Advanced Financial Accounting and Reporting
“A number of authors have questioned why, despite their apparent technical failure CF [conceptual framework] projects continue to be undertaken. A brief study of the countries and circumstances of CF projects suggested that the major rational for undertaking CFs was not functional or technical, but was a strategic manoeuvre for providing legitimacy to standard-setting boards and the accounting profession during periods of competition or threatened government intervention.” (page 89)
Hines, R D (1989), ‘Financial Accounting Knowledge, Conceptual Framework Projects and the Social Construction of the Accounting Profession' Accounting, Auditing and Accountability Journal 2 (2) pp72-92
The above extract is from a paper by Ruth Hines. To what extent are these ideas reflected in the international convergence programme?
Generally accepted accounting principles (GAAP) are the rules which influence accounting in each country. They are usually made up of a mixture of national company law, national accounting standard and stock exchange requirements. However, international accounting standards and statutory requirements from other countries also affect GAAP.
By reviewing current accounting standards and producing new ones, a conceptual framework for financial reporting can be made. A converged conceptual framework is a way in which all accounting bodies would establish a series of sound, appropriate accounting rules that would form as a reference for accountants in financial reporting. Therefore a theoretical basis would be created for determining what should be accounted for, how they should be measured, and what way they should be presented to the users of the financial statements. A conceptual framework project aims to develop this improved common conceptual framework that can make creating future accounting standards an easier and more efficient process. Succeeding in creating a conceptual framework would help to ensure that standards are principles-based, consistent and make it easier for investors to make decisions based on the available financial reports. A principles-based approach is often preferred because it gives companies flexibility should new situations arise, and following the highly publicised Enron disaster, it was thought that if a principles-based approach was used it could have been avoided.
A conceptual framework has several advantages, the main being the standardisation in accounting practice with little inconsistencies. A conceptual framework would also help reduce the number of standards that accountants have to follow and focus in more on principles - which serve more as guidelines, rather than strict rules. Interference from third parties, such as political parties is also avoided.
Of course, with advantages come disadvantages. It needs to be remembered that financial statements have a variety of different users - investors, lenders, suppliers, employees, customers etc, so it is difficult for a conceptual framework to be created that will suit everybody. Given this, sometimes it really is suitable for variety in accounting standards, thereby serving different purposes. Also, it has not actually been proved that a conceptual framework would make it any easier to prepare standards and ensure their implementation.
The IASB produced a document in July 1989 entitled, Framework for the preparation and presentation of financial statements. This is basically the conceptual framework in which all standards set by the IASB are set and so decides how financial statements are formed and what is made available in them. The document takes a look at the objectives, underlying assumptions, qualitative characteristics and elements of financial statements, and then goes onto look at how to recognise and measure the elements.
This leads on to the current debate surrounding the determination of objectives and characteristics of financial reporting. In the Draft Conceptual Framework for Financial Reporting (2008), it states that"The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders and other creditors in making decisions in their capacity as capital providers".This is known by the ASB as the"resource allocation decision-usefulness objective"(2007).Although there are other users of financial statements such as employees, customers, the government and the public, an entity will obtain economic resources from its capital providers and so this group specifically will have"the most critical and immediate need for general purpose financial information about the economic resources of an entity"(2008). This means information needs to be provided that satisfy mainly their needs.
Stewardship is another objective of financial reporting. This looks into the competence and integrity of managers and whether their strategies at managing the business have been successful. This means shareholders and other users are able to know that the behaviour of management is in line with their own objectives, that strategies are in place to make the best use of the assets and that these assets are being accounted for appropriately. Following this objective also limits the problems that can occur from agency theory, which is the conflict that can occur in a business between shareholders and management. For example, instead of maximising shareholder wealth, managers may have other incentives such as striving toearn a higher salary or status within the company. It is also disadvantageous to shareholders as itis often difficult and expensive to continuously monitor the actions of management. The agency theory tries to resolve the problems of different goals between owners and management.
Obviously as the same financial statements are intended for various different users, it is difficult for accountants to be able to come up with a procedure of reporting that suits all of these users.
Conceptual framework projects are often seen to fail to achieve the purposes that they set out to achieve, so why are they still being undertaken? Dopuch and Sunder (1980) stated that it could be on the basis of maintaining accounting knowledge; accountants want to keep their professionalism and reduce the threat of government intervention.
In 1973, the first international standards body was formed; they were named the International Accounting Standards Committee. In 2001 they became the independent international body, named the International Accounting Standards Board (IASB). International standards have been used more and more since this reorganisation in 2001. ‘As of 2009, the European Union and over 100 other countries have adopted (or have decided to adopt) international financial reporting standards (IFRS) issued by the IASB or a local variant to them.' FASB. As already noted, despite the previous conceptual framework project failures, since 2002, the FASB and the IASB are working on converging U.S. generally accepted accounting principles (GAAP) with IFRS. In addition to this, from 2009, China and Japan are also trying to set their standards in line with IFRS. The Securities and Exchange Commission (SEC) are also trying to make the use of international standards by U.S. public companies a mandatory or optional choice, which will be looked at closer later.
Although accounting bodies have been aiming to create international harmonisation for many years there are certain barriers that make convergence difficult. There are many doubts emerging about international harmonisation and accounting standards quality. One of the big problems is fair value accounting; obviously each national accounting body will have different ideas as to how an entity should value their assets on the balance sheet. The IASB and FASB are proposing different fair value standards, the FASB proposes a model which values assets at fair value whereas the IASB is proposing a mixed measurement model which will see bank's loan books valued at amortised cost. Christodoulou,C (2009) In July this year the IASB published a draft standard potentially restricting the scope of fair value accounting while the FASB hinted at expanding it. Veron.N (2009)
Another barrier is that the US accounting body (FASB) follows a rules-based approach to accounting standards whereas the IASB follow a principles-based approach. As mentioned earlier, it was believed that principles-based approach could avoid big scandals such as that with Enron, so is it going to be easy to implant this into US GAAP?
Some countries make accounting standards a legal requirement so if a converged conceptual framework can be achieved then these countries are going to have to change their legal systems.
As well as this, laws around the world are different for tax purposes. Tax authorities in different countries are unlikely to want their revenue to be affected by a change in accounting regulations. Also tax consequences can make companies reluctant to account for items according to their substance. Martin.R and Jarvis.R (2004).
There are also worries that larger economies such as the U.S. and China will have more control when creating the converged standards. The IASB has no legal authority but is responsible for its constituent nations, each of which will have its own agenda and will be concerned for its own well being so that standards are treated appropriately to their economy. The IASB and FASB will need to be responsive to the real-world concerns of businesses, and not let their independence ignore other countries, although the boards do need to be strong enough to resist outside political pressure. Williams.P (2006)
In 2004, both the IASB and FASB decided to develop an improved, common conceptual framework that adds to their current frameworks. The project was set to look at addressing issues that affect the prospects of new or revised standards and to consider concepts applicable to private sector organisations, but one of the main aims of this new project was to look at any omissions in the current frameworks or any changes in the environment since they were issued.
This shows that as time passes, the FASB and IASB are growing closer and closer to creating a converged conceptual framework. This is again demonstrated in 2006 when the FASB and IASB released a Memorandum of Understanding, which detailed the progress they hoped to achieve by 2008. They assured that they still shared the same objective of creating common accounting standards over time, of the highest quality. They also stated that they aimed to serve the needs of investors by replacing weaker standards with stronger ones.
In 2008, they updates this Memorandum of Understanding and stated that they had made progress on bringing U.S. GAAP into line with IFRSs; the FASB introduced a fair value option and adopted IRFS approach to accounting for research and development assets acquitted in a business combination. The IASB had published new standards on borrowing costs and segment reporting, through converging IFRS with U.S. GAAP. They also released information on areas where they are going to continue working on improving, including: business combinations, fair value measurement, presentation of financial statements, intangible assets, leases, revenue recognition and much more. This was evidence that they were persisting well to move forward with this project.
Also in 2008, the SEC published a proposed Roadmap, for the possible use of IFRS by U.S issuers by the beginning of 2014. It stated that it would be decided by the SEC if IFRS would be beneficial for investors and public interest by 2011. It also stated that certain U.S issuers could be using IFRS by as early as the end of 2009 if they met certain criteria.
IFRS is now accepted and used by listed companies in approximately one hundred and thirteen countries around the world, and this is expected to grow in the near future. This is leading further to the belief that IFRS could become the main set of accounting standards that provide a common ground for companies to report and for investors to compare.
It has been thought by some accounting standard setters around the world that due to developments in the world economy such as globalisation, accepting globally accepted accounting standards by converging their framework with that of the IFRS was a good move forward to ensure consistency and comparability of financial reporting.
Almost all of the listed companies within the European Union complied with IFRS by 2005, with the remainder making the change in 2007, leading to greater uniformity and efficiency for investors. However, the increasing amount of companies having to adopt international standards has led to the perception that IFRS is overly complex and is complicating the search for appropriate form of financial reporting for entities not covered by the EU Regulation. In particular, there is a difficulty in knowing the correct difference between large and small company accounting. The needs of small and medium companies appear to have been ignored in favour of the requirements of the huge global companies.
The U.S needs to look at their situation in relation to their investors and capital markets. They have one of the biggest and most liquid capital markets in the world and U.S GAAP has been used for financial reporting by all public companies, plus many private companies and foreign companies.
Taking U.S. investors' situation into account, it should be noted that many of them have started to invest internationally. As well as this, a large amount of U.S. companies compete on an international scale, so the need to be able to at least understand IFRS statements to stay ahead in competition. These points seem to add to the notion of IFRS being a requirement for these investors. The SEC has also advised that for U.S. investors to be in the best position, they need to be able to compare U.S companies with companies from around the world and using the IFRS framework would provide a way for them to do this. This would ensure that investors are in the best position to make informed decisions.
This is the case for all investors around the world who decide to place their money in companies in foreign countries. For it to be reliable, a single set of high-quality accounting standards consistently applied across all countries is needed. To determine whether IFRS should be used in the U.S., the extent to which IFRS is used around the world and the consistency of its application should be considered. However, the large number of countries using IFRS can not alone decide if the U.S. should also adopt it.
The issue of having a converged conceptual framework is always going to be a topical debate. Even though it seems the US and international bodies for accounting are enhancing their efforts in order to converge their two sets of rules, and now meet monthly to meet their June 2011. The progress shows that complete harmonisation could not only be possible but also be imminent.Christodoulou, C. (2009). However, there will always be critics of it. It could be seen that due to the technical failures that authors have noticed, the idea of a converged conceptual framework could just be a way for the accountants of bigger, more successful companies to make it better and easier for themselves. As already noted, it will be smaller companies and poorer countries that will have the hardest job in working towards the conceptual framework.
Nicholas Veron (2009) feels that the convergence process has been pushed too hastily. Due to the success of the EU adoption, Sir David Tweedie, the chairman of the IASB, wanted to achieve this same success in the US before 2011 when his term ends. This has caused the IASB to neglect to combine support both in Europe and their constituents in the global investment community.
Some of the major difficulties to achieving harmonisation are standards for loans and financial securities. The IASB and FASB are going to need to be careful to keep their draft standards in sync and may hold back some standards to avoid confusion, as Sir David Tweedie (2009) said, “If we have different words, people will start interpreting them differently”.
References and Bibliography
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2. BPP Learning Media (2008) ACCA Study Tect Paper F7 Financial Reporting (United Kingdom) Chapter 1. Pages 43-51.
3. Christodoulou.C (2009) IASB and FASB increase convergence pace. Available from:http://www.accountancyage.com/accountancyage/news/2252263/iasb-fasb-increase-convergence. Accessed on 28th February 2010.
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