International Convergence Project & Its Relevance - Assignment Example

?The International Convergence Project Table of Contents Table of Contents 2 Introduction 3 International Convergence Project & Its Relevance 4 Current Situation of Global Convergence 8 Conclusion 12 References 13 Introduction This project includes a discussion on International Convergence Project being carried out by IASB through the IFRS guidelines. Convergence is a process of narrowing the differences between the accounting standards of various countries and IFRS. The global relationships among people, cultures and economic activities have increased considerably in the past decade and most of this globalised state of economy can be attributed to reduction in international trade barriers such as tariffs, import quotas and export fees. Globalization has undoubtedly contributed to the economic growth in developed as well a developing countries through the principle of comparative advantage and increased specialization. With the benefits of globalization, the policy makers have also recognized the need for uniform disclosures by firms engaged in multinational businesses. As accounting is a universal language for business, it becomes all the more important to have sound and comparable accounting principles to enable the capital providers, analysts and regulators to understand the health of business and make relevant decisions. Understanding this need the standard setters have come up with the international convergence project for uniform accounting standards. This project includes the discussion on need for uniform accounting standards in modern financial world. The benefits that accrue on behalf of adoption of single accounting standard framework by majority of the countries have also been provided. Furthermore the empirical evidence post-IFRS adoption by European firms has been included. Lastly the current state of convergence project has been provided. The benefits of this process are purported by many to have outweighed the one-time costs associated with convergence. International Convergence Project & Its Relevance The increased integration of capital markets of the world has resulted in majority of the investors owning securities that are issued by foreign firms. These firms disclose their financial information under IFRS or their national GAAP. Accounting standards play important role in regulation of global financial markets. This has made it important to establish a single set of high quality financial accounting standards. The function of financial accounting standards is to define the rules for national regulators and participants of capital markets such as banks and borrowing firms. A common accounting language can provide the investors greater confidence in transparency and comparability of financial statements. The global standards are seen as a key to safety of global financial arena. These standards are purported to be means of mitigating the volatility of capital flows across markets, reduction in probability of bankruptcies and reduce systemic risks. The foundation of convergence process was laid in early 2000s when in 2002 the two major standard setting bodies IASB and FASB formalized their commitment in a Memorandum of Understanding (MoU) to the convergence of IFRS and US GAAP under the Norwalk Agreement (Kieso, Weygandt & Warfield, 2010). The objectives of the convergence of standards were to achieve completeness and improve consistency, as historically both the accounting standards by IASB and FASB have been incomplete. As a result the two boards identified short-term and long-term projects that would eventually lead to convergence. Some short-term projects were borrowing costs and fair value accounting for financial instruments, issued in 2007 and since then uniformly followed by both the standard setters. Long-term projects included issues like the conceptual framework, leases and revenue recognition. Additionally European and US regulators have agreed to the recognition of each other’s accounting standards for firms listed on various world securities exchanges. The international convergence project is underway and many projects are already completed with elimination of significant differences. This has allegedly reduced the costs associated with reconciliation requirements while resulting in greater transparency and comparability. In UK the Accounting Standards Board (ASB) issues the accounting standards in collaboration with other countries’ standard setting bodies and IASB (Financial Reporting Council, 2011). In 2006 ASB in its exposure draft stated its willingness to converge the UK accounting standards with IFRS for the improved credibility and understanding the financial reporting. To do so ASB proposed the convergence of UK standards and IFRS and to issue the appropriate standards provided that the burden of accounting standards requirements is proportionate to the benefits and to use a phased approach with a period of 3-4 years to bring the UK standards fully into line. However the idea of phased approach was dropped later and instead it was proposed that the IFRS-based UK accounting standards will be issued but not made mandatory until 1 January, 2009 (ASB, 2006). The on-going debate over the convergence project is if the benefits of the convergence outweighs the costs associated with it and whether this has been helpful to investors. The convergence of accounting standards is expected to bring more transparency in disclosures. Ray Ball compares the IFRS standards with already established national GAAP and describes the benefits of uniform adoption of IFRS: 1. IFRS reflects more economic substance than legal form. 2. IFRS reflects the economic gains and losses in timely fashion 3. Earnings are more informative under IFRS 4. Useful balance sheets 5. Addresses the problems that have long prevailed in Continental European practices such as manipulation of provisions, hidden reserves, smoothing of earnings and hiding economic losses from public. 6. Improved financial reporting quality enables small investors to compete better with professionals and reduce risks. 7. The elimination of international differences has eliminated the adjustments, which analysts had to make to firms’ financials more comparable internationally (Ball, 2006). In a 2004 study of foreign-listed and domestic listed firms in UK, Germany, France, Australia and Japan it was found that there was a considerable support for international standards the choice of which depended upon their national regulators and standard setters assistance and institutional framework to achieve better comparable international reporting (Tarca, 2004). An analysis of economic and policy factors in relation to IFRS adoption in U.S. showed that such move involves a cost-benefit trade-off of comparability and benefits to investors, persistent future cost savings for multinational firms and one-time transition costs to be borne by firms and economy as a whole (Hail, Leuz & Wysocki, 2009). Proponents of IFRS’ convergence process provide one of the much-publicised benefits of moving to IFRS that is the increased liquidity of capital markets and reduced cost of capital for firms by providing enhanced disclosures to investors. However this can only be true if IFRS adoption has lead to improved reporting quality and comparability. The empirical evidence on European firms regarding the effect of mandatory IFRS reporting since 2005 on the stock prices’ ability to reflect information is consistent with disclosures under IFRS. This means that the stock prices revealed new firm-specific information in the period in which IFRS was adopted. Moreover IFRS adoption increased the ability of the analysts to incorporate industry related information in the prices (Beuselinck et al, 2010). The economic stability of a country is directly related to the stability and efficiency of its stock markets. This is evident from the results after the mandatory adoption of IFRS by over 100 countries, which showed that these firms experienced increased market liquidity and decreased cost of capital. The results were better in the case of voluntary adoption of IFRS standards. It was also found that the capital market benefits were experienced only in those countries that had enforced IFRS adoption strictly or those that provided these firms with incentives to be transparent. However the results were not just the outcome of IFRS adoption but the strict enforcement and reporting incentives also played a significant role (Daske et al, 2008). These results show that the IFRS adoption has actually led to increase in transparency and comparability of financial disclosures provided that the countries create an enforcement mechanism and incentives for their firms to diligently adopt IFRS. This is likely result in improved financial markets scenario rather than just the strict enforcement of global accounting standards. Another major event that has necessitated convergence of standards is the economic crisis in 2008, which led to collapse of financial markets across Europe and U.S. Improved regulations and disclosures have become all the more important for financial markets since the crisis. Current Situation of Global Convergence Figure 1: IASB Adoption Map Source: (Schroeder, Clark & Cathey, 2010) Figure 1 shows the deadlines of those countries that have the option to adopt IFRS or the adoption has been under consideration. Since 2005 when EU asked the European listed firms to adopt IFRS for financial reporting the trend has gradually moved towards adoption of IFRS. Presently more than 40% of Global Fortune 500 firms use IFRS for reporting and the trend is likely to continue so. In achievement of global uniform adoption two factors are responsible- one, more than 100 countries either require the use of IFRS or they have already adopted. Second the joint efforts by IASB and FASB. Presently three countries are pursuing the IFRS adoption- Japan, India and U.S. In 2009, IASB and FASB reviewed their status of joint projects under the Norwalk Agreement and developed strategies and timelines to ensure the timely completion of the projects remaining such as consolidation, financial instruments, de-recognition, revenue recognition, fair value measurement, leases, insurance contracts, financial instruments with equity characteristics, financial statement presentation etc. There are certain practical difficulties in achieving these objectives for example differences in opinions on financial instruments’ measurement and asset impairment (Deloitte, 2011). The two boards met in April 2011 to reflect the progress of their joint convergence project and provided the following details: 1. Both the boards have completed five major projects under MoU with remaining three projects that are revenue recognition, financial instruments and leasing. The standards that are converged or substantially converged are fair value measurement, joint arrangements, consolidated financial statements, post-employment benefits and other comprehensive income. 2. Priority is given to remaining projects and insurance accounting. The three MoU projects revenue recognition, leases and financial instruments and the insurance accounting are under priority of the two boards since November 2010. 3. They have extended the completion target beyond mid 2011. The time limit has been extended to permit further consultation with the stakeholders. Their plan is to complete the three priority projects first. IASB expected the insurance accounting project to be completed in second half of 2011 whereas FASB has planned to issue ED in similar period for insurance contracts. 4. Sufficient time to give to those adopting converged standards (IFRS, 2011). The progress on short-term projects and MoU projects are provided in table 1 and 2. Under the short-term projects the joint ventures and investment properties are remaining to be completed whereas the income tax project is a low priority presently. The maximum of MoU projects are in their final stages. Although completion of project does not end the responsibilities of standard setters because the convergence is not based on any strong theoretical framework and therefore the weaknesses in the convergence process is likely going to be more prospective rather than retrospective. Table 1: Short-term Convergence Projects Source: (IFRS, 2011) Table 2: MoU Projects Source: (IFRS, 2011) Conclusion This project is an attempt to critically analyze the need of global uniform accounting standards, accrued benefits from the convergence of standards and the progress of the convergence project. During the past decade the world economy has become globalized with increased integration of capital markets. This has resulted in investors across the markets to own securities in multinational firms. An effort to bring single set of high quality standards is a result of globalised economy. The recent financial crisis in 2008 made this convergence process all the more important as accounting standard play a significant role in regulation of global financial markets. The analysis of benefits of IFRS adoption by Ray Ball and other empirical studies on European firms post IFRS adoption n 2005 shows that the convergence of IFRS standards with national GAAP has lead to increased transparency in disclosures and improved efficiency in capital markets. From the progress report of IASB and FASB on convergence process, it is clear that despite being very challenging the two boards have been able to converge or substantially converge the major short-term and MoU projects. The remaining projects are likely to be completed within the revised timeframe. The two most challenging parts of the international convergence project are the adoption of IFRS by remaining countries and probable weaknesses of the converged standards. The latter is going to be more prospective rather than retrospective. References ASB. (2006). ASB’s Convergence Strategy, ASB Public Meeting 19 January 2006. Ball, R. (2006). International Financial Reporting Standards (IFRS): pros and cons for investors, Accounting and Business Research, International Accounting Policy Forum. pp. 5-27. Beuselinck, C. et al. (2010). Mandatory IFRS Reporting and Stock Price Informativeness, Discussion Paper No. 2010-82. Daske, H. et al. (2008). Mandatory IFRS Reporting around the World: Early Evidence on the Economic Consequences, Journal of Accounting Research 46 (5), 1085-1142. Deloitte. (2011). Deloitte| Global convergence - path to achievement. [Online]. Available at: http://www.deloitte.com/view/en_IE/ie/services/audit/hot-topics/7fd95980d0a07210VgnVCM100000ba42f00aRCRD.htm. [Accessed on December 29, 2011]. Financial Reporting Council. (2011). Accounting Standards Board - About the ASB. [Online]. Available at: http://www.frc.org.uk/asb/about/. [Accessed on December 29, 2011]. Hail, L., Leuz, C. & Wysocki, P. (2009). Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors. IFRS. (2011). Progress Report on IASB-FASB Convergence Work 21 April 2011. Kieso, D.E.,Weygandt, J.J. & Warfield, T.D. (2010). Intermediate Accounting: IFRS Edition, Volume 1. U.S.A.: John Wiley and Sons. Schroeder, R.G., Clark, M.W. & Cathey, J.M. (2010). Financial Accounting Theory and Analysis: Text and Cases 10th ed. U.S.A.: John Wiley and Sons Tarca, A. (2004). International Convergence of Accounting Practices: Choosing Between IAS and US GAAP, Journal of International Financial Management and Accounting 15:1. Read More