Chapter 6

1. Chapter 6 International Accounting Standards and Global Convergence

2. Strategic Decision Point • Rules-based or principles-based standards? • Rules-based • Detailed and complex standards • Resulted in transaction manipulation • Enlarged gap between managers and owners • Principles-based • Reflects “true” underlying economic substance • Provides increased protection for companies • Makes comparability across companies difficult

3. Comparability of Accounting Information • International pressure exists for comparability, especially with MNEs • Different approaches to comparability • Harmonization is more flexible • Standardization suggests a state of uniformity

4. Which groups are interested? • Governments • Trade Unions • Investors (including financial analysts) • Bankers and lenders • Accountants and Auditors

5. Pressures for Harmonization

6. Governments • Government involvement in accounting determination varies across the world • Do governments really use corporate reports? • Information needed by governments is often too extensive to include in the report • Governments can demand whatever information they need • Information needs are extensive and confidential • These things suggest governments may not be important users of corporate reports • Is this a paradox? • Explained by situations where governments might be users

7. Government use of annual reports • Use reports, along with segmental information, to check performance of local subsidiaries of MNEs • Governments wish to monitor MNE operations as a whole • Governmental needs in differing departments can be accommodated by an annual report • Developing countries would have more information without bargaining for it with increased corporate disclosure

8. Governmental use of annual reports • Interest in extranational operations of MNEs • Intergovernmental organizations use this information for policy formulation (UN, EU). • Many governments desire increased bargaining power for information as members of intergovernmental organizations

9. Intergovernmental Organizations • United Nations • 1976 study revealed lack of information • 1979 – Working Group of Experts established • Emphasis on developing countries • Have different interests from those of OECD and IFRS • Major aim is international disclosure standards • Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) established in 1983 • Current issues deal with corporate governance • Monitoring role in endorsing desirable standards • UNCTAD – represented in • Standards Advisory Council of the IASB • Advisory Panel of Small and Medium-sized Entities of the IASB

10. Intergovernmental Organizations • Organization for Economic Cooperation and Development (OECD) • Represents industrialized nations • Issued Guidelines for Multinational Enterprises • Aimed at strengthening confidence between MNEs and governments • Not required by law • Guidelines are becoming more of a benchmark • Aim is to promote improvements in comparability and harmonization of standards

11. Intergovernmental Organizations – European Union • Involved in international harmonization of standards as part of company law harmonization • Goal is to promote European economic integration and development • No company should be at a disadvantage because of legal differences between countries

12. International Organizations – European Union • Interests of shareholders, lenders, suppliers, and other parties are protected • Directives in the EU have the force of law and must be ratified by member nations • Regulations become law without national ratification

13. Intergovernmental Organizations – European Union • Fourth Directive – approved in 1978 • Requirements relate to • Disclosure • Classification and presentation of information • Methods of valuation • Compromise between European and Anglo-American systems • Contains detailed requirements for historical cost accounting with some flexibility

14. Intergovernmental Organizations – European Union • Fourth Directive • Level of disclosure and transparency increased • “true and fair view” concept adopted • Does not adequately address • Foreign currency translation • Leases and funds • Cash flow statement

15. Intergovernmental Organizations – European Union • Seventh Directive – adopted in 1983 • Control criteria other than ownership is applied on an optional basis • Requirements • Worldwide consolidations • “Fair value” approach for assets purchased through acquisitions • Equity treatment of associated corporations • Segmental disclosures of turnover by line of business and geographical area • Disclosure has been substantially improved

16. Intergovernmental Organizations – European Union • Additional Directives • Eighth Directive – adopted in 1984 • Deals with qualification and work of auditors • Includes minimum educational requirements • Encourages mobility of professional auditors • Proposed directive for employee disclosure was put aside due to MNE and government opposition • Issues readdressed in Charter of Fundamental Social Rights

17. Intergovernmental Organizations – European Union • Harmonization of stock exchange regulations and securities laws is also a prerogative • Ensure investor access to sufficient information • Promote capital market and stock exchanges • No plans for new directives • “Mutual Recognition” approach was once considered more effective • IFRS adopted in 2005

18. Trade Unions and Employees • International Trade Union Confederations • European Trade Unions Confederation • International Confederation of Free Trade Unions • World Confederation of Labor • Industry-specific trade unions • Deal with individual MNEs • National Trade Unions • Influence MNEs on a variety of levels • Information needs depend on contact with MNEs and purpose of information

19. Trade Unions and Employees • Power exists in the nation where they operate • Unions have not grown beyond national boundaries as MNEs have • Trade union pronouncements are aimed at establishing policies concerning MNEs • Main concern centers on subsidiaries • Transfer pricing policies are a major concern • MNE subsidiary transactions have received little attention to date by regulatory bodies • Information about the terms, conditions, scale, security, and location of employment are of concern

20. Investors • Owners or potential owners of shares in the MNE parent corp. or a subsidiary • Interests are represented by international financial analyst organizations and IOSCO • Concerned with current lack of comparability • Some want information approach rather than a market approach to disclosure

21. Investors • International organizations • ICCFAA and IOSCO • IOSCO - works for multilisting and international trading • IOSCO is closely associated with the IASB • Want comparable information • Interested in segmental information of MNEs • Interested in consolidated results

22. Bankers and Lenders • Information needs are focused on financial positions, performance, and future prospects • Concerned with security of loans advanced • Significant impact in France, Germany, Japan • Have more direct access to required info • International banks are involved in harmonization and often require special financial reports (IFC, World Bank, etc.)

23. Accountants and Auditors • International Accounting Standards Board • Formerly the IASC • Governed by 14 board members • Objectives • Propose international standards and promote their acceptance • Work toward improvement and harmonization of standards • Works for comparability of accounting standards

24. Accountants and Auditors • IASB • Adopted 41 IAS standards, completed 5 new standards, and revised 15 existing standards • Achievements • Completed a core set of standards in 2000 as agreed with IOSCO for cross-board and national listings • Recent efforts are focused on EU compliance with IFRS in 2005 • Endorsement by IOSCO was limited • Members of IOSCO are permitted to require reconciliation of certain items, supplementary information, and eliminate some options existing in IAS • Members will individually determine whether or not to endorse IFRS for cross-boarder listings

25. Figure 7.2: The IASB’s Governance Structure

26. Accountants and Auditors • IFRS and U.S. GAAP • IASB and FASB are working toward similar accounting standards • FASB is researching international convergence • Objectives include • Identify every substantive difference between U.S. GAAP and IFRS • Catalog those differences according to the strategy for resolving them • Recommend further agenda decisions to the Board to further the objective of convergence with IFRS

27. Accountants and Auditors • IFRS and U.S. GAAP • Benefits of convergence according to the FASB • Increased efficiency in capital markets by increased comparability and transparency from nation to nation • Reducing the administrative burden for MNEs by allowing only one set of financials to be prepared • Enable U.S. companies access to capital markets throughout the world without reconciling U.S. GAAP to IFRS

28. Accountants and Auditors • IFRS and U.S. GAAP • Street, Nichols, and Gray (2000) suggest the gap is narrowing • Major differences are in the areas of • Property, plant and equipment revaluations • Deferred taxes • Goodwill • Capitalized borrowing costs • SEC desires enforcement of international standards if they are in place

29. Accountants and Auditors • Rules versus Principles • Recent scandals and aftermath perhaps show a need for principle-based standards • Sarbanes-Oxley requires the SEC to examine the feasibility of principles-based standards • Problems with principles-based standards • Guidance for application • Comparability • No guidance for complex transactions

30. Accountants and Auditors • Rules versus Principles • Survey by Mike Ng (2004) • 93% of companies surveyed reported that is was possible to apply rules-based standards but not reflect the economic substance of the transaction • Only 7% of companies surveyed believed principles-based standards would lead to a better reflection of economic reality • Results show that neither approach will ensure that companies report the economic reality of transactions

31. Accountants and Auditors • Noncompliance with IFRS is problematic • IASI states that compliance means following IFRS and each interpretation of IFRS • Improper accounting treatment is not condoned by explaining accounting treatments applied or by footnotes (paraphrase IASI). • Street and Gray (2000) found that only 775 of the companies in their sample stated they were fully compliant with IAS. • International accounting firms are not supporting the enforcement of IAS • New structure of the IASB should help with compliance

32. Accountants and Auditors • International Federation of Accountants • Sets international auditing guidelines • Promotes international convergence of standards • International Auditing and Assurance Standards Board • Independent body under the IFAC that creates International Auditing Standards (ISA)

33. Accounting and Auditors • Reforms by the IFAC in cooperation with accounting firms, member bodies, regulators, and accounting organizations include: • Establishment of the Public Interest Oversight Board to oversee IFAC’s standard setting process • Increased transparency with regard to IFAC governance and international standard setting • Public participation in the standard-setting process • A more formal process of communicating with international regulators

34. Accountants and Auditors • International Forum on Accountancy Development (IFAD) • Created after the Asian financial crisis to aid developing nations • Encourages conformity with IFRS • Developed the International Financial Framework to aid in improving standards within national financial frameworks • Conducted a GAAP Convergence Survey (2002) • 90% of countries surveyed plan to convert to IFRS • Majority of countries surveyed plan to converge with IFRS by establishing a government regulation or a standard-setting body • Half of the countries surveyed see a barrier to convergence in the complication of standards

35. Accountants and Auditors • International Association for Accounting Education and Research • Promotes excellence in accounting education • Contributes to development of international standards

36. The International Harmonization and Disclosure Debate • Some see harmonization and disclosure as a means to create a balance of power between MNEs and domestic corporations • More industrialized nations will not be totally supportive of increased regulation • Regional integration • Long-term goal to remove market imperfections and eliminate regulatory barriers (EU) • Many countries are more concerned with protecting their own business community at the expense of others

37. The International Harmonization and Disclosure Debate • Differences in reporting are due to differences in domestic needs • With domestic corporations, there is little concern for international standards • Natural accounting coordination will be a lengthy process according to research • Regional economic groupings (EU) and intergovernmental organizations (UN) will help

38. The International Harmonization and Disclosure Debate • Future developments will be centered on MNEs • May be less disclosure now in practice because of the complex nature of MNEs • National reporting requirements may limit disclosure