The European Union Necessity to Adopt International Accounting Standards - Term Paper Example

Running Head: The European Union Necessity to Adopt IAS Why the European Union felt it was necessary to adopt International accounting standards forall listed companies from January 2005? Name of Student Name of Subject Course Name of Professor 7 March 2008 1. Introduction The Europe Union aims to have an efficient capital market for its Member States by having a an efficient and effective financial information system in a transparent European capital market even before 2002 Enron scandal in the US; hence the latter events could only be considered to have triggered the early adoption of IAS in 2002 to require its application to all listed companies in Europe as of 2005. This paper seeks to defend this assertion as it attempts to discuss why the European Union felt it was necessary to adopt International accounting standard for all listed companies from January, 2005. 2. Analysis and Discussion 2.1 - The events surrounding the Enron scandal in the US have triggered the European countries to adopt a more rationalized accounting standard that would applied in the whole Europe from 2005. The Enron scandal was directly linked to the failure of the US generally accepted accounting principles (GAAP) on accounting (Prentice, Robert, 2002; Choi and Fisch, 2003) that caused the European Union (EU) members to lose their trust on said accounting rules and conventions. Said members of EU have even persuaded the US to change its GAAP with the IAS due to ineffectiveness of the former to address financial reporting problems as experienced in the case of Enron. It was as in February 21, 2002, that Fritz Bolkestein, European internal market commissioner has urged US Securities and Exchange Commission to replace US GAAP with the IAS. Mr. Bolkestein was quoted to have referred to the ‘cookery book’ approach of US GAAP that must be replaced with the more ‘substance over form’ approach of the IAS (Deloitte Touche Tohmatsu, 2008). The meat of the EC Commissioner’s objection to the US GAAP was the fact it has rigid rules and that “one just have to tick the boxes and one comes come with the answers.” The emphasis was more on the rules and the form and not in the substance. The EU’s lack of trust for the US GAAP was more evident by the fact Mr. Bolkestein was even prepared to ask the SEC to allow listed US-listed European companies to submit IAS financial statements without reconciliation to US GAAP (Deloitte Touche Tohmatsu, 2008). The attitude of the EU to what happened to Enron scandal and subsequent to declaration made by European Commissioner Bolkestein have triggered for the adoption of the IAS into the EU. The seriousness of the attitude materialized after EU has urged the SEC to adopt IAS in February 2002 as subsequent even which resulted to an overwhelming adoption of the IAS by European Parliament in the following month, in March 13, 2002. It was by a vote of 492 for, 5 against and 29 abstentions , on that said date, that the European Parliament endorse the Commission’s proposal that all EU listed companies must follow standards issued by the International Accounting Standards Board in their consolidated financial statements not latter than 2005. As to whether non-listed companies must also follow IAS, it was reported that that Member States are permitted to decide. In certain cases until 2007, Member States were also given the option to exempt certain companies temporarily from IAS requirement. The option was made available only under these two cases: (1) listed companies in the EU and in on a non-EU exchange and are following another set of internationally accepted standards and (2) companies that have only publicly traded debt securities. From these decision to approval made by the EU through the European Parliament showed its determination to adopt IAS for the whole EU membership while being ready not to even use US GAAP as alternative even to those European companies listed in the US that currently prepare US GAAP financial statements. The seriousness of the decision was to be followed by move of the European Finance Ministers urging swift adoption of IAS in April 2002. It was also as a result of their response to Enron-related issues, that the European Council of Finance Ministers (ECOFIN) of the 15 European Union countries has urged the adoption of the EU regulation that would require all listed EU companies to use IAS starting in 2005. Having even therefore agreed to push the US Securities and Exchange Commission to accept IAS financial statements file by European Companies without the reconciliation to US GAAP that is currently required, these ECOFIN Ministers have moved further by urging several policy actions on financial reporting. One of these policy actions is the speedy adoption of the proposed regulation requiring the use of IAS by listed EU companies from 2005, in line with the Barcelona Council conclusions. This means that there were already plan by EU to adopt a uniform standard even the Enron scandal has resurfaced in the US as evidence by the presence of Barcelona Council conclusions. Hence the financial scandals must be considered to have triggered the speedy adoption of the IAS into the EU. To assert the seriousness of the deadline to use IAS as of 1995, the ECOFIN Ministers have also moved for preparation of the Commission’s endorsement decision of existing IAS so as to make it possible for listed EU companies to prepare the change-over in time for the 2005 deadline. The EU preoccupation with deadline in 2005 was a strong determination to really have the IAS implemented by that time. The finance ministers were willing to move everything just to make the objectives happen. Thus as a third policy action they also moved for the further development of EU and national enforcement mechanisms so as to ensure proper harmonized application of IAS within the EU in coordination with the Committee of European Securities Regulators (CESR). Their decision to have the IAS by 2005 was also evidenced but the finance ministers’ move to have a continued dialogue with US authorities to encourage their acceptance of IAS financial statements prepared by listed EU companies for listing within the US without reconciliation to US GAAP from 2005 onwards. 2.2. - The to need create an efficient capital market and an actual level playing field within the Union is the motivating reason for the adoption of the IAS in to EU. The Committee Of European Securities (CESR) (2003) dramatized the need for an efficient and effective financial information system in a transparent European capital market which should be based on the development and the harmonization of: (a) clear and enforceable financial reporting standards (i.e. IFRS) and other disclosure requirements (e.g. prospectus and regular reporting requirements) which can be timely and efficiently interpreted; (b) transparent corporate governance systems; (c) auditing regulation, including technical, ethical and quality control standards up to develop first external line of defence against inappropriate application of financial reporting standards; and (d) independent institutional oversight. As could be seen above having clear and enforceable financial reporting standards and other disclosure requirements to allow timely and efficient interpretation is a requirement to have a transparent European capital market. Adoption therefore of the IAS (some are now IFRS) after having lost trust of the US GAAP could only be an indispensable requirement if a transparent European capital market is a desired as objective. A transparent capital market is in turn seen as an effective tool to create an efficient capital market and an actual level playing field within the Union. It must be made clear however that transparent corporate governance systems, auditing regulation and institutional oversight are needed to support the objective as standard will not work by its self but needs the cooperation and support of those involved particularly the managements of companies from the Members States, the accounting and auditing profession in the EU and government authorities in the form of Accounting Directives to give the standards of force of law and enforcement of harmonization practices throughout Europe. These combined actions is believed to help improve investors’ confidence of listed issuers in Europe (CESR, 2003) It will be the work CESR to develop a common approach to enforcement through Europe in behalf of the EC’s act of liaising with Member States. CESR in turn sets its Sub-Committee on Enforcement (SCE), to do activities under an agreed work plan whereby standards, guidelines and practices will be considered by the enforcers. This work plan provides for principles on which harmonization on the institutional oversight systems in Europe may be achieved as viewed by CESR (2003). Consistent with the requirement for auditing to ensure compliance with IAS, the Federation of European Accountants (FEE) has proposed in January 2002 that by 2005 national auditing standards in the EU should require auditors of financial statements to their audit in accordance with the International Standards on Auditing (ISAs) and that financial statements report should also in accordance with ISAs (Deloitte Touche Tohmatsu, 2008). This must be taken as standard requirement as auditors perform an enforcement of the IAS function. 2.3 The adoption of the IAS into EU The actual adoption of the IAS into EU in June 2002 could reflect more about its reasons for implementation of IAS as of 2005. The fact that it is adopted at an earlier date which provided almost three years before the actual implementation should be a good period to prepare for transition from the Member States. The Council of the European Union has adopted an ‘IAS Regulation’ requiring listed companies, including banks and insurance companies, to prepare their consolidated accounts in accordance with IAS from 2005 onwards. As stated earlier, Member States may defer application until 2007 for those companies that are listed both in the EU and elsewhere and that currently use US GAAP (or other GAA) as their primary basis of accounting as well as for companies that have only publicly traded debt securities (Deloitte Touche Tohmatsu, 2008). Based on declared purpose or goal of the Regulation, which is to eliminate barriers to cross-border trading in securities by ensuring that company accounts throughout the EU are reliable, transparent, and comparable, the same can reconciled with need to have an efficient and effective financial information system in a transparent European capital market. By adopting by the EU, the Regulation is considered to have the force of law without requiring transposition into national legislation but Member States were given the option to extend the requirements of the Regulation to unlisted companies and to the production of individual accounts (Deloitte Touche Tohmatsu, 2008) The IAS Regulation has acquired more legitimacy by its approval by the Parliament on 19 July 2002 and its publication into law on 11 September 2002. It cannot however be considered that the Regulation be absolutely applicable as the European Commission is given the authority to determine the applicability within the Community of international accounting standard to include the present and future IFRS. An Accounting Regulatory Committee was therefore created to advise the Commission in this regard and sets a deadline of 31 December 2002 for decision regarding existing IAS. Conditions for application include not being not contrary to EU Directives, being conducive to the European public good, and it must meet the criteria of understandability, relevance, reliability and comparability (Deloitte Touche Tohmatsu, 2008). It is therefore evident in the regulation to have the indispensable participation of national accounting standard setters; securities, banking and insurance regulator; central banks including the ECB; the accounting profession; users and preparers of accounts whose views should be consulted in the implementation process. The European Financial Reporting Advisory Council (EFRAG), which is a private sector accounting profession creation in Europe, is tasked to present coordinated views to the Accounting Regulatory Committee and the Commission (Deloitte Touche Tohmatsu, 2008). 2.4 What is enforcement of the standards and how should it be done? As stated earlier enforcement of standards on financial information provided by the issuers is a requirement to have a harmonized application of IAS within Europe. The declared purpose of enforcement by CESR (2002) is to protect investors and promote market confidence by contributing to the transparency of financial information relevant to the investor’s decision making process. As far the financial statements are concerned enforcement constitutes to a consistent application of the IFRSs in the EU financial regulated markets (Principle 9) (CESR, 2002). Hence CESR’s related principle 10 has defined standard enforcement as (1) monitoring compliance of the financial information with the applicable reporting framework: (2) taking appropriate measures in case of infringements discovered in the course of enforcement (CESR, 2002). By working within principles that it proposed when approved, the CESR is expected to do its work under the EU system for the benefit of the whole membership. 3. Conclusion: The European Union felt it was necessary to adopt international accounting standard for all listed companies from January 2005 and onwards because of the need for an efficient and effective financial information system to support a transparent European capital market which is an indispensable requirement of an efficient capital market that and an actual level playing field among investors within the Union. This is will in turn achieve the successful economic integration of the Members States of the European Union (Çarkoglu and Rubin, 2003; Evans, 1996). Adoption of the IAS must be supported transparent corporate governance, auditing regulation and independent institutional oversight. All these four must developed and harmonized throughout Europe and it is the job of CESR that will enforce the same by its application of necessary principles that must not violate EU rules and regulations. References: Çarkoglu and Rubin (2003) Turkey and the European Union: Domestic Politics, Economic Integration, and International Dynamics; Frank Cass, 2003 CESR (2002) Proposed Statement of Principles of Enforcement of Accounting Standards in Europe, {www document} URL http://www.iasplus.com/resource/cesr0210.pdf, Accessed March 7, 2008 Choi and Fisch (2003) How to Fix Wall Street: A Voucher Financing Proposal for Securities Intermediaries; Yale Law Journal, Vol. 113 Deloitte Touche Tohmatsu (2008) International Financial Reporting Standards in Europe {www document} URL http://www.iasplus.com/restruct/euro2002.htm, Accessed March 7,2008 Evans (1996) The Integration of the European Community and Third States in Europe: A Legal Analysis; Clarendon Press Prentice, Robert (2002) Whither Securities Regulation? Some Behavioral Observations regarding Proposals for Its Future; Duke Law Journal, Vol. 51 The Committee Of European Securities (CESR) (2003 ) Standard No. 1 On Financial Information Enforcement Of Standards On Financial Information In Europe {www document} URL http://www.iasplus.com/resource/03-073.pdf , Accessed March 7, 2008 Read More