Account standardization, IFRS and US GAAP - Essay Example

?Financial Accounting Introduction Account standardization, IFRS and US GAAP Accounting refers to the systematic way of summarizing, analyzing and reporting the financial transactions. Accounting helps in clearly understanding the financial position of the organization and comparing it with other organizations within a particular financial period. The general purpose of the financial statement is to be prepared in accordance with the international accounting standards. The need of the accounting standards emerges because auditors and financial analyst are generally confronted with problems of accounting like biasedness, misinterpretation, inaccuracy and ambiguity. To minimize these kinds of errors a set of accounting standards was developed which was universally accepted and recognized. Without these accounting standards each and every business entity had to develop their own business standards which would make it impossible to compare the financial information with other business organizations. International Financial Reporting Standards (IFRS) are accounting principles and standards formulated by the International Accounting Standard Board (IASB) which is situated in London. These established accounting standards are ideally applicable equally to all the organizations worldwide. During 1973- 2000, the international accounting standards were formulated by the predecessor organization of the IASB formerly known as International Accounting Committee (IAC) (Beke, 2011). Since April 2001, the accounting standards set by IASB are taken into consideration. The investors need to be aware of the different types of accounting standards existing in different countries. The investors require the access to financial information based on universal accounting standards. The investors are constantly facing different types of economic choices that require the comparison of financial information. The advantages provided to the potential and institutional investors are as follows 1) IFRS promises accurate, timely and comprehensive financial information relative to the national accounting standards they replace for financial reporting in most of the countries adopting these standards (Beke, 2011). 2) Compared to the accounting professionals the small potential investors are less likely to understand the financial information from the financial statements. A financial report of high and genuine quality improves their understanding and makes them better informed and also reduces their risk of trading (Beke, 2011) 3) IFRS helps in eliminating most of the financial adjustments that the financial analyst have made historically in order to make the company financial statements comparable internationally (Beke, 2011) 4) IFRS provides reduced information costs and information risk to potential investors (Beke, 2011). Before March, 2008 the US listed foreign issuers of securities were required to prepare financial statements with respect to the US Generally Accepted Accounting Principles (US GAAP) or include reconciliation to US GAAP as a part of the financial statement reporting (Liu, 2011). This step became a prerequisite in the United States of America (USA) because of lack of widely accepted high quality accounting standards. Most of the foreign institutional investors file their annual reports on form 20-F which incorporates reconciliation. This reconciliation is often viewed as an unnecessary and expensive step by the foreign issuers of security (Liu, 2011). The European Union, New York Stock Exchange and the American Stock Exchange have allowed the Securities Exchange Commission of USA to allow foreign companies to use the IFRS to list on the US stock markets without the reconciliation or compliance with the US GAAP accounting principles. This was done as IFRS is considered a high quality accounting standards although there are some significant differences between the IFRS and US GAAP accounting standards. However, the investors need to be informed the differences between the IFRS and US GAAP accounting standards for predicting the investment failure. As per a survey conducted by the Chunhui Liu to report the differences between the IFRS and US GAAP it was found that the incomparability rate among different companies was only 5 percent (Liu, 2011). The incomparability occurred mainly due the fact that the net income adjustment of different companies was different. Most of the companies listed on the New York Stock Exchange use consolidated financial statements to adhere with the US GAAP accounting standards (Ortiz, 2005). The five basic principles according to which the consolidated financial statements should be made by the foreign investors are as follows 1) To use domestic GAAP principles directly (the 20 F form includes consolidated shareholder’s fund and net income from domestic GAAP to US GAAP ) 2) To use US GAAP directly if allowed 3) To use IFRS accounting principles directly if allowed 4) To prepare the consolidated financial statements according to the US GAAP and domestic at the same time ( Companies often want to prepare their consolidated financial statements in accordance with the domestic and US GAAP accounting principles. 5) To prepare the consolidated financial statements as per the IAS standards and domestic GAAP accounting principles at the same time ( Companies often want to prepare their consolidated financial statements in accordance with the domestic and IAS accounting principles) (Ortiz, 2005). The emergence of trading, selecting a particular investment portfolio is contributed to the evolution of financial economics. Financial economics is treated like a logical discipline based on concepts like “Arbitrage theory”, “Gaussian framework” and “Perfect irrationality” (Jovanovic, 2008). Economist Robert introduced the terminology “Arbitrage” which was an extension of the economic law of a price in a perfect capital market which emphasizes that the forces of competition will ensure that the given commodity will be sold at a given price (Jovanovic, 2008). Thus we can observe that financial economics became a scientific discipline during 1950-1960 and the credit goes to various economists for integrating mathematical concepts with economical theories and concepts (Schinckus, 2008). Consumer goods or financial products In the economic reality the consumers can choose from a wide array of financial products and that too from a variety of financial organizations (Siriopoulos and Philippas, 2009). Financial innovation would be termed as a process which involves the incorporation of combination, composition and the usage of a new technology and new knowledge in the development of new financial products, services, administrative process. Financial innovation is defined as the process of creation and diffusion of a new financial product, service and functional technique whenever such technique is required (Siriopoulos and Philippas, 2009, p.940). Financial innovation has made it easier for the areas in capital movement and accumulation, risk management and in deriving conclusions for decision making related to financial transactions. There has been sophistication of financial products which has resulted out of the investors needs and requires a higher professionalization of shareholders (Schinckus, 2006). The needs of the investor have been influenced by factors like changes in financial regulations, changes in the taxation system, changes in interest rates, exchange rates etc. The sophistication in the financial markets has led to a higher volatility in the capital markets because it has led to the increase in the speculative financial activities compared to the hedging activities. The availability of different types of financial products has increased the chances of speculation among the consumers and has also posed as a potential problem resulting from financial innovation. The basic objective of a financial product is to cater to the needs and wants of the investors however if there is no buyer then the utility of creating a new financial product is vain. The emergence of complex financial products like derivatives, hedge funds etc have increased the liquidity and the volatility of the stock markets. Apart from the financial products the investment profile and the needs of the investor are diversified and if hedging activities are important then the finance will tend to be more speculative. The emergence of sophisticated financial products will satisfy the wants and needs of the investor and at the same time each investor can find the financial products with respect to their specific financial needs and wants. However, the investment companies have increased their expenditure on advertisements of financial products and services which reflects that these companies have become more consumer oriented. The influence of the media on the purchase behaviour of the consumers is huge and the way the advertisements are portrayed plays a pivotal role in their purchase behaviour. Thus we can observe that culture, income, friends, ritual and the media are major contributing factors in the consumption pattern of the financial products. As observed that there are usually four types of consumer behaviour pattern while purchasing financial products. 1) Repeat Passive 2) Rational Active 3) No purchases 4) Rational dependant. 1) Repeat Passive behaviour is used to structure the purchases of financial services like financial transaction and to some extent deposits and loans (Beckett, Hewer and Howcroft, 2000). Consumer involvement in these types of financial services is limited but they still remain as a necessity. The switching cost in this quadrant is low and the costs are high therefore making the purchase of the financial products for the consumers very expensive. 2) Consumers change their existing purchase and consumption pattern by buying financial product which is new, cheaper and the availability is easy. 3) Banks develop strategies which can increase the consumer involvement and confidence which can indirectly increase the purchases of financial products and instruments. 4) The financial products and service providers adopt the differentiation approach which distinguishes itself from its competing alternative (Beckett, Hewer and Howcroft, 2000). Although, it is not necessary that the consumption pattern of financial products would be of four types but it has been categorized by the financial service providers to understand the purchase behaviour of the consumers in terms. Technology cannot solve a basic problem faced by the market makers of the consumers like searching for the best prices, the screen is used to give details about the interest rather than act as a mechanism for revealing the true bid and offers when there are volatile markets (Grossman, n.d.). The emergences of automatic trading and electronic financial products have modified the organization of the financial markets. Technological changes in the financial market have allowed integration of the financial systems and process and in return have increased the returns to scale and scope of financial and investment banking. Initially, New York Stock Exchange was the only exchange which performed trading through electronic means, initially all stock exchanges performed trading through telephonic means (Allen, McAndrews and Strahan, 2001). Majority of the financial tasks in banking and investment banking is carried out through the electronic mode. The technological innovations might have infused the idealized concept of an efficient market among the investors but in reality there is no such thing as a perfect financial market, technological innovations only improves the efficiency of financial market. Account standardization and Financial Markets The interests of the activities of the individual investors and institutional investors have become global and there has been active involvement of the various organizational bodies in developing a globally accepted high quality accounting framework beneficial to the investors. The existence of an efficient and liquid capital market can only be possible if the investors are provided with transparent, relevant and reliable information. This is possible with the existence of a global financial reporting framework body which encourages accurate and proper financial reporting. The individual and institutional investors depend highly upon high quality and relevant financial information irrespective of the geographic location. To ensure that there is a flow of high quality accurate information in the capital market companies need to ensure that effective financial reporting and accounting is practiced. Auditors need to check and verify whether the financial reporting is done accurately it complies with the accounting standards and regulations of GAAP. It should be ensured that the accounting standards used must be of high and genuine quality and must be supported by a regulatory body that ensures that the accounting standards are regularly monitored, interpreted and applied. High quality accounting standards is necessary for the development of a high quality financial reporting framework. Accounting standards of high quality are prerequisite for the efficient functioning of the financial markets because decisions related to the allocation of capital depend heavily on relevant and credible financial information. In certain countries the accounting standards have been developed as per the needs of the creditors of that country, for example In the United States of America (USA) the accounting standards have been established to meet the needs and wants of the participants of the capital markets. The US accounting standard provides an accounting framework which provides consistent, transparent, relevant and reliable financial information. The main objective of this organization is establish a set of accounting standards that would be applicable equally to financial reporting by the organizations worldwide. The purpose of using international accounting standard is that it ensures similar accounting transactions are given the same accounting treatment resulting in a globally comparable financial statement (Beke, 2011). However, it is not possible for all the corporate institutions to follow international accounting standards because the economic, political and cultural conditions are not the same globally. Various economists are planning to create a set of accounting standards that will be accepted universally by all the corporate institutions. With increasing globalization the individual and institutional investors need access to financial information based on universally accepted accounting standards. Harmonization of accounting standards is used to reconcile different points of view of the investors and the economists, corporate institutions spend huge amount of money preparing and auditing financial reports and statements as per the different national rules and regulations. It is also observed that proper accounting standardization leads to promotion of financial innovation. Using universally accepted accounting standards also results an increase in the sales (Beke, 2011). In various countries the accounting system does not take the interest of the investors into consideration but takes the interest of the credit banks and the tax into consideration. The IFRS accounting standard is most suitable for various corporate institutions as it is almost similar to the Anglos Saxon method of accounting (Beke, 2011). The accounting standards system would help in promoting financial innovation a larger scale. It will also help in lowering the costs of data processing system since it processes the differed data (Beke, 2011). Apart from lowering the transaction and data processing system, the accounting standards can enhance the cross border investment opportunity and increasing their benefits. It can create investment opportunity by enhancing the ability of predicting the profit rate. Accurate financial reporting becomes a prerequisite for the investors as it will provide him with clear and better investment opportunity, as they would not investment in companies without clear financial details. Accurate financial reporting has a positive effect on the credit rating of the companies and allows the companies to become closely integrated. Thus we can observe that the accounting standardization and accurate financial reporting is important to the investors and financial analysts who are specialized in collecting, measuring, analyzing and disseminating the financial information. Legal Framework and Financial Market The legal regulations play a vital role in providing legal protection to the individual and institutional shareholders. Unregulated financial marketing environment can lead to exploitation of the investors of different countries. The legal system of a country allows disclosure, approval procedures for financial transactions and facilitation of private litigation whenever there are problems related to self dealing. There is laissez faire intervention and the government monitors the framework related to trading and leaves enforcement to the respected parties. The violation of legal rules includes punishment like fines and imprisonment for a stipulated time frame. There are anti self dealing laws in approximately 72 countries which cover both public and private organizations. The legal environment in terms of trading differs from various countries. For example in Italy if a business director is interested in purchasing shares then he has to notify the other directors and the internal auditor for security purposes (Djankov et. al., 2008). Once the decision is approved then the buyer of the shares has time of 15 days to make documentation of the required transaction (Djankov et. al., 2008). In United Kingdom (UK), the regulation laws related to self dealing has evolved from the original common law of equity under which the board of directors of the company cannot enter into an engagement with the company when they have a conflicting personal interest (Djankov et. al., 2008). In 2002 the common law of equity was modified and shareholder approval in self interested financial transaction was permitted rather than specific financial transactions. There is a huge difference between the civil and common law countries. In 48 percent of the common law countries shareholders can approve of a financial transaction made by the director of the company and the remaining 16 percent are not allowed for approval in the transactions (Djankov et. al., 2008). Financial development of the country is largely dependent on the stock market development of the country although there is no specific method to measure the financial development but it acts as an indicator to estimated the financial growth of the country. Stock market development is relatively associated with the economic growth of the company even after controlling the development of the banking sector. Equity market transaction relies heavily on the legal system more than the banking institutions for the protection rights of the investors (Lumpkin, 2010). The US government has introduced a series of laws for the over the counter (OTC) derivative trading, in the year 2009 there was introduction of four laws related to the trading of market derivatives (Telpner and Piracci, 2009). They were introduced to reduce the risk related to derivatives markets, promoting efficiency and transparency in these markets and prevent fraud, manipulation in the derivative trading market (Telpner and Piracci, 2009). Legal laws of different countries differ in terms of responsiveness to changing social, economic and political conditions of the country (Beck, Kunt and Levine, 2002). Thus we can observe that the financial markets are controlled by legal, social, economic and cultural factors and vary from different countries. Dealing in securities market can produce favourable results to the investors as long as it complies with laws and regulation of trading. Computerization of the trading system has not only revolutionized the way the exchange system works but also has changed the mindset and thinking of the consumers about cross border investment. References Allen, F., McAndrews, J. and Strahan, P., 2001. E-finance: An introduction [online] Available at: < http://fic.wharton.upenn.edu/fic/papers/01/0136.pdf > [Accessed 08 May 2013]. Beck, T., Kunt, A.D. and Levine, R., 2002. Law and finance: Why does legal origin matter? [pdf] Available at: < http://www.nber.org/papers/w9379.pdf?new_window=1> [Accessed 08 May 2013]. Beckett, A., Hewer, P. and Howcroft, B., 2000. An exposition of consumer behaviour in the financial services industry. International Journal of Bank Marketing, 18 (01), p.15-26. Beke, J., 2011. How can international accounting standards support business management? Journal of Management and Business Research, 1(1), p.26-34. Djankov, S., Porta, R. Silane, F.L. and Shleifer, A., 2008. The law and economics of self-dealing. Journal of Financial Economics, 88, p.430-465. Jovanovic, F., 2008. The construction of canonical history of financial economics [pdf] Available at: < http://benhur.teluq.uquebec.ca/SPIP/fjovanovic/IMG/pdf/jovanovic_2008.pdf > [Accessed 08 May 2013]. Liu, C., 2011. IFRS and US-GAAP comparability before release No. 33-8879. International Journal of Accounting and Information Management, 19 (01), p.24-33. Lumpkin, S., 2010. Consumer protection and financial innovation. OECD Journal, 10 (1), p.01-20. Ortiz, E., 2005. GAAP choice by European companies. Emerald Group Publishing Limited, 17 (01), p.36-51. Schinckus, C., 2006. The financial simulacrum: The consequences of the symbolization and the computerization of the financial market. The Journal of Socio-Economics, 37, p.1076-1089. Schinckus, C., 2008. Financial economics and non-representative art [pdf] Available at: < http://ead.univ-angers.fr/~granem08/IMG/pdf/C.Schinckus.pdf > [Accessed 08 May 2013]. Siriopoulos, C. and Philippas, D., 2009. Influence of financial innovation to the validation of operational risk. Emerald Group Publishing Limited, 35(11), p.940-947. Telpner, J. and Piracci, J., 2009. How OTC derivatives: Proposed legislative and regulatory efforts to impose a more rigid regulatory structure. Journal of Investment Compliance, 10(3), p.26-33. Read More