Globalization of Financial Reporting - Essay Example

Globalization of Financial Reporting Introduction Multinational corporations need to be global and act local in terms of creating their strategies for treating the world as one market but recognizing that they should utilize a standardized or local approach to products and markets. Recognition must be made that the primary operating structure is geographic or local in nature. All subsequent local markets eventually report to a centralized office which oversees the global aspects of the corporation, areas in technology, finance, marketing, human resources, and others. In designing the organizational structure for international operations, the structure should meet both the strategies of the home office and the requirements of the local market. As such, the structure should be “contingency based, taking into account the variables of that particular system at that specific point in time.” (Ch. 8: Organizational Structure, n.d., 1) The most important variables to consider are the firm’s strategy, size, technology, and environment of those countries in which the country operates. In addition, other relevant variables that affect the company’s operations are: geographic dispersion, time differences, language, culture and business practices. These could actually be classified according to resources (man, materials and market), the processes, the controls and incentives and the culture of the organization as well as that of the host country. These variables interact consistently to ensure that the global company maximizes the utilization of its resources and assure its profitability. Thereby, each and every component or variable is important in defining the success of the firm’s international operations. In this regard, this essay is written with the objective of proffering the ways in which globalization has affected one of the critical areas in an organization’s operations – its financial reporting. In addition, as the process of globalization continues, the discourse would determine how financial reporting will eventually change in the future. Financial Reporting and Accounting Practices: Definition of Terms The effect of globalization to organizational structure, particularly financial reporting and accounting practices are tremendously being evaluated triggered by the need to standardize reporting concepts and practices for international users. Currently, the system being used by majority of global organizations is the International Financial Reporting Standards (IFRS). According to Forgeas (2008, 1), “for many years, countries developed their own accounting standards. They were rules-based, principle-based, business-oriented, tax-oriented … in one word, they were all different. With globalization, the need to harmonize these standards was not only obvious but necessary.” As indicated in her article, “by the end of the ’90s, the two predominant standards were the U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). And, both standard setters, IASB (International Accounting Standards Board) and FASB (Financial Accounting Standards Board), initiated a convergence project even before IFRS was actually adopted by many countries.” (Forgeas, 2008, 1) This development was validated by Miller when he averred from an interview by Churchwell (2006, 1) that “globalization is the major issue in determining the future of financial reporting. As financial and product markets become global, the need for a global set of accounting information to facilitate global transactions has really become overwhelming. This is clear in practice, both with the International Accounting Standards Board attempting to pull together one set of global standards and with the U.S. Financial Accounting Standards Board agreeing to an attempt to converge U.S. standards with international standards.” Rationale for Globalized Financial Reporting The Gale Group (2008) identified several reasons to standardize and harmonize financial reporting in global markets, to wit: (1) for a more efficient functioning of markets through uniformity in the language of business; (2) to achieve the mission to “decrease the costs of preparing and interpreting financial statements, and decrease the cost of capital because investors will face less information risk” (Gale, 2008, par. 3); (3) to set a framework which would serve as a guide for standard-setting decisions; (4) to develop and apply principles-based standards as against GAAP’s rule-based standards; and (5) to promote consistency in financial reporting applications and enforcement of international standards. Effects of Globalization on Financial Reporting Interesting insights on the effects of globalization on financial reporting were revealed in the article published by the Gale Group. One effect of globalization is that as global companies converge on applying the IFRS, it is presumed that higher quality reporting is associated with recommended standardization. Concurrent with this, reporting of higher quality is tantamount to result in cost of capital which is substantially lower than previously computed with GAAP. The model used to confirm results of this insight is strongly linked to financial statement transparency. Investors interpret transparency in financial statements reporting to explanatory power for returns. As indicated in the Gale Group report, “the explanatory power depends on the information contained in individual line items on the statements of financial position and income, as well as financial statement notes that investors use when assessing the relation between these two summary measures and changes in firm value.” (2008, par. 15) The effect of transparency and disclosure as “crucial elements of better functioning markets” in globalization was also confirmed in the study entitled Connecting Financial Markets to a Changing World conducted by the U.N. Global Compact and Swiss Federal Department of Foreign Affairs (2004, 49). In addition, globalization necessitates the application of the IFRS creating “less earnings management, more timely loss recognition, and more value relevance than those based on application of non-US domestic standards.” (Gale, 2008, par. 20) This result makes financial reporting using IFRS due to globalization of higher quality. There is a reverberating effect from the higher quality impact that financial reporting elicits from globalization. Higher quality of financial reporting gives the effect of improved market performance. (Gale, 2008, par. 24) This insight was clearly explained through “the expertise acquisition effect, whereby the quality of accounting and extent of convergence affect investors incentives to learn foreign accounting, in turn affecting market performance. The findings also reveal that the interaction of these two forces can result in increased market performance when convergence increases the quality of domestic standards, and vice versa.” (Gale, 2008, par. 24) As investors who are more exposed to market forces due to globalization learn more about the standardized financial reporting indicated in the IFRS. Their awareness of the concepts and applications improve and develop market performance. Financial Reporting in the Future In an interview conducted by Churchwell of Gregory Miller, professor at Harvard University, Miller revealed that Europe is currently the leader in implementation of the IFRS. Accordingly, Miller averred that “after that, individual countries such as Australia and Canada announced they would be converging with IAS soon. By this point, many countries have indicated they intend to be on IAS within the foreseeable future, so it has really picked up steam.” (Churchwell, 2006, par. 16) By then, the U.S. was still on the stage of converging to IFRS from predominantly sticking to GAAP. As globalization progresses, financial reporting proffers greater challenges in terms of demanding more disclosures of a wider range of details ranging from executive compensation to environmental issues. An Oracle White Paper entitled “The Future of Financial Reporting” written by O’Rourke revealed that stakeholders will increasingly be more demanding “more disclosures to improve transparency into the inner workings of companies and the impacts on the environments in which they operate. Reporting of income statements, balance sheets, and cash flows is no longer sufficient—stakeholders are demanding disclosures related to executive compensation, energy usage, environmental issues, hiring and labor practices, charitable programs, and other social issues.” (Oracle, 2008, 2 – 3) The negative impact of applying global accounting standards was revealed as “these changes can make life more complex for finance executives, who need to be aware of the coming changes, the impact on their financial results and the ability to raise capital. They also need to know which accounting standards were used to prepare the financials of other companies they are working with or considering as partners.” (O’Rourke, 2008, 4) Other inputs that need to be closely evaluated as seen to be included in financial reporting in the future are items such as sustainability indicators, other industry and company specific performance metrics, an emerging electronic publishing standard, or concisely “increased regulatory compliance requirements, global accounting standards, more disclosures, as well as streamlined communication of financial results.” (O’Rourke, 2008, 6) Conclusion Globalization provides the impetus for rapidly changing and adapting financial reporting in the future. The effects of globalization on accounting standards and systems for financial reporting have been revealed to encompass cost of capital, high quality affecting market performance and greater transparency and demand for disclosure, among others. The future poses more challenges as it looks forward to a global accounting standard. As more countries become aware of the importance to converge to this standard, those countries which had the initiative of being ahead gains the competitive advantage in this ever evolving global market. Reference List Chapter 8: Organizational Structure and Control Systems, n.d., Viewed 07 February 2010. Churchwell, C., 2006, “Financial Reporting Goes Global.” Working Knowledge, Harvard Business School. Forgeas, R., 2008, “Is IFRS That Different From U.S. GAAP?”, The American Institute of Certified Public Accountants, Viewed 07 February 2010. < http://www.ifrs.com/overview/General/differences.html> O’Rourke, J., 2008, The Future of Financial Reporting: A Market Perspective, Oracle Corporation, Viewed 07 February 2010. < http://www.oracle.com/appserver/business- intelligence/hyperion-financial-performance-management/docs/hyperion-wp- futurefinance.pdf> The Gale Group, 2008, 6 Globalization of Financial Reporting. Goliath Business Knowledge in Demand. Viewed 07 February 2010. < http://goliath.ecnext.com/coms2/gi_0199-6684458/6-Globalization-of-financial-reporting.html> The U.N. Global Compact and the Swiss Federal Department of Foreign Affairs, 2004, Connecting Financial Markets to a Changing World, Viewed 07 February 2010, < http://www.docstoc.com/docs/11325887/Connecting-Financial-Markets-to-a- Changing-World> Read More