The International Financial Reporting Standards - Essay Example

College: Financial Accounting-IFRS and GAAP IFRS is the International Financial Reporting Standards. It provides the whole body of accounting standards and disclosure requirements. It has been in existence since mid 1970s. GAAP is the Generally Accepted accounting Principles, which encompasses accounting and reporting standards, applied in the United States but not universally. However, financial reporting in the United States is currently influenced by the International Financial Reporting Standards (IFRS). This reporting application is having an impact on business decisions. Over the past 2 year, there has been a tremendous change in the field of Financial and Accounting reporting. There has been progress towards the development of single, globally accepted accounting standards. The goal is however yet to be realized. The United States is currently working towards the convergence of Generally Accepted Accounting Principles with International Financial Reporting Standards (IFRS). Crucial convergence projects from the International Accounting Standards Board (IASB) and the U.S Financial Accounting Standards Board (FASB) have continued to produce good results in an effort to converge the two Accounting and Financial reporting standards. This process of dissecting and eliminating the possible difference between that may the two standards is however costly and consumes a lot of time. The alignment of the underlying principles and the overall methodologies is an effective approach. A significant difference continues to arise though the underlying principles and the overall methodology regarding these standards are harmonized. As the FASB and the IASB continues on their convergence work, the U.S Securities and Exchange Commission (SEC) continues to make significant progress aimed at increasing the acceptance of the IFRSs and abolishing the US GAAPs .Also, PWC has helped companies' to successfully understand the IFRS. It has developed a clear IFRS conversion methodology which is aimed at providing lasting solutions (Vincent C. Ross and Institute of Accounting 23). The Association of Chattered Certified Accountants (ACCA) argues that the convergence of US GAAP and IFRS is crucial because the harmonization of the two standards will help to raise the investors confidence around the world .This is because the same accounting policies and procedures will be used world wide for same events. The harmonization is also believed to have a cost reduction impact as far as individual companies are concerned .This is due to the high level of confidence in timely and reliable information. The harmonization is also essential for companies that have joint listings with America and other countries. The preparation costs thus will be minimized. In addition, the convergent of the two standards will enhance worldwide mobility of labor in that professional and in particular, the accountants will be eligible to work in other countries as the same reporting standards apply elsewhere. The IFRS framework states that the ultimate aim of financial statements is to give information in relation to an entity to users for decision-making. The users of the information in the financial statement include the consumers, employees, management, government, competitors, among other users. The assumptions underlying in the International Financial Reporting Standards are that the entity is a going concern one and that the entity uses the accrual accounting concept in preparing the financial statements except cash flow preparation. In accrual, concept revenues and expenses are recognized once they occur and not that cash is paid or gained. In going concern, the company is deemed to continue in its operations even in the future neither does it have intentions to close down or curtail its operations. The company directors are thus bound to evaluate whether the going concern hypothesis is appropriate during the actual reporting of financial statements. Notes to financial statements should be disclosed indicating any aspect that may expose the company is going concern status in doubt. The financial statements are thus prepared with the assumption that the economic entity will continue to operate even in the near future. The financial statements for IFRS includes ;a statement showing the financial position, an income statement which is comprehensive, a statement which indicates changes in equity, cashflow statement and notes to the financial statements. According to IFRS, the following notes should be clearly explained; Statement of accounting policies and procedures of identification, evaluation and recording of transactions and other events, a significant non-cash expenses included in the profit before tax that include depreciation, amortization, impairment losses, profit or loss on disposal must be disclosed separately. Also IFRS recommends notes to financial statements on wages and salaries indicating the amount due to ordinary employees, the executives and directors and other non cash benefits and pos-employment benefits such as pension. However, in both IFRS and GAAPs accounting principles, an entity must meet all the standards and requirements including disclosure for it to comply .Also according to the two standards, the pecking order of other optional sources is precisely explained which includes the industry's practice. However major differences between the two accounting reporting standards still exists and includes; FRS is designed to be used by profit making entities only unlike GAAP which is designed for use by both profit and non-profit making entities e.g. members sport club e.t.c. IFRS uses bold and plain paragraphs unlike the GAAPS though in both cases, all paragraphs carries equal weight and must be attended to. Other characteristics pertaining IFRS includes the lack of acceptance on Last-In -First -Out(LIFO) method in inventory management, the use of a single step method for the write down of impairment, the use of different probability and objective measurement for contingencies among others. Also concerning GAAP, the overriding purpose of financial statements is free and fair presentation with regard to the U.S GAAP whereas in the IFRS the objective is to provide information for decision making the stakeholders i.e. management, employees, consumers, government, competitor's e.t.c. However, there arise some significant differences and similarities concerning accounting treatment for both IFRS and US GAAPs. The actual differences between the two reporting frameworks usually depend on the specific circumstances. A lease agreement is an agreement conveying the right to use property usually for a stated period. Under the International Financial Reporting Standards, Leases forms a basis for accounting for the lease arrangements. The International Accounting Standards (Vincent C. Ross and Institute of Accounting 23) provides three interpretations that form the core International Financial Reporting Standards for accounting for leases. The GAAP on the other hand provides detailed and voluminous guidance as far as accounting for lease is concerned. More than 50 documents take charge in regulating the accounting for leases. This disparity of the amount of literature usually provides the major differences between the two reporting frameworks. However, both frameworks clearly distinguish between finance leases and operating leases. A lease is a financial one if it all the rewards and risks are substantially transferred on the ownership of a property. Thus if it does not transfer rewards and risks on ownership, it is regarded as operating risk. The classification of lease is thus made at the beginning of the lease (Vincent C. Ross and Institute of Accounting 17). The substance rather than the form of the transaction usually determines the classification of a lease. Some of the situations that may render a lease to be a finance one are; if the lease shifts the possession of an asset at the end of the lease period, if the lessee has the choice to buy the asset at a lower price than the fair value at a time when the asset purchase options matures. Others include if the lease term forms a major element of the life of an asset and if the lessee has option to continue the lease for a second period at a relatively lower price than the fair value of the asset leased. Under finance (capital) lease, the fair market value of the asset is capitalized and the lease obligation written off over the lease period. On the other hand, under the operating lease arrangement, the lessee lends the asset and is thus required to make rent payment, which are recognized as an operating expense through the income statement. Operating leases are for short period and can be cancelled within a short notice e.g. hiring of office equipment, renting of a car e.t.c. The differences also emerge where the leased asset is made of both land and building or in a situation where both the leaseback and sale transactions are together. In case of such situations, the two frameworks take account of different and additional detailed guidance, which may call for a different course of action. Under IAS 16 on property, plant and equipment, the gap between the two frameworks is usually wide. An earnings per share helps to provide an assessment of interest of every ordinary share belonging to a parent entity during the actual reporting time. They express the income of a company which is attributable to the ordinary shareholders of a company divided by the number of weighted ordinary shares outstanding and which rank for dividend during the period. EPS shows the maximum amount that can be paid as ordinary dividend from the normal profit of a company. There are two types of EPS i.e. Basic EPS and Diluted EPS. Basic earning refers to the profit of a company attributable to the ordinary shareholders. Basic EPS is the profit for the period divided by the number of ordinary shares outstanding during the period. The profit after tax attributable to the shareholders is reduced by the dividends declared or non-cumulative and cumulative preference shares, interest and premium attributed to convertible shares and shares repurchased at par. Under diluted EPS, a company may enter into commitment to issue shares in the future that would result in change in the basic EPS. Such commitment will include; issue of convertible debt and preference shares, share option and warranties, employee share option plan and contingently held shares. However, the dilution of basic EPS will usually arise due to two factors namely; the increase of the shares issued and changes in profit available to the shareholders e.g. interest saved on convertible debentures. Several differences exist in the diluted EPS calculation for the two frameworks. In US GAAP, the method that is applied is the treasury stock one for instruments such as warrants and options. This method calls for the inclusion of additional number of shares in the denominator of EPS by determining a weighted average of the incremental shares. Some convertible debt securities provide the issuer with a choice to either cash or share the settlement. Generally, the GAAP has the opinion that contract agreements may be completed in the common shares. This presumption however may be dealt with if specific policy gives a reasonable basis, which will assure that contracts will be settled in cash. On the other hand under IFRS, the guidance does provides that dilutive common shares for each time period shall be computed independently and that the weighted average for the common shares does not need to be included. Contracts that maybe settled either using cash or common shares are always alleged to be completed using common shares. The common shares from contingently securities needs to be included in the EPS determination when the price of contingency is met. In accounting for diluted shares under IFRS, the following illustration may be applied; ABC Ltd had 10,000 $20 ordinary shares outstanding. The company had also issued 10%convertible debentures of $100 each and the amount outstanding at the debentures was $1Million.The debentures are convertible into equity shares on the basis of 16, $20 for every 10 debentures. The rate of tax, which is attributable to the company, is 20%while the profit after tax attributable to the shareholders is 11 Million. The basic Earnings per Share (EPS) =Profits attributable/Weighted average number of shares. I.e. 11000000/10000=$1100 The diluted Earnings per Share = (Profit attributable to shareholders +Interest net of tax) divide by (the shares outstanding at the beginning +shares out of conversion) whereby interest net of tax = (10%1000000)-Tax@20%=80000 and the number of debentures = (100000*16)/10 * 16=16000 shares out of conversion. In the past two years, the FASB, which sets the US GAAP, and the IASB, which sets the International financial reporting standards, have tried to eliminate the major differences arising form the two reporting standards. According to Hewitt, the SEC has plans to abolish reconciliation condition (Tucker 34).Indeed indications are revealing that SEC is having an interest in the standardized application of the international accounting standards. The objective thus is to encourage quality and regular application of the International Financial Reporting Standards (IFRS) Works Cited Tucker, Jenny. Earnings Warnings and Subsequent Changes in Analyst Following (October 26, 2009). Journal of Accounting, Auditing and Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1500021 Vincent C. Ross and Institute of Accounting. Journal of accounting, auditing & finance, Volume 2, Issue 3. Warren, Gorham & Lamont, 1990. Read More