Switching the Standards for Financial Statement - Literature review Example

Accounting (Students Name) (Course Name) (Instructor’s Name) Date Introduction The increased need by local and international companies as well as individual to diversify their investment portfolio, calls for proper and accurate financial information from business entities. It is imperative to ensure that accountants keep financial statements which depict the true position of their companies. The financial statements provide information that is used by investors, shareholders, employees and sponsors to judge the performance of the companies. In this regard, it is fundamental for the financial documents of a company to provide relevant and reliable information that will guide the users during the decision making process. In addition, the statements should provide information that is comparable. In this way, it will be easy for the investors to emulate the most profitable and well managed investment. International Financial Reporting Standards (IFRS) is one of the major reporting techniques that are used by most of the companies in their local and international transactions. GAAP entails the collection of rules that accountants and auditors follow during the preparation of their financial statement. This paper will critically evaluate the ethical challenges associated with switching the standards for financial statement from US GAAP which is a rule based technique to the principle based IFRS. US GAAP US GAAP are mostly used by the American companies. Being a rule based technique of financial reporting; companies emulate the same reporting format. As a result of the competition from foreign countries, Accounting Standard Committee was formed in 1973, to issue the international guidelines to the international and local companies on how to report the financial statements. However, in 2001 International Accounting Standard Board was formed with an aim of issuing the International Financial Reporting Standards (IFRS). The use of US GAAP was highly valued in US especially by the securities and the exchange commission (SEC) that required all foreign companies that use IFRS to reconcile their statements with the GAAP principles. This was followed by the recognization of the IFRS by the SEC as the globally accepted technique of reporting the financial statements. International Financial Reporting Standards As stipulated by Keryn et al, (2009). International Financial Reporting Standards system is based on four assumptions. First, it assumes that a business entity will continue to operate in the future. Secondly, it emulates the accrual basis that depicts that transactions are recognized when they occur. IFRS system is adopted by many countries globally that include South Africa, Australia, Pakistan, Turkey, and EU among others. This is due to the qualitative nature of the financial statements prepared under the IFRS. By use of IFRS, statements exhibit characteristics of relevancy, understandability, comparability and reliability. Convergence between GAAP and IFRS According to Rebecca and Mark (2008) the compatibility of the US GAAP and IFRS is been spearheaded by the International Standards Board in collaboration with the Financial Accounting Standard Board. However, there still exist some differences that make the convergence of the two reporting techniques a challenge. First is the associated cost of converting the financial statement prepared using the US GAAP in order to fit the requirements of the IFRS. As stipulated by Rebecca and Mark (2008) ethical challenges are likely to be experienced by the auditors dealing with the financial statements as well as the accountants who prepare the financial documents. IFRS is recognized by most US based firms as the financial reporting system that is used by the non-profit making entities and privately owned companies. Most of the firms emulates small sections of the IFRS policies and ignore the major parts of the principles. The structural differences that exist between the US GAAP and the IFRS are due to the fact that the former is based on rules while the latter is principle based. According to the independent auditors in US who rely on GAAP, the financial statements of their customers do not portray any variance from the stipulated rules. However, it is vital to note that the financial statement prepared under the US GAAP, were not depicting the true economic circumstances, neither were they fair nor transparent. According to Steven (2008), the use of IFRS, would improve the reporting of the financial statements by adoption of professional judgment by the accountants and the auditors. As stipulated by the Gong et al (2011), one of the ethical challenges that the accountants are likely to face from their management is to develop the financial statement in such a way that they portray the financial position of the companies in the most favorable perspective. According to the US GAAP, auditors report that the financial reports are in accordance with the GAAP rules. Through adoption of the IFRS, clients will easily agree with the independent auditors if the auditor’s reports are similar to interpretations of their clients. The adoption of the IFRS principles to replace the US GAAP will also be a challenge to the auditors during financial representations. This is due to the fact they may create a difference in treatment of a fact statement between two different companies. This will make it hard for the comparison of the performance of various entities. It is due to this reason that individuals with interest in the US based entities are against the IFRS. Steven (2008), argues that reporting of financial reports among similar entities need to be consistent an aspect that is portrayed by the IFRS system. According to IMA, the preparation of the accounting information must uphold high level of ethics. First, they should give fair report that is not deceiving to the users of such information including the shareholders, banks and management teams. In addition, all relevant information should be disclosed. Such information is fundamental in analyzing and understanding the reports as well as in giving the recommendations that would improve the performance of the company. In the same way, the accountants should disclose the deficiencies and delays that have been experienced during the preparation of the financial statements. The diversified representation of the auditing report by the auditors community is another area that needs to be converged. For example, in US the auditors only need to report that the financial statement are in conformity with the GAAP.In UK on the other hand, auditors provide qualitative nature of the reports and states that the financial statement portrays the true and fair view of the economy situation. According to Van der Stede and Wim (2011), it is crucial for auditors to give information that is qualitative in nature. In UK, auditors are supposed to provide information that shows the true and fair view of their companies otherwise the directors may not approve the financial statements. Role of ethics in accounting The major importance of ethics in accounting is to give guideline to the accountants in order to ensure they perform their duties in a fair way. In this way, a high level of confidence is created among the members of the public. Some of the major organizations that have issued various codes of ethics to strengthen the existing set ethics include Institute of management accountants and the Institute of Internal Auditors (IIA). According to Steven (2008, it is crucial for the accounting organizations to ensure that their members follow the set code of ethics as stipulated by the IFRS. Laura and Steven (2009), argues that US GAAP recognizes only two aspects of capital maintenance. These include financial capital maintenance and the physical capital maintenance that are based on the cost accounting that was adopted in the past. On the other hand, IFRS authorizes the aspect capital maintenance during deflation and inflation in addition to the two concepts adopted by US GAAP. In this way, the IFRS takes into account the changes of capital as a result of the changes in the performance of the economy. As mentioned earlier, auditors should ensure that the information in their financial reports is adequate and prepared in a professional manner. In this regard, IFRS requires that the auditors should derive their decision based on a number of statements. The first one is the cash flow statement. This is a document that shows all the cash inflow from various activities and how it has been used in the business. Secondly, the auditors should scrutinize the comprehensive income statement. This entails reconciliation of income statement and profit and loss account (Laura and Steven, 2009). Thirdly, the auditors should examine the documents showing the changes in company’s equity. Fourthly, it is crucial for the auditor to check the statement showing the financial position of their companies. After thorough scrutiny of the financial statements, IFRS recommends that auditors should include notes that show all the accounting principles that have been adopted to prepare the financial report. For companies that use the IFRS for the first time, they should emulate all the concepts of the IFRS. Advantages and disadvantages of using IFRS In order to improve the reporting of the financial statements, it is vital to apply principles as laid down by IFRS rather than the rules which are applied by US GAAP. Keryn et al (2009) argues that one of the benefits of adopting IFRS is that it will reduce investors’ costs of comparing the performance of different investment portfolio. In addition, extensive studies of the various financial statements will ensure that the information given by the auditors is of high quality. Due to the transparency of the report, investors and financing organizations including banks will be willing to invest more funds resulting to an improved capital base for companies. Even though the costs of adopting the IFRS are considered to be high, the enforcement of the principles will ensure that the differences that exist in the reporting of the accounting information will be eliminated and effective comparison of the entities will be achieved. Globalization has forced many companies to emulate IFRS. Due to the high usage of IFRS in many countries, US based firms will enhance the financial transactions that occur between them and companies using IFRS in foreign countries. This will ensure that investors and other stakeholders are aware of the performance of the US companies. As indicated by Zeff (2007) the due to the use of professional judgment under the IFRS system, auditors and account preparers will not waste a lot of time while following the rules set by the US GAAP. In Addition, IFRS advocates for maintenance of statements in simple and transparent form in order to make all the stakeholders understand the information given by the statement (Scapens, 2006). Despite the advantages associated by adopting IFRS, US companies will incur high costs during relearning of their accountants. Even though the accountants and the auditors of the financial statements have the basic knowledge of preparing the books of accounts, the will need more training to ensure the statements are true and fair as depicted by IFRS. In the same way, the US entities will experience reduced profits during the first three years due to the increase in the relearning expenses. Nevertheless, the costs associated with switching to IFRS, will be offset by the globalization of the companies and effective presentation of reliable information. Conclusion The importance of the accurate and reliable financial information cannot be underrated by organizations. There is need for US to adopt the IFRS, in order to ensure that financial statements provided by the accountants reflect true and fair view of the financial position of their companies. In this way, the financial scandals that have engulfed US and other countries will be easily detected. The adoption of IFRS has been proposed by various professional including Ed Nusbaum and Sam Dipiazza, the Chief executive officers of Grant Thornton and PricewaterhouseCoopers respectively. As a result of the IFRS, US companies will easily compare their financial performance with foreign firms. This will greatly benefit the investors, shareholders as well as the financial institutions. This calls for more training of the accountants and the auditors using the US GAAP in order to make them comply with the principles of the IFRS. Even though the training will reduce the profits of US companies in the short run it will be of great importance once the IFRS is globally accepted. References Gong J., Wim A. Van der Stede, & Mark Y. (2011). Real Options in the Motion Picture Industry: Evidence from Film Marketing and Sequels. Contemporary Accounting Research, 24, Keryn, C., Greg, C., & Jayne M. (2009). Adoption of International Financial Reporting Standards: Impact on the Value Relevance of Intangible Assets. Australian Accounting Review 18: 237–247 Laura, D., & Steven, D. (2009).Interpreting the Public Interest: A Survey of Professional Accountants. Australian Accounting Review, 19(1), 11-23 Rebecca, S., & Mark M. (2008). Defining Principles-Based Accounting Standards. The CPA Journal Scapens, R. (2006).Understanding management accounting practices: A personal journey British Accounting Review, 38(1), 1-30 Steven, S. (2008). Contemporary Accounting Research. Accounting, Auditing and accountability Journal Van der Stede, A. (2011). Management Accounting Research in the Wake of the Crisis: Some Reflections. European Accounting Review, 12, 263-285 Zeff, S. (2007). Some obstacles to global financial reporting comparability and convergence at a high level of quality. British Accounting Review, 39(4), 290-302 Read More