Chap003 international accounting Doupnik and perara

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Chap003 international accounting Doupnik and perara

Chapter 03 - International Convergence of Financial Reporting




Chapter Outline

    I. Accounting harmonization is a process that reduces alternatives while retaining a high

     degree of flexibility in accounting practices.

     A. Harmonization is different from standardization (or uniformity) which implies the

     elimination of alternatives in accounting practices.

     B. The objective of accounting harmonization is to have comparable financial statements

     from companies in different countries.

     C. Harmonization of regulations (de jure harmonization) does not necessarily produce

     harmonization of practices (de facto Harmonization).

    II. There are many arguments for international harmonization of accounting standards. The

     arguments include that it would:

     A. Make financial statements of companies in different countries more comparable, and

    hence make it easier for investors to evaluate foreign firms.

     B. Simplify for MNCs the evaluation of possible foreign takeover targets.

     C. Reduce the cost for MNCs to consolidate foreign listed companies.

     D. Make it easier for companies to access foreign capital markets.

     E. Make it easier for MNCs and international accounting firms to transfer accounting

     personnel to other countries.

     F. Raise the quality level of accounting practices internationally.

    III. There also are several arguments against international harmonization of accounting


     A. Considering the differences among countries in terms of socio-politico-economic

     systems, it would be almost impossible to arrive at a set of accounting standards that

     would satisfy all of the parties involved.

     B. Nationalism international standards would be perceived as a set of standards

    developed to suit the requirements of other countries, and hence would not be

    received favorably.

     C. It is unnecessary to force all companies worldwide to follow a common set of rules.

     D. Today’s global capital market has evolved without harmonized accounting standards.

     E. It would lead to a situation of standards overload.

    IV. The International Accounting Standards Committee (IASC) was established in 1973 by

    professional accounting bodies in ten countries (Australia, Canada, France, Germany,

    Ireland, Japan, Mexico, the Netherlands, the United Kingdom, and the United States) with

    the broad objective of formulating “international accounting standards.”

     A. In its first 15 years, the IASC’s main activity was the issuance of International

    Accounting Standards (IASs), many of which allowed multiple options to accommodate

    existing accounting practices in various countries.

     B. The IASC undertook a Comparability Project during the period 1989-1993 to eliminate

    most of the choices of accounting treatment permitted under IASs.


Chapter 03 - International Convergence of Financial Reporting

     C. The final phase in the work of the IASC began with the IOSCO agreement in 1993 and

    ended with the creation of the IASB in 2001. The main activity during this phase was

    the development of a “core set” of international standards that could be endorsed by

    IOSCO for cross-listing purposes.

    V. The International Accounting Standards Board (IASB) has the primary responsibility for

    international harmonization/convergence of accounting standards.

     A. The IASB was formed in 2001 to replace the IASC with the objective of developing a

    set of high quality accounting standards to be used through out the world.

     B. The IASB follows a due process procedure and uses a principles-based approach in

    developing international standards.

     C. The IASB has 14 members 12 full-time and 2 part-time. Seven full-time members

    serve as liaison with national standard setters. Technical competence is the most

    important criterion for selection as a Board member.

     D. In addition to the IASB itself, the other main components of international standard

    setting include the IASC Foundation and its Trustees, the International Financial

    Reporting Interpretations Committee (IFRIC), and the Standards Advisory Council


     E. International Financial Reporting Standards (IFRS) consist of IFRSs issued by the

    IASB, IASs issued by the IASC (and adopted by the IASB), and Interpretations

    developed by IFRIC.

     F. As of March 2008, 41 IASs and 8 IFRSs had been issued, but only 30 IASs were still in


     G. The IASB has a conceptual framework (Framework for the Preparation and

    Presentation of Financial Statements) that serves as the basis for developing IFRS.

     H. The IASB also has issued a set of guidelines for first time adopters of IFRS (IFRS 1).

VI. There are a number of ways in which a country might adopt IFRS.

     A. Replace national GAAP with IFRS.

     B. Require parent companies to use IFRS in preparing consolidated financial statements.

     C. Require stock exchange listed companies to use IFRS in preparing consolidated

    financial statements.

     D. Require foreign companies listed on a domestic stock exchange to use IFRS.

     E. Require domestic companies listing on a foreign stock exchange to use IFRS.

VII. There are some concerns about adopting IFRS.

     A. They are too complicated for some companies.

     B. Using them as the basis for taxation could be a problem.

     C. Some IFRS, for example, those related to financial instruments and fair value

    accounting, are controversial.

     D. Guidance for first-time adopters is inadequate.

     E. In countries which do not have well-developed capital markets, and where the users

    are satisfied with the local standards, the adoption of IFRS would be of little benefit.

     F. There could be language translation issues.

    VII. Despite the difficulties, there is a worldwide trend towards convergence with or adoption of

    IFRS, as evidenced by:

     A. Support for the IASB structure and its highest common denominator approach.


Chapter 03 - International Convergence of Financial Reporting

     B. The IASB’s initiatives to facilitate and enhance its role as a global standard-setter, for

    example, by issuing guidelines for first-time adopters, holding public round table

    forums, and having direct liaison with some national standard setters.

     C. The European Union requiring the use of IFRS by publicly traded companies in

    preparing consolidated financial statements.

     D. The FASB/IASB convergence project (the so-called Norwalk agreement).

Answers to Questions

    1. The ultimate goal of both harmonization and convergence is to achieve international

    comparability in financial reporting, and both are processes that take place over time.

    However, while harmonization refers to the reduction of alternative accounting practices in

    different countries, convergence refers to the process of developing a set of high quality

    financial reporting standards for use internationally (the process of global standard setting).

    Until the establishment of the IASB in 2001, the main objective of the IASC was to achieve

    international harmonization in accounting standards. Accordingly, the focus was to achieve

    consensus among different countries with regard to accounting standards. In this process

    different countries were allowed to have different accounting standards as long as they did

    not conflict, for example, the harmonization program of the European Union. On the other

    hand, convergence implies the adoption of one set of standards internationally.

    2. The potential benefits for a multinational corporation from convergence of financial reporting

    standards are derived mainly as a result of international comparability of financial reporting

    standards and practices. Examples of such benefits include: reduction of financial reporting

    costs for multinational corporations that seek to list their stocks on foreign stock exchanges;

    reduction of cost of preparing worldwide consolidated financial statements; and ability to

    transfer accounting staff to other subsidiaries overseas more easily.

    3. The EU Directives were not completely effective in generating comparability across EU

    member nations because the Directives:

     a. allowed countries to choose among available options in many areas and

     b. did not cover many accounting issues, such as leases and translation of foreign currency

    financial statements.

4. The three phases in the life of the IASC were:

     a. 1973-1988 lowest common denominator approach to standard setting

     b. 1988-1993 reduction of existing options in IASs through the Comparability of Financial

    Statements Project

     c. 1993-2001 development of core set of standards under the IOSCO Agreement

    5. IOSCO’s endorsement of IASs legitimized the IASC’s claim as “the” international accounting

    standard setter. This also helped in addressing, at least partly, the problem of IASC’s lack of

    enforcement power.


    Chapter 03 - International Convergence of Financial Reporting

    6. Twelve of 14 members of the IASB are full-time. They are required to sever all ties to former employers to establish their independence. The most important criterion for selection of IASB members is technical competence. These aspects of the Board’s structure confirm the IASB’s commitment to develop the highest quality standards possible. In addition, the IASB follows an open process in which constituents are able to provide input and feedback on IASB projects and proposed standards. The geographical representation is achieved through the method of appointing the IASC Foundation Trustees.

    7. A principles-based approach to accounting standard setting refers to the development of standards that provide the basic guidelines for accounting in a particular area without getting bogged down in detailed rules. The IASB uses a principles-based approach in developing IFRS. Traditionally, the U.K. and the member countries of the British Commonwealth have adopted this approach.

    8. IFRS appear to cover most of the major accounting issues. With the issuance of IFRS 2,

    “Share-based Payments,” IFRS even provide guidance with respect to the accounting for stock options. Other than banks and financial institutions (IAS 30), IFRS do not provide

    rules for specific industries. On the other hand, IAS 41, “Agriculture,” provides guidelines for

    a particular sector of the economy for which rules are lacking in many countries.

    9. The IASB has adopted a principles-based approach to develop a set of accounting standards that constitute the “highest common denominator” of financial reporting. This approach is in sharp contrast to the approach adopted by the IASC in its early years. Also, unlike the IASC, the IASB is now formally linked to national standard setters. Seven of the 14 Board members have a direct liaison relationship with influential national standard setters and the IASB has entered into a formal agreement to converge its standards with those of the U.S. FASB. The major change is in the emphasis of the role of the IASB, from harmonization to global standard setting.

    10. The different ways in which IFRS might be used within a country include: ; Required of all companies domiciled within the country.

    ; Required of parent companies in preparing consolidated financial statements; national

    GAAP used in parent company-only financial statements.

    ; Required of all companies (both domestic and foreign) publicly traded within the country;

    non-listed companies use national GAAP.

    ; Required of foreign companies that are publicly traded within the country. Domestic

    companies use national GAAP.

    ; Required of domestic companies with foreign operations and/or foreign stock exchange

    listings. Domestic companies without a foreign presence use national GAAP. ; Instead of requiring the use of IFRS in each example above, a country could allow the

    use of IFRS in lieu of domestic GAAP in each situation.


Chapter 03 - International Convergence of Financial Reporting

    11. There are several factors that might inhibit worldwide comparability of financial statements

    even if IFRS are required in every country. First, even though the Comparability Project of

    the 1990s reduced the number of alternative methods allowed, several IFRS continue to

    allow companies to choose between a benchmark and an allowed alternative treatment. If

    the benchmark is adopted by one company and the allowed alternative by another company,

    strict comparability will not exist. (It should be noted that this is also true within a country if

    domestic GAAP allows choice among alternatives, for example, in depreciation and

    inventory valuation methods.) Second, even if the same treatments are selected, cross-

    national comparability could be harmed if accountants apply the principles-based IFRS

    differently. Differences in cultural values across countries could cause accountants to have

    biases, for example, with respect to conservatism that could influence their judgment in

    applying IFRS.

    12. IAS 1 indicates that, if existing IFRS do not provide guidance in a specific area,

    management should refer to the definitions, and recognition and measurement criteria for

    assets, liabilities, income and expenses set out in the Framework.

13. The overriding principle in IAS 1 is “fair presentation.”

    14. A firm should claim to prepare financial statements in accordance with IFRS only if it

    complies with all requirements of each Standard and each applicable Interpretation.

    15. Refer to Exhibit 3.5. Note: The information in Exhibit 3.5 can be updated by going to the

    IASPlus web site ( It has a list of countries, which have adopted IFRS.

    16. Until 2007, the SEC required foreign companies, which used IFRS, listed on U.S. stock

    exchanges to reconcile their financial statements to U.S. GAAP. In November 2007, the

    SEC decided to remove this requirement recognizing that IFRS is a high quality set of

    accounting standards which is capable of ensuring adequate disclosure for the protection of

    investors. As a result of this decision, foreign companies have been allowed two options in

    preparing financial statements, namely U.S. GAAP or IFRS. It has been argued that this has

    created an anomaly and that those two options should also be given to domestic listed

    companies in the United States.


    Chapter 03 - International Convergence of Financial Reporting

    Solutions to Exercises and Problems

    1. A major concern particularly in continental Europe is that the IASB is attempting to impose a certain style of accounting on every country. The reason for this concern is the fact that IFRS are based on Anglo-Saxon accounting principles, which are not the basis of accounting systems in most continental European countries. There is also a concern that the IASB standard setting process is dominated by representatives from Anglo-Saxon countries. Recognizing these and other similar concerns, the IASC Foundation Constitution Committee is currently undertaking a review of its constitution, and has identified as one of the key areas for consideration the appropriateness of the IASB’s existing formal liaison

    relationships. The Committee recognizes that the IASB should liaise with a broad range of national standard-setters, beyond the ones currently recognized in the Constitution. In addition, the IASB has attempted to make the standard setting process more transparent, by holding public meetings to discuss accounting issues, and increasing the opportunities for interested parties to contribute to the standard setting process.

    2. a. The ultimate objective of adopting IFRS is to ensure that financial statements

     prepared by firms in different countries are comparable.

     b. There are several issues that might hamper the EU from achieving the objective of

     financial statement comparability through the use of IFRS:

    ; The preparers of financial statements need to interpret and understand the

    requirements included in financial reporting standards in a consistent manner.

    Language will be a major issue in this regard. The IFRS are written in English and

    need to be translated into different languages. It is possible that the meanings of

    some of the terms used may be lost in translation, because of the absence of any

    equivalent terms in a particular language. This would be an impediment to achieving

    comparable financial statements.

    ; The decision to adopt IFRS in EU member countries involves a change in accounting

    values (especially conservatism and secrecy) in most EU countries. The main focus

    of accounting in these countries has been either taxation or providing information to

    government, whereas IFRS are aimed at providing information for the efficient

    working of the capital market. Eight of the ten countries which gained membership of

    EU in May 2004 were former Soviet Union countries. Changing the accounting

    culture in these countries in particular will be a major challenge facing the EU.

    ; In addition, there is lack of a tradition in exercising professional judgment in financial

    reporting in many EU countries. Using professional judgment within the principles-

    based system of IFRS to comply with IAS 1’s overriding principle of “fair

    presentation” might be something that EU accountants will need to learn how to do

    over time.

    ; Another major challenge is the absence of an adequate accounting infrastructure,

    particularly in most of the new member countries. Successful adoption of IFRS

    requires, among other things, a well-developed accounting profession, a business

    sector that supports IFRS, and an effective enforcement mechanism. The EU will

    have challenges in all these areas given the backgrounds of its member countries.


Chapter 03 - International Convergence of Financial Reporting

    3. Some of the key points to include in your report include:

    ; Make sure that IFRS are translated into each of the EU’s local languages without

    altering the substance of the financial reporting requirements.

    ; Develop an educational and training program to educate accountants about IFRS.

    ; Propose reorientation of the system of professional accounting education focusing on

    market based economic imperatives.

    ; Emphasize the need for an effective enforcement mechanism in each EU member

    nation with appropriate disciplinary procedures to deal with non-compliance.

    ; Ensure that the accounting oversight body remains independent from outside


    ; Request adequate funding to allow the oversight body to discharge its responsibilities


    ; Propose setting up a web page for the accounting oversight body to respond to on-going


    ; Introduce measures such as seminars to convince the business community of the

    benefits of adopting IFRS.

    4. Examples of countries that might have their own, different reasons for not permitting the use

    of IFRS include the United States, Mexico, and Japan. The reasons can be summarized as


     United States: U.S. GAAP is considered to be better-suited (superior) for the U.S. capital

    market environment than IFRS. Permission for U.S. companies to use IFRS would amount

    to lowering the quality of the standards.

     Mexico: Mexico’s business activities are strongly influenced by U.S. investment and trade

    through NAFTA. For Mexican companies, it is more important to follow U.S.GAAP than

    IFRS to be able to access the U.S. capital market.

     Japan: Traditionally, Japanese financial reporting has been based on tax rules, and the

    main source of finance for business has been bank credit. Cross-ownership is also common

    among Japanese companies. The outside equity capital market has not been a major

    source of financing or a major influence in developing financial reporting standards in Japan.

    An outside equity market-oriented set of accounting standards like IFRS might not be

    relevant for the Japanese environment.

    5. The purpose of this exercise is to encourage students to use the Internet to search for

    relevant information about the various initiatives taken by the IASB from time to time. The

    information required for this exercise is directly available from the IASB website.

    6. The purpose of this exercise is to encourage students to find the necessary information

    independently. They can select their home country or another country of their choice. In

    completing this exercise, students will become familiar with how a particular professional

    accounting body responds to the global trend toward convergence in financial reporting



    Chapter 03 - International Convergence of Financial Reporting

    7. There are several reasons why Anglo-Saxon accounting might be of interest to Chinese accounting regulators. First, China has expressed a commitment to adopt IFRS. To be successful in adopting IFRS, a clear understanding of Anglo-Saxon accounting is necessary, as IFRS are based on Anglo-Saxon accounting. Second, Anglo-Saxon accounting has evolved over a long period of time in a particular socio-economic and political environment, focused on capitalism, whereas in China, the focus has been on communism. Adopting capitalist measures in a communist environment is a major challenge for the Chinese regulators. Translating some of the fundamental concepts of Anglo-Saxon accounting, such as true and fair view, into the Chinese language would be another challenge. Further, the main purpose of Anglo-Saxon accounting is to facilitate the efficient working of the capital market, which is self-regulated.

    8. Honda Company raises a large proportion of its funding from overseas markets, particularly from the United States. The Company’s shares are listed on the New York Stock Exchange.

    As a condition of listing, it must submit a set of annual financial statements based on US GAAP. As the U.S. financial reporting standards are generally considered to be of high quality, financial statements prepared by using them are also accepted in other overseas stock exchanges. If Honda Company used IFRS in preparing its consolidated financial statements then it would have to submit a separate reconciliation to the U.S. SEC. So, the company’s desire to access the U.S. market easily could be the possible reason for preparing its consolidated statements in conformity with U.S.GAAP.

    9. The purpose of this exercise is to provide students with an opportunity to learn how different pieces of information can be extracted from different sources and used to address a given issue concerning international harmonization of accounting standards. For this exercise, students need to log on to the NYSE website at, and determine the country

    origins of foreign companies listed on the exchange. Students might find the IASPLUS website ( to be a useful source of information to solve part b. of this exercise.

    10. The ultimate objective of the efforts at setting global standards for accounting and financial reporting is to make corporate financial reports comparable, regardless of their geographical origin. However, setting global standards alone is not sufficient to achieve this objective. Some commentators argued that the rules-based approach to setting accounting standards was responsible for the accounting scandals in the U.S. However, the Parmalat scandal in Italy showed that this was not necessarily correct, and that scandals can happen anywhere, because the reasons are much more complicated than just the nature of the accounting standards used. The lesson referred to in the Financial Times statement is that effective

    enforcement is equally important as the type of regulation or accounting standard used, and that enforcement effectiveness is influenced by factors such as the availability of adequate resources for the enforcement agencies, and their level of independence from political interference.

    11. The purpose of this exercise is to encourage students to look beyond the text book to search for the relevant material. The chapter provides the structure for this exercise. What is required is to expand on the material that is already in the textbook.


    Chapter 03 - International Convergence of Financial Reporting

    12. In accordance with IFRS 1, First Time Adoption of IFRS, the following steps must be taken

    by the fixed assets accounting department manager in preparing IFRS-based financial statements.

    ; Identify the IFRS effective as of December 31, 2007 that are relevant in accounting for

    fixed assets.

    ; Determine the amounts related to fixed assets that will appear on the January 1, 2006

    IFRS opening balance sheet based on IFRS in effect at December 31, 2007.

    ; Preparation of the IFRS opening balance sheet will require:

    ; Determining whether any costs expensed under previous GAAP should have been

    capitalized as a fixed asset under IFRS and, conversely, whether any costs

    capitalized as a fixed asset under previous GAAP should have been expensed under

    IFRS. If so, make necessary adjustments.

    ; Determining whether any assets classified as a fixed asset under previous GAAP

    would not be under IFRS, and vice versa. If so, make necessary adjustments.


Chapter 03 - International Convergence of Financial Reporting

    Case 3-1: Jardine Matheson Group

    As required by IAS 1, Jardine presents a consolidated income statement (profit and loss account), balance sheet, cash flow statement, and statement of changes in equity in its annual report.

Presentation of Profit and Loss Account

    Jardine uses the “function of expenses” format in its income statement as allowed by IAS 1.

    The company does present the minimum items required as shown in the illustrative IFRS income statement in Exhibit 3-3.

Presentation of Balance Sheet

    Jardine does classify assets and liabilities as current and non-current as required by IAS 1. The format used by Jardine is considerably different from the illustrative IFRS balance sheet in Exhibit 3-4, but the minimum items required by IAS 1 are presented, with the possible exception that Jardine does not separate “retained earnings” from “other reserves,” but instead combines these in the line item “revenue and other reserves.” There are considerable terminology differences such as:

IAS 1 Jardine Matheson

    Property, plant and equipment Tangible assets

    Inventories Stocks and work in progress

    Cash and cash equivalents Bank balance and other liquid funds

    Trade and other payables Creditors and accruals

    Retained earnings Revenue and other reserves


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