Accounting theory: comparability - Essay Example

Topic: Accounting theory Introduction Comparability is one of the fundamental applications in the accounting practice. In fact, it is one of the basic features of Generally Accepted Accounting Principles GAAP. Not only in the GAAP principles, but also in the framework of the International Financial Reporting Standards (IFRS), comparability ensures that an entity’s financial data does not differ from the entities doing business in the same industry. In the United States of America, corporations are required to comply with the GAAP principles; on the other hand, in most of the other countries, companies are legally bound to comply with the IFRS. Although the concept of comparability does not differ much in both accounting principles-the GAAP and the IFRS- yet the financial information of companies, working under the IFRS and the companies working under the GAAP, do not share much similarities and can be sufficient enough to be incomparable. Consequently, many international and local investors are ill-equipped to properly and fully understand financial statements of two companies-one working under the IFRS and another one under the GAAP principles. Additionally, the regulators like Securities and Exchange Commission (SEC) consider such situation as a stumbling-block towards implementing uniform accounting theories, principles and practices because of the presence of dual accounting systems globally. Now, by the end of 2015, this duality in accounting systems would be considerably reduced or minimized as the United States of America is determined to replace the GAAP with the adoption of the IFRS. The decision of the adoption of the IFRS is brought by many factors such as the globalization of capital markets (the SEC, web). Nowadays, investors, brokers, institutional investors are more engaged in financial transactions beyond national boundaries. This is mainly caused by the ever-faster communication and integrated global financial and capital markets. Also, the IFRS has potential to become a global accounting standard (the SEC, web). In many countries of the world, including Australia, have adopted the IFRS and more than other 85 countries have fully enforced the accounting rules, practices and theories. This figure is increasing and recently approximately 113 countries permit or require IFRS reporting for domestic and listed companies (iasplus, web). However, the effects of convergence cannot be avoided; it would directly or indirectly impact on the economic, political and social aspects. The costs of convergence and benefits from convergence would be compared and analyzed; the accounting standards would be improved, comparability would be easier and doable beyond national boundaries. But successfully taking the financial world under the monopoly of the IASB as the accounting setting standards body would not be an easy work to do. The entire process of IASB funding and standards setting process and successful completion can be the biggest political challenges. Additionally, multinational companies operating in Australia may not require modify their accounting treatments. In this paper, causes, effects of the convergence of US GAAP into the IFRS are discussed, and finally a conclusion is included as well. Causes of switching to the IFRS Globalized capital markets Faster communication means have invalidated the significance of national physical boundaries. Nowadays, investors, brokers, institutional investors do not even need go to the capital markets. From their home, they can easily use the facility of the Internet to make their economic and investment decisions. Due to the availability and use of technology, considerably less time is consumed to complete a financial transaction in comparison with the time taken and consumed in the transaction taking place a few years back. Previously, the investors were ill-equipped to reach the required type and quantity and quality of financial information needed to evaluate and make economic decisions. At that time, they had no such faster and more reliable communications that today exist to facilitate the entire process of communication. Additionally, thanks to the facility of the Internet, the U.S. investors are made sufficiently capable to access to real time securities transaction data form stock exchanges and other small and large securities markets from This globalization of trading requires the need to access fair and reliable disclosures. With the help of such fair disclosures, a comparability and comparative analysis of the companies operating globally would not take much evaluation time. Furthermore, many American investors have diversified investment in securities outside the United States of America. Such diversified investment outside America does not facilitate the investors to fully and properly understand the accounting policies and practices which are directly or indirectly affecting their investment in the non-U.S companies outside America. In order to facilitate U.S. investors and enabling them to make more informed economic and financial decisions with the use of single set of high-quality of financial information, convergence of the U.S. GAAP into the IFRS would definitely bring such financial benefits; which directly and indirectly will increase the process of capital formation and revenue generation, adding much needed foreign inflows requirement to the American economy. IFRS as the Global Accounting Standard Many countries have accepted and adopted the IFRS in capital market throughout the world. Till this point of time, more than 113 countries either have adopted or permitted to adopt the IFRS for the purpose of financial reporting (IASplus, web). Many reasons have required the adoption of the IFRS. For example, in Canada, the accounting standard setters did not disagree that the global financial markets are fast integrating and globalized and some other recent development in the capital markets further cemented their view towards the adoption of high-quality accounting standards. They considered that it is opportune time to converge Canadian GAAP with IFRS, allowing that convergence to take place over a transitional period (Cica, web). In Australia, consistency and comparability of Australian financial reporting with the global financial reporting across global financial reporting, was a part of strategy to adopt the IFRS (Asic, web). On the other hand, in the European Union Members the situation was considerably different as the members states before the adoption of the IFRS, the members had accounting standards that were separately established in each geographical boundaries. Further, permission was required in order to use accounting standards that were used in other member state. The adoption of the IFRS gave them a single set of accounting standards by which companies operating in the E.U. could report. Additionally, more and more countries are adopting the IFRS, including Israel, and Brazil has hinted to adopt the IFRS. Implications The convergence into the IFRS undoubtedly is to bring vast economic, political and social implications. The economic implications would be the cost benefit analysis, and politically, governance and management of the IASB, its funding and development and enforcement of accounting standards, the funding and the IASB are going to be such challenges that are waiting for the IASB and FASB. Socially, the investors and other stakeholders are going to have an opportunity to properly and fully understand the true and fair financial statements and they can be easily comparable and understandable than ever before. The convergence would not be free of cost. A considerable amount of cost would occur, which would increase the cost side of many corporations working currently under the accounting framework of the FASB. One-time or short term costs are going to take place with the IFRS adoption. The American listed companies will have to modify or adjust their accounting systems and subsequent processes and update the internal control procedures of documentations. Additionally, in the very first year of publishing under the framework of IFRS, corporations will have to issue at least one year of comparative prior period financial information, under the requirements of IFRS 1, this could be required up to three years which is under the running regulatory framework of the SEC (). Additionally, the corporations will have to provide sufficient knowledge and training to their employees. This training will enable employees to draft and prepare the financial statements under the framework of the IFRS. Not only employees but also shareholders will be provided a sufficient amount of awareness and knowledge relating to the implications of switching to preparing the financial statements under the IFRS; they may need to arrange video call conferences, and road shows. Further, it may also be needed to hire IFRS consultants and other specialists to fully and properly upgrade the corporations accounting system with the requirements of the IFRS. However, on the one side this will increase the cost of corporations, at the same time, the auditing and advisory firms will observe a sufficient increase in their revenues in return for the services they will provide to update the corporations. Further, undoubtedly, the adoption of the IFRS can impact federal government and state-run industries like financial institutions, telecommunications and utilities as well. For example, financial institutions’ capital requirements are decided with the use of GAAP financial statements. As a result, the impact of IFRS adoption on the level of reported earnings of U.S. corporations is unclear rather ambiguous, this could increase the chances of earnings volatility, especially, if the convergence into the IFRS were to expedite the use of mark-to-market accounting (Hung and Subramanyam, 2007; Muller et al., 2008; Christensen and Nicolaev, 2008). Politically, the IASB’s governance will be considerably tested. The convergence into the IFRS by the U.S. corporations will bring the presence of single global accounting standard setter. Will it be sufficiently capable enough to fulfill the requirements and expectations of so many shareholders and stakeholders at time? To answer this question would not be an easy task as much has been clear and much is yet to be appeared politically, economically and socially as well. Without any doubt, the adoption of the IFRS will end the existing competition between the U.S. GAAP and IFRS, placing the IASB to rule the global corporate world. In other terms, the IASB will have a monopoly status. and in the literature of economics of accounting standards, many authors consider monopoly to be a part of problem rather than a part of solution (Benston et al. 2006; Meeks and Swann, 2008; Stulz, 2008). They argue that a monopolist standard setter does not respond quickly to the relevant changes in the market place, to think through them and provide and implement the best accounting standards for investors. Additionally, the IASB would be a central to each accounting changes occurring in countries under its domain. At the time, if the U.S. implements the IFRS, the ISAB would be under a possible political pressure. The absence of competition among standard setters may push stakeholders, such governments, to inquire from the IASB to justify both the costs of maintaining its accounting operations and its existence as viable single accounting standard setter. Additionally, the smooth running of the IASB would not be an easy task as consensus from the participants must be sought before going to pronounce any amendments in the existing accounting standards or to introduce a new accounting standard. Such level of arrangement cannot be easy to persist and manage as many political players do not prefer to remain away from influencing on the working of global institutions. For example, experience from the international institutions like the International Monetary Fund (IMF), the World Bank or the United Nations informs that the a single global standard setter will face ever growing political pressure in order to reach and implement a uniformly consensus based decisions, affecting global political interests and governments while issuing or evolving global accounting standards (Werle, 2001; Charnovitx, 2005). Further, a single set of global accounting standard setting requires a compromise among the diverse constituents across the globe. Different states have different goals and objectives with respect to financial reporting regulation. The existing IFRS are devised to serve the needs of external investors for the purpose of attracting investment inside; this could turn into a potential risk for the U.S. is that internal stakeholders may influence the IASB to change or modify a certain accounting treatment at the cost of external investors. Socially, different stakeholders will have multiple uses. And financial reporting may be influenced by a number of social and local customs. Some religions and stakeholders’ personal views, attitude towards disclosure and confidentiality requirements, and community development may be further enhanced by the adoption of the IFRS. Some religions do not prefer to adopting certain accounting practices and theories rather they avoid them. For instance, in the religion of Islam, charging, receiving, recording and imposing interest is totally disallowed and they consider it as inhumane and has declared it as an ‘Un-Islamic’. Additionally, some nationalities have different investment attitude towards certain accounting practices; for example, most of the Japanese people consider that the higher gearing depicts a sign of confidence in a company. Additionally, some cultures do not support the confidentiality of disclosure rather they prefer openness and maximum possible disclosure. Furthermore, in United States and in United Kingdom, the main corporate objective of shareholders and management to increase wealth in the short term; however, that is not the same case in other countries of the world, where management and shareholders are not only concerned to increase the wealth but also required to contribute for their employees, social development projects such community centers, long term infrastructure development, long term stability, welfare of the society as well. The social stakeholders would be keenly monitoring the adoption of IFRS. The community and social groups like, Friends of Earth, would observe this change closely. Each social group has its own agenda and manifesto. Currently, these social groups observe the impacts of FASB accounting rules and their environmental accounting on the environment. Undoubtedly, they have much at stake at time when global weather condition is experiencing a considerable change in its behavior. More importantly, these social groups prefer to see the role of IASB towards environmental accounting and its disclosure requirements. Currently, there are no stricter rules and regulations relating to the carbon footprint, and greenhouse gases. There are no compulsory requirements on the corporations to prepare and publish their environmental reporting; even if some companies are publishing that is voluntary. Interestingly, some observers on the topic are of the view that the voluntary publications of environmental reporting is directly or indirectly produced in a way to increase the volume of sales in U.S. under such circumstances, the adoption of IFRS will be closely monitored by the social groups, expecting and hoping their concerns will be taken into account when new accounting policies are implemented in this regard. Conclusion The IASB and FASB have collectively agreed to introduce the IFRS by the end of 2015. With this convergence, the existing GAAP will cease to exist and the IFRS will replace its position. Additionally, the FASB will also be merged into the IASB, and the it will the role of IASB who will determine the further course of action on different accounting concepts, theories, practices and so on. Currently, there exist environment of competition in the field of accounting due to the presence of the IASB and the FASB, competing accounting boards. This competition will end with the adoption of IFRS by U.S. and will enthrone the IASB as a single global accounting standards setter body. This enthronement will have political and economic and social implications. Such implications will not only be intensive but also extensive as well. Politically, the IASB will come under severe pressure to legitimize its existence as an effective international accounting setting body, such is going to put more pressure on the IASB. Due to the huge political and economic implications are caused by the accounting standards, the successful journey on the way towards meeting the expectations of the shareholders and stakeholders will not be an easy task for the IASB. To move on successfully, a consensus of each stakeholder will be the biggest challenge for the IASB. Additionally, the U.S. corporations will have to bear additional cost to meet the requirements of the IFRS, besides providing training to the staff, additional qualified consultants will be required to guide corporations to meet the requirements of the IFRS. At the same time, this will increase additional revenue for the auditing and advisory firms working in the US. Also, the federal and state system will also experience a change in managing their roles; as many utilities and telecommunication companies work either under the federal or state administration, they will need to accommodate the changes required by the IFRS. Work cited Hung, M., and K. Subramanyam, , Financial Statement Effects of Adopting International Accounting Standards: The Case of Germany, 2007 Review of Accounting Studies 12, 623–657 Muller, K., E. Riedl, and T. Sellhorn, Consequences of Voluntary and Mandatory Fair Value Accounting: Evidence Surrounding IFRS Adoption in the EU Real Estate Industry, Working paper, Pennsylvania State University and Harvard University. 2008, Christensen, H., and V. Nikolaev, , Who Uses Fair-Value Accounting for Non-Financial Assets Following IFRS Adoption?, Working paper, University of Chicago 2008. Benston, G., M. Bromwich, R. Litan, and A. Wagenhofer, , Worldwide Financial Reporting: The Development and Future of Accounting Standards, Oxford University Press, Oxford. 2006 Meeks, G., and G. Swann, , Accounting Standards and the Economics of Standards, Working paper, University of Cambridge and University of Nottingham. 2008 Stulz, R., , Securities Laws, Disclosure, and National Capital Markets in the Age of Financial Globalization, NBER Working Paper No. W14218. 2008 Werle, R., Institutional Aspects of Standardization – Jurisdictional Conflicts and the Choice of Standardization Organizations, Journal of European Public Policy 8, 392–410. 2001 Charnovitz, S., , International Standards and the WTO, Working paper, George Washington University. 2005 Australia strategy towards IFRS, web. 29 April, 2011,< http://www.asic.gov.au/asic/asic.nsf/byheadline/Your+questions+about+implementing+the+IFRS?openDocument#1.> IFRS by Jurisdiction, web, 29 April, 2011. Available at Canada and IFRS, web, 29 April, 2011. IFRS report, Securities and Exchange Commission, web. 29 April, 2011. Read More