International accounting

1. International accounting Chapter 4: International Harmonization

2. Learning objective: • Assess the arguments for and against international harmonization or standardization of financial reporting; • Illustrate how harmonization can be measured; • Outline the history, purpose and activities of the International Accounting Standards Committee (IASC); • Explain how the IASC had different effects in different types of country; summarize the relevance of other bodies for harmonization; • Explain the structure and workings of the International Accounting Standards Board.

3. Introduction • The preceding (and the following) chapters make it clear that there have been major differences in the financial reporting practices of companies around the world.

4. Introduction • This had led to great complications for those preparing, consolidating, auditing and interpreting published financial statements.

5. Introduction • As the preparation of internal financial information often overlaps with the preparation of published information, the complications spread to management accounting.

6. Introduction • To combat these difficulties, several organizations throughout the world have been involved in attempts to harmonize or standardize accounting. Market forces also contribute to this, as will become clear.

7. Introduction • Harmonization’ is a process of increasing the compatibility by setting bounds to their degree of variation. ‘Standardization’ appears to imply working towards a more rigid and narrow set of rules.

8. Introduction • It is also important to distinguish between harmonization of rules (de jure) and harmonization of practices (de facto). Tay and Parker (1990) point out that de facto harmonization/standardization is more useful than de jure harmonization/standardization.

9. Reasons for, obstacles to and measurement of harmonization

10. Reasons for harmonization • Standardization can reduce administrative costs, improve the quality of accounting and increase comparability. • The pressure for international harmonization comes from those who use, regulate and prepare financial statements.

11. Reasons for harmonization • Financial reports produced in one country are used in various other countries.

12. Reasons for harmonization • Investors and financial analysts need to be able to understand the financial statements of foreign companies whose shares they might wish to buy. • They would like to be sure that statements from different countries are reliable and comparable, or at least to be clear about the nature and magnitude of the differences. • They also need confidence in the soundness of the auditing.

13. Reasons for harmonization • Those companies that wish to issue new shares more widely than on their domestic markets will see the advantages of harmonized practices in the promotion of their issues. • International credit grantors such as the World Bank also face the difficulties of international comparison.

14. Reasons for harmonization • The international accountancy firms support harmonization partly because it is good for their large clients. • Also, the tax authorities throughout the world have their work greatly complicated, when assessing foreign incomes, by differences in the measurement of profit in different countries.

15. Reasons for harmonization • Example of the need for harmonization • Cost (FIFO, LIFO or weighted average) (e.g. some Japanese companies until 2007); • The lower of FIFO and net realizable value (e.g. common IFRS practice); • The lower of LIFO and current replacement cost (e.g. common US practice). • Adding all the differences together, the effects on earnings or shareholders’ equity can be very large,

16. Obstacles to harmonization • The most fundamental of obstacles to achieving uniform practice was the size of the present differences between the accounting practices of different countries.

17. Obstacles to harmonization • The general dichotomy between investor/fair accounting and creditor/tax/conservative accounting is an obstacle that cannot be overcome without major changes in attitudes and law.

18. Obstacles to harmonization • Indeed, it is not clear that it should be overcome. If the predominant purposes of financial reporting vary by country, it seems reasonable that the reporting should vary.

19. Obstacles to harmonization • Harmonization is most useful when it concerns similar users who receive information from companies in different countries.

20. Obstacles to harmonization • It may be that the relevant companies should follow two sets of rules: one for domestic and another for international consumption, or one for individual entity statements and another for consolidated.

21. Obstacles to harmonization • Another obstacle is the lack of an international regulatory agency.

22. Obstacles to harmonization • A further problem is nationalism. This may show itself in an unwillingness to accept compromises that involve changing accounting practices towards those of other countries. • Another manifestation of nationalism may be the lack of knowledge of or interest in accounting elsewhere

23. The International Accounting Standards Committee

24. History and purpose of the IASC • The IASC was founded in 1973 by the accountancy bodies of nine countries: • Australia, Canada, • France, Japan, Mexico, • the Netherlands, the United Kingdom with Ireland, • the United States and West Germany

25. History and purpose of the IASC • A predecessor body, set up in 1966, was the Accountants’ International Study Group (AISG) at which the professional bodies of Canada, the United Kingdom and the United States examined their differences in accounting practices.

26. History and purpose of the IASC • The preliminary discussions towards setting up the IASC were held at meetings arranged in the margins of the Congress in Sydney in 1972. • Another background factor was that the UK joined the Common Market (later EU) in 1973. • Both the UK and the US professions were concerned about the draft Fourth Directive, which contained unattractive accounting rules for UK companies and for the European subsidiaries of multinationals

27. History and purpose of the IASC • The IASC was independent from all other bodies, but from 1983 a close connection was established with the International Federation of Accountants (IFAC)

28. History and purpose of the IASC • The IFAC concentrates on such matters as auditing, management accounting and the World Congresses of Accountants. • The IASC was concerned only with international accounting standards. Its aim was ‘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’

29. History and purpose of the IASC • From 1983 to 2001, the IASC’s Constitution provided for it to be run by a board of up to 17 members: 9 or 10 from developed countries, three or four from developing countries and up to four other organizations, generally drawn from the IASC’s consultative group (which included such bodies as the World Bank, the International Confederation of Trades Unions and the International Federation of Stock Exchanges).

30. History and purpose of the IASC Board members of IASC (at 31 March 2001)

31. History and purpose of the IASC • Each was represented on the board by a delegation of two or three part-time people, with one vote per delegation.

32. History and purpose of the IASC • Board members of the IASC contributed much of its budget. • The remaining members of the IFAC/IASC paid their subscriptions to the IFAC, which then funded • another element of the IASC budget. Publication revenue and donations were also important.

33. The standards and acceptance of them • The IASB adopted these standards en bloc in 2001, but made major amendments and additions from 2003 Standards were preceded by exposure drafts. In order to be published, an exposure draft had to be approved by a two-thirds majority of the IASC’s board; a subsequent standard by a three-quarters majority.

34. The standards and acceptance of them • In 1989, the IASC published a conceptual framework, which is somewhat similar to that of the FASB. • There are also strong similarities with the later Australian and British frameworks. • The framework was also adopted by the IASB and is used when preparing standards.

35. The standards and acceptance of them • Countries influenced by the Anglo-American tradition are most familiar with setting accounting rules in this way, and are most likely to be able to adopt non-governmental rules. • It is not surprising, then, that the working language of the IASC was English, that its secretariat was in London and that most standards closely followed, or compromised between, US and UK standards

36. The standards and acceptance of them

37. The standards and acceptance of them

38. The standards and acceptance of them • By the late 1980s it had become clear that the substantial number of options in IASs were an obstacle to further enhancement of the status of the IASC’s work. • In particular, IOSCO, a committee of governmental regulatory bodies, held out the possibility that its members (e.g. the SEC) might accept IASs for the financial reporting of foreign companies listed on their stock exchanges. • However, IOSCO made it clear that a reduction in options was essential.

39. The standards and acceptance of them • After several years of detailed argument over the removal of options, 10 revised standards were agreed in November 1993 to come into force in 1995.

40. Was the IASC successful? • The IASC’s basic objective was to publish and promote the acceptance of standards on a worldwide basis. This objective might once have been thought to be too ambitious in one respect and not ambitious enough in another.

41. Was the IASC successful? • Until fairly recently, to attempt worldwide standardization seemed a hopeless and unnecessary target. • The greatest benefits come from standardization among countries where there are companies that publish financial statements and that have foreign investors, auditors, parents or subsidiaries.

42. Was the IASC successful? • Until the 1990s, to try to bring the accounting of the Soviet Union or China into line, for example, not only would have had very few benefits but also would have been impossible. • However, the IASC became an important influence on Russia and China when their communist economic systems were dismantled, and so the description ‘worldwide’ is now appropriate, as examined later.

43. Was the IASC successful? • More fundamental aim of standardizing accounting practices was recognized.

44. Was the IASC successful? • Success in this area up to 2001 will now be examined for four types of country: developing countries, emerging nations, continental Western Europe and Japan, and capital-market countries.

45. Developing countries • The adoption of IASs was a cheaper route for these countries than preparing their own standards and has the great advantage of making life easier for those domestic or foreign companies or accountants with international connections. • The other advantage is avoidance of the politically unattractive alternative (for some countries) of adoption of US or UK standards. This use of IASs is of great value to these many countries and serves the interests of international harmonization by avoiding the creation of different rules.

46. Developing countries • However, there are some doubts about the suitability of the standards for developing countries • For example, the complication of the standards and the extensive disclosures that they require might involve costs that exceed the benefits for a country with few listed companies.

47. Emerging nations • Somewhat similar remarks as for developing countries may be made about those nations that moved from communist to capitalist economics, such as China and Eastern Europe. • They needed a ‘quick fix’ to their accounting practices as they changed at breakneck speed from economies with no ‘profit’, no shareholders, no independent auditors and no stock markets.

48. Continental Western Europe and Japan • Certainly, in 1973, the standard-setting philosophy and the dominant idea of serving capital markets with ‘fair’ information was largely alien to continental Europe or Japan. Nevertheless, the IASC moved forward with considerable support from these countries and remarkably little acrimony

49. Continental Western Europe and Japan- The factors that helped this were • The large representation of non-Anglo-Saxon countries on the board and working parties, and the eventual appointment of a Frenchman and then a Japanese as chairperson of the IASC; • National delegates from these countries who had been trained in large accountancy firms or multinationals and who were not governmental bureaucrats;

50. Continental Western Europe and Japan- The factors that helped this were • The desire in several board-member countries to strengthen their capital markets and modernize their accounting (particularly strongly felt in France and Italy from the 1970s onwards); • The increasing internationalization of the financial world, such that even some German and Japanese companies started to raise finance overseas; • A desire to avoid US dominance of accounting, so that the IASC seemed the less bad alternative.