International Accounting Standards - Essay Example

Type the of International Accounting Standards Do we need an International Accounting Standard? – A review of its relevance Enter your Name 10/30/2008 Anyone who has ever dabbled with business knows the magic that is associated with the word “profit”. It seems to encapsulate the basic reason for the existence of any business entity. For every man on the street, the success or otherwise of a business enterprise… Profit – what is it Anyone who has ever dabbled with business knows the magic that is associated with the word “profit”. It seems to encapsulate the basic reason for the existence of any business entity. For every man on the street, the success or otherwise of a business enterprise gets measured in terms of the profit it has earned during the current financial year. But as any student of business knows, evaluation of managerial efficiency or corporate health is not that straightforward an issue. There are two reasons for that. Firstly, all organisations are not established with the objective of earning profit, especially those that are owned and operated by the public sector. If you feel confused at this comment, just think about the London tube railway. Though nobody would be unhappy if it could earn what is commonly known as commercial profit, would any citizen ever quiz the service it provides and, would any government ever dare to even think of discontinuing the service as it is not a profit making venture? Obviously not, since it was conceived as public utility. The second reason why profit calculated by the mercantile method is not always a true indicator of the commercial success of business enterprise is the accrual concept and the conservative approach which lie at the heart of any set of accounts prepared anywhere in the world. By taking into account all possible or even vaguely plausible expenses and ignoring all incomes except those that are absolutely sure, the accountant in effect tries to take a hyper conservative approach and presents a situation which cannot be worse. It might suit those at the helm of affairs of business houses, but these two basic tenets of accountancy do indeed paint a picture which is bleaker than what the actual situation is. Thus many stalwarts of accounting profession strongly feel that a trend of profits, instead of profits earned in individual periods and considered in isolation, would be a better estimate to gauge the financial health of an enterprise. And there is, rather was, a lot of confusion regarding how far conservatism could be stretched while drawing up accounts for a financial year. Some opinion makers of this profession were passionate about the independence of accountants and argued in favour of the judgement and “common sense” of the accountant who is drawing up the accounts. The general refrain of this school of accountants was, an accountant would be the best judge to decide how far conservative he would be and what all incomes and expenses he would consider and what all he would ignore. Though it sounds pretty logical and places a huge expectation of propriety on the shoulders of an accountant, which no doubt all seasoned members of the profession would be able to bear quite easily, the fact remains that if an accountant becomes the sole arbiter regarding issues of propriety and relevance; individual notions, biases and perspectives would start playing a decisive role in determining profits earned by an organisation during an accounting year. This lack of specificity about the definition of profit and a clear guideline as to how it should be calculated would, however, lead to some serious problems in other spheres of business and commerce. How would, for instance, managerial efficiency and hence credit rating of an organisation be measured across the board, or, what would be the criteria for determining corporate tax are some of the problems that would swamp government policy makers in the Internal Revenue Department. Thus the need for a proper guideline for drawing up financial accounts was felt and accepted by every country and there are well established norms in this regard in every economy.(Stickney, Weil, & Davidson, 1991) Business crosses frontiers As competition intensified in domestic markets, corporations started looking beyond domestic markets not only for a larger client base but also to raise capital. Various securities markets spread around the world now got interconnected, though in a roundabout way, as investors started looking for higher returns all across the globe. The measuring rod for evaluating corporate efficiency however still remained the published financial statements which obviously included Balance Sheet and Cash Flow Statements. And, the single most important figure in this entire exercise, perhaps needless to state separately, was profit. So, it was only natural for both investors and corporate entities to expect that profit be calculated in a uniform manner throughout the world. This overwhelming need of fast coalescing securities and consumer markets across the world that are being forged into a humungous whole, highlighted the need of a common and internationally accepted set of standards for writing up financial accounts of companies across the world. But there exists an obstacle to this seemingly logical requirement. Regulators in securities markets all over the world remain ever alert to ensure that unsuspecting small investors are not duped by large corporate houses and thus are very stringent regarding the financial information that is dished out to the prospective investors within their jurisdiction. So, every regulator insists that financial details are drawn up according to the standards prescribed by it and the net result is a mind boggling array of differing sets of financial results for any company that wants to operate across frontiers. An example might clarify the issue a bit more. Under US based GAAP, all expenses incurred on account of research and development are to be charged to the Profit and Loss Account as and when they are incurred but under IAS 38, while all costs on research are to be charged in the year of expense, costs on development are capitalised if such costs fulfil certain criteria. Thus an enterprise following IAS 38 would report a higher income in years when development costs are incurred than what it would have reported had it followed GAAP. The difference does not end here. There would be difference in cash flow statements too. Companies adhering to GAAP would report cash flows related to development activity under operating cash flows whereas companies adhering to IAS would report development related cash flows under investing activities. Thus, it will be extremely difficult for an ordinary investor to unravel this tangle to get a correct picture of the state of affairs and any direct comparison of figures arrived at through diverse systems would obviously be misleading and might result in erroneous decisions.(Pownall & Schipper, September 1999) Diverse Cultures and Attitudes Though it might sound rather farfetched, but economic system, legal system and even culture and language of a country do play significant roles in accounting disclosures and enforcement of existing rules. There are solid historical reasons too that have helped in formulating accounting rule books in various countries. For example, companies in Japan and Germany have been historically not required to furnish as many disclosures as their compatriots in United States and United Kingdom had to do. The reason for this anomaly is not that difficult to identify. Companies in Japan and Germany have traditionally depended only on a limited number of banks and financial sources and the relation between the lender and the borrower has always been based more on mutual trust rather than dry accounting details. But as corporate entities of continental Europe and Japan grew in size and global markets evolved, regulators and business entities realised the need for increased transparency. As a natural consequence, the disclosures became more elucidatory and adherence to rule books became more stringent.(Collins, March 1989) Non-US companies that wish to raise money from the US capital market now have to incur two major expenses before they can make any foray into this resource. The first thing that these companies need to do is recast their audited accounts so that they are reconciled with GAAP requirements. This, as is obvious, is a costly affair and many companies prefer to avoid US capital markets rather than go through this procedural exercise. But for those companies who are ready to brave this, there is another equally costly procedure which waits to be fulfilled. US regulators have made it mandatory for all companies that wish to raise money from its capital markets to adhere to several stringent SEC filing requirements. These requirements are more of legal nature than being related to accountancy but they are costly nonetheless. These restrictions have reduced the competitive edge of US capital markets and with interest rates levelling out across economies, “a company may elect to go to London, Amsterdam or Zurich, where the same costs dont exist and the company can get the money at the same rate."(Fleming, September 1991) So, there is perhaps no need to overemphasise the need for a uniform accounting and disclosure system for all those companies that want to operate at a global scale. The era of judgement exercised by individual accountants is in all probability gone forever. There is a need for commonness so that every stakeholder from every corner of the world can operate with equal degree of ease without any scope of any miscommunication or misunderstanding whatsoever. Conversion to International Accounting Standards – with modifications wherever necessary The need for a uniform accounting standard has now been well established and many countries are gradually converging on a common format. The Financial Reporting Standards Board (FRSB) and Accounting Standards Review Board (ASRB) have had their hands full for quite a few years in drafting a new set of accounting principles which would be compatible with International Financial Reporting Standards (IFRS). The work is almost complete and New Zealand has been the first country to completely convert to International Accounting Standards. In fact, New Zealand made it a legal requirement to follow International Accounting Standards as early as December 2004. Australia followed suit and made the IAS mandatory by July 2005. While introducing these new guidelines, regulators in both these countries had to take two steps backward as it were to take one step forward. Some disclosures such as audit fees paid, comparative prospective information, details of valuers etc. are critical for maintaining transparency in corporate management in the business environment prevalent in New Zealand. The regulators were quite justified in being reluctant to let go these vital disclosures which are not required under IAS. Similarly, the scope of presenting an indirect cash flow statement was considered as an unwarranted step backward and New Zealand regulators stuck to the earlier requirement of direct cash flow presentation. As a sort of compromise, while most of the requirements of IAS have been accepted a few disclosures and statements which are peculiar to the business climate of New Zealand have been retained. Australia has also done the same thing. Thus companies that are operating in New Zealand and Australia can now with little or no difficulty operate in various security markets across the world. Similarly, companies that would like to enter markets in Australia and New Zealand can also do so at the cost of drafting a few extra disclosures and annexure. Surely this was like having the best of both worlds, so to say. The New Zealand and Australian experience goes on to prove that International Accounting Standards need not be a straitjacket which must be strictly adhered to by everybody. Amendments that are justified and necessary for business and commerce in a particular country or economy can very well be retained while keeping intact the main framework of International Accounting Standards.(Warren, July 2005) This allowance or freedom to incorporate or reject parts of the International Accounting Standards to make them more relevant to a particular business environment is in a way a throwback to what Robert Morison was trying to mean when he had said in 1970s that accountants should take a “common sense” approach while drawing up a Balance Sheet and related disclosures. Objectives and Standards The job of accountants employed by a company is to project as far as possible a true financial picture of the company and the auditors’ job is to systematically evaluate and authenticate all information that are relevant and crucial to the accounts prepared by the company. In general, audited accounts have a far greater degree of credibility than unaudited ones. Most of the securities markets around the world allow a company to submit only accounts that have been audited by properly certified auditors. Thus, auditors have a very important role to play in ensuring rectitude and propriety of a set of accounts. In order to uphold their lofty position auditors need to have an independent attitude which does not get influenced by client’s interests. In recent years the independence of auditors is increasingly coming under a cloud of suspicion as more and more auditing firms are diversifying into consulting activities where they are also advising clients on taxation, information systems and financial management matters. It might become very difficult for an auditor to maintain an impersonal sense of independence while dealing with the accounts books of a client who also takes advice on taxation matters. (Lowenstein, June 1996) This has become an increasingly thorny issue and doubts about propriety and sanctity of published financial figures are now more frequently raised as some high profile scams and deliberate misrepresentations resulting in massive inaccuracies in financial reporting by highly respected corporate houses have come to surface. A case in point is that of Enron Corporation which was forced to declare bankruptcy in 2002 after years of losses in off-the-books partnerships and aggressive pricing schemes it had followed to prevent any competition from encroaching in its territory. All these losses were skillfully hidden from public sight through some “imaginative” bookkeeping by its auditors Arthur Andersen LLP. The SEC enquiry which was inevitable after the collapse of this showpiece of American entrepreneurship, blamed the auditors in equal measure as they blamed the executives of this corporate giant. The situation became so bad that Arthur Anderson had to close business altogether. While the sordid saga of Enron was unfolding, another shameful instance of criminal negligence by auditors came to the fore when it was unearthed that telecommunications firm WorldCom Inc. did unethical accounting jugglery to inflate non-existent profits by $ 11 million. Europe was also not left unscathed by this epidemic of greed. It was discovered in 2003 that Dutch grocery chain Royal Ahold NV had also indulged in “creative” accounting to overstate its profits by $500 million. Instances of such high profile frauds have quite justifiably made the common investor rather jittery about investing in equities. This sense of uncertainty in the minds of investors can only be removed if it is made mandatory for all business entities to use only a uniform code of financial reporting. Experts around the world are of the opinion that though GAAP and IASB are equally good and well structured, the latter happens to be a better tool to tackle frauds of such elaborate and intricate nature. With guidelines of framing a set of accounts being same all over the world, it will become all the more difficult for fraudsters to muddle issues and fool the unsuspecting investors and regulators around the world. References: Collins, S. H. (March 1989). The Move to Globalization. Journal of Accountancy . Fleming, P. D. (September 1991). The growing importance of international accounting standards. Journal of Accountancy . Lowenstein, L. (June 1996). Financial Transparency and Corporate Governance: You Manage What You Measure. Cloumbia Law Review , Volume 98, No.5. Pownall, G., & Schipper, K. (September 1999). Implications of Accounting Research for the SECs Consideration of International Accounting Standards for U.S. Securities Offerings. Accounting Horizons . Stickney, C. P., Weil, R. L., & Davidson, S. (1991). Financial Accounting: An Introduction to Concepts, Methods and Uses. New York: Harcourt, Brace, Jananovich Publishers. Warren, K. (July 2005). Converting to international accounting standards. Chartered Accountants Journal, 18-21. Read More