International Harmonization of Financial Reporting

Summary of Diversity Research Findings as of 1995

Micro/macro, code-law and common law, were found to consistently be highly correlated with patterns of financial reporting around the world. Culture appeared to play an important role everywhere, but what characteristics dominated remained unclear. Inflation and trading relationships, in some countries, seem to matter a great deal. Economic variables were implicated but the importance of their role was unclear.

These findings left many questions unanswered, including the following:

Could diversity be reduced throughout the world? If so, how? Would it be wise to reduce diversity? If so, how much? What are the costs vs benefits of imposing upon the business world a reporting system with far less diversity? Would it happen by itself naturally? How could mandated changes be enforced?

Beginning in the 1970s:

Efforts began to reduce financial reporting diversity. These early fledgling efforts were met with great resistance. Most of the early effort began in Europe, as an extension of the dream of many for economic and political unity on the European continent. The International Accounting Standards Committee (IASC) was also formed by professional accounting groups in 1973.

In the 1980s:

Progress, though incomplete and imperfect, was made in Europe.

The EU began to endorse changes in reporting practices. The 4th and 7th directives were implemented. EU directives were given the force of law. For the first time, some reporting diversity, especially in the extremes, was reduced.

On the other hand:

The IASC floundered with a small staff and little support. It mostly issued low level, anything goes standards copied from others. Many countries, regardless of how economically significant, around the world were equally represented on the IASC. Most major economic players ignored the IASC.

In the 1990s:

Berlin wall falls, and not long after, the USSR collapses with it. US capital markets take off, continuing an unprecedented bull run that drives share prices up, on average, over 1500% from 1982-1999. Many economies around the world go into steep decline (e.g., Japan and Russia). Bank capital becomes scarce. The Asian crisis occurs in 1998, sparked by the collapse of Indonesias currency, markets and economy.

In the wake of these events:

American (corporate?) influence expanded dramatically. The importance of equity financing grew and shaped business interests around the world. Currency manipulations and shifts reached unprecedented levels as attempts were made to stabilize the world economy. The concept of harmonized financial reporting was given new credibility and support.

What is harmonization?
Harmonization -- the process of increasing the level of agreement in accounting standards and practices between countries.

Harmonization
The two levels of Harmonization

Harmonization in accounting standards, which is increased agreement in accounting rules. Harmonization in practice, which is increased agreement in actual accounting practices. Harmonization in standards may or may not result in harmonization in practice.

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Harmonization
Harmonization

Is different from Standardization. Harmonization allows for different standards in different countries as long as there are not logical conflicts. Standardization involves using the same standards in different countries.

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Some of the Significant Harmonization Efforts of the 1990s and 2000s: IOSCO

Worked to achieve improved market regulation internationally. Worked to facilitate cross-border listings. Advocated for the development and adoption of a single-set of high quality accounting standards.

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The EU

The EU achieved in monetary union in a phased-in fashion between 1999-2002. The EU also added many new members from Eastern Europe. The EU stopped making separate standards. As of 2005, it requires members to use IFRSs.

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Harmonization Efforts
IASB

Preceded by the IASC (International Accounting Standards Committee). Works toward harmonization of international accounting standards. IASB was created in 2001.

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The Question of Credibility

The crucial problem was how to be effective. SEC indicated an international standardsetter would have to be FASB-like, i.e., driven by expertise, not geography. EU wanted geographical representation to be emphasized. IASB decided to be expert-driven.

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History of IASB Why now (2001)?

1987&89- Beginning of effective attempts at IASC to reduce flexibility. IOSCO lobbies for common standards. E32 issued. 1995- IOSCO demands acceptable set of standards. Agreement between IASB and IOSCO that IASs can be used in cross-border listings as an alternative to national standards IF core standards were created. Core standards are completed in 1998.

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Major Players Jump on Board

1998-Germany allows internationally recognized rules for consolidated statements. 2000-IOSCO recommends acceptance of 30 IAS core standards for cross-border listings. 2005- EU makes IASs compulsory for all firms preparing consolidated statements.

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IASB- Structure and Process

Comprised of 14 members (12 full, 2 parttime). 7 members are liaison with a national board. Standard development process is open. Standards are principles-based. Since establishment of IASB, focus is on global standard-setting rather than harmonization per se.

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IASB Structure and Process

Up until 2000 Issued IASs After 2000- Issues IFRSs (Intl financial reporting standards) Similar process to FASB- in the sunshine due process. SIC- final step- interprets the standards.

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IASB- Structure and Process

Publication of an exposure draft and/or standard-requires 8 of the 14 members approval. Financed mostly by selling publications. At end of 1998, IASB found itself in competition with FASB, as many firms sought to be listed on US Exchanges.

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Geographical Backgrounds of IASC Trustees- 2001-2002

5 4 3 2 1 0 Number US Japan Australia Canada S Africa France Germany Switz Brazil China Denmark Italy Holland UK

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IASB Members- 2001

5 4 3 2 1 0 Number US UK Australia Canada S Africa France Germany Japan Switz

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Companies referring to the use of IAS standards in 2001

70 60 50 40 30 20 10 0 # of companies Austria Bahrain China Cyprus Czech Rep Denmark Switz France Germany Hong Kong Hungary Kuwait Latvia S Africa

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IASB-Limitations

No Power to Enforce or require use of standards. Result-Each country individually decides whether to accept IASs. Major holdouts that still do not accept IAS standards- US, Canada, and Japan.

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Principles-Based Approach to Accounting Standard Setting

IASB Perspective

IASB attempts to follow a Principles-Based approach to standard setting. As such accounting standards are grounded in the IASB Framework.

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Principles-Based Approach to Accounting Standard Setting

A Principles-Based approach

Represents a contrast to a Rules-Based Approach. Attempts to limit additional accounting guidance (e.g., FASB EITFs, FASB Interpretations). Is designed to encourage professional judgment and discourage over-reliance on detailed rules.

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IASB Framework and IFRSs

IASB Framework

Similar to the relationship between U.S. GAAP financial statements and the FASB Conceptual Framework.

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IASB Framework and IFRSs

IASB Framework

Provides the basis for financial statements presented in accordance with IFRS.

Includes: The objective and underlying assumptions of financial statements. Qualitative characteristics of information. Definition, recognition, and measurement of elements in financial statements. Concepts of capital maintenance.

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IASB Framework and IFRSs

IASB Framework

The objective and underlying assumptions of financial statements:

Primary objective is to provide information useful to decision making. Underlying assumptions include accrual-basis and going concern.

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IASB Framework and IFRSs

Qualitative characteristics of information

Understandability should be understandable to people with reasonable financial knowledge. Comparability allows for meaningful comparisons to financial statements of previous periods and other companies.

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IASB Framework and IFRSs

Qualitative characteristics of information

Relevance useful for making predictions and confirming existing expectations. Reliability free from bias (neutral) and represents that which it claims to represent (representational faithfulness).

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IASB Framework and IFRSs

Elements of Financial Statements

Definition assets, liabilities, and other financial statement elements are defined. Recognition guidelines as to when to recognize revenues and expenses. Measurement various bases are allowed, historical cost, current cost, realizable value, and present value.

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IASB Framework and IFRSs

Concepts of Capital maintenance
Financial capital maintenance One approach to income measurement. Net income represents the increase in net financial assets, excluding owner transactions. The approach in U.S. GAAP.

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IASB Framework and IFRSs

Concepts of Capital maintenance
Physical capital maintenance Another approach to income measurement. Net income represents increase in physical productive capacity. Excluding owner transactions. Requires current costs for measurement of certain physical assets.
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IASB/FASB Convergence
The Norwalk Agreement

Reached in 2002. Between the IASB and FASB. To work toward accounting standards convergence.

Learning Objective 7

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IASB/FASB Convergence
FASBs key initiatives in the Norwalk Agreement Joint projects boards will work together to address some issues (e.g., revenue recognition). Short-term convergence to remove differences between IFRSs and U.S. GAAP for issues where convergence is deemed most likely. IASB liaison IASB member in residence at FASB.

Learning Objective 7

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IASB/FASB Convergence

Monitoring IASB projects FASB monitors IASB projects of most interest. Convergence research project identification of all major differences between IFRSs and U.S. GAAP. Convergence potential FASB assesses agenda items for possible cooperation with IASB.

Learning Objective 7

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