International Issues in Accounting and Audit - Essay Example

International Issues in Accounting and Audit Introduction With the Enron accounting fraud and other major corporate accounting failures in the recentdecades, companies today increasingly focus on setting accounting standards to prevent the possibility of accounting malpractices and stakeholder dissatisfaction. Recently many companies across the globe had used GAAP (Generally Accepted Accounting Principles) to prepare their financial statements and compare them with those of other firms. However, GAAP was not accepted worldwide because of several reasons, and hence there is a need for common accounting standards. Considering the growing complexity of accounting work, many countries have adopted IFRS as their basis for financial reporting as it is expected that IFRS can significantly improve the quality of information on corporate finance. Although there are numerous potential advantages associated with a common set of global reporting standards, it is difficult to implement IFRS in a way that the benefits of a harmonised reporting system could be achieved. This paper will critically explore and discuss the potential benefits as well as negative impacts/limitations of adopting the IFRS in the United Kingdom. International Financial Reporting Standards (IFRS) International Financial Reporting Standards, commonly abbreviated as IFRS, are designed as a common global reporting framework for businesses so as to make company accounts well understandable and comparable despite cross border barriers. The growing international shareholding and trade activities make it necessary to establish a common global language for business affairs with regard to accounting and reporting. Such a common global framework is also particularly important for firms that have a presence in several countries. Today the IFRSs increasingly replace different national accounting standards as multinational corporations wish to keep their accounts easily understandable and comparable across the globe. IFRS are authorised on the ground of historical cost paradigm with the exception of IAS 29 and IFRIC 7, which are authorised on the ground of constant purchasing power paradigm (Legardere, 2007). Although IFRS were initially introduced as a framework to harmonise accounting practices and procedures across the European Union, this concept has progressively become attractive around the world due to the increased value of harmonisation. IFRS are sometimes referred to as the original name of International Accounting Standards (IAS). The International Accounting Standards Committee (IASC) issued IAS over the period 1973-2001. On 1st April 2001, the new International Accounting Standards Boards (IASB) undertook the responsibility for setting international accounting standards from the IASC (Value based management.net, n.d.). The IASB adopted existing IAS and Standing Interpretations Committee standards (SICs) and continued to develop new standards, which were jointly termed as International Financial Reporting Standards later (Ibid). Although IFRS financial statements are prepared in various forms and sizes, they all have certain features in common, and they mainly include relevance, faithful representation, comparability, verifiability, timeliness, and understandability. Since IFRS financial statements are very relevant to end users, they can make sound decisions regarding the company. Faithful representation is another major characteristic of IFRS, and therefore financial statements will be free from bias and errors. They will represent a true and fair view of the state of affairs of the organisation. On the strength of improved comparability of IFRS financial statements, it is easy to compare financial statements from two separate periods or financial statements of two companies in the same industry so that managements can make well informed decisions about their operations. Verifiability is another potential feature of IFRS as it helps people reach common decisions based on the information presented. Using IFRS approach, it would be easy for companies to prepare their financial statements in a short time and to make the operational results available to stakeholders in a timely manner. Finally, understandability is a superior characteristic of IFRS as even common people do not need the assistance of a management professional to understand the financial statements prepared under IFRS. Currently IFRS are widely used in many parts of the world, including EU, India, GCC countries, Russia, Singapore, South Africa, Turkey, Australia, Pakistan, and Malaysia when these standards are yet to be adopted in the United States. According to the US Securities and Exchange Commission, over 113 countries around the world including entire Europe permit or require IFRS reporting whereas 85 requires the same for all domestic, listed companies (Novartis.com, n.d.). Benefits of adopting IFRS in UK The European Union has already accepted the IFRS and therefore it would be really beneficial for the UK to adopt this new concept. Improved access to capital, growing cross-border listings, new investment opportunities, greater transparency, and comparability are some of the major benefits of adopting IFRS in the country (Madawaki, 2012). IFRS adoption would greatly assist UK companies to review existing policies and frame sound operational strategies. As experts point out, IFRS can greatly promote effective corporate reporting which in turn would enhance the operation of efficient capital markets in the country. It is obvious that strong capital markets can increase UK firms’ exposure to potential investments and thereby enhance the overall economic growth of the nation. Likewise, better transparency and disclosure from adopting IFRS can extremely benefit stakeholders to monitor the actions of managerial persons and minimise information asymmetry and the risk of misappropriation. Evidently this situation is helpful to reduce the cost of capital. Companies those had extensive prior disclosures, cost of switching to IFRS concept is relatively lower, and therefore they can cheaply replace their existing reporting system. IFRS advocates claim that adopting this reporting system in UK can notably trim down the costs of comparing alternative investments and improve the quality of information. It is expected that investors would be more willing to finance various business ventures as IFRS offer increased understandability and comparability. Therefore this reporting system may aid the country to attract more potential investments. Companies that have strong multinational interests will be benefited more from IFRS adoption because this reporting system is being increasingly accepted around the globe. It is evident that many of the world’s leading multinational companies like Vodafone Global Enterprise, Cable & Wireless Communications, Jessica Kingsley Publishers, River Island, and British Petroleum are based in UK. Therefore, switching to IFRS has long term positive impacts in the UK context. In the opinion of Rich et al (2011, p. 1246), the IFRS concept can aid companies and investors to access foreign capital markets more easily and this favourable situation can be a stimulus for the economic growth. The authors add that companies are required to streamline their financial reporting processes under IFRS and this reporting concept enhances a more effective use of company resources (Ibid). Evidently optimal use of resources would assist UK companies to save for the future and prevent the situations of overconsumption of resources. Rich et al also argue that “IFRS generally require more judgments than the strict application of rules”. This particular feature is extremely helpful to prevent financial misappropriation issues that have often occurred under US GAAP (Ibid, p.1246). In addition, the application of professional judgment can eliminate the difficulties associated with the rule based accounting practices. The increased use of judgement under IFRS may benefit UK companies to prevent accounting malpractices and other financial abuses. In short, adopting IFRS can have a positive effect on the net income of UK companies. Referring to the words of Kaur (2011, pp. 15-16), the IFRS implementation would aid the country to follow a consistent financial reporting basis, which in turn can enhance internal communications, group decision making, and quality of reporting. The writer continues that some other potential benefits of IFRS adoption include improved management information, harmonisation of internal and external reporting, benchmarking with global peers, access to international capital markets, better information to investors, and streamlining reporting processes (Ibid). Adopting the IFRS would enable the UK companies to evaluate all financial components of the organisation on a single financial reporting platform. Thus, this concept can eliminate the need for multiple reports and major accounting adjustments for preparing the final consolidated financial statements. Under the US GAAP and other accounting standards, the true value of business combinations is not accurately stated in the financial statements instead this amount is generally added to the goodwill. The IFRS can overcome this pitfall as this reporting framework particularly necessitates ‘accounting of net assets taken over in a business combination at fair value’ (Kaur, p.16). IFRS contain better provisions for the recognition of intangible assets so that a more accurate financial reporting can be achieved. Finally, another major benefit of IFRS adoption in UK is that this process would influence companies to maintain a global view. To make it clear, the IFRS would aid firms to obtain a deeper understanding of their current position as they gain better exposure to global standards. As a result, companies may prefer to set standards and targets based on a global business environment rather than restricting their considerations to local business landscapes. To sum up, adopting IFRS in UK can significantly restructure the way the UK business world operates and increase UK firms’ access to international capital markets. Furthermore, UK companies can improve their strength in meeting stakeholder information needs timely and effectively. Negative impacts or limitations Although IFRS have many advantages, particularly in terms of understandability and comparability, this concept has a number of negative impacts or limitations in the UK business environment. The major cited negative impact of IFRS is high installation costs. According to the Institute of Chartered Accountants in England and Wales, costs relating to the IFRS implementation process represent developing an IFRS project team, staff training, internal audit and management, seeking external technical assistance, obtaining tax consultancy services, updating software and IT systems, communication and external auditing costs, and meeting external data requirements (Fox et al). In addition, the recurring IFRS costs may increase up to 24% of the turnover based on the size of the company (Ibid). Referring to the results of an FTSE 350 survey by PriceWaterhouse Coopers, most companies are forced to hire additional staff for IFRS implementation because lack of unskilled IFRS staff poses great challenges to the implementation process (Ibid). One of the major limitations of IFRS adoption in UK is that these reporting standards are still not adopted in the United States. It is clear that US is a long standing partner of UK politically and economically, and both the countries have strong business interests in each other’s markets. Therefore adopting IFRS in UK would cause great troubles to American companies operating in the UK market, and this situation in turn would lead to many accounting difficulties in US-UK business transactions. Similarly, UK companies operating in the United States are forced to follow the US GAAP They cannot adopt the reporting standards of the home country. In short, UK companies share a notable percent of the US market, and hence it may not be better for the UK to completely adapt to a new reporting environment. Experts claim that IFRS would increase the volatility of income statement, and consequently this situation would make it more difficult to evaluate a company’s performance. For instance, a prior research identified that 85% of managers in FTSE 350 companies reported that they found more difficulty explaining their operational outcomes since the adoption of IFRS (Fox et al, 2013). To justify this, Ernst & Young found that companies were more interested to use non-IFRS information in their presentations. In a research, PwC noted that most of the insurance companies under study provided an alternative measure of profit, usually European Embedded Value (EEV) (Ibid). These findings directly point to the negative consequences of IFRS adoption in the United Kingdom. Although some of the costs associated with IFRS implementation in the country may be transitory, additional resources and a comprehensive updation of IT systems will be often needed. While adopting the IFRS, it would be inevitable to make necessary changes to computing and other information systems. Evidently such an overall change in the reporting environment may cause great troubles to the reporting staff that are not much familiar with the practices and procedures under the IFRS. Fox et al indicate that companies spent over £1 million on external costs and a huge amount on internal costs for implementing IFRS. Many companies faced time constraints on implementation as IFRS were completely a new concept to them and there were not enough well-trained personnel to manage the implementation process (Ibid) . In the words of Fearnley and Hines, “the absence of an IFRS that is equivalent to a national standard is problematic, for example, the UK’s FRS 5 Reporting the Substance of Transactions” (as cited in Fox et al, 2013). This issue appears to be a major limitation of adopting IFRS in UK. Similarly management professionals and accounting experts have different opinions about the implementation of IFRS in the country. Referring to Fox et al, many UK stakeholders suggest that small firms should not come under the provisions of IFRS, and an IFRS equivalent to the UK ASB’s Financial Reporting Standard for Small Entities (FRSSE) has to be specifically introduced for small enterprises (Ibid). As a result of these barriers to IFRS adoption, there is a possibility that companies would disclose only the same sorts of information that may technically adhere to statutory requirements (ADAA IFRS News, 2013). Hence financial statements would not communicate adequate information to stakeholders, and thus they may become ‘boiler-plate’ reports only (Ibid). In other words, financial statements would no longer serve its stated purposes, and therefore stakeholders may find it difficult to make well informed decisions. Therefore, it can be argued that businesses and investment decisions are likely to be greatly affected by the IFRS adoption in UK. Wright and Hobbs (2010) suggest that IFRS have significantly impacted the M&A decisions of several companies and the efficacy of share-based payment schemes in smaller enterprises. Another challenging issue associated with IFRS adoption in UK is that it negatively impacts investor confidence as investors are doubtful about the feasibility of IFRS. To illustrate, a PwC report indicates that “in its sample of companies, 29% of investors had disinvested because of IFRS and 21% had decided not to invest in a company in the first place” (as cited in Fox et al). Undoubtedly, it is a horrible situation that a new reporting standard drastically affects investor confidence and capital requirements of an organisation. In total, adopting IFRS in UK may adversely affect the country’s investment sector. Conclusion From the above discussion, it is clear that adopting IFRS in UK can have a range of benefits and negative impacts. This new reporting system has been widely accepted in the Europe, and hence it is better for the UK to switch to this framework so as to take advantages of common reporting standards. Increased understandability and comparability are two major advantages of IFRS implementation in UK. In addition, the country can enjoy lower cost of capital and improved access to international financial markets with the adoption of IFRS. High cost of installation is one of the major challenges associated with IFRS implementation in the country. This new reporting system would not deliver the stated benefits unless it is properly implemented by qualified professionals. Finally, the United States is still following the US GAAP, and the country refuses to accept the IFRS. Since the UK has strong business alliances with US, it would create great reporting complexities if UK switches to IFRS. References ADAA IFRS news. 2013. International Financial Reporting Standards (IFRS). ADAA Highlights IFRS news, updates from the IASB, IFAC and the Accounting Profession. [online] available at: http://www.adaa.abudhabi.ae/Documents/AASD-Publications/IFRS%20Digest/2013/ADAA%20IFRS%20Digest%20July%202013.pdf [accessed 6 May 2014]. Fox, et al. 2013. 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