The Main Components of a Set of International Financial Reporting Standards - Term Paper Example

Case study: IFRS is Big Four Gravy Train Name Institution Date Abstract Globalization of international markets has necessitated adoption of a common accounting standards and language for all sectors within economies. This is manifested by a paradigmatic shift in various economies which are dropping UK GAAP for IASB’s IFRS. There are powers and forces behind this growing shift. However, for local authorities, the paradigm presents managements with conflicting approaches relative to business specificity. Given the uniqueness in service delivery, adoption of IFRS by the authorities should be a well weighed approach. This is to ensure that accounting purposes of the authorities are maintained. This need is reflected in Australian local authority governments. Case study: IFRS is Big Four Gravy Train Introduction Theoretically, any financial statements presented should post a reflection of the economic reality. Generally Accepted Accounting Principles (GAAP) refer to a system or body of accounting standards, procedures, concepts basically developed by the Financial Accounting Standards Board (FASB) and also informed by convention practice in various industry practices. International Financial Reporting Standards (IFRS) refer to a set of accounting practices, rules and standards uniformly used across the globe. Globalization and international markets has necessitated adoption of a common accounting standards and language. As such, there have been several systems. Currently there is a trend in accounting practice and standards. Countries are shifting from the GAAP to IFRSs. However, this shifting has been termed as being more theoretical and not reflecting the economic value (Jeanjean & Stolowy 2008). This paper attempts to demonstrate the ideological and political conflict revolving around the shift. It will delineate the forces and reasons being given by IASB and allies in favor of the shift more so for local authorities. This will detail a critical literature review after which it shall create linkage to Australian local government authorities presenting reasons as to why change should or should not be effected. Contrasting IFRSs with UK GAAP Though the main components of a set of IFRS statements are similar to those of the UK GAAP, there exist a number of differences between the two standard systems, with IFRSs being considered a paradigmatic shift from the UK GAAP. The similarities are in financial statements including balance sheet, income statement, cash flow statement and explanatory notes (PricewaterhouseCoopers Chartered Accountants 2005). IFRSs are swiftly taking over the global financial across diverse sectors and practice. This is especially so with globalization which is a threat to both GAAP and its originators (Bratton & Cunningham 2009). These changes exist between the financial reporting systems as affected by incentives, regulatory factors, and law enforcing systems and institutions amongst others factors. With regard to the treatment of tangible long-lived assets, literature and practice have also demonstrated differences. Under the GAAP, these assets are considered on a cost basis. This is contrary to the IFRS’s treatment of the same in which the assets are carried at cost or fair value. If carried as on the cost basis, there is imminent impairment resulting in a charge done to current income in case the assets value is impared. Under the IFRS, in case of the impairment, the change and loss is tackled by only making changes to the balance sheet. This implies that in case the impairment of the asset value is recovered, there can or must be reversals in the balance sheet. As such, GAAP demonstrates a conservatism motivation by managing uncertainties through asymmetric recognition of losses as contrasted with profits. Critiques further cite this as favoring verifiable numbers. This has been faulted by practice and literature for hewing more to traditional accounting thereby limiting manager’s flexibility of option with respect to balance sheet presentation (Bratton & Cunningham 2009). This is with reference to IFRSs which allows managers ample room for revaluing assets. This amounts to greater range of value treatments which have greater subjectivity affecting the determination of balance sheet entries. The implications indicated above mean that under GAAP, any write-down due to impairment is irreversible unlike in IFRSs where values of the asset can change alongside external factors at the manager’s discretion. Additionally, impairment is recognized on the income statement under GAAP. The same impairment is taken care of in balance sheet adjustments under IFRSs. Changes into IFRSs and regarding valuation and income measurement, there are several considerations. Citing just a few in this paper, these depict paradigmatic shift. In the IFRSs, any investments in quoted shares are considered at fair value with changes through profit for a reporting period. This implies that one discounts any receivables for the shares to their NPV. This is unlike UK GAAP under which it is not possible as per CA 2006 indicating that the amounts considered in profit and loss may need to be reclassified as share premium (PricewaterhouseCoopers Chartered Accountants 2005). Any revenue is measured and valued under IFRS by the amounts receivable. As such, service income requires delays in profit recognition subject to performance of a significant act. Additionally, revenue is considered subject costs incurred. IFRS allows organizations to recognize all revenue up-front even upon partial performance. This shows an emphasis on measurement and essence of value. This is unlike GAAP with a finality approach that matches revenues to expenses and does not recognize the value of partial performance and up-front consideration (Bratton & Cunningham 2009). Literature and practice have also demonstrated IFRSs as being able to present more economically real reports. In inventory accounting, GAAP allows more flexibility between a report’s choice over either first-in-first-out (FIFO) and last-in-last-out (LIFO) approach. The order of sale of goods is vital in cost accounting. Given the current price instabilities rocking the international markets, to which the accounting standards were formed, FIFO is the more real approach. It more closely shows the economic reality on the balance sheet by considering inventories close to current values. Contrary under LIFO, the income statement shows prevailing economics with the cost of goods showing current prices. This makes the IFRSs the better option due to its primacy and focus on balance sheet which requires FIFO (Bratton & Cunningham 2009). IFRS and Accounting needs in local authorities Local authorities, by nature of their business and utility provision orientation have a markedly different financial management system from the business and corporate sector. This is because the business and corporate units have a focus on profit and market adaptation. Local authorities also have a focus on state budget subventions which are their major limitations. As such, their financial management reports and accounting standards ought to demonstrate budgeting realities and execution factual information. Execution efficiency is the main focus of the reporting. In this reporting literature highlight several points of concern. Firstly, the report should demonstrate knowledge of full and factual information of the receipts-expenditures balance efficiency. In this efficiency, it is vital to demonstrate a focus on social and economic programs. Thirdly, this is done with transparency. Finally, there is a focus on the efficiency and effectiveness of the programs implemented. The aforementioned are some critical normative requirements for a good and value-based accounting system in local authorities (Center for Economic and Social Development (CESD) 2007). Accountability is a key factor entrenched in transparency within the public sector. Literature has made reference to it as being multifaceted (Kluvers & Tippetm 2010). On the basics it entails having obligation to render an account over a responsibiity. The multi-facetedness of local authorities is enhanced by the fact there are more points of consideration beyond the profit and loss parameters and that there are more users of the accountability information (Center for Economic and Social Development (CESD) 2007). Commenting on the shifting trends of public accountablity towards more private sector practices, Kluvers and Tippetm take stage with contracting. This is a key factor in relationships and to whom accounting information is vital. Using IFRSs further complicates accountablity for local authority managers. It is virtually impossible for them to capture all information relevant for each relationship. There are relationships between service beneficiaries (citizens) and managers, elected officials and citizens and between the managers and elected officials. This is a major difference between accountability in the private sector and that in the public sector. According to Funnel (2003) accountability should not be reduced to the scope of performance, progress and accomplishments. This is so especially for local authorities whose core function is service delivery. Accounting in the authorities cannot therefore adequately capture all necessary information under IFRSs. IFRSs have a focus on value and measurement. These are quantitative measures which capture information about performance efficiency. This is a managerial accountablity aspect which conflicts with the political nature of service delivery in the authorities. This is unlike operations in local authorities whose accountabilty is more political. Thus , relying on IFRSs for financial management reduces service delivery from the political activity, it should be, into a technical issue (Funnell 2003). It is important that the accouting standards and systems made to use by local authorities consider the stewardship nature of local authorities management. According to Taylor & Rosair (2000) the shift of accountabilty to the more private sectors’ type changes the authorities’ management approach from stewardship to managerial accountabilty. Whereas this is deemed as a broadening move, there is reduced participation of all concerned stakeholders. Use of IFRSs in managerial accounting will derive information that only communicates to a few participating accountees who may not include the wider public. Stewardship focus ensures a focus on all public at all levels of government. In their study exploring the mechanisms of local authority accountability Kluvers & Tippetm (2010) reported the essence of four factors: information, values, enforcement and relationships. With respect to relationships, they report on accountability relationships as being hierarchically structured. This hierarchy ought to diminish to the broader community. This is coroborated by an increasingly changing role of local government and changing relationships cited by Pillora and McKinlay (2011). In a place like Australia and other developed nations, there has been a decreased voter turn-out for elections and decreasing trust. As such, inteventions are to ensure the trust is rebuilt. The focus is to shift trend to community governance. With reference to resources, it is therefore important that local authorities adapt a system enhancing the participation. The CIPFA Finance Advisory Network (FAN) reports that there is potential for UK local authorities to introduce IFRSs in their systems. It offers a guideline for such an introduction citing the need for a retrospective approach. In this approach, authorities will make their accounting as if they have always used IFRSs thus the need to review all UK GAAP reports into IFRS. However, they cite several issues of concern between IFRSs and local authorities. These include terminologies, extra communication needs, relationships with subsidiaries, authorities’ ability to effectively engage with valuers for the purposes of balance sheet, values and measurements and reconciliation between UK GAAP and IFRS (CIPFA FAN 2009). The extra communication needed reflects the need for adopting authorities to be prepared to explain their accounts in deeper details to all stakeholders under IFRS. CIPFA also cite budgetary areas of concern such as employee benefits, leases, and asset revaluation. This is to correspond with new balance sheet requirements. Why IFRSs are imposed on local authorities in spite of failure to serve the purpose. Who, or what forces are behind this push? Literature and practice have shown that IFRSs are so far not sustainable given the clouding issues of concern. However, policies continue to impose IFRSs in local authorities across nations. One of the major forces behind this push is the direction that governments, at all levels, need be in line with global trends. This makes reference to IFRSs as a global trend with hundreds of countries adapting it, in the place of GAAPs. There are claims that universal adoption of IFRSs as a set of ‘high-quality principle-based standards’ (Sunder 2011, pp 291) is likely to result in global comparability. However, these claims are overblown since accounting standards are less like an even valuation and measurement system and more like a unit currency. This is so in contemporary economies where accounting standards perform in both roles (Sunder 2011). The biggest force behind popularizing the IFRS is the International Accounting Standards Board (IASB). Under this board, Jeanjean & Stolowy (2008) report that over 100 countries had implemented IFRSs or were planning to do so by 2008. In the same article they cite the use of incentives for countries which may be intepreted as sanctions blackmailing countries into adoptig the standards. Hail, et al. (2009) indicate the role of political and economical competition in this IFRS influence. Citing the US willingness to cooperate internatioanally, they demonstrate that IFRS has political benefits. The US is using the influence to ensure security of its strategic presence through various bodies such the UN, OECD and IMF. Though the US Security and Exchange Commission, this government provided for foreign companies to have access of the capital markets while using IFRS. The European Union has also been so. This is a lobbying activity (Jeanjean & Stolowy 2008). According to Hail, et al. (2009), there also a focus of monopolizing the IASB. As such, the body is bound to receive a lot of lobbying from governments, international bodies, and corporates. The push is also influenced by monetary gains and global power related to the monopoly. Having found way into corporate accounting, the shift is now to the secondary market: local governments. This may explain why more powerful countries are less likely to adopt IFRS and less willing to let an international body control universal accounting standard (Ramanna & Sletten, 2009)s. This also presents a global ideological war amongst the more powerful nations over standards control. The IASB and the Big 4 accounting firms The Big4 accounting firms refer to Pricewaterhouse Coopers, Deloitte, Ernst & Young and KPMG. With the development of IFRS by the IASB, there has been increased adoption in many countries. The Big4 have presence at the international level and linkages. They are mostly involved in business consultations, corporate audit, and corporate tax consultations. The IASB has been keen to popularize IFRSs through various means. These include international organizations, government and local representatives. The role of the Big4 cannot be understated neither can it be ignored in the increasing popularization of the system. Firstly, these firms have been in the fore-front developing literature in the view of the need to adopt IFRS. There is literature that points-out to them as having a mapping or association with international standards such as US GAAP and the IFRS (Hoffman & Watson 2009). This relationship between the IASB and the Big4 in popularization of the IFRS may be discussed as a cartel. This with reference to the benefits both parties accrue from the adoption of IFRS in as many countries. IASB benefits economically as well as amassing immense power and authority in global matters. On the other hand, the Big4 are using the IFRS as a competitive advantage. Literature documents the effects of adopting IFRSs as aforementioned. There is a general conclusion that with the adoption of IFRS there has been increasing audit fees. This has also been reported in countries such as Malaysia and China (Phua & Chris 2011). This is related to increased risk and legal considerations and the need for more thorough reports. IFRSs adoptions imply that the reporting will be of higher quality and more refined than previous standards. This may indicate the heightened preference given to the standards by investors. Research has found that larger firms are more likely to give more quality audits and that investors perceive that such audits are more stringently prepared. As such the market demand is high for the auditing standards required. In the auditing markets, the Big4 have the most enhanced systems and resources to undertake the requirements of the new system. This is in terms of intellectual resources, financial, technological, human resources, organizational and goodwill from investors (Phua & Chris 2011). As such, they have a competitive advantage over smaller firms and can charge more amounts from clients. As such, the Big4 are using their resources to entrench competitive advantage over small and mid-sized firms. In the Malaysian study aforementioned, the small firms have to charge lower audit fees in order to attract clients and stay in business amidst cut-throat competition. In addition, they can only attract smaller firms for audits and consultancy. On the other hand, the Big4 can provide services to big commercial firms accruing economies of scale relative to their size and ability. As such, this leaves countries stuck on whether to adopt or not. This is in the torn interest between protecting small local firms against multinationals and trends. However, given that most state-owned organizations and audit needs will be charged relatively lower than private companies, there is a likelihood of more adoption. This is also in addition to the need for conformity to global standards and international trade partners policies and trends. Should IFRSs be adopted in local authorities in Australia? With regard to whether IFRS should be adopted in local authorities, the paper will take several approaches. As a basis, it is vital that the management of the authorities weigh the pros and cons of the subject matter. This is with reference to the guiding basics financial management in the local authorities. These are stewardship, value for money, accountability and forward planning. In addition to this, the authorities are utility based with a focus on information, values, enforcement and relationships (Kluvers & Tippetm 2010). On one hand, the authorities may adopt IFRS. This is in response to globalization and contemporary trends in financial management. this may also be with reference to the authorities’ subsidiaries. However, this paper is of the opinion that the Australian local authorities should not as yet adopt the IFRS. Firstly, there are changing roles and relationships in the country’s local authorities (Pillora & McKinlay 2011). There has been reducing participation of the community in local authority affairs. Pillora and McKinlay (2011) cite voter partcipation as an indicator. As such,the management of the authorities should focus on encouraging more partcipation. As aforementioned, using IFRSs may limit the ability of the authorities in this endeavor. This is because of the shift towards managerial accountability as opposed to stewardship. This has been deemed as a broadening move. However, it results in reduced participation of the community due to the kind of information derived and reported. The australian governemt has been cited as having started devolution process in which it intends to release decision-making over services delivery to the local government and communities (Pillora & McKinlay 2011). This move requires a more autonomous management of local authorities as well as increased participation. This may not be delivered by IFRSs unless the issues of concern aforementioned by CIPFA FAN (2009) are focused upon. these issues are relevant in the Australian given the Australian systems of governance heavily borrow from UK (Pillora & McKinlay 2011). Finally, the Australian authorities may have to eventually adopt the IFRS, with time and events. In this regard, the adoption should be gradual and controlled and involving all the relevant stakeholders in local authorities. Conclusion The shift and competition between the UK GAAP and IFRS are both ideological and practical. This is so with reference to balance sheets and statement of incomes in line with valuation and measurement. The shift is paradigmatic given the need to do system overhauls once IFRS is adopted. This shift is now being forced on local authorities in spite of significant evidence of the failures of IFRS in local authorities’ financial management. This has been linked to international forces such as globalization and ideological power competitions. This is linked to monetary gains. The forces include countries, and organizations such as the IASB, the Big 4, and the IMF. Finally, the IFRS is a misfit for Australian local authorities. Any shifting should be gradual and closely monitored. Bibliography Bratton, W. & Cunningham, L., 2009. Treatment differences and political realities in the GAAP-IFRS debate. Virginia Law Report, 95, pp. 989- 1023. Center for Economic and Social Development (CESD), 2007. 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The effects of participating parties, the public and size of government departments' accountability diclosure in annual reports. Accounting, Accountability, and Performances , 6(1), pp. 77-98. Read More