The Process of Global Harmonisation of Financial Reporting - Essay Example

CRITICALLY EVALUATE THE PROCESS OF GLOBAL HARMONISATION OF FINANCIAL REPORTING Contents Introduction 3 Remembering 3 Understanding 4 Applying 5 Analyzing 6 Evaluating 8 Creating 9 References 11 Introduction Harmonisation of financial reporting standards has been a highly demanded issue of discussion and debate among accounting professionals around the world. Accounting Standards are reliable financial statements of best accounting practices. These standards are issued by recognised accounting bodies that define various aspects of accounting treatments, measurements, and disclosures of important transactions or events. These standards guide corporate entities as to how the items constituting financial statements should be presented in annual and quarterly financial reports. The information furnished by financial statements are aimed at different stakeholders like shareholders, management, regulatory bodies, suppliers, creditors, lenders, competitors, researchers, and the society at large. Remembering The International Financial Reporting Standards (also known as IFRS) was conceptualised and developed by the International Accounting Standards Board (IASB) in 2001. After one year of inception of IASB, the member states of European Union (EU) committed to adapt IFRS standards for all listed corporations under their jurisdiction. Such regulatory enforcements were due to come into effect from 2005. In 2003, the first IFRS was officially issued and by this time almost 19 countries were required to comply with global reporting standards. Nearly 70 countries have since then mandated IFRS for listed companies and further 23 countries have either allowed listed companies to voluntarily adopt IFRS or have mandated IFRS in listed entities (Ramanna and Sletten, 2009, pp.1-5). In the year 1985, Piper and Samuels, defined ‘harmonisation’ as the process of bringing the current international accounting standards into some sort of agreement so that the financial statements of different entities from different nations are prepared as per a common set of principles of disclosures and measurements (Samuels and Piper, 1985). Understanding Harmonisation of financial reporting would increase the level of agreement related to presentation of information disclosure in practicing accounting standards between countries. The process of harmonisation will ensure development of a single global community irrespective of the diversity of stakeholders. The process will increase awareness among investors in capital markets and also develop a sense of responsibility in publicly traded firms regarding appropriate financial disclosures (Roberts et al., 1998). Harmonisation of financial reporting will facilitate undisputed international transactions by minimising exchange costs. This argument is based on the rationale of flow of ‘perfect’ information (through standardisation) and hence improving quality of market information. According to Rahman et al., the process of harmonisation may be classified into two aspects namely, Formal Harmonisation – Provides a theoretical perspective regarding diversities and similarities between rules and regulations of different groups, clusters, and nations (Wolk et al, 2001). Material Harmonisation – Provides a practical perspective with respect to harmonisation of Accounting Practices applied by different corporate entities (Wolk et al, 2001). Harmonisations will also improve government accountability and facilitate auditors and regulators to receive and evaluate same standard of information. In the world of 21st century where there is absence of free trade, harmonisation of global reporting will provide different business entities an equal ‘playing field’ by providing more accurate and less risky national tariffs, quotas, and other trade engagements. This will also allow better allocation and management of resources by managers and investors through valued informed decision making (Doupnik, 1987, pp.12-27). Applying The critical analysis of the process of harmonisation of financial of financial reporting reveals how relevant it is to the current discussion by raising some issues such as accounting of reconciliation and standardisation. The process of reconciliation allows foreign entities to prepare their financial statements on the basis of accounting standards of home country. However, such reconciliation requires firms to additionally provide critical accounting measures such as shareholders’ equity or net income available to owners in the country where the financial statements are filed (Choi et al., 2002). The objective of reconciliation is to reveal the major divergences between accounting practices. With the help of reconciliation international investors will be able to receive data regarding profits and assets based on common set of accounting principles. This will make the task of comparison of financial statements much easier by the regulators and investors. On the other hand, there is fine line of distinction between harmonisation and standardisation. The former is defined as the process by which market participants agree to follow similar accounting practices whereas the later is defined as ‘imposition’ of narrow and rigid set of rules and regulations (Choi et al., 2002). Thus, standardisation requires that all nations should follow the method adopted by one country while harmonisation focuses to reconcile different point of views and adapt to mutually agree accounting practices (Bran et al., 2011, pp.53-56). Analyzing The strengths and weaknesses of the view are discussed as follows: Strengths Increased Reported Segments – Academic researches reveals that few entities reported single segment after implementation of IFRS 8 and increased the number of reported segments. This increased the volume of reports and also provide and more detailed information to stakeholders (IFRS, 2013, pp.18-22). Comparability between Entities – The increased number of reporting segments however created another issue which is comparability. Many investors have been found to be concerned about the comparability between segments, which is a major requirement of the investors (IFRS, 2013, pp.18-22). Mutual Recognition – The possibility of mutual recognition implies acceptance of national financial statements in foreign countries even though such statements may not be prepared in accordance with Accounting Principles of foreign country (Choi et al., 2002). An example of such mutual recognition is between Canada and United States, where the financial statements of Canadian companies will be recognised and accepted by US-GAAP and vice-versa. Impairment of Goodwill – Investors consider this factor as very important when evaluating performance by some sectors to be subdued but still at time of merger and acquisitions of such firms cost high fortunes to acquirer (IFRS, 2013, pp.18-22). Weaknesses Definition of ‘Operating Result’ – There is absence of defined sub-total for operating results in IFRS. This could become a major hurdle in the process of harmonisation which could lead to perceived lack of comparability of performance in reporting segments (IFRS, 2013, pp.18-22). Link between Management remarks and Presentation - Auditors have found that when management notes agree with the basis of segmentations used in financial statements and the basic financial presentation, then it often leads to cross-validation of multiple data sets which requires verification on the depth of information. This was also one of the main reasons for implementation of IFRS 8 which required that management commentary should agree with sections of operating segment information (IFRS, 2013, pp.18-22). Heterogeneous Accounting Philosophies between different Nations Clarity in Definition of ‘Investment Activities’ – While most firms believe it should only include capital expenditure (post-event) other consider marketing, R&D expenditures (pre-event) should also be included. The central argument here is that pre-event items are strategic and indicate future direction of business whereas post-event items are genuine expenditures involving predictable cash flows (IFRS, 2013, pp.18-22). Evaluating The overall argument regarding the strength or weakness of harmonisation can be revealed by highlighting and evaluating some of the events that has increased the importance of the process of harmonisation over the years. Some of the important arguments justifying the strengths and weakness of harmonisation process are discussed as follows: IOSCO Endorsement – This decision allows multinational entities to use IAS for international trade offerings which also opened the door for IAS to be used by companies listed on international stock exchanges (Fritz and Laemmle, No Date, pp.31-36). EU regulations – It requires all listed European companies to prepare consolidated financial statements on basis of IAS, 2005. This decision was important because it prohibits any influence of US-GAAP in reporting standards and IAS is in reconciliation to GAAP (Fritz and Laemmle, No Date, pp.31-36). Development of 33 Accounting Standards – IASB has developed 33 accounting standards since its inception that encourages companies to use IAS if they do not have standard accounting standards bringing international parity in financial reporting (Fritz and Laemmle, No Date, pp.31-36). Cooperation with national standard-setters – There are eight national standard setters in IASB which are represented between IASC Foundation. Thus, active revision of accounting standards may not have been possible without cooperation between national standard setters. The basic argument is establishment of identical standards coordinated by their agendas (Fritz and Laemmle, No Date, pp.31-36). Cooperation of FASB and IASB – In the year 2002, there was an announcement to design a single set of accounting rules which was worked together by IASB and FASB. This was considered as a major breakthrough for acceptance of IAS (Turner, 2001). Thus, acceptance of IAS without reconciliation will motivate regulators and corporate further consideration of IAS while presenting financial reports (Fritz and Laemmle, No Date, pp.31-36). Creating Harmonisation is the process by which differences between accounting practices between countries are reduced. The IASC is concerned about removing the unnecessary differences in accounting principles globally. But the study has found that harmonisation of financial reporting suffers from lack of synchronisation between issuance of standards at countrywide level in different countries (Rivera, 1989, pp.320-342).The establishment of IFRS under the new regulatory framework was notable initiative in the process of harmonisation and it is expected that the process will ultimately set new benchmarks both in national and international level (IFRS, 2013). Many of initial hurdles in implementation of harmonisation process have been overcome and there has been considerable progress towards convergence of accounting procedures and principles among countries (Dudovskiy, 2013). Differences in reporting standards have reduced and convergence initiatives are more effective than before (especially after the global financial crisis of 2008). References Bran, N., at al., 2011. IASB FRAMEWORK REGARDING THE HARMONIZATION OF FINANCIAL STATEMENTS. [Pdf]. Available at: http://www.upet.ro/annals/economics/pdf/2011/part4/Bran(Stan)-Margarit(Stanescu)-Eftene.pdf. [Accessed on February 10, 2014]. Choi, F. et al., 1992. International Accounting. 2nd edition. New Jersey: Prentice Hall. Choi, F. et al., 2002. International Accounting. 4th edition. New Jersey: Prentice Hall. Doupnik, T. S., 1987. “Evidence of International Harmonization of Financial Reporting”. International Journal of Accounting, Vol 23(1). Dudovskiy, J., 2013. Need for Harmonisation as a Reason for International Differences in Financial Reporting. [Online]. Available at: http://research-methodology.net/need-for-harmonisation-as-a-reason-for-international-differences-in-financial-reporting/. [Accessed on February 10, 2014]. Fritz, S. and Laemmle, C., No Date. The International Harmonisation Process of Accounting Standards. [Pdf]. Available at: http://liu.diva-portal.org/smash/get/diva2:18878/FULLTEXT01.pdf. [Accessed on February 10, 2014]. IFRS, 2013. 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