Financial Advance Accounting: IFRS - Essay Example

IFRS – A Critical Analysis International Financial Reporting Standards (IFRS) sets out accounting standards and procedures for reporting financial information of a company to the outside world. It is very much necessary that these financial reports that become available to the stakeholders of a company help them considerably in their decision making process. IFRS was first introduced by International Accounting Standards Board (IASB). IASB was set up as an independent body in United Kingdom. IFRS actually lays down principles and rules that are to be followed by an organisation while reporting its financial information through the financial statements. The accounting standards in accordance with IFRS are supposed to serve the public organisations all around the world as compared to the existing local standards that are prevalent in a particular country where the company operates its business. This is due to the fact that it would assist in the financial reports being more transparent and comparable in nature. It is also supposed to provide economic stability of the countries. Many companies in different countries all around the world have already adopted IFRS in the recent years. However the transition from the existing local standards to IFRS is associated with considerable costs for the organisations that tend to implement it for the first time. Companies need to be cautious and careful while making such changes in their financial reporting procedures because of the incurrence of various training and technical associated with it. However compared to the costs, the benefits are plenty in implementing IFRS and hence it is worthwhile for companies to make such changes. IFRS and its adoption by different companies all around the world helps in enabling harmonisation and comparability. However harmonisation and standardisation are two different things and do not have the same meaning. Standardisation can be defined as the process of agreement on accounting standards by different relevant parties. With respect to the financial reporting phenomenon, standardisation leads to the process of removal of alternatives in accounting procedures. Harmonisation is not that much stringent and is flexible in nature. However it also leads to the reduction in alternatives of accounting procedures that are available. This type of harmonisation in the accounting policies followed in different countries is extremely important and beneficial for companies that operate globally. A particular country is benefited in several ways through the adoption of IFRS. Firstly, it leads to the enhancement of foreign investments that are made by the investors outside the country. Information asymmetries that are existent amongst different countries are reduced considerably through the prevalence of accounting standards that are uniform in nature. This is important because information asymmetry is created through the investors in the host country having better knowledge and information than the investors abroad. Local investors are more aware about the different economic opportunities in the country and they can predict more accurately about the future economic developments in the country. Different countries following different standards for reporting financial information makes it tough for foreign investors to have an access to all the relevant financial information about companies situated abroad. Understanding of the GAAP followed by different countries requires proper training for the foreign investors which results in the need of more time. This results in the reduction of cash flows for the foreign investors because of the extra transaction costs that are needed to be incurred in the form of time spent and training undertaken. This in turn leads to foreign investors expecting higher level of returns on their invested amounts (Young, & Guenther, 2003, p. 553). The deal that occurs between the foreign investors and the local company is often delayed because of the added pressure regarding compliance of set procedure and regulations that exists in the host country. Hence, adoption of accounting procedures laid down in IFRS leads to the reduction in information asymmetry, thereby enhancing the volume of foreign investment (Gordon, & Bovenberg, 1994, p. 27). When anomalies exist in the accounting information of a particular company, it signifies that there is an opportunity available to make significant abnormal profits. It may also lead the foreign investors to think that the organisation is facing some problem financially. Multinational companies also have the advantage of incurring fewer costs in the form of costs related to information technology or audit fees. This results in those companies having more available financial resources which they are able to invest in the companies. With globalisation, lot many companies now operate its business in different countries in the world. This requires the companies to have auditors who have the capability to properly understand and assess the implications of financial standards that exists in different countries. Currently, most of the multinational companies are relied on the big four audit companies of the world. It includes PWC, Deloitte, KPMG and Ernst & Young. These four audit companies have adequate resources and expertise available in various nations of the world. With the adoption of IFRS, it would result in the enhancement of audit companies who would be responsible for auditing different multinational companies. Audit costs would be reduced because of increased competition. For a multinational company which has its subsidiaries located in different countries, the formulation of financial statements would take less time and would not have the requirement of having many expert staffs. Accounting procedures become easier because of international standards. Hence, as a result of all these reductions in costs it would mean company’s profits would increase. This would further lead to the enhancement of economic growth of the developing nations of the world. The countries which have recently become developed are engaged in the business of outsourcing its cheap labour to the developing nations which are characterised with high rates of unemployment. Harmonisation in the standards of accounting procedures would result in further increase in outsourcing of accounting professionals by the companies. This in turn would result in the increase of foreign investments in these developing countries and lead to the creation of more opportunities in employment and thereby resulting in economic stability in the country. An agency problem exists in companies which results in the reliance on management officials of a company by its investors regarding the business performance of the company. Accounting standards and its applications in host countries may lead to the difficulties for foreign investors. It might result in foreign investors having the feeling that more directors are required to be appointed in the host country from the nations which have already adopted IFRS. The top level management officials of the company would thus comprise of many foreign nationals. It would have been possible that these positions were available for expert professionals of the host country. In general, a company which is reluctant to apply IFRS in its accounting procedures results in reduction of opportunities for employment and reduction in foreign investments. The competition between different companies all over the world would increase and would thus encourage innovation. The financial statements of different countries could be easily compared by the foreign companies as a result of IFRS being adopted in the companies. When increased number of companies would adopt IFRS, the organisations who have encountered enhanced flows of capital and trading till now, would get to know that the competition would increase as a result of increased foreign investments. Hence better performance would be required from the companies. This would result in increased innovation with respect to various aspects like product differentiation, product quality, customer satisfaction, etc. High amount of profits are viewed as the financial statements being more attractive for the investors. Cost of equity also gets reduced because of IFRS being adopted by all the companies. The investors are facilitated with wider access to the financial statements of different organisations which reduces the risk of asset acquisition. Investment risks would be more appropriately assessed by the investors. When accounting standards that are existent locally in different nations are used, it creates a notion about the investments being more complex and thus riskier. The investors might have problems associated with the specific regulatory board in a country or the auditors that are employed by the companies there. The process of harmonisation in accounting standards because of IFRS being followed would mean the investors would have greater information regarding investment risks of a company which ultimately results in the reduction of costs of equity. The investors become happy with lower returns. The organisations also have wider access to capital which results in increasing the liquidity of the company with the opportunity of raising more capital from the market (Covrig, Defond, & Hung, 2007). Trading activities have increased in nations where IFRS have already been adopted. The probability of financial crisis is also reduced because of IFRS. The financial statements of different organisations become transparent which leads to significant reduction in the company management officials from resorting to means of the creation of hidden reserves (Iatridis, 2010, P. 165). Resorting to the means of earnings management is also greatly reduced. Income smoothing becomes difficult for the company management. Studies show that earnings management and creative accounting practices have greatly reduced and resulted in timely reporting of loss recognition by companies (Ball, & Shivakumar, 2004, p. 2). There is an increased volume of disclosure of information available in the different financial reports prepared by the organisations who have already adopted IFRS. However this type of disclosure requirements may lead to the disclosure of much information about a company to the investors which can have an adverse effect on the competitive advantage enjoyed by the companies. If assets amortisation leads to higher profits for a company, it does not have a significant impact on the stock prices of the companies because the investors already have that information. Application of IFRS is also accompanied with cost saving since it results in the reduction of earnings manipulation and a creditor who wishes to lend money to a particular company would be encouraged to do so. This also results in the reduction in companies resorting to practices which lead to a situation of bankruptcy of the company (Beke, 2011, p. 38). Fair value accounting is also encouraged through IFRS adoption. Arms length pricing system replaces the previously historical costs system for measuring asset values. This approach of fair value is thus more transparent in nature and is significantly helpful for the investors in their decision making process. During the period of recession, the organisations are compelled to lower its asset values. Thus fair value accounting is associated with significant importance during the recession periods. Hence it can be concluded that IFRS is associated with many benefits. It also results in the development of economic stability in various nations of the world because of enhanced foreign investments in those countries. Transaction costs like audit fees, training costs, accountancy costs, etc. are greatly reduced for the potential investors. The financial statements prepared by different companies becoming more transparent as a result of adoption of IFRS greatly reduce the practice of creative accounting and earnings management in different countries. IFRS imposes some disclosures that are mandatory in nature with regards to off balance sheet items. Hence it becomes difficult for organisations to do any manipulation in their asset values or profit figures. The investors are facilitated with greater understanding of the financial figures mentioned in financial statements prepared by the companies in accordance with IFRS. Hence perceived risk by the investors associated with investment projects of the companies is greatly reduced which makes the investors happy with lower returns on their investments. It is supposed that IFRS worked well in the recent subprime crisis in USA that resulted in Global Financial Crisis (GFC). However, it can be criticised that subprime crisis have very little to do with accounting standards. It can be considered as a fraud that occurred in the appraisals of real estates and self-serving borrowings which is beyond the expectation of its buyers to be able to pay off its obligations. Finally fair value procedures of accounting are encouraged through IFRS. This leads to the increased corporate governance to be followed by the organisations and be more concerned about the interests of general public. References Ball, R., & Shivakumar, L., 2004. Earnings Quality in U.K. Private Firms: Comparative Loss Recognition Timeliness. [Pdf]. Available at: . [Accessed 19 May 2012]. Beke, J., 2011. International Accounting Standardization and Economics Practice. International Journal of Economics and Management Sciences. 1(1). [Pdf]. Available at: . [Accessed 19 May 2012]. Covrig, V. L., Defond, M. J., & Hung, M., 2007. Foreign Mutual Funds Holdings, and the Voluntary Adoption of International Accounting Standards. Journal of Accounting Research, 45(1). [Online]. Available at: . [Accessed 19 May 2012]. Gordon, R. G., & Bovenberg, A. L., 1994. Why is Capital so Immobile Internationally?: Possible Explanations and Implications for Capital Income Taxation. [Pdf]. Available at: . [Accessed 19 May 2012]. Iatridis, G., 2010. IFRS Adoption and Financial Statement Effects: The UK Case. International Research Journal of Finance and Economics, 38. [Pdf]. Available at: . [Accessed 19 May, 2012]. Young, D., & Guenther, D. A., 2003. Financial Reporting Environments and International Capital Mobility. Journal of Accounting Research, 41(3). [Online]. Available at: . [Accessed 19 May 2012]. Read More