Factors Contributing to SEC Adopting International Financing Reporting Standards - Research Paper Example

? Factors Contributing to SEC Adopting International Financing Reporting Standards Table of Contents Introduction 2 Reasons for the adoption of the IFRS by SEC 3 Unification of the world reporting standards 3 Preventing investors in economic crisis 3 Incorporation of proxy disclosure rules 4 Quality of the standards 5 Independence of the drafting body 6 Advantages of adopting the IFRS 6 Harmonization of financial reports 7 Saving time and costs in the reporting 8 Advantages of IFRS to investors 8 Research hypotheses 12 Research methodology 13 Data and Results 14 Conclusion 16 References 18 Appendices 20 Introduction In the recent past, there has been an increase in the need for the world to adopt the IFRS. The standards were originally developed by the European Union nations as a way of harmonizing their financial reporting standards. However over time many countries globally have adopted them as their financial reporting standards. Although the US is yet to follow suit, there is a growing enthusiasm towards their adoption by the SEC. Such a move will concequently make it mandatory for the organizations to report using these standards. Currently, efforts are underway to implement the international financial reporting standards in the US accounting field. This is in appreciation of the importance of these standards in cushioning global firms in times of economic hardships. Adopting such standards will undoubtedly assist firms in reducing costs associated with financial reporting since the standards are globally acceptable. This will also enhance transparency in financial reporting as well as offer a standard comparison platform on performance. In addition, it will reduce the time taken by most multinational organizations in reporting their financials. Investors will also benefit from this development since information about performance of companies will be available to them in similar standards. This paper seeks to show how effects of globalization and increased market interdependence necessitate the need for all countries to have common reporting standards. In addition, the paper will outline the financial benefits associated with a common reporting standard in the context of international business. Reasons for the adoption of the IFRS by SEC Unification of the world reporting standards Poon (2012) observes that in 2010, the SEC took a stand on the adoption of the IFRS in the US. Citing the advantages of the use of the IFRS for the United States firms, the SEC decided to embark on a plan to ensure that all organizations in the United States adopt the IFRS. The unification of the reporting standards seeks to put the United States in the same accounting standards as the rest of the world. According to Erchinger& Melcher (2007), the world’s capital markets are likely to gain from the convergence of the world financial reporting standards. The quality applied while drafting these standards, their comprehensive nature, and the extent of their application are the main reasons why the world hopes to benefit from these standards (Erchinger& Melcher 2007). SEC in determined efforts to protect the interests of the United States investors sought to implement these standards amid stiff objections by some firms. The first attempts to reconcile the standards of the IFRS with America’s GAAPs in 2007, focused on changing the SEC’s policies so as to accommodate the adoption of the IFRS (Erchinger& Melcher, 2007). Preventing investors in economic crisis In the last decade, the American economy suffered one of the worst economic crises ever in its history. The financial sector being the worst hit sector of the economy showed the laxity of the various state agencies in implementing the policies of the country. Several financial organizations in the country were almost shut down while those that survived were faced by a myriad of problems. This crisis helped reveal a number of problems in the financial management in both the public and sector. These problems were closely associated to the reporting of financial status in most the organizations (Kothari & Lester, 2012). Investigations on the main reasons why there was a crisis within some sectors such in investment, banking and insurance companies revealed that massive misreporting in financial reports by the management and their accounting and control departments was rampant(Kothari & Lester, 2012). Companies intentionally reported very impressive financial results, while in reality this was not the actual status. This was aimed at luring investor as well as portraying a favorable financial status to their shareholders. In fact, some of the organizations were already financially crippled way before the financial crunch hit the economy. However, with poor management of organizational resources and misappropriation of investor funds, managers through treachery still convinced investors that their firms were the best investment options in the United States (Mala & Chand, 2012). While professional investors detected this and avoided these firms, small investors, due to lack of information and expertise in analyzing the performance of the organizations fell for the misguided reports. Consequently, there was absolute loss of the invested funds in these organizations. However, the IFRS looks at the ethics in reporting and requires close scrutiny and full disclosure of an organization’s financial reports which in turn minimizes the likelihood of such misreporting happening in future (Mala & Chand, 2012). Incorporation of proxy disclosure rules IFRS requires organizations to make full disclosures of financial performance, status as well as other aspects like compensation plans for organizational managers and the CEOs. Even though the SEC has sought to introduce the new proxy to disclose executive compensation packages, it does not, by any means, set pay scales or set caps on compensation rates of the managers and the CEO. Previous research points out that the SEC, through IFRS sought to introduce compensation caps for the CEOs and managers but this has not been realized. IFRS hopes to make the compensation packages, remuneration standards and CEO benefits a transparent process (De George, et al. 2013). Therefore, the CEOs, through the new system, cannot add to themselves hefty pay packages and benefits without the consent of the shareholders. This further seeks to provide investor security by protecting their funds from misappropriation and embezzlement (DeFelice&Lamoreaux, 2010). In addition, companies are required to highlight through their long-term orientation plans of their activities any planned restructuring to their compensation plans. Such restructuring should scrutinize and revise payment of any managers based on their performance. Laxity of some of the organizational managers contributes to poor performance (Ben-Amar &Zeghal, 2011). With a guarantee of a salary, regardless of the performance standards of an enterprise, managers tend to relax with little or no willingness to work or peruse organizational goals and objectives (De George, et al. 2013). While in the short run this may not pose serious problems whatsoever to the performance of the organization, it could be a reason for a crisis in the long run. Non performing managers are likely to produce bad results for the company. Some mean managers could also put an organization at risk, especially by careless short-term investments decisions focusing at increasing organizational profits in the short run. This means that the organization cannot make profits which jeopardize its future operations (Ben-Amar &Zeghal, 2011). Such managers, as the IFRS dictates, do not have the capacity to serve in these positions. Quality of the standards Having the mandate of protecting the investors in the United States, the SEC makes sure that all standards adopted in the financial sector are highly cognizant of the relevant needs of the industry. A close evaluation of the IFRS by a commission under the SEC ascertained the quality of IFRS and consequently recommended them for adoption in the US financial sector in 2010 (Poon, 2012). The major benefits of the implementation of a single set of global accounting standards, is in the uniformity of the financial information by all global companies. However, some of the countries choose to either selectively applies the standards or modify them to suit their specific economic requirements. This makes it challenging to unify the global reporting standards. Independence of the drafting body Another reason for the adoption of the IFRS by the SEC is the apparent independence of the IASB. This is the body that developed the IFRS. Any form of interruption by interested parties of the IASB is highly discouraged. Funding of the board or any government intervention through appointments to the committee that developed the IFRS would undermine the quality of the IFRS. As such, the SEC established both the funding channel and the election of the board of the IASB (Poon, 2012). The IASB receives its funds from the IFRS foundation, which also oversees its operations. The monitoring board, comprising of public capital market authorities has the mandate of adopting and making known the accounting standards used in their jurisdictions (Poon, 2012). With this understanding, the SEC declared the IFRS as an independent board with uncompromised quality and having the very intention of protecting the investors. Therefore in adopting these standards, the commission felt was convinced it was a good step towards protecting the interest of the United States investors. Advantages of adopting the IFRS Despite the recommendation to adopt of the IFRS by firms and companies in the world, the United States is yet to adopt these standards. In fact, some of the investors cannot differentiate between the IFRS and the GAAP. Most of them rely on advice provided to them solely by their investment advisors as their understanding of the IFRS. As such, few know the importance and associated benefits of these IFRS to an international investor. Most of the investors believe that the adoption of the IFRS ought to be an individual decision, rather than a collective decision. The decision to depart from the current standards, they argue, solely depends on the organizational network of a company. Local firms are yet to understand the meaning and the advantages of adopting the IFRS (De George, et al. 2013). However, those firms with global networks have full knowledge of the standards, and can make conceptual decisions on the implementation of these standards. However, as outlined by the IFRS, their main objective is adoption of a common global reporting language which makes company accounts acceptable globally and understandable across different economic setups (De George, et al. 2013). Harmonization of financial reports Harmonized financial reports for multinational firms serve to consolidate their financial reports (Ramanna&Sletten, 2009). Currently, companies that have a global network have no capacity to harmonize their financial reports in different global locations. Companies continue to spend considerable amounts of their incomes and time to harmonize their financial reports. A company with many branches has to report its financial status collectively. As such, their head office calls for financial statements of all its branches across the globe which it then uses in drawing up its financial position statements (Erchinger& Melcher, 2007). Notably, all organizations whether subsidiaries of a large multinational or a regional firm have to draw their annual or semi-annual financial reports in accordance to the standards of the host country. Subsequently, a company with many branches will receive the financial reports of its subsidiaries in different styles. In order to draw a final draft, the organization has to interpret the various financial reports, translating them and later report them according to the country’s financial reporting standards (Erchinger& Melcher, 2007). IFRS seeks to solve this problem for these multinationals. As it is a requirement, all organizations should ensure that they use a common reporting standard. Saving time and costs in the reporting Globalization has had its effects on the manner and nature of operations, not only within an economy but also globally. The liberalization of the world trade, as well as the increase in the volumes of international trade, which has significantly contributed to the increase in imports and exports has led to an increase for investments around the world. There is an increase in the number of companies involved in international trade where they have to open branches in different countries. The differences in the reporting standards currently in use complicates the decision making process of the company (Poon, 2012). In essence, a company having branches in different countries will have difficulties preparing its financial statements for all its branches. The fact that there is no particular internationally accepted way of preparing financial reports in most cases causes delays for these companies. Moreover, these firms have to keep translating their reports into different forms in order to meet the required reporting standards (Poon, 2012). The IFRS seeks to introduce a common reporting standard that allows all firms globally to report in a similar manner. The impact of this in organizations is incredible since it will save time and the extra costs involved in the reporting process. Harmonized financial reporting of the organizational reports, reduces the time and costs involved in consolidation of the individual reports (Erchinger& Melcher, 2007). Advantages of IFRS to investors Investors hope to gain considerably from the implementation of the IFRS in the United States. With the IFRS advocating for a more comprehensive, accurate, and timely reporting of financial statement information with international standards, the public financial reporting in individual countries that adopt them becomes irrelevant. Accuracy of the financial reports also means that decisions made by investors while investing in these organizations are also accurate (Kothari & Lester, 2012). Since the IFRS requires the companies to report a true and fair view of their financial position, information presented to the public scrutiny contains no errors. This reduces investor risks as the information obtained and used by the investors only comes from verifiable sources. With the IFRS, all firms should report all the relevant information and in a specific way and thus can only but report a true and fair state of its finances. It eliminates any form of undercover dealings that managers could use as there are more transparent checks and balances introduced. Most of these investors while making decisions in most cases use reliable information thus minimizing any risks associated with misinformed decisions. Further, it saves investors time in interpreting financial statements regardless of their economic background. By using equal standards and reporting language, all firms present closely related financial information, therefore saving an investor time in interpreting the financial statements (Ball, 2006). There are two classes of investors interested in financial information of companies. These are the small investors and the corporate investors. While small investors hold a small amount of investment portfolio and in some cases do the investment themselves (such as individuals and organizational), corporate investors may be involved in more diverse investment business. Mostly, corporate investors are companies and firms whose core business is investment. Corporate investors have their own financial analysts and forecasters, whose main work involves analyzing the performance of possible investment opportunities. This helps them in avoiding many of the investments risks associated with different markets. Small investors on the other hand due to the limited size of their investment portfolio cannot hire the services of analysts. They are therefore more likely to lose to the professional investors, especially whenever they have inadequate information on the investments they target. With the IFRS, there is availability of information to all investors, whether small or professional. Even without the services of an investment analyst, an investor using the available information presented in properly reported financial statements can make reasonable decisions (Ball, 2006). Since information is crucial in making decisions in a free market, they are able to compete equally in the investment market. IFRS seeks to eliminate the differences between the various reporting standards used internationally, thus making the entire process smooth and cost effective (Poon, 2012). Making investment decisions in the past has rather been a difficult experience for most of the investors. Having to harmonize the financial information from companies in different countries is not only time consuming but also costly to an individual investor. However, adoption of a common language in the reporting of financial statements makes it possible for the comparison of financial information internationally (Ball, 2006). Since investors do not have to process financial information, adopting the IFRS would reduce the costs to investors as well as time used by the investors while making investment decisions. However, the multinational organizations are likely to gain more from the use of these policies. Since they have to create large databases of their financial reports, the use of common reporting standards would mean that the organization uses similar standards regardless of the country of operation (Erchinger& Melcher, 2007). Existing shareholders in such companies thus gain more in terms of divided due to increased earnings. IFRS versus GAAP IFRS are standards designed to facilitate a universal accounting and financial language for ease of understanding and comparison. GAAP on the other hand describes the general foundation of guidelines for financial accounting and reporting as well as accounting practices. According to IFRS each interim financial period is viewed as a discreet reporting period while the GAAP views each interim period as an integral part of the entire annual reporting period. This is the most significant difference in the treatment of interim costs within the accounting period (Ball, 2006). Also, IFRS consolidates and defines management power as the parents company’s ability to govern financial and operations of an entity. GAAP on the other hand focus on the control of financial interests only. In reporting consolidated statements, IFRS requires such consolidation but there are limited exemptions from preparing consolidated statements for companies that are wholly owned subsidiaries. GAAP on the other hand requires all to be prepared but with very specific industry exceptions (Poon, 2012). Despite the apparent difference in treatment of some accounting procedures, the two frameworks share some similarities. Under both standards, the complete set of financial statements required for reporting are similar. These are statements of financial position, statement of profit and loss, cashflow statements and accompanying company notes. Both sets also require any changes in equity to be reported. Finally, the standards treat inventory based on cost. As such, they define inventory as assets held for resale or in the course of production. In addition, the full cost of inventory is taken to include all direct expenditures including allocable overheads associated with the inventory up to the point of sale (Ramanna&Sletten, 2009). Research hypotheses As the literature review indicates, there are numerous gains for companies and firms on adopting the IFRS. A section of the managers and CEOs however think otherwise. Citing the costs of implementation as well as the change from one system of reporting to another, these managers feel that this ought to be an individual rather than a collective action for the organizations. Research into the United States firms also reveals little knowledge on the understanding of the IFRS. However, the SEC seeks to provide investors and shareholders with adequate information on the adoption of the IFRS. Subsequently, it seeks to provide them with the knowledge and understanding on the advantages of adopting the IFRS and the proxy disclosure rules. Although this has not yet happened, there is a high likelihood that they will be adopted with time. This study thus seeks to hypotheses that significantly, there are accrual benefits from the adoption of these IFRS and proxy rules by the organizations. These when adopted could serve as a tool for checks and balances in the operations of their managers. Previous researches on the proxy disclosure rules argue that the SEC seeks to set caps on the amount of income and benefits that organizational managers receive for their services to the organizations. This is the main reason why most managers in the United States do not support the adoption of the proxy rules. Therefore, the second hypothesis for this study is that there are no particular rules set by the SEC seeking to limit the earnings of managers. Rather, the main aim of the research is to provide guidelines on the disclosure of managers’ salaries and the means used in computing their salary packages. In the recent past, investors have been the worst affected stakeholders in organizations during the times of economic crises. While they entrust managers in managing their funds, managers on the other hand mismanage their funds, through undercover dealings as well as highly risky ventures for short-term profitability. In the end, the organization suffers from losses caused by poor management. To cover their mistakes, such managers result into creative accounting and creating misleading financial reports of their organizations. Therefore, the third hypothesis of this study is that how these proxy disclosure rules seeks to expose relationships between associates, colleagues, and consultants, for a better evaluation of the recommendation given to the investor from the consultants, avoiding misleading information to the investors. Research methodology This research used qualitative data collection methodology in order to obtain relevant data for the study. By researching from online sources, this research obtained data from previous research conducted, relative to the IFRS and the proxy. However, the method having to rely on the previ8ouis data could test the quality of data. Academic journals obtained from the EBSCO hoist search engine and Pro quest featured as references and data sources. By searching for the key terms, “SEC proxy rules” and “IFRS implementation in the United States,” journal articles with relevant information on the number of countries currently using the IFRS, whether in a modified state or otherwise were selected. Out of all the journal articles selected, only one was selected to feature in this study (appendix IV). Additionally, any journal article with “proxy rules” too qualified. Further screening however led to the selection of two journal articles. One of these articles showed the increment in the level of compensation of a CEO, according to the guidelines of the proxy rules, (appendix I) while the other showed the frequency of disclosure of CEO compensation before adopting the proxy (appendix II). Data and Results CEO compensation according to proxy guidelines seeks to remunerate CEOs according to their level of performance, rather than on a straight-line basis (Ben-Amar &Zeghal, 2011). This helps in computing the amount of CEO compensation with reference to their performance, rather than their job. As revealed in appendix I, the use of shares in remunerating a CEO leads to a lower amount of retirement benefits than when computing retirement benefits using the supplemental executive retirement benefits. With the issue of CEO compensation being one of the most controversial issues in most of the countries, authorities have taken over the mandate of deciding the method used in computing the CEO compensation. While some advocate for a straight-line computation models, others seek for a performance-based approach. The advantage of a performance-based approach is that it only rewards the CEO whenever they have recorded an increment in their performance, and at the same time, do not reward them for a performance. Comparing two CEOs, both employed at the age of 50 and have allowances accruing to $5 million, the supplemental executive retirement benefits would lead to a higher retirement package (appendix II), while the shares model would lead to a low benefits payment (appendix I). Over the requisite period, also known as the vesting period, all types of equity grants, stock options included are expressed at fair value. The SEC directions require the disclosure of the full value of equity based grants as well as the potential future vesting. With the understanding that the reporting of the expense should take place for all the years until the end of the requisite service period, compensation costs recognized in the fiscal year includes expense incurred during the prior year grants. The proxy disclosure rules require that the compensation for the award take the assumption that there will be a performance of the requisite to vest. With the disclosure rules having to follow the guidelines, rather than disclosing the entire value upfront, is very important for companies since where a company provide a large single grant for services would be performed over a number of years, such as to an incoming exceptive. Thus, the representation of these differences is as expressed in appendices III and I. This shows that there is little interference in the operations of the organization by the rules. By only providing the essential guidelines for the computation, the SEC leaves individual companies to draw their benefits up to their desired levels. This proves the previous research wrong, which argued that the SEC sets caps on the limits of the CEO earnings. Ben-Amar &Zeghal (2011), while seeking to research on the level of disclosure conducted a study among the Canadian firms. The study, which involved180 firms in Canada, sought to prove that there was poor disclosure of CEO compensation to the general meeting. At least 13 of the firms under study had never disclosed their CEO compensation. This was approximately 7.2% of the total firms under study. 56 firms confirmed that they had disclosed their CEO compensation twice to their shareholder, which translated to approximately 30.9% (Ben-Amar &Zeghal, 2011). 21 out of the total 187 firms confirmed that they had disclosed at least thrice their CEO compensation to the shareholders (Ben-Amar &Zeghal, 2011). This formed at least 11.6% of the total respondents. This study shows the low levels of disclosure of CEO benefits to the shareholders. While the current reporting standards does not mandate the disclosure, with companies having the freedom of either disclosure or not, the proxy rules of disclosure requires all companies to disclose these earnings to the shareholders (Ben-Amar &Zeghal, 2011). Lack of disclosure of such information allows managers to award themselves hefty salaries and benefits, regardless of the company performance. The research also sought to find the response of other countries in the adoption of the IFRS globally. With the numerous benefits that the standards provide to investors, understanding what investors in other regions felt about these standards was important (Ramanna&Sletten 2009). This enabled the comparison of these adoption rates with the United States non-adoption status. It also sought to test the quality of these standards with the rate of adoption by different countries in the world. With critics of these standards in America regarding them as of questionable quality, this study sought to understand what other countries felt about these standards. This study held that if there was a low level of uptake of the IFRS standards by countries globally, them the quality of these standards was questionable. However, if many countries had adopted them, then their quality is unquestionable. Appendix IV reveals that globally, more countries have adopted the IFRS, in different capacities. The European Union, being the originator of these standards had fully adopted those (Ramanna&Sletten, 2009). Other countries in different regions that had adopted these standards were Latin-American, Asia-pacific, countries in the Caribbean region, the Middle-East countries, and sub-Saharan Africa. This shows the quality of these standards, as over 100 countries had adopted them globally. Conclusion In the recent past, since the recommendation of the IFRS as global standards of reporting, countries have started adopting them due to the advantages that they pose. Since they hope to harmonize global financial reporting standards, IFRS indeed pose numerous advantages to investors globally. With increase in the level of globalization, and more businesses opening branches in different countries, drafting their financial reports is not only a time consuming activity, but also costly. Investors also suffer, especially when making investment decisions due to inadequacy of information as well as misleading information contained in the financial reports. Shareholders of companies have lost in equal capacity, with some of their managers and CEOPs granting themselves hefty salaries and pay packages, against a backdrop of poor performance and risky dealings. Poorly managed firms, with impressive balance sheets and statements of income suffer during economic crises. The IFRS however hope to transform all this, by introducing proper reporting standards as well as the disclosure of the CEO earnings and their computation to the shareholders of the organizations. With the harmonization of global financial reporting standards, financial reporting by multinational corporations is an easy task. It is due to these benefits that the American organization s are likely to acquire from these IFRS, the SEC seeks to adopt them for the American case. References Ball, R. 2006. “International Financial Reporting Standards (IFRS): pros and cons for investors.” Accounting & Business Research (Wolters Kluwer UK), 365-27. Ben-Amar, W., andZeghal, D. 2011.“Board of directors' independence and executive compensation disclosure transparency: Canadian evidence.” Journal of Applied Accounting Research, 12(1), 43-60. doi:http://dx.doi.org/10.1108/09675421111130603 De George, E. T., Ferguson, C. B., & Spear, N. A. 2013.“How Much Does IFRS Cost? IFRS Adoption and Audit Fees.” Accounting Review, 88(2), 429-462.doi:10.2308/accr-50317 DeFelice, A., andLamoreaux, M. G. 2010.The SEC's IFRS Work Plan. Journal Of Accountancy, 209(4), 22-25. Erchinger, H., and Melcher, W. 2007.“Convergence between US GAAP and IFRS: Acceptance of IFRS by the US Securities and Exchange Commission (SEC).” Accounting In Europe, 4(2), 123-139.doi:10.1080/17449480701727908 Kay, I. T., and Seelig, S. 2007.“Using Career Service Shares to Replace Supplemental Executive Retirement Benefits: A Practical Response to the New SEC Proxy Disclosure Rules.” Journal of Pension Planning & Compliance, 33(3), 1-20. Kothari, S. P., and Lester, R. 2012.“The role of accounting in the financial crisis: Lessons for the future.” Accounting Horizons,26(2), 335-351. Retrieved from http://search.proquest.com/docview/1081894601?accountid=45049 Mala, R., and Chand, P. 2012. “Effect of the global financial crisis on accounting convergence.” Accounting & Finance, 52(1), 21-46. doi:10.1111/j.1467-629X.2011.00418.x Poon, W. W. 2012.“Incorporating IFRS Into The U.S. Financial Reporting System.” Journal Of Business & Economics Research,10(5), 303-311. Ramanna, K., andSletten E. 2009.“Why do countries adopt International Financial Reporting Standards?” Working Papers -- Harvard Business School Division Of Research, 1-46. Appendices Appendix I: CEO compensation using share based payment Adopted from: Kay, I. T., and Seelig, S. 2007. Using Career Service Shares to Replace Supplemental Executive Retirement Benefits: A Practical Response to the New SEC Proxy Disclosure Rules. Journal Of Pension Planning & Compliance, 33(3), 1-20. Appendix II: CEO compensation using supplemental executive retirement benefits Adopted from: Kay, I. T., andSeelig, S. 2007. Using Career Service Shares to Replace Supplemental Executive Retirement Benefits: A Practical Response to the New SEC Proxy Disclosure Rules. Journal Of Pension Planning & Compliance, 33(3), 1-20. Appendix III: Frequency of disclosure of CEO compensation before adopting the proxy, a case study of Canada Adopted from: Ben-Amar, W., andZeghal, D. 2011. Board of directors' independence and executive compensation disclosure transparency: Canadian evidence. Journal of Applied Accounting Research, 12(1), 43-60. doi:http://dx.doi.org/10.1108/09675421111130603 Appendix IV: List of countries that have adopted the IFRS according to region Adopted from: Ramanna, K., andSletten, E. 2009. Why do countries adopt International Financial Reporting Standards?. Working Papers -- Harvard Business School Division Of Research, 1-46. Read More