International Convergence of Accounting Standards - Literature review Example

Accounting for Decision Makers (941N1) Assessment: Report The International Convergence of Accounting Standards Table of Contents i.Abstract 1 1.0.Introduction 2 2.0.Understanding International Convergence of Accounting Standards 3 3.0.Rationality of the Accounting Standards 4 4.0.Benefits of International Convergence of Accounting Standards to Financial Institutions 7 5.0.Benefits of Convergence of Accounting Standards 10 6.0.Challenges Inherent in Convergence of Accounting Standards 11 7.0.Conclusion 13 i. Abstract The aim of this report is to provide benefits inherent in a single global set of accounting standards to users of financial statements. To conceptualise the current position of the international convergence of accounting standards, the paper further highlights some of the problems that users of financial statements face when attempting to achieve the goal of convergence of accounting standards. To provide succinct position of the argument, this report examines the continued debate regarding the convergence of accounting standards. Debates have opined that establishing a single set of standards reduces the differences in financial reporting practices between different nations. 1.0. Introduction Financial reporting requires that those in positions make reports readily available for the processes of making decisions. Tracing back in the histories, there have been cases of diversities with regard to financial reporting in different countries; which have been attributed to differing legal systems, cultural orientations, business structures and tax systems. International Financial Reporting Standards (IFRS) have been attempting to harmonise this diversity by making information easier and comparable for not only analysis but promotion of allocation of properties. Findings from different studies have indicated that converging accounting standards is essential in the sense that it eases the current globalized nature of business across the world. However, it is essential to find whether convergence of accounting standards make financial reports more dependable or it is just a case of standard- setters. These positions are informed by the need to establish ethical issues of objectivity, integrity, comparability, and quality financial reports rather than just focusing on converging standards that ignore aspects such as the dynamism of business practices and culture across countries. 2.0. Understanding International Convergence of Accounting Standards To conceptualise benefits and challenges of a solitary accounting standards inherent to users of financial statements, an understanding of the accounting standards is essential. From the surface, international convergence of accounting standards would insinuate a situation where there is a set of ratified standards that all nations can adopt for their accounting purposes, and the efforts of standard-setters towards attainment of a given goal. On the other hand, this definition has been stretched by different scholars to encompass different theoretical models as well as problems universal standards can bring to the already dynamic nations. According to Cordazzo (2013), convergence of accounting standards are set of regulations ratified to serve as a contract template among nations seeking to participate in organisations such as creditors, management or investors. Ball (2012) saw international convergence of accounting standards as different policy documents that are issued to guide different aspect of treatments, measurements and revelations of transactions as well as events, linked to GAAP. From what these scholars argued about, international convergence of accounting standards was ratified to have standardization processes enabling users from different countries to have reports that can be understood and compared easily between nations or companies. The issue that has been debated upon is not international convergence of accounting standards but the process of convergence. European Union Parliament (2012) noted that it is through understanding the process of convergence that accounting processes will discern importance and challenges inherent in the standards. According to Nicolaisen (2014) the process of attaining convergence requires different parties to reach agreement as to the standards that will help in serving as the genesis for the processes of financial reporting as well as auditing globally, making a determination how to facilitate the adoption of these standards and finally, taking the actions needed to enhance implementation. On the one hand, there is consensus among scholars that the problem expected to be solved by convergence is the inherent inefficient processes of reconciliation barriers that have been preventing foreign firms from accessing local markets (Nicolaisen 2014; Persaud 2010). Within the realm of what constitute the standards and the convergence process, assessment of benefits as well as challenges of international convergence of the standards will be premised on the fact that nations have been attempting to come up with unitary accounting standards and the efforts made by standard-setters, more so the IASB and FASB, towards attainment of the goal. 3.0. Rationality of the Accounting Standards Rationality of the argument has been pegged on different theoretical models that have been suggested in attempts to ascertain benefits and challenges inherent in international convergence of accounting standards. Taking rational utility maximization theory on different case studies, this theory evokes the need for calculating utility maximise who cannot be victims of what previously amounted to irritating behaviours from accounting practices. A good case of such misbehaviors relates to accounting and communication frailties at Parmalat. The investigation revealed that the Company (Parmalat) had established several subsidiaries to able it channel huge financial resources to the administration of the Company who in turn failed to prove the full extent of the offshore transactions (Wang 2010). The Company overstated assets by recording nonexistent assets, understating its debts, overstating profit while diverting Company’s money to personal family account. For the Company to hit fatalities, Parmalat had to use various wholly owned entities among which included Bonlat in the Cayman Island subsidiary---which existed during the final five years and the Bank holder of America’s false account. The uncollected receivables from the Company were all moved from the working corporations to the candidate objects, where their real worth was concealed. The outcome of the whole issue is what Leon Festinger termed as cognitive dissonance as an aversive motivational state occurring when people entertain two or more contradictory attitudes, values, beliefs, or behaviors simultaneously (Wang 2010). From this case, the rationality of international convergence of accounting standards is to ensure that business accountants and managers have code of reporting so that they are strong rational agents with long-term horizon. Relating the case of Parmalat to rational maximization theory, international convergence of accounting standards requires code of practice that help accounting processes to have accountant with capability of rational choice of a given behaviours in accordance to set decision rules (axioms according to the theory). Scholars assess the rationality of international convergence of accounting standards in terms of different principal characteristics of International Financial Reporting Standards financial statements (Kraal et al. 2015; Christensen et al. 2015; Fontes et al. 2005). In particular, Christensen et al. (2015) reflected on the International Accounting Standards Board’s which requires that like and unlike transactions and events should be accounted for and reported. In addition, Kraal et al. (2015) through IASB, advice against choices in accounting treatment and has reconsidered transactions and events for which IFRS permit a choice of accounting treatment. International convergence of accounting standards elaborates on the measurement policies used under national ‘Generally Accepted Accounting Principles’ (GAAP) and IFRS. This in turn will be used to investigate whether national comparability has increased under IFRS within country comparability (Barth et al. 2008). Secondly, international convergence of accounting standards is concerned with the assessment of policies used under IFRS and whether they are similar to what was previously held. Another rationality of the standards is to address fair value measurement in IFRS financial statements (International Accounting Standards Board Expert Advisory Panel 2008). International convergence of accounting standards is concerned with the amount of fair value measurement takes place in IFRS statements. This objective is aimed at informing readers on whether capital market participants are notified about the impact of IFRS. Generally, International Accounting Standards Amendments (2010) indicated that key rationality of international convergence of accounting standards is to reveal the impacts of options in standards on comparability, for the benefit of reviewing the impact of IFRS. As a matter of fact, there has been need to monitor systems to control rogue trading in securities division. There is need to control a situation where traders make large bets on future stock market moves but they fail to purchase the needed off-setting hedge (Haverals 2011). This report contextualizes the rationality of the standards by citing Mr. Kweku Adobili and his trading activities in old City trader at UBS. The proposed control and monitoring process by international convergence of accounting standards take considerations of the scandalous wiping of about £4 billion off the value of shares in UBS, affecting the investments of thousands in the company. If this can be done through international convergence of accounting standards then Kerviel and Adobili would not have purchased off-setting hedges that ultimately led to the creation of fake transaction that did not involve cash flowing to and from the bank. Casabona et al. (2012) add that when institutions can create a control and monitoring mechanisms as stipulated under international convergence of accounting standards then unauthorized trading is eliminated. The best way to do this is to ensure that institutions make sure that there is off-setting of securities that are basically purchased to hedge the risks linked with the derivatives bought or purchased. 4.0. Benefits of International Convergence of Accounting Standards to Financial Institutions Studies have indicated that corporate code, corporate governance, and code violator evade or connive the regulators though well planned fraudulent activities where by principle, the audited records send to different central financial institutions are usually profited-based because it is the same account audited that is likely to be published showing bogus profit (Tarca 2004; James 2009). While the aim of this practice has been to make shares of such institutions attractive at the capital market, this practice has affected the normal functioning of ‘straightforward’ banks. This was the case with Central Bank of Nigeria where one bank engaged in the malpractice before being forwarded to the Nigeria Deposit Insurance Corporation (NDIC) had a depleted deposits base for the bank to make payment for inconsequential 1 percent insurance premium to NDIC (Kral et al. 2015). For the same period or accounting period, the fraud anticipated that accounts sent to the Federal Inland Revenue Services (IFRS) was to portray a reduced profits so that they do not pay any tax related to corporate. The aim of international convergence of accounting standards is to bring accountability, transparency and integrity in banks with regards to their financial reporting. As a matter of fact, the levels of dispute as cited above was responsible for the country’s (Nigeria) losing the Foreign Direct Investment (FDI) in the gas and oil sector to countries such as Ghana that has started oil production in commercial quantity which unlike Nigeria, is seen to be having stronger financial reporting standards in position. Other than the case of Nigeria and Ghana, this report has reviewed a number of studies especially those that have previously researched on how fair value measurements would be persuasive under IFRS than under national GAAP (International Accounting Standards Conceptual Framework 2008; Kral et al. 2015). Kral et al. (2015) in particular argued that IFRS are fair value based accounting framework with some exceptions for historical cost. This view had been found by Nicolaisen (2014) who noted that financial reporting under IFRS largely involves the measurement of assets and liabilities. The report has sought these authors based on their stance on International Accounting Standard Board and its relevance on the use of fair value measurement. Persaud (2010) on the other hand suggests that in relation to mandatory requirements, the observation is expected to increase the use of fair value measurement for financial instruments and share-based payment. This view has been supported by Kral et al. (2015) but added that greater use of fair value measurement should be useful to investors so that evidence may provide explanations for improvements in the information environment. The situation has been true in some financial institutions in Asia and Europe. The first finding is that in Australia, 23 financial companies (20%) reported held-for-trading securities under IFRS. Secondly, under United Kingdom (UK) GAAP, 12 financial companies were measured against fair value and 9 used the cost model while under IFRS, all companies used fair value (Kral et al. 2015). In addition, the research recognized that national comparability does not change in Australia indices for held-for-trading securities for both AGAAP and IFRS. In the UK indices increase significantly under UK GAAP and IFRS. Both UK and Australian companies showed an increase in the use of fair value measurement for available-for-sale financial assets. Under IFRS, 51% of UK companies and 46% of Australian use fair value. These changes represented a significant increase in national comparability for Australia and a non-significant decrease for the UK. Consequently, both UK and Australian companies show an increase in the use of fair value measurement for derivatives. Under IFRS, 92% of UK companies and 89% of Australian use fair value compared to ‘nil value’ from UK and 3 Australian companies under prior national GAAP. A few companies ( reported as ‘about six’) in UK and 19 in Australia measured held-for-trading derivatives at fair value at each balance sheet date under national GAAP but used the lower of cost and net realizable value approach for hedging derivatives. Generally, for financial institutions, international convergence of accounting standards is that set of regulations that educate on ways of measurement of transactions, the measurement of the resulting assets, liabilities and equity items on their initial recognition in the financial statements. Secondly, it highlights issues on how to allocate the total amount at which a transaction or other event is measured among its component parts. It is also through such regulations that accounting theory and practice can realize the values used to determine that the historical cost of transactions does not change in any circumstances. For the connectedness between financial institutions and international convergence of accounting standards , the report elaborates practices of ensuring that the carrying amounts of assets do not exceed the amounts that can be recovered from the use, sale or receipt of a given assets. 5.0. Benefits of Convergence of Accounting Standards Discriminatively, one would argue that the benefit of convergence of accounting standards is when it lowers costs of transactions for preparers of accounting and financial reports, as the reports would be complying with a single set of accounting norm or standard, rather than multiple sets. However, this is not the case. Taking a case study on Parmalat, after their failures in corporate governance and fraud, convergence of accounting standards recommends the use of explicit evaluation of assets in accordance with expected returns. This statement is true owing to the fact that in case a market for a given asset exist, it is likely that market value of the same asset can be adopted in the process of determining the financial position of the same firm. To contextuaise this point, in May 28th 2010, Financial Accounting Standards Board (FASB) came up with external advisory committee/panel that was tasked with reviewing the issues related with accounting that emerged from financial crisis. While this panel established a single standard that could be used for measuring fair value, its influence on IFRS was experienced when the body (FASB) published a proposal titled ‘Financial Instruments Disclosure’ that was aimed at improving standards of practices in accounting and financial management (Christensen et al. 2015). Arguments from International Accounting Standards Board (2008) posit that through accounting convergence and the influence from FASB, IFRS has narrowed the difference between the accounting standards of countries that retained their own standards. A case study on this argument was conducted by Nicolaisen (2014) who investigated Deloite Toucher Tohmatsu. The report showed that more than 1150 countries have been influenced to work with IFRS policies either in their entirety or partially. It is for this reason that Australian Accounting Standards Board (AASB) was influenced to adopt its equivalent of IFRS and termed it as (AIFRS) that was used in guiding its reporting entities (Nicolaisen 2014). This has also been the case in England. This point is important when it comes to relating IFRS, EU, FASB and accounting convergence. Again, in accordance with EU Parliament, IFRS has been influenced to adopt a single principle or set of accounting reporting standards which is considered as essential in ensuring a high degree of comparability and transparency of financial statement and therefore the efficient functioning of what has been EU capital market (EU Parliament, 2012). 6.0. Challenges Inherent in Convergence of Accounting Standards Despite benefits that the report has enumerated regarding convergence of accounting standards, quantitative assessment of the anticipated costs of convergence between local standards and IFRS has been documented by different scholars. Scholars such as Persaud (2010) have mentioned the difficult in retrieving or obtaining data from organisations to ascertain the extent of challenges that have been brought by convergence of accounting standards. However, there is consensus among scholars that convergence has been generating both the one-off transitional costs as well as on-going costs related to maintenance of standard-setting for global accounting principles. While taking a case study on 12 different institutions across Europe, Christensen et al. (2015) found that when assessed in the short term, successful convergence will likely entail protracted negotiations among local standards boards and IFRSB, not to mention the various national standard-setters, government officials, regulators and interested professionals with concerned with participating in the processes of convergence. From the perspective of the author, the challenge of convergence comes in the sense that the whole process will require expenditure in terms of money and time. Christensen et al. (2015) add that in such a situation, organisations are likely to be faced with costs when dealing with direct compliance. This is attributed to the fact that such organisations will need to retrain users, preparers, regulators, and auditors to apply and interpret the converged global standards. On the other hand, studies have found that convergence impose a cost on issuers in the sense that it deprive issuers the ability to make a choice to operate in jurisdictions or areas where the accounting rules can succinctly reflect the structure and nature of their activities and businesses (Haverals 2011). These findings were further supported by different studies that have assessed the theory that showed that companies/organisations decide to follow a given portfolio of accounting standards or policies that they are sure will maximise their contractual positions, more so with regard to management and debt remuneration, and that organisations may therefore sustain huge costs if they are compelled to adhere to new accounting rules. Additionally, processes of converging accounting standards have been found to be having the effect of replacing two separate-monopoly standard-setting with what studies term as ‘super-monopoly’ (International Accounting Standards Board Expert Advisory Panel 2008). The implication of this point is that the usual monopoly inefficiencies that have been resulting in a lack of innovation as well as flexibility when it comes to the standards will ultimately be produced. As Haverals (2011) suggested, the process of accounting may be subjected to a situation where global monopoly standard-setters are becoming prone to ineffective over-regulations. This is possible owing to the fact that the established standards may lack the competitive incentive to control its regulatory impulses. 7.0. Conclusion This report sought to assess benefits and challenges inherent in a single global set of accounting standards especially to different users of financial statements. Based on different cases studies including Parmalat that have been reviewed, the report concluded that the inherent benefits of establishing a single set of accounting standards is far much beneficial compared to challenges that report has also elucidated. Contrariwise, the report also notes a number of challenges that are brought by such standards. For instance, there is concern among studies that the ultimate standards from standard-setter may be a product of political compromise instead of having optimal accounting standards that suit different needs. It is inevitable to argue that the most powerful nations; both economically and politically would capture or dominate the standard setting processes with an aim of ensuring that standards are determined in the interest of their nations instead of the interest of global capital markets. References Ball, R., 2012, International Financial Reporting Standards (IFRS): pros and cons for investors. 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