The Potential Benefits to Investors Arising from the Switch to International Financial Reporting Standards - Research Paper Example

The Potential Benefits to Investors Arising from the Switch to International Financial Reporting Standards Table of Contents Introduction…………………………………………………………………………………3 Arguments against thesis……………………………………………………………………4 Arguments favoring thesis………………………………………………………………….6 Conclusion………………………………………………………………………………….8 Introduction The International Financial Reporting Standards (IFRS) have the potential to benefit investors who are currently operating under the Generally Accepted Accounting Principles (GAAP). The request for all American investors to switch to the IFRS was made by the Security Exchange Commission (Jamal et al., 2008). This commission was established in 1934 through a law that was signed by President Roosevelt. The organization was formed with the aim of providing investors with appropriate protection and at the same time maintaining an efficient and orderly market. The International Financial Reporting Standards are a set of standards that were designed to facilitate a common global language for particular transactions that enable companies to be on common grounds with other firms internationally. This approach is advantageous for all parties especially in modern times when there are more international investments and trades. From an accounting perspectives it makes the professional obligations easier to meet as the records kept are similar for all firms, unlike use of local accounting standards which make the reliability and comparison of documents a complicated processes. On the other hand, the Generally Accepted Accounting Principles are regulations and standards for accounting purposes that are implemented for a particular jurisdiction. This makes them different among firms depending on the laws that are regulating them and hence raises the complications that are addressed by the International Financial Reporting Standards. The GAAP involves different accounting convections, standards and rules that are followed by companies in the preparation and summarizing of different financial statements and records. There are three basic rules and guidelines that are implemented by GAAP USA and these include detailed rules and standards which are issued by APB and FASB, basic accounting principles and guidelines and practices that are generally accepted in the industry. There are different Generally Accepted Accounting Principles and examples include GAAP USA, GAAP United Kingdom, GAAP Germany and GAAP Russia. However, the majority of organizations such as the Security Exchange Commission are obligating larger listed firms to adopt the policies and document their financial transactions using the International Financial Reporting Standards. This transmission and conversion will benefit the firms and future shareholders as well as make the accounting process simpler and faster. Therefore, investors in the United States will benefit from the adoption of the IFRS by the larger firms. The paper will illustrate different arguments in support of the thesis and will also make an illustration of points against the above mentioned thesis. This format will give a clear indication of the situation and the necessity for this transition and some negative attributes that may be associated with changes from local to international accounting guidelines. Arguments against thesis There are several reasons why the change to IFRS will not directly benefit investors and may in fact have some negative implications on the firms. Some firms have been reluctant to change to the IFRS due to the advantages they possess from using GAAP, which are also evident for the United States investors. A comparison of IFRS and GAAP is useful in illustrating the advantages that are possessed by the later and therefore, oppose the opinion presented by the thesis. One of the main disadvantages of the IFRS is the cost that is incurred by the companies that have to change to this system. The costs include changes in the internal systems to make them compatible to the new standards of reporting and there will also be costs required for training employees to use the new system. Other disadvantages that may exist for investors include the decreased level of regulation on different companies by the IFRS. This is due to a plethora of reasons some of which are beyond the IASC or IASB control as it is very difficult to enforce this application on different firms all over the world. The GAAP however, has a smaller jurisdiction making the regulation and evaluation of firms following these principles easier. Another disadvantage that exists in converting all the companies in the United States and the rest of the world to operate under IFRS is that it creates a monopoly for the IASB. This is investors and any form of business field as competition is one of the main factors stimulating quality. A monopoly will result in a decrease in the efficiency and regulation of the records of firms as the quality will decrease and there will be no competition or other alternative such as GAAP. Therefore, the results that are published by different firms will be less reliable which may negatively affect the decisions made by investors (Averkamp, 2014). As mentioned above, the companies will incur huge costs from the transition that will be made from GAAP to IFRS. Studies have shown that there will be a total cost of eight billion dollars for all multi-national companies to adopt the IFRS policies whilst the average costs that are incurred by each firm is approximately four hundred thousand dollars (Sedki et al., 2010). In addition, despite the large sums of expenses that will be incurred by the companies the results from this change will only begin to appear years after. Therefore, the investors will not immediately benefit from this and the companies will instead be faced with the dilemma of compensating for these expenses. There is also the issue of the IFRS stressing importance on the utilization of fair value as the main basis of liability and asset measurements. This is likely to affect both the investors and the company due to the fact that this approach will increase the volatility as the reporting of assets takes place (Sedki et al., 2010). There are clear indications that adopting the IFRS may not bring the expected benefits for which it was created. The main purpose of the IFRS was to create a platform for comparison to enable investors to make more accurate decisions and at the same time encourage investment from international sources. However, since the introduction of the IFRS in 2005, less than ten thousand firms have adopted these guidelines. There are still more than seven million SMEs in the European Union that are still using their local accounting and reporting standards. Hence, this shows that the comparison will not be fully accurate as many companies have not adopted IFRS. This shows that the costs that are incurred by the firms in changing to this system are unnecessary as the move will not fully perform its intended objective. The GAAP provides investors with more accurate and well supervised guidelines that are specific for a particular country or region. Furthermore, if a firm uses GAAP the financial statements that are issued are likely to be of a higher quality than documents that will be presented under an IFRS monopoly (Hail et al., 2010). Regulations and in smaller and are likely to be specific for that particular region, hence companies are not conformed to international regulations which may be difficult and at times impossible to apply in certain business environments. Investors are well informed about the business environment which they wish to venture; hence, GAAP is likely to provide investors with the most accurate information. The IFRS does not provide an accurate comparison platform as the majority of international companies do not use these guidelines. Arguments for the thesis Despite the above mentioned negative attributes associated with IFRS and the advantages of GAAP, there are still several evidences which prove that it is advantageous for companies to adopt IFRS. Kwatinetz wrote an article illustrating the ways by which the GAAP rules have negative implications on investors (Sedki et al., 2010). As established above, the principles are most relevant to investors if they are accurate as this enables them to make the most appropriate decision. The problem with the GAAP is that they are purist and aimed at accurately presenting the company’s financial results (Sedki et al., 2010). However, this theory increases the probability and opportunity for misrepresentation of statements which is difficult for auditors to detect, furthermore, the transparency of the financial statements is reduced for the ordinary users. Despite the above mentioned expenses that a company may incur whilst making the transition, studies have shown that GAAP creates additional costs that supersede the benefits of these principles. Therefore, the overall effect of the process is material misunderstanding of the actual performance of the company. Therefore, this illustrates that some important aspects are neglected by GAAP during the implementation of accounting standards (Sedki et al., 2010). In different aspects, accounting principles are heading towards methodologies that illustrate an appearance of increased objectivity; however, the reality is that the accounting principles are still very subjective. Theoretically, the above mentioned subjectivity is liable to auditing; however, the reality is that the majority of auditors do not have the capability or knowledge to fulfill this obligation. Hence, the situation creates an illusion which shows more accuracy theoretically, however, practically the reporting by comparable companies is inconsistent and there is an increased potential for misstatements (Averkamp, 2014). In the past the changes in methodology were effective in determining the fair value and the portfolio of each company profile and valuation (Hail et al., 2010). This was equal to the valuation that was established by investors at any time before an investment was made. In essence, before any transaction, investors would have already performed a detailed analysis on the market and established which they are willing to invest (Hail et al., 2010). Hence, in this period if businesses had the opinion that the value of its shares had become impaired; it would subsequently mark down its share value. However, the change in the accounting rules requires venture firms to now provide statements that show valuations based on forecast revenues and multiples of trailing. However, the problem lies in the fact that the forecasts of smaller and new firms are frequently inaccurate and can give a misrepresentation of company valuation. The values are also very difficult for the auditors to give an accurate judgment on their accuracy (Hail et al., 2010). Another disadvantage of GAAP is that investors are liable to selling or buying stocks based on the initial numbers that are presented according to GAAP with the assumption that the company is short of the estimates that were made by the analysts. Therefore, the release of GAAP earnings first may lead to the investors making the inappropriate decisions since the press and analysts have consistent reports of pro forma estimates for expected earnings (Mehta et al., 2013). Other benefits for investors are associated with the use of IFRS itself rather than the disadvantages of GAAP. As mentioned above, the IFRS gives a standardized platform for comparison of financial statements on an international level (Daske, 2006). This is subsequently removes the trade barrier that is presented by using local standards. Therefore, the IFRS makes American consistent with European businesses consistent in both microeconomic elements and financial reporting (Daske, 2006). In addition the IFRS also gives the investors access to foreign capital markets which makes them easier to compare under one financial system. The advantages of the IFRS can also be mentioned in terms of its relevance as it is a reflection of economic substance and legal formalities (Mirza, 2010). This makes the statements presented more accurate and fair including the transactions that are made by the companies. The IFRS also has detailed and timelier presentations of gains and losses making it more reliable than GAAP (Mirza, 2010). Conclusion In summation, there are several benefits that are attained for investors if companies use the IFRS. This makes one platform upon which financial statements may be assessed. Despite the fact that the quality may be jeopardized by the creation of a monopoly by the IASB, the details that are required in the guidelines are more complex and detailed which makes them likely to be accurate. The GAAP is also subject to inaccuracy due to the documenting principles that are implemented in the reporting of statements. GAAP provides competition for IFRS which is likely to increase the quality of valuation that is given to the investors. Despite this factor the IFRS is beneficial in the sense that the statements provided are more accurate and better representation of the value of a company at a given time. Therefore, using these principles would be beneficial to investors in the United States. References Averkamp, H. (2014). Introduction to Accounting Principles. Accounting Coach Retrieved from: http://www.accountingcoach.com/accounting-principles/explanation Daske, H. (2006). Economic Benefits of Adopting IFRS or US‐GAAP–Have the Expected Cost of Equity Capital Really Decreased?. Journal of Business Finance & Accounting 33.3‐4 329-373. Jamal K., Benston G., Carmichael D., Christensen T., Colson R., Moehrle S., Rajgopal S., Stober T., Sunder S. and Watts R. (2008). A perspective on the SEC's proposal to accept financial statements prepared in accordance with International Financial Reporting Standards (IFRS) without reconciliation to US GAAP. Accounting Horizons 22.2: 241-248. Hail L, Christian L, and Peter W. (2010). Global accounting convergence and the potential adoption of IFRS by the US (Part I): Conceptual underpinnings and economic analysis. Accounting Horizons 24.3: 355-394. Hail, L., Leuz, C., and Peter W. (2010). Global accounting convergence and the potential adoption of IFRS by the US (Part II): Political factors and future scenarios for US accounting standards. Accounting Horizons 24.4: 567-588. Mehta, Kalpesh J, Yass A. Alkafaji, T P. Ghosh, and Nandakumar Ankarath. (2013). Understanding Ifrs Fundamentals: International Financial Reporting Standards. Hoboken, N.J: Wiley. Internet resource. Mirza, A. (2010). Wiley Ifrs: Practical Implementation Guide and Workbook. Hoboken, N.J: Wiley. Internet resource. Sedki, S. S., Smith, A., & Strickland, A. (2014). Differences and Similarities Between IFRS and GAAP on Inventory, Revenue Recognition and Consolidated Financial Statements. Journal of Accounting and Finance, 14(2), 121. Read More