Advantages and Disadvantages of Developing a Set of Globally Accepted Accounting Standards - Assignment Example

EXECUTIVE SUMMARY This paper has highlighted some of the advantages and disadvantages of developing a set of standards that will serve companies all around the world. It must be noted though, that IFRS is inevitable and soon there will be a globally accepted set of standards that will be used to govern the practice of accountancy. The challenge, then, is to ensure that the various factors in the business world-business models, cultures and business trends- are considered when these standards are being created. This will ensure that their acceptance will not be a problem. TABLE OF CONTENTS Executive summary……………………………………………………………1 Table of contents………………………………………………………………2 Part A – Advantages and disadvantages of developing a set of globally accepted accounting standards…………………………………………………………3 Part B –Comparing and contrasting presentation of financial statements in UD GAAP and IFRS…………………………………………………………………7 Summary…………………………………………………………………………9 References................................................................................................... GLOBAL ACCOUNTING STANDARDS PART A The fight for a set of globally accepted accounting standards was recognized decades ago. However, it is only the recent financial scandals like Enron in the US to create a sense of urgency in the push for such standards. At present, there are two sets of standards of accounting that are accepted around the world. These are US GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). Attempts are being made to consolidate these two sets into one ideal code that will cover companies all over the globe. Developing a set of globally accepted accounting standards is a daunting task that requires a lot of time and effort. However, there are several advantages that will be realized as a result of this. First, there is increased transparency in the evaluation of publicly traded companies. Because all companies will use one set of standards to judge their work, there is a uniform application of ethical standards. Secondly, creating a global set of accounting standards may lead to improved quality in reporting of financial statements. The main reason behind this is that organizations will have to follow the same rules in their financial reportage. However, other researchers suggest that improved quality of financial reporting will depend more on how the existing standards are enforced rather than how the standards vary. A third advantage is that a global set of accounting standards will facilitate comparability. Companies based in different countries but are trading in the same market can analyze their accounting information from the same viewpoint. Consequently, the comparisons will be more accurate and will enable the companies to make strategic decisions with more confidence and information. Fourthly, economic gains will be realized as a result of using a global set of accounting standards. It provides timely information for external investors to evaluate the performance of companies across borders and also leads to better quality accounting/financial reportage. It is important to note that this is not always the case. Evidence suggests that improved quality of financial reporting only took place in countries that had institutional arrangements that provided strong incentives for high quality financial reporting. Fifth, countries without an established set of national accounting standards could adopt IFRS and so have a ready-made set of standards which would meet the needs of domestic companies and have credibility in international capital markets. Sixth, a global set of accounting standards creates a level playing field because companies are using the same codes of rules. But to every advantage there is a disadvantage. some countries will enforce the rules differently than others, for example, IFRS offers fewer rules to US companies, and the SEC does not provide methods of implementation that exist in other countries like the EU, thereby reducing comparability. Secondly, despite the widely accepted fact that IFRS is an inevitable occurrence, there is the chance that most countries will not fully adopt these standards and will instead modify the rules to suit their respective cultures. Thirdly, the initial cost of converting to IFRS will be significant because companies will have to engage in staff training and providing IT support. Fourthly, the IFRS is less detailed than GAAP and this lack of specifics may create uncertainty among companies used to revealing full details of their accounts. If this is exploited by companies with dishonorable intentions, fraudulent scams may increase. Fifth, imposing a set of accounting rules for all companies, regardless of size, will put the small and medium sized companies at a disadvantage. For example, the costs involved in the administration and training of staff can affect their competitiveness. However, it is argued that these costs may not significantly affect their competitiveness because all other companies will incur these same costs. Sixth, a global set of accounting standards may inconvenience companies that are not publicly traded. Private companies are not under obligation to reveal accounting information, and state corporations have vague institutional codes on accounting practices and how to report to stakeholders. A practical example would be Microsoft Corporation. It is an American software development company and is listed in the NYSE and also in Europe. The US operates on GAAP while European countries follow standards set by the IASB. There are some divergences and some similarities when it comes to these standards. For example, GAAP requires that Microsoft Corp present its income statement in a vertical format, but in Europe, the company will have to use the comprehensive income statement as propagated by the IASB. Also, GAAP is more detailed as regards to how much information shareholders should receive from the company. As for IFRS, the standards do not emphasize a lot of detail and this can create loopholes through which the company can get away with accounting malpractices. Furthermore, the company will have to provide an audit report that shows which standards they used, whether it was US GAAP or IFRS, in the US. In Europe, the expected standard is IFRS and the company will have to follow these standards. However, because of the varying standards, it may be challenging to compare the performance of the different branches of the company that are located in different continents. Comparability is not easy because of two sets of standards that dictate how their financial reporting will be done. The US GAAP is more rigid than the IFRS and this means that customizing the accounting standards to suit the location of the company will be more difficult in the US than in Europe. To summarize, both sets of standards have strengths and weaknesses that need to be addressed before a fully comprehensive set of globally acceptable standards can be arrived at. The differences need to be dealt with because they might very well be the stumbling block in the path to a uniform code of standards for the accounting profession. PART B The IASB is an international standard setter, and it has come up with the IFRS. IFRS proposes that companies present their financial statements in a comprehensive income statement format, whereas US GAAP uses the profit and loss account. The comprehensive income statement operates on the concept of ‘remeasurement’, where changes in expected results, like profit or loss, will be seen in terms of cash flow. A comprehensive income statement is one that “embraces all income, expenses, gains and losses, including those currently reported in equity, but excluding transactions between the entity itself and equity holders. The reason behind this change is the “increased use of current values in IASB standards”. Current values affect the fixed assets and long-term liabilities of companies, and it is important to report these changes in an honest manner. The honest way would be through a comprehensive income statement with a horizontal format. At the moment, financial instruments that are available for sale and other derivatives are recycled into the income statement. However, IFRS pushes for a comprehensive income statement that will eliminate recycling. The new format requires that core earnings are identified. It also requires that recurring earnings should be distinguished from non-recurring earnings. It further proposes that those earnings which are not controlled by management should be separated from those within management’s control. Diagrammatically, the income statement proposed by the IASB will be divided into columns rather than the vertical format favored by traditional income statements. This will make it easier for users to interpret the statement. It is divided into segments, for example business profit, financial expense, taxation, etc. However, the new comprehensive format has come under criticism because it does not take into account the different business models that exist. For example, money-lending institutions like banks will define their business as being in the financial sector. The comprehensive income statement proposed by the IASB makes a distinction between business and financial and this is confusing to the banks. In US GAAP, the income statement does not show other comprehensive income (OCI). Instead, the information was shown in two statements, the profit and loss account and the income statement. In conclusion, the IFRS differs slightly with US GAAP in the format and content of the income statement. The comprehensive income statement contains sections that have not been included in the traditional income statement, for instance “core” earnings. The IASB is however in the ongoing process of streamlining this standard so as to arrive at a mutually agreeable yet practical result that will not diminish from the standards of accounting. SUMMARY The purpose of this paper was to point out the benefits and limitations of the creation of a set of globally acceptable standards of accounting. It also endeavored to illustrate how the two main sets of accounting standards, US GAAP and IFRS, are similar to each other and also how different they are from each other. While a mutually agreed upon set of standards is not yet a reality, it is soon approaching. Further research should be carried out into ascertaining that the standards do not cause unnecessary tension and also that they are well applied because ultimately, the aim is to provide a uniform base for performance of accounting. REFERENCES Illinois CPA Society, 2009, ‘International Financial Reporting’ Retrieved on May 8, 2009 from http://www.icpas.org/hc-ifrs.aspx? Knowledge at Wharton, 2005, ‘Must Accounting Rules be Global? ’ Retrieved on May 8, 2009 from http://www.wharton.universia.net/index.cfm? Miller, Brandon L. 11 Nov. 2008. EzineArticles.com. 8 May 2009 International-Financial-Reporting-Standards---Advantages-and-Disadvantages&id=1679687>. Chua, W. F., and Taylor, S. L. Diffusion. Journal of Accounting and Public Policy 27, pp. 462-473. Zeff, S., 2008. Australia – viewed March 18th, 2009 http://www.frc.gov.au/reports/other/Ken_Spencer_2008.asp. PAGE 10 Read More