Chapter 3 - International Convergence of Financial Reporting

2/13/2021
Chapter 3:
International
Convergence of
Financial
Reporting
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
 Explain the meaning of convergence
 Identify the arguments for and against international
convergence of financial reporting standards
 Discuss major harmonization and convergence efforts
under the IASC and IASB, respectively.
 Explain the principles-based approach in setting
accounting standards
 Describe the difference in approaches taken by the IASC
and FASB in setting accounting standards
 Describe the support for, and the use of, IFRS across
countries
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Learning Objectives (2)

 Examine the issues related to international convergence of
financial reporting standards
 Describe the current status of the IASB/FASB convergence
project
 Explain the meaning of “Anglo-Saxon” accounting
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International Harmonization of Accounting

Standards
 Evolution of IASC and IASB shows international accounting
standard-setting in the private sector:
 With the support of the accounting bodies, standard-setters,
capital market regulators, government authorities, and
financial statement preparers
 Harmonization allows countries to have different
standards as long as they do not conflict
 Accounting harmonization can be considered in two ways
 Harmonization of accounting regulations or standards
 Harmonization of accounting practices
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International Harmonization of Accounting

Standards (2)
 Other factors leading to noncomparable accounting
numbers despite similar accounting standards
 Quality of audits
 Enforcement mechanisms
 Culture
 Legal requirements
 Socioeconomic and political systems
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Harmonization Efforts through IASC

 First Phase [Lowest-Common-Denominator Approach]
 First 15 years 1973-1988
 Issuance of 26 IAS Standards
 Usually allowed multiple options
 Produced little if any comparability of financial statements
across countries
 Second Phase [Comparability Project]

 Next 5 years 1989 to 1993
 Publication of “Framework”
 Objectives of financial statements
 Qualitative characteristics of financial information
 Definitions of elements of financial statements
 Criteria for recognition of financial statement elements
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Harmonization Efforts Through IASC (2)

 Final Phase IOSCO Agreement 1993-2001
 Core set of international Standards
 30 in total ending with Financial Instruments
 Ended with creation of IASB
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Other Harmonization Efforts

 Several international organizations involved
 REGIONALLY
 European Union
 Association of Southeast Asian Nations
 WORLDWIDE
 United Nations
 OTHER ORGANIZATIONS INVOLVED
 IOSCO
 Facilitate cross-border listing of high-quality accounting standards
 IFAC
 Over 120 countries and 150 member bodies
 Promotes adherence to high-quality professional standards on
 Auditing
 Ethics
 Education
 Training
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Other Harmonization Efforts (2)

 IFAD launched by IFAC
 To help developing and emerging nations
 Membership includes
 World Bank
 International Monetary fund
 Asian Development Bank
 IOSCO
 IASB
 SEC
 Large Accounting Firms
 Primary aim: promote transparent financial reporting, duly
audited to high standards by a strong accounting and
auditing profession.
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Other Harmonization Efforts (3)

 European Union
 Aim: create a unified business environment
 Harmonization of company laws and taxation
 Promote full freedom in the movement of goods and labor
 Creation of community capital market
 2 Directives to Harmonize Accounting

 Fourth Directive: provides considerable flexibility
 Valuation rules
 Disclosure requirements
 Format of Financial Statements
 Seventh Directive : Consolidated Financial Statements
 Led to reduced differences but not complete comparability
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International Forum on Accounting Development

(IFAD)
 Created as working group
 Basel Committee
 IFAC
 IOSCO
 Large Accounting firms
 OECD (Organization for Economic Cooperation and Development)
 UNCTAD (United Nations Conference on Trade & Development)
 World and regional banks
 OBJECTIVES
 Promote importance of transparent financial reporting
 Accounting responsibility to support public interest
 Focus on accounting/auditing needs of developing countries
 Cooperation between
 Governments
 Accountants and other professions
 International financial institutions
 Regulators
 Standard setters
 Capital providers
 Issuers of financial statements
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IASB
 Problems of IASC led to creation of IASB
 Lacked legitimacy due to being created by accounting
profession (self interest)
 Lacked legitimacy due to part-time board members not
selected due to technical expertise
 IFAC tried to take control of IASC twice
 IASB focus on convergence rather than harmonization
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Structure of IASB
 Organized under independent IFRS Foundation
 Monitoring Board
 IFRS interpretations Committee (IFRSIC)
 IFRS advisory council (IFRSAC)
 Working groups
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IASB-Monitoring Board
 Members:
 European Commission
 Japanese Financial Services Agency
 SEC
 Emerging Market Committee of IOSCO
 Technical Committee of IOSCO
 Function
 Enhance public accountability of IASC foundation
 Participate in trustee nominations
 Oversite of IASB activities
 Agenda-setting process
 IASB efforts to improve accuracy/effectiveness of financial
reporting
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EXHIBIT 3.2—The Structure of the IASB
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IASB (contin.)
 Responsibilities
 Develop/issue IFRS and Exposure Drafts
 Approve interpretations of IFRIC [interpretation committee]
 Board
 16 members
 At least 13 full time
 Selected based on professional competence and practical
experience
 4 from Asia/Oceania region
 4 from Europe
 4 from North America
 1 from Africa
 1 from South America
 2 at large from any area
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IASB: IFRS Advisory Council

 Provide forum for participation by those with interest in
international financial reporting
 OBJECTIVES
 Advise IASB on its priorities
 Inform IASB of their views on IASB major standard-setting
projects.
 Approximately 40 members serving 3-year terms
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IASB: IFRS Interpretations Committee

 Responsibilities
 Interpret application of IFRS/provide guidance on issues not
specifically addressed in IFRS or IAS’s
 Publish Draft Interpretations for public comment
 Obtain Board approval for final interpretations
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From Harmonization to Convergence

 IASB: From Harmonizer to global standard-setter
 Goal of convergence can be interpreted in different ways:
 Diminishing differences among accounting standards
 Agreement on core set of common standards with varying
interpretations of non-core issues
 Efforts of IASB are directed toward developing a high-
quality set of standards for use internationally for financial
reporting purposes.
 Build ‘highest common denominator’ of financial reporting
 Adopted principles-based approach to standard setting
 IASB’s structure similar to FASB since FASB has best
institutional structure for developing accounting standards.
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Concerns with IFRS Convergence

 Complicated nature of specific standards such as financial
instruments and fair value
 Tax-driven national accounting…is IFRS basis for taxation
a good approach?
 Insufficient guidance on first-time application of standards
 Cost/benefit for countries with limited capital markets
 Investor/user satisfaction with national accounting
standards
 Language translation difficulties
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Presentation of Financial Statements (IAS 1/IFRS 1)
 Provides guidance on:

 Purpose of the financial statements
 Components of the financial statements
 Overriding rule of fair presentation
 Accounting policies: if guidance lacking
 Refer to requirements/guidance in other IASB standards
 Definitions for assets, liabilities etc.
 Pronouncements of other standard-setting bodies
 Basic principles and assumptions
 Accrual basis
 Going-concern assumption
 Consistency/comparability
 No offsetting of assets/liabilities/revenues/expenses
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Presentation of Financial Statements

 Structure and Content of Financial Statements
 Current/noncurrent distinction
 Items to be on face of financial statements
 Items to be disclosed in the notes
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Principles-Based Approach to International

Financial Reporting Standards
 IASB follows a principles-based approach to standard
setting vs a rules-based approach
 Standards establish general principles for recognition,
measurements, and reporting requirements for transactions
 Limits guidance and encourages professional judgment in
applying general principles to entities or industries
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Arguments for Convergence

 Facilitate better comparability of financial statements
 Easier evaluation of potential investments in foreign securities
 Facilitate international mergers and acquisitions
 Reduce financial reporting costs
 Cross-listing would allow access to less expensive capital
 Reduce investor uncertainty and the cost of capital
 Reduce cost of preparing worldwide consolidated
financial statements
 Simplify auditing
 Easy transfer of accounting staff internationally
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Arguments for Convergence (2)

 Raise the quality level of accounting practices
internationally
 Increase credibility of financial information
 Enable developing countries to adopt a ready-made set of
high-quality standards with minimum cost and effort
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Arguments against Convergence

 Significant differences in existing standards
 Enormous political cost of eliminating differences
 Nationalism and traditions
 Arriving at universally accepted principles is difficult
 Need for common standards is not universally accepted
 Well-developed global capital market exists already
 May cause standards overload
 Differences in accounting across countries might be
necessary
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IASB Conceptual Framework

 Framework for Preparation and Presentation of Financial Statements deals with:
 Objectives of financial statements and underlying assumptions
 Qualitative characteristics that affect the usefulness of financial statements
 Definition, recognition and measurement of the financial elements
 Concepts of capital and capital maintenance
 Purpose of Framework: assist IASB in developing standards and revising existing standards.
 Framework Id’s potential users of financial statements
 Investors
 Creditors
 Employees
 Suppliers
 Customers
 Governmental agencies
 General public
 PRIMARY OBJECTIVE OF FINANCIAL STATEMENTS IS TO PROVIDE INFORMATION USEFUL FOR DECISION
MAKING
 Must be on Accrual basis
 Must be a going-concern
 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
 Understandability
 Relevance: used to make predictions of the future or confirm expectations from past
 Reliability: neutral, (free from bias) and represents faithfully what it purports to
 Comparability
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Elements of Financial Statements: Definition,

Recognition, and Measurement
 Assets: resources controlled by enterprise which will provide
future economic benefits; only recognized when probable
economic benefits will come
 Liabilities: present obligations arising from past events to be
settled through outflow of resource; recognized when probable
outflow will occur
 Income: increases in equity other than from transactions with
owners.
 Expenses part of income that decreases in equity
 Revenues part of income that increases in equity
 Equity: assets minus liabilities
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Concepts of Capital Maintenance

 Financial Capital Maintenance
 Historical cost
 Physical Capital Maintenance

 Current cost
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Adoption of IFRS
 Several different ways to adopt IFRS
 All companies: IFRS replaces national GAAP
 Consolidated with IFRS parent company with national GAAP
 Stock exchange-listed: listed companies use IFRS non-listed
companies use national GAAP
 Foreign companies use IFRS domestic companies use national
GAAP
 Domestic companies that list on foreign exchanges use IFRS
others use national GAAP
 European Union requires domestic-listed companies to use

IFRS for consolidated accounts
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IAS/IFRS in the European Union

 All listed companies use IFRS since 2005
 Improve quality of corporate financial reporting
 Increase comparability and transparency
 Promote development single capital market in Europe
 Denmark and Estonia require IFRS even non-listed companies
 EU allows ‘carve out’ of IAS 39 “Financial Instruments”

 Some claim ‘Using IFRS as adopted by EU’
 European accounting enforcement systems:

 Germany, Finland, Netherlands…no institutional oversight of
financial reporting
 Considerable cross-jurisdictional variation due to existing
legal/cultural differences
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IAS/IFRS in United States

 1996 SEC announces 3 criteria for cross-listing
 Comprehensive generally accepted basis of accounting
 High quality, comparability, transparency and full disclosure
 Rigorously interpreted and applied
 1996 FASB publishes comparison of IFRS/GAAP

 26% Similar approach and guidance
 36% Similar approach but different guidance
 26% Different approach
 12% Alternative approaches permitted
 2007 SEC removes requirement foreign private issuers using IFRS must
reconcile to U.S. GAAP [20f no longer needed]
 2007 AICPA recommends to SEC allowing U.S. Companies to use IFRS
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IAS/FRS in United States (2)

 2008 SEC: Roadmap for Potential use of IFRS by U.S.
Companies
 2008: AICPA private companies allowed to adopt IFRS
 Beneficial to subsidiaries of foreign companies
 2011 National Association of State Boards of
Accountancy, support convergence of IFRS and GAAP
instead of adoption of IFRS
 Actual narrowing of differences
 International companies no longer have to reconcile IFRS to
GAAP
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FASB and IFRS Convergence

 Ultimate goal: single set of high-quality, international
accounting standards that companies world-wide would
use for both domestic and cross-border financial reporting
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The Norwalk Agreement

 Proposed Changes as per the discussion paper published
jointly by two boards:
 Decision-useful objective encompassing information relevant
to assessing stewardship
 Stakeholder approach (vs. U.S. framework of shareholder
approach) — users other than capital providers explicitly
acknowledged
 Asset of an entity would be present economic resource to
which, through an enforceable right or other means, entity has
access or can limit others’ access
 Emphasis on principle and guidance development for fair
value measurements in IFRS—exit price as measurement
base, or, if not—develop additional guidance
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FASB Initiatives to further Convergence

 Joint projects with IASB
 Revenue recognition
 Business combinations
 Review Conceptual Framework
 Short-term Convergence Project
 SFAS 123
 SFAS 151
 SFAS 153
 Liaison IASB member: full time IASB member in residence at
FASB headquarters
 Monitoring of IASB projects
 Convergence research project
 Consideration of convergence potential in Board agenda
decisions
 2011 FASB IASB completed Fair Value Measurement project
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Challenges to International Convergence

 What is or should be primary purpose of financial statements
 U.S. investors most important
 Germany creditors most important
 France needs of government high priority
 Politics: did IFRS (fair value accounting) cause financial crisis?
 SEC world’s most respected securities regulator
 Effectiveness of enforcement of IFRS in different countries
 Differences in education philosophy
 Visible repercussions for financial statements in different
countries
 Efficacy of mandating high-quality accounting standards when
low regulatory quality exists
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FASB IASB Joint Conceptual Framework Project
 Began October 2004

 Single document instead of series of concept statements
 Reflect changes in markets, business practices, economic
environment
 November 2006 IASB discussion paper on fair value measurement
 February 2007 FASB issues SFAS 159 “The Fair Value Option for
Financial Assets and Financial Liabilities”
 March 2010 Joint Exposure Draft “Conceptual Framework for
Financial Reporting –The Reporting Entity”
 Reporting entity: ‘an entity for which there are users who rely on the
financial statements as their major source of financial information about
the entity”
 September 2010 completion of first phase
 IASB required consideration of conceptual framework if no standard or
interpretation exists….FASB not required to consider framework
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Harmonization Efforts
 Several organizations were involved at global and
regional levels
 International Organization of Securities Commissions (IOSCO)
 International Federation of Accountants (IFAC)
 European Union (EU)
 International Forum on Accountancy Development (IFAD)
 International Accounting Standards Committee(IASC)
 International Accounting Standard Board (IASB)
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Future of IASB/FASB Convergence

 IASB Chairman suggests IASB would no longer seek to
converge with U.S. GAAP
 IASB no longer feels failure to converge equals fatal for
IFRS project
 Previous thought is without U.S. IFRS separates based on
regions, now not so
 Inconceivable IFRS adopters reverse decision due to cost
 Consultations between IASB/FASB continue
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End of Chapter 3
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2/13/2021

Learning Objectives (2)

International Harmonization of Accounting

International Harmonization of Accounting

Harmonization Efforts through IASC

 Second Phase [Comparability Project]

Harmonization Efforts Through IASC (2)

Other Harmonization Efforts

Other Harmonization Efforts (2)

Other Harmonization Efforts (3)

 2 Directives to Harmonize Accounting

International Forum on Accounting Development

 IASB focus on convergence rather than harmonization

EXHIBIT 3.2—The Structure of the IASB

IASB: IFRS Advisory Council

 Approximately 40 members serving 3-year terms

IASB: IFRS Interpretations Committee

From Harmonization to Convergence

Concerns with IFRS Convergence

Presentation of Financial Statements (IAS 1/IFRS 1)

 Provides guidance on:

Presentation of Financial Statements

Principles-Based Approach to International

Arguments for Convergence

Arguments for Convergence (2)

Arguments against Convergence

IASB Conceptual Framework

Elements of Financial Statements: Definition,

 Equity: assets minus liabilities

Concepts of Capital Maintenance

 Physical Capital Maintenance

 European Union requires domestic-listed companies to use

IAS/IFRS in the European Union

 Denmark and Estonia require IFRS even non-listed companies

 EU allows ‘carve out’ of IAS 39 “Financial Instruments”

 European accounting enforcement systems:

IAS/IFRS in United States

 1996 FASB publishes comparison of IFRS/GAAP

IAS/FRS in United States (2)

FASB and IFRS Convergence

The Norwalk Agreement

FASB Initiatives to further Convergence

Challenges to International Convergence

FASB IASB Joint Conceptual Framework Project

 Began October 2004

Future of IASB/FASB Convergence

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