About This Chapter
Although the United States had implemented a procedure for rigorous accounting regulations within its own borders, one serious problem arose. As business became more international, the issue of countries developing their own, unique accounting standards became apparent. The financial statements of a company in one country could not be compared to that from another country as the rules in drawing them up were different. If a foreign company wished to be listed on the New York Stock Exchange (NYSE), it would either have to do reconciliation with U.S. Generally Accepted Accounting Principles (GAAP) or draw up new financial statements complying with U.S. GAAP.
It did not make sense that countries’ accounting regulations were different and it was confusing when operating at the international level. One solution was that all countries should use U.S. accounting standards. An alternative approach was to establish an international body that would be responsible for issuing standards. As it was apparent that some countries would be reluctant to abandon their own standards for those determined by the United States, an international standard setting body appeared to be the only viable option.
It is frequently easier to determine the best way to make progress and more difficult to put it into action. If we are to have international accounting standards (IASs), an organization must be formed to develop these standards. Funding will be required and the agreement of countries to comply with the standards.
In this chapter, we examine the problems of national accounting standards and the factors that operated to give a country its own particular form of accounting regulations. We describe the background to the formation of the International Accounting Standards Committee (IASC). This body issued IASs commencing with IAS 1 Presentation of Financial Statements and ending with IAS 41 Agriculture. Many of the standards issued are still in operation.
After several years the IASC was succeeded by the International Accounting Standards Board (IASB). This body retained all the IASs that had been issued. It also continues to issue regulations but name them International Financial Reporting Standards (IFRSs). It commenced with IFRS 1 First Time Adoption of International Financial Reporting Standards and in 2016 issued IFRS 16 Leases.
We complete this chapter by looking at the progress toward international accounting. We examine the adoption of some countries, such as Australia, Canada, and the countries in the European Union that have adopted international standards. We also examine the move toward international accounting in countries such as China, India, and Japan. The progress of the United States toward converging with international standards and its retreat from that aim is left to Chapters 3 and 4.
The Problems of National Accounting
As can be seen from the explanations in the previous chapter, the demands and pressures of national, political, and economic environments largely formed the route that countries followed to establish their own standard-setting bodies. The structure, operation, and authority of the national standard setters are shaped within existing national practices and conventions.
Standard setters work within a coalition of interests, including reporting organizations, shareholders, the media, and political groups. The powers of these interested parties differ, and the need and desire of the accounting standard setters to gain the support of these particular factions also vary. For example, the United States is notable because of the considerable statutory authority of the Securities and Exchange Commission (SEC) to participate in the standard-setting process and the extent to which lobbying takes place.
Given the unique histories of national accounting standards development in each country, it is not surprising that there are significant differences in their specific accounting regulations. In the early years of the 20th century, there seemed to be little need for countries to discuss with each other how accounting standards should be formulated and applied. However, opinions were to change.
The creation of the European Union highlighted the problems. The different countries in Europe had different accounting systems. This made it difficult for conducting trading operations and cross-border investment. The European Commission started to tackle this issue in the 1970s. Several directives were issued with which all EU countries were compelled to comply. The purpose of the directives was to make financial statements more comparable in terms of presentation, format, and measurement, which were implemented by all EU members by 1991.
There were also changes taking place in the United States. In the latter half of the 20th century, there were some highly publicized examples of very profitable companies in Europe that wanted to list shares on the NYSE. In order to do so, the profitable company had to redraft those financial statements in accordance with U.S. GAAP. In some instances, the previously declared profit for a financial year turned into a loss due to the application of different accounting standards.
The Classic Case
Possibly the most famous case is that of Daimler Benz AG, a German company that wished to list its shares on the U.S. Stock Exchange in the early 1990s. To do so, it had to reconcile the profit it had shown for 1993, which was prepared in accordance with German GAAP, with what the profit would have been if the company had adopted U.S. GAAP. The net income, or profit, the company had reported in its German financial statements was DM615 million. After the company had made all the adjustments to comply with U.S. GAAP the reported net income turned to a net loss of DM1839 million.
This significant difference in the financial results of Daimler Benz demonstrated that accounting regulations at the national level did not make sense when viewed from an international perspective. It is reasonable to question how a company can make a profit under one set of accounting rules but this turns into a loss when other rules are applied. Which rules are the correct ones? Accounting regulations needed to be changed, but the question was how this could be achieved.
In the following sections we provide an answer to this dilemma. We describe the development of international accounting regulations and the gradual involvement of various countries.
The International Accounting Standards Committee
The IASC was founded in 1973 by the accountancy bodies, not the governments, of nine countries: Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland (UK), and the United States. It was established as a private sector nongovernment organization (NGO) with a part-time body of standard setters who met three or four times a year in cities around the globe. The organization was based in London, with a small, full-time secretariat. At this point in the chapter, it is worth mentioning that the IASB is still based in London, although its formal meetings are held in various countries.
The objectives of the IASC were:
- To formulate and publish, in the public interest, accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance;
- To work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements.
The above objectives were extremely ambitious for an organization that was resourced very modestly and had no enforcement powers. The IASC intended to achieve these objectives by:
- Ensuring that published financial statements comply with IASs in all material respects;
- Persuading governments and standard-setting bodies that published financial statements comply with IASs;
- Persuading authorities controlling securities markets and the industrial and business community that published financial statements comply with IASs.
It is important to emphasize that the IASC was not established primarily to promote the growth of international capital markets. The reverse was the case and it was the increasing globalization of markets and business that led to increasing pressure for IASs to promote comparability.
Although the IASC made considerable progress, it had a number of weaknesses that meant that it was less effective than was required. Its main problems were:
- Too many of its standards allowed alternative choices in accounting treatment and were open to different interpretations. This allowed flexibility in drawing up corporate financial reports, thus allowing countries and companies to claim to be following IASs but still draw up financial statements that were not fully comparable.
- The IASC did not have enforcement powers or mechanisms to obtain compliance. Thus, consensus could only be achieved by issuing standards containing sufficient flexibility to obtain widespread acceptance.
- There were structural and resource problems that the IASC could not remedy. The members of the IASC were from national professional accounting bodies. Many of these had no responsibility for standard setting in their own countries, thus reducing IASC’s ability to influence and persuade national standard setters.
- There was the question of how much independence the IASC needed from the professional accounting bodies to conduct its activities. The technical contribution of the professional accounting bodies was essential but was regarded by some as placing the IASC in the direct influence of one particular interest group. There were other interest groups represented, for example, analysts and academics, but professional accounting bodies were perceived as dominant. To some extent, this perceived dominance also weakened the possibility of achieving a mechanism for enforcement. Few would wish to allow professional accounting bodies, however well intentioned, to make the regulations for worldwide accounting as well as having the power to enforce them.
Although interest was expressed in making progress in internationalization, the major national economies were still relying on national accounting standards. It was the smaller countries that tended to adopt international standards. The question whether the IASC could achieve its goal of being truly international still remained. Either a complete overhaul of all aspects of the IASC was required or a new body needed to be formed. The latter was the course of action chosen.
The International Accounting Standards Board
The IASB was established formally in April 2001 with the following objectives:
- Developing in the public interest, a single set of high-quality, understandable, and enforceable global accounting standards;
- Helping participants in the world’s capital markets and other users make economic decisions by having access to high-quality, transparent, and comparable information;
- Promoting the use and vigorous application of those standards;
- Bringing about convergence of national accounting standards and IASs to high-quality solutions.
The IASB “adopted” the IASs issued by the IASC and commenced issuing its own standards entitled IFRSs. It has a technical role of setting standards. It has no authority to compel companies to adopt standards, to monitor their compliance, or to take action to remedy practices with which it disagrees. National governments determine whether they will adopt IFRSs.
Its structure of the IFRS Foundation is displayed in Figure 2.1.
Figure 2.1 The IFRS foundation
The IFRS foundation monitoring board was created in January 2009. The Board is responsible for approving appointment of trustees and ensuring that they discharge their duties. The IFRS Foundation Trustees is responsible for governance and funding. It is the oversight body of the IASB. The IFRS advisory council gives advice to both the trustees and the IASB. Its members consist of analysts, preparers, and academics. These are appointed by the Trustees.
The role of the IFRS Interpretations Committee (IFRIC) is a crucial one. It examines newly identified financial reporting issues not specifically dealt with in IFRSs and issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop in the absence of authoritative guidance. IFRIC interpretations are subject to IASB approval and have the same authority as a standard issued by the IASB.
Not all of the issues brought to the Committee will lead to an interpretation. The committee may decide to pass the issue to the IASB or that the standard does not require any interpretation. The committee does not give advice to individual companies and firms of accountants who may have difficulties in understanding a particular standard.
Our interest is focused on the IASB, the body responsible for issuing IFRSs. The process in issuing a standard has the following six stages:
- Establishing an agenda
The IASB evaluates the merits of adding a potential item to its agenda, mainly by reference to the needs of investors.
- Planning the project
In developing a plan to conduct the work, the Board will decide whether to conduct the work by itself or jointly with another standard setting body.
- Issuing a Discussion Paper (DP)
It is normal practice for the Board to issue a DP and ask for comments. In issuing a DP, the Board gives a comprehensive review of the issues, possible approaches in addressing them, and their own preliminary views.
- Publishing the Exposure Draft (ED)
The ED is the IASB’s main vehicle for consulting the public. The ED sets out a specific proposal in the form of a proposed standard (or amendment to an existing standard).
- Publishing the standard
The Board has to decide whether to publish revised proposals for comments as a second ED or whether to proceed to issuing a standard. When the IASB is satisfied that it has reached a conclusion on the issues arising from the ED, it instructs the staff to draft the IFRS.
- Implementation of the standard
After an IFRS is issued, the staff and the IASB members hold regular meetings with interested parties, including other standard-setting bodies, to help understand unanticipated issues related to the practical implementation and potential impact of its proposals.
This is an exhaustive, time-consuming process. Not only is there input from the two advisory bodies, but at the DP and ED stages, there is opportunity for the public to make comments and suggestions. All of this documentation, including copies of the comment letters, is available on the IFRS website.
Once issued, standards may subsequently be revised if there are changes in business practices or deficiencies in the standard. If the issues are extensive, the existing standard may be withdrawn and a new standard with a new IFRS number issued. In addition to these major changes, the IASB annually conducts an improvement project, which may make minor amendments to some standards.
As far as the present standards themselves are concerned, there is some confusion because of the change of names and the apparent duplication of some individual standards. The IASC issued 41 standards between 1975 and 2000. The standards were numbered consecutively starting with 1 and each standard also had a descriptive title; for example, IAS 7 Cash Flow Statements. Most of the IASC standards are still in force.
When the IASB took over from the IASC, it adopted the IASs that were still in force and started to add its own standards, which were titled IFRS. Once again these standards are numbered consecutively, starting with 1, and have a descriptive title, such as IFRS 3 Business Combinations.
When referring to the issued standards, either the term IASs or IFRSs is used. It is essential, however, to attach correctly the term IAS or IFRS when referring to a specific standard, for example, IAS 2 Inventories or IFRS 2 Share-Based Payment. In this book we use the term International Standards to mean both IASs and IFRSs.
The IASB has made substantial progress with the acceptance of international standards. It is claimed that there are more than 100 jurisdictions that have adopted international standards. However, caution should be expressed about the rigor and extent of that adoption. In some instances, the adoption is partial, with only certain types of organizations in a particular country compelled to comply with the international standards. We examine this issue when we consider certain countries at the end of this chapter.
A few countries maintain that their standards are similar to and are based on international standards, but this does not mean that there is full compliance. A list of countries that claim to have adopted international standards and the scope are given on the IAS Plus website (http://www.iasplus.com/en/jurisdictions).
Two research papers that have investigated the characteristics of adopting and nonadopting companies have arrived at interesting conclusions.
The first paper examined 102 non-EU countries.1 The researchers found that more powerful countries are less likely to adopt IFRS and suggested that they are reluctant to surrender standard-setting authority to an international body. This is pertinent to the United States where the SEC has the ultimate authority for accounting regulations. The researchers also found that a country is more likely to adopt IFRS if its trade partners or countries within its geographical region are IFRS adopters.
A later study took a different perspective and examined how standards were accepted and implemented.2 Their sample included 183 nations around the world. They gave significant focus to the 25 largest nations according to the gross national product. They concluded that the probability of assuring strict implementation of accounting and reporting standards may be affected by weak national cultural ethics, unstable authoritarian forms of government, and economic power measured by high debt levels and rapid growth rates.
Of course, adoption is only one part of the process and for standards to be effective, some form of monitoring and enforcement is required. The IASB does not have direct powers or procedures to ensure companies in individual countries comply with international standards, but national mechanisms may already be in operation or are being created. The IASB, however, has to rely on the mechanisms in place in individual countries to ensure enforcement.
The first stage of monitoring for compliance with international standards is within the company where control systems, including internal audit, can ensure that standards are applied. The commitment of management is also required to ensure that financial statements fairly represent the financial performance and position of the organization.
A second stage in ensuring compliance with international standards is an audit conducted by an auditor who is deemed to be independent of the company. An audit will involve an examination of the procedures, processes, and records of the company, and the financial statements that are drawn from those records. The auditor will express an opinion on those financial statements in a standard audit report.
There are different national rules on the status of organizations that require an external audit. At a minimum, an external audit is normally required by those companies whose shares are listed on a stock exchange and the auditors are reporting their opinion to the shareholders.
The specific duties performed by an external auditor will normally be set out in the contract with the company. The auditors will be expected:
- To ensure that all the necessary information and explanations for the audit have been obtained.
- To ensure that proper books of accounts have been kept and maintained by the organization.
- To confirm that the accounts dealt with in the report are in agreement with the books of accounts and are in conformity with national regulations.
- To issue an auditor’s report that should contain a clear written expression of opinion on the financial statements taken as a whole.
It is not the normal duty of an auditor to conduct a fraud investigation. Unfortunately, research indicates that there are important differences in the understanding between auditors and users of the purpose of the audit and the meanings of statements made in the audit report.3 One misunderstanding that appears in most countries is that users of financial statements mostly believe that auditors search for fraud and financial manipulations. That is not the case, although if they encounter such practices the auditors should report them.
The final and critical stage is the monitoring and enforcement mechanism held by a regulator. There are models currently employed at the national level. There are security commissions, such as the SEC in the United States, stock exchanges that can delist companies for regulatory transgressions, and other national bodies that have some legal support.
The funding of the work of the IASB comes through the IFRS Foundation. This is a not-for-profit organization whose primary source of income comes from contributions from jurisdictions that have put in place international financing regimes. Contributions that come from other sources and the international accounting firms are the most significant source of support.
Since the commencement of the convergence project, the United States has been a major contributor as a country, usually ranking in the top three donations from all countries. In Table 2.1, we show the annual contributions from the United States for the period 2008–2016. All contributions are translated into sterling on the date they are received.
Table 2.1 U.S. contributions to the IFRS foundation
Source: IFRS Annual Reports.
It is noticeable that the contributions from the United States have been declining steadily since 2010 apart from the spike in 2014. This increase was due to a contribution by the Financial Accounting Foundation of £1,839,231, leaving a balance figure of £766,734.
The year 2012 was when it started to become apparent that the United States did not intend to continue with the convergence agreement, although no formal announcement was made. A reduction in contributions is a hit to IASB. In 2016 the salaries and related costs for its 137 employees amounted to £16 million, and the IASB depends on external funding. The withdrawal of the United States is a double blow. First, a major country is not using international standards, thus weakening the goal of worldwide accounting regulations. Secondly, the loss of contributions from the United States must be replaced from other sources if the IASB is to continue its work.
The Progress of Internationalization
Although it is claimed that many countries are using international standards, it does not necessarily mean that those apply the same regulations to economic transactions. Even where a country claims it has adopted standards, caution must be present when examining the financial statements of companies within that country. The reasons are:
- Some counties may decide to adopt international standards. If so, it is highly likely that the standards will apply only to certain organizations, that is, the large listed companies. Other types of organizations such as small- and medium-sized companies will continue to rely on national standards. Some countries adapt international standards, in other words change them to some degree to meet their particular needs.
- National accounting traditions are likely to continue where scope for this exists within IFRS rules. This is not to suggest that the continuation of practices is merely due to inertia, but that the reasons for the barriers to internationalization, described earlier in this chapter, remain relevant.
- The mix of political and other pressures on regulators varies from country to country, caused partly by the financing system, legal system, and tax system. Some countries have well-organized lobby groups of finance directors. Regulators may be hesitant to fully adopt international standards because of political pressures and may delete certain paragraphs of the standards or search for part wordings where there is room for different interpretations.
- The implementation date of a standard can vary from country to country. New standards generally are in force on the date of annual periods beginning on or after January 1, but early applications are normally permitted. The result is that two different versions of international standards can be in force at the same time depending on the implementation year chosen by a particular country compared to the choice by another country.
- The year-ends of companies can differ. Some may find that a new international standard becomes applicable in their financial year. Others, with an earlier year-end date, will not have to comply with the IFRS until the following year’s financial statements. In some countries, for example, Australia and the United Kingdom, corporate accounting periods do not necessarily end on December 31. In other countries, that may be the usual year-end date.
- Enforcement regulations are not always stringent in some countries. Although it may be claimed that international standards have been adopted in a country, the lack of strong enforcement may mean that companies have considerable latitude in how the standards are applied.
Given all the above reasons why international accounting may not be effective, it would appear difficult to put forward an argument that international accounting works. One response is to argue that the number of countries adopting international standards has been increasing since the establishment of the IASB in 2001. This suggests that many countries do find general benefits, but there are also other specific advantages of internationalization.
- Many small countries do not have sufficient resources to fund a rigorous standard-setting process of their own and therefore adopt international standards to ensure sound financial reporting by companies.
- The debates generated through the process of internationalization have meant that countries have gradually changed their own practices to fit better with international standards. Although the United States has not adopted international standards, its relationship with the IASB has led to several changes to U.S. accounting practices.
- By focusing on specific accounting issues and promoting discussions and research, the IASB has brought about a general improvement in the nature of financial accounting and reporting. This applies not only to those countries adopting international standards but to nonadopters as well.
- A study4 examined the effect of accounting standards and investor protection on value relevance of earnings and book value of equity among EU countries during the years 1999 to 2007. It concluded that international standards led to improvements on these issues.
- A large sample of firms that were using international standards in 26 countries revealed that, on average, market liquidity increased around the time of the introduction of IFRS.5 There was also a decrease in firms’ cost of capital and an increase in equity valuations. Reservations on their findings included the strength of the enforcement measures in the country concerned. This is an aspect that has been observed in several studies as critical to the success of international accounting.
- A sample6 of non-U.S. borrowers from 40 countries during 1997 through 2005 investigated the effect of the voluntary adoption of IFRS on price and nonprice terms of loan contracts and loan ownership structure in the international loan market. It showed that banks charge lower loan rates to IFRS adopters than to nonadopters. Banks impose more favorable nonprice terms on IFRS adopters, particularly less restrictive covenants. Banks are more willing to extend credit and IFRS adopters attract significantly more foreign lenders participating in loan syndicates than nonadopters.
Internationalization in Individual Countries
We started this chapter by explaining the establishment of the IASC in 1973 by national accounting bodies in nine countries: Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland (UK), and the United States. It is revealing to examine the progress toward international accounting by these countries, and others, at the end of 2016. There have been numerous articles written on international accounting adoption and a very useful main source of information is an excellent website that updates the position of their progress frequently.7
In considering the application of international standards in other countries you should remember that there are three main forces that determine general disclosure of financial and nonfinancial information by companies, as illustrated in Figure 2.2.
Figure 2.2 Influences on financial disclosures
We would add that, in addition to the above three factors, some of the hurdles that we discussed in Chapter 1 are still present. Taxation regulations differ and the dominant culture in the country may not readily accept the principles of international accounting. The adoption of IFRSs is not merely a technical accounting decision but also a political one.
An analysis by the IFRS organization in 2017 concluded that of the 49,000 domestic listed companies on the 88 major securities exchanges in the world approximately some 27,000 use IFRS Standards. Of those companies not using IFRS Standards, almost 90 percent are listed in China, India, Japan, and the United States.
In the following section we look at practices of those countries that attended the meeting in 1973 to agree on the development of IASs. We also examine the regulations in China, India and Japan.
The Institute of Chartered Accountants first issued its Recommendations on Accounting Principles in 1946. It is argued “. . . these were virtually copies of similarly titled documents produced by the Institute of Chartered Accountants in England and Wales.”8 Possibly this similarity helped Australia to transfer to IFRSs.
The present position is that the Australian Accounting Standards Board (AASB) is the body responsible for issuing accounting standards. The AASB is an Australian government agency that develops and maintains financial reporting standards that are applicable to entities in the private and public sectors of the economy, and have the force of law for corporate entities under section 296 of the Corporations Act 2001. The standards must also be applied to all other general-purpose financial statements of reporting entities in the public and private sectors.
When the AASB first started to adopt IFRSs as Australian Accounting Standards, it made some modifications to the international standards. This resulted in the removal of some alternative accounting methods and adding required disclosures for the financial statements.
In 2007, the AASB modified Australian Accounting Standards so that their requirements were identical to the standards issued by the IASB for for-profit entities. Some additional disclosure requirements have been retained, and some non-IFRS-compliant requirements apply for not-for-profit and public sector entities. It is intended that compliance with Australian Accounting Standards ensures the financial statements and notes of the entity comply with IFRSs. Australia also applies the “true and fair view” concept as does the United Kingdom.
The following extract from Wesfarmers Limited Annual Report captures their legal basis:
In our opinion, the accompanying financial report of the Group is in accordance with the Corporations Act 2001, including:
- giving a true and fair view of the consolidated financial position of the Group as at 30 June 2017 and of its consolidated financial performance for the year ended on that date; and
- complying with Australian Accounting Standards and the Corporations Regulations 2001.
Source: Wesfarmers Annual Report 2017, page 140.
The costs of adopting international standards can be high for the individual companies. A survey by George, Ferguson and Spear (2012)9 of publicly traded Australian companies concluded that there was a mean level of increased audit costs of 23 percent in the year of the transition to IFRSs. Further investigations revealed that companies with greater audit complexity, not surprisingly, experience greater increases in compliance costs for the transition to IFRSs.
Prior to 1946, there were no accounting regulations in the country until the Canadian Institute of Chartered Accountants (CICA) commenced to issue Bulletins that codified existing practice largely as a service to their members. In 1967, the Bulletins were published in the form of an official Handbook.
There were further developments when, in 1972, the Canadian Securities Administrators issued National Policy Statement 27, requiring publicly traded companies in Canada to follow the Handbook recommendations. Three years later, the regulations implementing the Canada Business Corporations Act were revised to specify that GAAP in Canada would now be defined as the practices and guidance within the CICA Handbook.
The years from 1981 to 1998 were unusual ones in Canada. Two competing standard-setting bodies existed during this period: the CICA and the newly formed Accounting Standards Authority of Canada. It is contended that the “alternative standard-setter, the Accounting Standards Authority of Canada, experienced significant implementation issues and was unable to overcome advantages accruing to the CICA by virtue of locked-in users, first mover advantage and reputation advantage” (Richardson, 2011, 110–111).10 It may be that some countries experience similar implementation issues if they are attempting to adopt IFRSs.
The CICA established the Accounting Standards Oversight Council (AcSOC) in 2000. The role of AcSOC is to serve the public interest by overseeing and providing input to the activities of the Accounting Standards Board (AcSB). The AcSB is responsible for establishing standards of accounting and reporting by Canadian companies and not-for-profit organizations.
The international accounting regulations developed in Canada in the early 2000s started to debate its own position. It was faced with three choices:
- Continue to set its own standards. This would be an expensive activity and separate it from the practices of many other countries.
- Adopt U.S. standards. This would be inexpensive but may make it appear as merely a follower of its more powerful neighbor.
- Adopt international standards. This would be expensive but would demonstrate its position as a player in the global business market. There was also the fact that the United States had started its convergence project and would, most likely, converge fully with IFRSs at a future date.
Given these scenarios, in January of 2006, the AcSB published a strategic plan to implement IFRSs. These have been mandatory in Canada since 2011 for Publicly Accountable Entities. The application of IFRSs in Canada, therefore, is broader than in Europe as it applies to many more types of entities.
- Publicly listed companies
- Enterprises with fiduciary responsibilities, such as banks, insurance companies, credit unions, securities firms, mutual funds, and investment banks
- Certain government corporations
Several Canadian companies have been listed on U.S. stock exchanges for many years. The current Canadian regulations provide an option for those companies to apply U.S. GAAP rather than Canadian GAAP.
There are entities in Canada, and some other countries, known as rate-regulated companies. These have a monopoly or dominant market position and provide goods and services such as electricity, gas, telephone service, water, and television cable to the general public. Regulatory bodies or governments are those that determine the prices that can be charged to customers for the services or products. Such entities had technical difficulties in complying with IFRSs. The issue of IFRS 14 Regulatory Deferred Accounts resolved the issues and compliance with IFRSs commenced for annual periods beginning on or after January 1, 2015.
As with Australia, the evidence of compliance with IFRSs can be found in the Auditors Report. The following extract is taken from a large Canadian company.
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Empire Company Limited as at May 7, 2016 and its financial performance and its cash flows for the 53-week period then ended in accordance with International Financial Reporting Standards.
Source: Empire Annual Report 2016, page 66.
Experiences in Canada support the findings on costs of adoption in Australia. A survey by the Canadian Financial Executives Research Foundation11 (2013) examined the transition costs and the recurring costs. The average total transition cost for larger-sized companies was $4,041,177. The lowest amount spent by a large company was $80,000 and the highest cost was $25.5 million. A perspective on the significance of the cost is given by comparing it to revenue. Costs as a percentage of revenues were 0.006 percent for the lowest spender and 0.08 percent for the highest spender.
As far as recurring costs are concerned, these can be separated into those for preparing the annual report and accounts and those for the interim financial statements. For the annual report and accounts, 48 percent of respondents reported that their costs were about the same. Fifteen percent reported cost savings. These arose from not having to reconcile their financial statements with U.S. GAAP, reducing the number of accounting frameworks the organization had to apply. The remainder (37 percent) reported that complying with IFRS proved to be more costly.
The European Union
All domestic companies in the European Union whose securities are traded in a public market are required to use IFRS Standards as adopted by the European Union in their consolidated financial statements. Traded in a public market refers to a stock exchange. The EU Accounting Regime requires that each IFRS is adopted individually for use in the European Union. The adoption process is sometimes referred to as “endorsement.” The process is as follows:
- The IASB issues a standard or an amendment to a standard.
- EFRAG (the European Financial Reporting Advisory Group) holds consultations with interest groups. EFRAG is an important and essential part of the adoption process.
- EFRAG delivers its advice to the European Commission whether the standard meets the criteria of endorsement. It also conducts an effect study about the potential economic effects of the given standard’s application in the European Union.
Based on the advice of EFRAG, the Commission prepares a draft endorsement Regulation. The European Accounting Regulatory Committee (ARC), set up in accordance with Article 6 of the IAS Regulation, votes on the Commission proposal. If the vote is favorable the European Parliament and the Council of the European Union have 3 months to oppose the adoption of the draft Regulation by the Commission.
If the European Parliament and the Council give their favorable opinion on the adoption and 3 months elapsed without opposition from their side, the Commission adopts the draft Regulation. After adoption, it is published in the Official Journal and enters into force on the day laid down in the Regulation itself.
In assessing whether a particular IFRS should be adopted in the European Union, the Regulation requires that it:
- be consistent with the true and fair view,
- be conducive to the public good in Europe and,
- meet basic criteria on the quality of information required for financial statements to satisfy users’ needs.
The time to review and adopt a new standard is lengthy. However, the only difference between IFRS and EU-adopted IFRS has been a “carve-out” of a few sentences in IAS 39 that barred the use of a form of hedge accounting applied by a minority of European banks.
The following example of an Independent Auditor’s Report is extracted from the Annual Report and Accounts of the UK Burberry Group plc.:
In our opinion, Burberry Group plc’s Group financial statements (the “financial statements”):
- give a true and fair view of the state of the Group’s affairs as at 31 March 2017 and of its profit and cash flows for the year then ended;
- have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union; and
- have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the IAS Regulation.
Source: Burberry Group plc Annual Report, 2016/7, page 119.
There are several items that are noteworthy and emphasize the difference between UK accounting and U.S. accounting. These are:
- For UK companies, financial statements must give a true and fair view. This is not a concept shared by the United States and many other countries.
- The statements have been prepared in accordance with IFRSs as adopted by the European Union. It is unusual for the EU not to adopt IFRSs fully, but one must be aware that possibility exists.
- The statements have also been prepared in accordance with the UK Companies Act 2006. Other EU companies have their own national legislation as illustrated in the following example from a French-based company:
The Statutory Auditors’ report includes information specifically required by French law in such reports, whether modified or not. This information is presented below the audit opinion on the Consolidated Financial Statements and includes an explanatory paragraph discussing the Auditors’ assessments of certain significant accounting and auditing matters. These assessments were considered for the purpose of issuing an audit opinion on the Consolidated Financial Statements taken as a whole and not to provide separate assurance on individual account balances, transactions, or disclosures.
To the Shareholders,
In compliance with the assignment entrusted to us by your shareholders’ meetings, we hereby report to you, for the year ended December 31, 2016, on:
- the audit of the accompanying Consolidated Financial Statements of Carrefour “the Group”;
- the justification of our assessments;
- the specific verification required by French law.
The Consolidated Financial Statements have been approved by the Board of Directors. Our role is to express an opinion on these Consolidated Financial Statements based on our audit.
Source: Carrefour Group Annual Report and Accounts 2016, pages 245–6.
We emphasize that the company, as a member of the European Union, complies with international standards. However, as with other countries that are members of the European Union, there are national legal requirements that also require compliance. Explanation of these is outside the focus of this book and, when examining the financial statements of EU companies, you can assume that they comply fully with international standards. You must also be aware that national legislation may also affect some disclosures.
The current position is with Britain being a member of the European Union. We are now confronted with “Brexit” and the declared intention of Britain withdrawing from the European Union. At this stage it is uncertain how this will affect international accounting, bearing in mind that the offices of the IASB are in London, England. The Institute of Chartered Accountants in England and Wales has identified several possible courses of action12:
- IFRS adopted by the EU procedure would be applied by UK listed companies.
This would be a simple and inexpensive route but it does mean that the United Kingdom has ceded authority to the EU process. This could mean that the United Kingdom would be required to comply with standards with which it did not agree.
- UK companies comply with standards issued by the IASB and ignore EU procedures.
This could mean that UK companies must comply with standards with which the United Kingdom does not agree and has had no opportunity to be a party to the decision making.
- A UK process that decided whether a standard should be endorsed.
This option is an expensive choice but has advantages. The process of adoption would be a powerful influence on the IASBs’ decision making as it would not wish to issue a standard that a major country rejected. It also ensures that UK listed companies must comply with a standard that recognizes the particular concerns and conditions in the United Kingdom.
In its publication the ICAEW proposes that the third option is the most preferable. Its discussions with others have shown that there is conditional support for this option. The argument in its favor is that most developed economies that have adopted IFRS have had some form of national endorsement mechanism. Also, the experience with EU endorsement shows that there have been few decisions that have disrupted the process.
There are some possible drawbacks. Decisions made by the United Kingdom may not correspond with those made in the EU endorsement process. This could lead to the United Kingdom and the European Union having different versions of an IFRS. Until the law and regulations post-Brexit are resolved it is impossible to determine how these issues can be resolved.
In the academic literature there have been several articles concerning the meaning of the word “adoption.” Zeff and Nobes (2010)13 claim that adoption means the full-scale voluntary use by a company of IFRSs as issued by the IASB, before such use became compulsory in its jurisdiction. Some would regard this as a very narrow definition but in their examination of several companies they concluded that:
- Not all of the IFRS content is always included in the national version;
- Not all companies in a country are compelled to use IFRSs;
- In some countries companies can voluntarily use IFRSs;
- Company financial reports do not always contain a statement that they do comply with IFRSs.
The authors offer suggestions to improve the full compliance with IFRSs, but the reality may be that countries want full control of the financial information provided by companies. The IASB can issue accounting standards but it has no authority to compel countries or companies to completely comply with them. Understandably, countries wish to retain control of the companies operating in its borders and, although financial information is important, countries require companies to also make public other information including corporate governance. We discuss these developments in the final chapter.
This country was a member of the group of country representatives that met in 1973 to discuss the internationalization of accounting regulations. On November 11, 2008, the Mexican SEC (Comisión Nacional Bancaria y de Valores [CNBV]) announced that all companies listed on the Mexican Stock Exchange would be required to comply with IFRS starting in 2012. Listed companies would have the option to comply with IFRS earlier—starting as early as 2008—subject to requirements that would be established by the CNBV.
In the period 2008 to 2010, the Mexican Institute of Certified Public Accountants auditing commission issued some amended auditing regulations to correspond with the international standards’ requirements. Additionally, IFRSs were translated into the local language. This assisted in the adoption of the standards. In 2012, domestically listed companies, except for financial institutions, commenced to use IFRSs as was the government intention.
Interestingly, Steinback and Tan (2014)14 have found that the adoption of IFRS has led Mexican companies to change some of their business practices. Two examples they provide are behavioral and strategic changes in areas such as hedging strategy. With such transactions the complexity of the IFRS standard has reduced hedging strategy and sales because contractual terms have to be amended to comply with IFRS. The article also includes the example of Coca-Cola FEMSA, which changed from Mexican GAAP to IFRSs. The company identified where there are optional accounting treatments, compared with the practices of foreign companies using IFRSs, prepared a formal strategy, and implemented a training program.
China was differently placed than the market-based economies that had adopted international standards. It had state ownership of many companies, underdeveloped capital markets, and a lack of qualified accountants.15 The country, therefore, chose the path of convergence rather than full adoption. In 2006, the IASB stated that Chinese standards were substantially converged with IFRS Standards. In addition, China has committed to adopt IFRS Standards for reporting by at least some domestic companies. The IASB also noted that several Chinese companies already produced IFRS-compliant financial statements because of their dual listings in Hong Kong and other international markets.
The movement to the adoption of international standards has led to other significant changes. One study16 found that the impact of IFRS convergence led to a decrease in conservatism used by companies but this was limited to geographic areas with high institutional quality. One effect of IFRS adoption was a growth in executive compensation as IFRS adoption led to a reduction in accounting conservatism, which was a feature of the previous regulations.
At this stage, it is impossible to predict whether full convergence will take place. One can argue that, although China is different from many other countries, it is now taking a global position and there may be a trend toward a market-based economy. One study17 found that nonstate-owned enterprises viewed the change more favorably, especially those with a greater need for external financing. Their research demonstrated that the convergence toward IFRS in China has significant consequences for investors (i.e., in terms of value relevance). It is not merely a political decision in response to the thrust of international accounting harmonization.
There would appear to be several barriers to China seeking further convergence. In particular, it remains a basic Confusion culture and finds a rules-based approach more acceptable than the IASBs principles-based approach. In addition, state-owned enterprises still dominate the economy and the restrictions on foreign investors reduce their demand.
There are few indications that there will be a move to full adoption of all IASs. There are also no obvious forces that would encourage China to make further efforts toward full convergence. Although this may be a disappointment for enthusiasts, the evidence suggests that there are boundaries to convergence.
India has Indian Accounting Standards (Ind-AS) that had been developed by the Institute of Chartered Accountants of India (ICAI). The Securities and Exchange Board of India (SEBI) had the legal authority to require all listed companies with subsidiaries to file consolidated financial statements complying with these standards. There was also an option for listed companies to opt to comply with international standards but only a very small number did so.
It is claimed18 that India has been in a state of gradual convergence with IFRS since 2007. In 2013, India revised its Companies Act to require listed and large companies to prepare consolidated financial statements in conformity with a new set of Ind-AS to be adopted by the ICAI. In 2015, the Ministry of Corporate Affairs announced its road map for adopting Ind-AS for 2016–2017. There is no complete convergence and differences remain in accounting for business combinations, control, financial instruments, and revenues.
The extent to which the convergence route will go is uncertain. Companies must comply with Ind-AS and these standards are based on IFRSs. However, there appears to be support offered by the Ind-IAS, although there were significant reservations on the awareness and challenges in the preparation for IFRS-based standards.
IFRS Standards are one of four permitted financial reporting frameworks for domestic listed companies. The others are Japanese GAAP, Japan’s Modified International Standards, and U.S. GAAP. The various studies that have been conducted suggest that there is considerable resistance to the full adoption of international standards.
One study19 considered the barriers to full adoption and identified a series of different environments that would prove problematic. One is the societal environment that is influenced by Confucianism. There is a work culture based on loyalty and the avoidance of conflict and values of thrift and moderation. Any new practices tend to be integrated into existing practices instead of replacing them.
The organizational environment has a large number of publicly traded listed companies but 99 percent of Japanese companies are privately owned and small in size. Companies tend to progress by making long-term relationships and avoiding competition and there are only a relatively small number of professionally qualified accountants.
The process of introducing internationalization comes under the authority of the Financial Services Agency. The authors comment that there could well be differences between “IFRS as issued by the IASB” and those “endorsed by the FSA.”
The difficulty of combining the aim of converging with the reality of the existing framework and international practices is illustrated in a study by Noriyuki Tsunogaya.20 A content analysis of relevant meetings of the Business Accounting Council of Japan was conducted. The authors concluded that it would be difficult to adopt fully international standards because of the need to achieve international comparability and maintain institutional complementarity between financial reporting and infrastructures such as accounting-relating laws.
A similar picture is also demonstrated in a study of Japanese financial executives.21 Although there is considerable discussion on convergence the authors conclude that the situation is similar to that of the United States. The AcSB of Japan is created to promote convergence with international standards being introduced in 2016, but that aim has been delayed indefinitely.
The authors conducted a survey with senior financial executives of 292 Japanese listed companies in 2013 to 2014. On the basis of their findings they concluded that a significant percentage of respondents consider the costs of IFRS to be a major impact but the benefits would be only moderate. Those perceiving substantial benefits were the large and overseas companies. As we mentioned earlier, the majority of Japanese companies are small and privately owned.
Limits of Internationalization
There is a danger in seeing the adoption of international accounting by a country as the only alternative to its use of its own national accounting. The encouragement for countries to adopt international accounting suggests that it is always the best method for all countries and the companies within their boundaries. The evidence suggests that this is not necessarily always the case and barriers to full convergence remain.
There are some advantages in adopting international standards. The time and expense for a small country to develop its own standards can be considerable. Although the adoption of international standards may require a levy to the IASB, it is usually less expensive than home-developed standards. The advantages for international companies or those companies connected in some way with international organizations are beneficial. All speak the same international language of finance.
However, smaller, national companies and their business contacts may be perfectly satisfied with their own national regulations. Being compelled to comply with the complexities of national standards can be very expensive. The IASB is aware of this problem and has issued the IFRS for SMEs Standard. This is approximately 250 pages and is intended for smaller companies. The users of such financial statements are identified by the IASB as lenders, creditors, and other users of SME financial statements. The emphasis of the information is directed at the disclosure of information on cash flows, liquidity, and solvency.
There are disadvantages of full adoption of international standards, which are rarely discussed. Possibly the most important is that countries have their own legislation to control business activities. They would not wish to relinquish part of their authority unless there were persuasive arguments to do so. There are also cultural and business practices that are fundamental to the country and we demonstrated these in our earlier discussions in this chapter. Finally, there is a large expense incurred. Companies may have to change their methods for collecting and recording data, auditors will need to become proficient in the new requirements, investors and other users may have to improve their capabilities, and accounting lecturers may have to change all their teaching notes.
The defects and problems of national accounting regulations are easy to understand. Imagine that you are in the United States and wish to buy goods from a company in Germany. You do a financial investigation and find that they appear to be a well-established company that made a healthy profit last year.
You discuss this with an accounting friend who examines the German company’s accounts and declares that the company had, in fact, made a loss. You are confused but even more so when your friend explains that different countries use different methods to measure company performance. You want to know whether there is a profit or loss. Being told it depends on how you do your calculations does not help.
Looking from a different viewpoint, you may be a company seeking additional finance for expansion of your business. You may be at the stage to list on a stock exchange. If you are in a country that already has IFRSs, you could list on its stock exchange. If it retains its own standard setting, you may have to draw up your financial statements using those national regulations.
The arguments for international accounting are compelling, although the barriers have, historically, been difficult to surmount. However, over recent years, they have been eroded gradually. International accounting has become more widespread, although its application in particular countries is not as rigorous as it could be. The IASB has no authority to monitor what companies are doing or enforce compliance so the full effect of international accounting is not fully known.
The research indicates that there are benefits to be enjoyed from adopting IFRS set by the IASB. The countries that make up the European Union have followed the route of complete adoption and it has been successful. There is also the path of convergence, in other words a country issuing their own standards based on the requirements of the IFRS. But for some countries which we have used as examples in this chapter, full convergence is difficult to achieve and may not even be desired.
There is also the contentious question as to what is meant by adoption of international standards. The research available shows that many countries go through a convergence process but do not fully adopt all IASs. Also, all companies in that country are not obliged to comply with international standards and usually it is only companies listed on a stock exchange. The evidence shows that we do not have full adoption on a global basis of international standards. The United States provides the main example of a country that commenced on the route of convergence, followed it for several years, and then withdrew. In the following chapter, we will discuss U.S. involvement in international accounting and how we have arrived at the present U.S. position.