International Harmonization of Financial Reporting

1. International Harmonization of Financial Reporting

2. 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.

3. 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?

4. 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.

5. 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.

6. 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.

7. 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 Indonesia’s currency, markets and economy.

8. 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.

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

10. Harmonization Objective 1 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.

11. 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.

12. 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.

13. 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.

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

15. The Question of Credibility • The crucial problem was how to be effective. • SEC indicated an international standard-setter 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.

16. 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.

17. 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.

18. IASB- Structure and Process • Comprised of 14 members (12 full, 2 part-time). • 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.

19. 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.

20. 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.

21. Geographical Backgrounds of IASC Trustees- 2001-2002

22. IASB Members- 2001

23. Companies referring to the use of IAS standards in 2001

24. 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.

25. 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.

26. 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.

27. IASB Framework and IFRSs IASB Framework • Similar to the relationship between U.S. GAAP financial statements and the FASB Conceptual Framework.

28. 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.

29. 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.

30. 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.

31. 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).

32. 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.

33. 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.

34. 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.

35. IASB/FASB Convergence The Norwalk Agreement • Reached in 2002. • Between the IASB and FASB. • To work toward accounting standards convergence. Learning Objective 7

36. IASB/FASB Convergence FASB’s 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

37. 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