature devoted to rival national systems of finance and corporate governance (Hopt et al. 1998, pp. 250-271). But it has been observed by Holger Daske, Luzi Hail, Christian Leuz and Rodrigo Verdis (2008) that when IFRS are introduced in an organization or economy, on average market liquidity increases. It has also been documented that a firm's cost of capital decreases while improving its equity valuations.

Deloitte (2003) states: "In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable."

There is also an opinion that effective regulation is the key to successful implementation of international standards, but international accounting and auditing standards themselves do not set out requirements as to how such effective regulation should be exercised (John Hegarty et al, 2004).

According to Securities and Exchange Commission, things may soon change where US's Generally Accepted Accounting Principles (GAAP) by FASB are concerned. As until recently, the FASB's development of GAAP had been mostly unfettered, except for the Securities and Exchange Commission's (SEC's) review (Melvin Houston, Alan Reinstein, 2001). Houston and Reinstein suggest U.S. firms should use this time to prepare for a worldwide shift toward uniform accounting standards, before such provisions become too onerous (Melvin Houston, Alan Reinstein, 2001).

This is what the report aims to explore, i.e. what IFRS is and how it applies to different organizations. This report will then further focus on several countries and how international reporting standards are affecting them and what are the practical implications when these standards are implemented.

To further prove the importance of an internationally consistent reporting system because of the increased cross-border transaction in the past ten years here are some facts: in 1992, foreign investors engaged in $149 billion of transactions in U.S. securities, which, by 1997, increased dramatically to a staggering $1.1 trillion.

Between 1975 and 1997, as per the studies of Frost and Chu, cross-border transactions in bonds and equities as a percentage of Gross Domestic Product (GDP) grew from 4 percent to 213 percent in the U.S (Frost, CA and F. Chu, 1998); from 2 percent to 96 percent in Japan; from 5 percent to 253 percent in Germany; and, from 1 percent to 672 percent in Italy (IASC, June 1999). This expansion greatly increases internationalized worldwide capital markets. In turn, it strengthened the need for internationally comparable financial statements and related accounting standards (Melvin Houston, Alan Reinstein, 2001).

International Financial Standards

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The requirement for an international standard of reporting is clear. As businesses and trade barriers between nations become less restrictive (e.g., under the influence of the North American Free Trade Agreement -- NAFTA), differences among national accounting and auditing standards become more troubling (Melvin Houston, Alan Reinstein, 2001). Thus an international reporting standard is required like the IAS/IFRS. IFRS are standards for the preparation of general-purpose financial statements, aimed at meeting the needs of a wide range of users, but predicated on the assumption that placing primary emphasis on the needs of shareholders will result in measurement, recognition and disclosure requirements that also meet the needs of other users. (Frederic Gielen et al, June 2005, pp. 5)

The IASB and FASB Frameworks aim to update and refine the existing concepts to reflect the changes in markets, business practices and the economic environment that have occurred in the two or more decades since the concepts were first developed (International Financial Reporting Standards, Wikipedia).

By and large, the objective of FASB framework is to create a thorough groundwork for future accounting standards that are principles-based, internally consistent and internationally converged (International Financial Reporting Standards, Wikipedia). As business between organizations across borders and worldwide increases, the need for standards to be internally consistent and internationally converged has and would increase and that is why IASB and the FASB are working together on this jointly.

IFRS helps in the decision making process which the investors undertake based on the financial statements of the company. By assessing the financials of the company, by looking at its balance sheet and income statement, the user can decide how healthy the organization is and how financially strong it is to invest in.

This globally accepted, high quality financial reporting framework provides consistently fair, liquid and efficient capital markets worldwide is by providing investors with information that is comparable, transparent and reliable.

That is why a dual objective is pursued, of upholding the quality of financial reporting domestically, while encouraging convergence towards a high quality global financial reporting framework

internationally (Melvin Houston, Alan Reinstein, 2001). Financial statements of foreign private issuers are now being prepared using the standards promulgated by the International Accounting Standards Committee.

While we cannot deny that U.S. accounting standards have played an important role in corporate financial policy (Gordon L. Clark, Daniel Mansfield, Adam Tickell, 2001 pp. 250-271), the IASC has become more important over the past five years as a means of stabilizing a "race to the bottom" than it may have been ten years ago (compare Braithwaite and Drahos 2000). For several listed companies around the world, the presentation of International Financial Reporting Standards (IFRS) has become one of the most significant regulatory changes in accounting history.

In the last few years FASB has found that there are few instances where IASC standards could be judged inferior to U.S. GAAP, whereas there are a number of instances where IASC standards could be judged more comprehensive and inclusive than U.S. GAAP (Bloomer 1999).

Identified by Braithwaite and Drahos (2000, 121) as a "private sector business organization which is committed to a process of continuous improvement in the development of international accounting standards for financial reporting," the IASC is "of profound importance to the globalization of financial regulation." Indeed, they argue that the IASC has sought harmonization "to progressively higher standards."

Who uses it? How does it affect those organizations?

Regulators expect that the use of IFRS enhances the comparability of financial statements, improves corporate transparency, increases the quality of financial reporting, and hence benefits investors (e.g., EC Regulation No. 1606/2002)

Comparing mandatory and voluntary adopters, we found that the capital market effects are most pronounced for firms that voluntarily switch to IFRS, both in the year when they switch and again later, when IFRS become mandatory.(H. Daske, L. Hail, C. Leuz, and R. Verdi, Journal of Accounting Research Vol. 46 No. 5 December 2008)

At present, the ROSC accounting and auditing assessments are undertaken in client countries of the World Bank (John Hegarty, Frédéric Gielen, Ana Cristina Hirata Barros September 2004) private sector has sought to increase the competence of individuals and firms to apply international standards. However, governments, for the most part, have not addressed the need to put in place proper incentives to ensure that this competence is actually applied in practice (John Hegarty, Frédéric Gielen, Ana Cristina Hirata Barros; September 2004)

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Market forces provide certain positive incentives to comply with high standards, but experience in both developed and developing economies suggest that countervailing disincentives operate to discourage such compliance.

International standards are not always geared to protecting the public interest. (John Hegarty et al, 2004).

While the governance of accounting and auditing standard-setting arrangements has been significantly improved in recent years and is still

being improved, some standards - particularly auditing standards - remain to be revised.

Implications on all Organizations

Information about corporate financial performance is a public good rather than a private matter that is the object of privileged access (Steinberg, Arner, and Olive 1999).

Global financial integration has had enormous implications for the autonomy of countries' accounting standards boards. There is considerable competition among financial markets for cross-border listings.

German legislation (1998) is allowing domiciled firms to use international accounting standards is indicative of the force behind global harmonization. But this legislation simply allowed rather than required the use of international accounting standards (Gordon L. Clark, Daniel Mansfield, Adam Tickell Jul., 2001, pp. 250-271)

Furthermore, much of the theoretical literature on corporate disclosure and finance presumes that firms are reluctant to disclose and will only report information required by law (see Admati and Pfleiderer 2000; Fishman and Hagerty 1997). Not only are there considerable costs associated with producing this kind of information, there is also some anxiety at the corporate level about the consequences of disclosure for firms' market positions.

1. High quality financial reporting contributes to promoting private sector growth and reducing volatility, through: (a) strengthening countries' financial architecture and reducing the risk of financial market crises, together with their associated negative economic impacts; (b) contributing to foreign direct and portfolio investment; (c) helping to mobilize domestic savings; (d) facilitating the access of smaller-scale

corporate borrowers to credit from the formal financial sector by lowering the barrier of high information and borrowing costs;2 (e) allowing investors to evaluate corporate prospects and make informed investment and voting decisions, resulting in a lower cost of capital and a better allocation of resources; and (f) facilitating integration into global financial and capital markets.

2. Financial reporting is also a building block of a market-based monitoring of companies, which allows shareholders and the public at large to assess management performance, thus influencing its behavior.

3. High quality financial reporting also contributes to strengthening the financial discipline of Government Business Enterprises (GBEs).

4. High quality financial reporting may also contribute to improving the assessment and collection of taxes on corporate profits. Countries currently have fundamentally different approaches to the relationship between accounting and taxation. At one extreme (total independence), income determination for accounting purposes is completely separate from income determination for tax purposes. At the other extreme (total dependence), either financial statements are prepared in accordance with tax rules, or income determination for tax purposes is determined by the choices made in financial statements.

Inconsistencies between international standards and the legal framework

12. Also fundamental to the implementation of international accounting and auditing standards is an unequivocal relationship between the legal framework (e.g., company law and securities law) and international

standards. The ROSC results point to several stress areas between domestic laws and the standards, which could adversely impact compliance, as well as monitoring and enforcement efforts.

Effect on the SME/Global Market

There is a much needed set of accounting standards for businesses that previously did not have the type of transparency that larger corporations are required to make publically available.

Probably the most significant impact this has on SMEs is the ability to provide lenders and investors with reliable and accurate records of their business' finances. As lenders and investors have standardized proof of a growing SME's risk and ability to repay, the economy will benefit as a whole.

Conclusions/ Recommendations

More emphasis should be placed on the deterrent incentives of robust monitoring and enforcement regimes to achieve a full and balanced combination of capacity and incentives.

International standards are not necessarily appropriate to govern all financial reporting obligations, this being especially the case with International Accounting Standards (IAS) / International Financial Reporting Standards (IFRS).

There is an urgent need for the International Accounting Standards Board to specify the circumstances in which the use of "full" IAS/IFRS is appropriate, and to develop different standards that would meet the needs applicable to the users of financial statements of other entities, particularly small and medium-sized enterprises (SMEs). Many stakeholders continue to have misunderstandings with respect to the very nature of international standards, which complicates efforts to plan, define and measure progress towards successful implementation.

many stakeholders believe that fraud detection should be recognized as a responsibility of statutory auditors in case of wrong representation of company financial position.