International Accounting Standards - Research Paper Example

International Accounting Standards Introduction International accounting standards serve as one of the most important documents in modern business world because all the financial disclosures made and accounting books prepared are governed by these standards. International Accounting Standard Board is responsible for formulation of all such standards which are than made compulsory for member countries to follow. IASB was formed in 2001 to replace the International Accounting Standards Committee which was founded in 1973. Though international accounting standards serve as the guiding principles behind the preparation of all accounting statements however, it is also important to understand that there are wider gaps between the practices suggested by the standards and what is actually required for the financial analysis purposes. A normal process for formation of any international accounting standard comprises of writing draft standards and then sending them to the members so that valuable comments can be received. After this process ends, another draft is issued to include the changes suggested by the members and finally after incorporating all the comments, the draft is issued as a standard. However, despite such extensive process of formulating the international accounting standards, financial analysts specially have to adjust the accounting statements in order to derive meaningful results from such statements. This is often done in order to calculate the fair value of the business so that the value reflects the current marketability of the business. This paper will discuss the International Accounting Standards-12, Income Taxes from the perspective of a financial analyst. International Accounting Standards Since, the formation of modern corporation, the need for having accounting standards to regulate the preparation of financial statements in on the rise. Accounting Standards are also critical due to the fact that they standardized the accounting practices but also allow uniformity in interpretation of information at the time of preparing financial statements. Apart from this, it was also necessitated that there must be a transparency and accountability of those who actually manage the affairs of the companies on the behalf of their shareholders. The need for having international accounting standards was also sought due to the liberalization of trade by most of the western countries. The disclosure of information to the public therefore becomes more important because of the increased role of managers in managing the affairs of the firm.(Greuning & Keen,2001). With the sole purpose of ensuring transparency in preparing financial statements, accounting standards therefore are there to ensure that the financial statements provide a fair presentation of the financial performance and position of the firm. Further, international accounting standards are also considered as necessary for ensuring that the disclosures made in different financial statements are properly presented and give true and fair view of the actual affairs of the company. With the above broader aims in mind, International Accounting Board prepares different Accounting Standards for the different items presented in financial statements prepared by the organization. These standards therefore basically provide guidelines as to how to calculate, present and disclose different accounting estimates affecting the information presented in financial statements. IAS-12 Income Taxes In order to comment on International Accounting Standard-12, Income Taxes, it is important that a brief introduction of the Standard is presented so that a better understanding can be developed for making valuable comments on the standard. The exposure draft E-13 for accounting for income taxes was issued in 1978 and after receiving and incorporating the comments from members, the standard was issued for the first time in 1979. It is also important to note that there have been significant changes in the accounting treatments prescribed under these standards as over the period of time; the basic nature of the income tax treatment in financial statements has relatively changed. The IAS-12 was implemented in order to address two main problems: 1. To address the temporary differences arising due to the differences between the value of the asset and the liability with relation to the tax base. 2. The different transactions and other specific events recognized under the current financial period of the firm. Accordingly, this standard therefore defined certain definitions in order to accommodate the various problems which needed to be addressed. For example, this standard distinguishes between the current as well as the deferred tax liability of the firm and allows firms to report both the taxes in their financial statements. (Camfferman & Zeff, 2007). This standard also makes it necessary to report the income taxes as separate item from the assets and liabilities of the firm in order to distinguish recognize the nature of this items and its impact on the different items in the financial statements. It is also critical to understand that before the implementation of this standard, most of the member countries did not considered income tax as an expense but rather it was considered as an item which was to be deducted from the profits at the time of its distribution. Apart from the above, it is really important to note that IAS-12 was the first serious effort to recognize the need for having an effective accounting system for recording income taxes. However, from the perspective of the financial analysis, this standard still lacks certain key elements which need to be addressed in order to reconcile the differences between the finance and accounting and how the both the disciplines can actually corroborate and facilitate each other in achieving the transparency of information disclosed in financial statements. The next section will discuss and provide some of the critique of the IAS-12 from the perspective of financial analysis and how this standard can be further refined to help the financial analysts. Critique of IAS-12 According to the IAS-12, income taxes are reported as the expense of the organization however, income taxes are not directly incurred as a result of the exchange of goods and services in normal course of the business. Due to its very nature reflected in the financial statements prepared according to IAS-12, income taxes therefore reduce the amount of profits available to the shareholders for distribution purposes. Since at the time of financial analysis and valuation, cash flow projections normally take into account net income of the business therefore cash flow projections may not be accurate because they take into account a non-business expense. In order to overcome this shortcoming, it is therefore important that the IASB must consider an alternative solution for correctly categorizing income tax items reflected into the financial statements.(Alexander et.al,2003). Deferred tax liability is another important issue which needs to be considered into account because of the incompatibility between the national legislative laws and the treatment of tax calculations prescribed under the standard. Normally, tax laws allow certain adjustments into the accounting profit of the organization therefore there arise a difference between the accounting profit as well as profit calculated for the purpose of taxes. Due to such differences, the issue of deferred taxes arise which can either give rise to increase in liability or the asset as the deferred tax figure can either be a payable towards the tax authorities or receivable from them. Such type of situation therefore can either over-estimate or under-estimate the profitability of the firm and the financial statements may therefore not reflect the correct profitability of the firm. It is because of this reason that the financial analysts often had to make adjustments in the accounting estimates to arrive at a reasonable and more accurate figure of accounting income of the firm. Further, the deferred taxes are represented from two different perspectives in financial statements i.e. income tax view and the balance sheet view. Under the income tax view, the deferred tax is basically a difference between the accounting income and the taxable income of the firm whereas from the perspective of balance sheet view, the deferred taxes reflects the differences between the carrying value of the assets and liabilities and their tax amount. This difference is again critical from the perspective of financial analysis because it can inflate or underestimate other accounting estimates thus providing a false view of the actual affairs of the firm.(Khan,2004). The calculation of tax base is another important issue which needs to be addressed in order to properly align IAS-12 with different finance concepts. For example, a loan or bond issue is not a taxable item under existing laws therefore its tax base is equal to its carrying value however, the economic benefits associated with such debt issues are not properly accounted for in order to compute the true impact of such items on the value of the firm. For example, if a bond is issued at an interest rate of 10% and subsequently, the interest rates go down therefore the bond shall technically be selling at a premium however, since loans and bonds are not taxable therefore the economic value derived through such upward increase in the market value of bonds is not properly reflected. Conclusion IAS-12 deals mainly with the accounting treatment of income taxes however, from the financial analysis points of view; this standard still lacks certain important additions in order to make it more aligned with the financial analysis. Reference list   1. Alexander, Britton, A, and Jorissen. A, (2004). International financial reporting and analysis. The International Journal of Accounting. 39 4, pp.333-335. 2. Greuning, H & Koen, M (2001). International accounting standard. New York: World Bank Publications. 3. Camfferman, K,. Zeff,S (2007). Financial reporting and global capital markets. Oxford: Oxford University Press. 4. Khan, Y (2004). Global Convergence on IAS-12: Why Temporary and not Timing difference? [Online]. [Accessed 31st May 2009]. Available from World Wide Web: . Read More