The convergence of accounting standards is indeed a lofty task, but necessary and worthwhile, explains Shariq Barmaky.
The implications of globalisation are becoming more apparent in financial reporting as current accounting and reporting practices no longer fully meet the information needs of capital markets in the 21st century.
There is a rapid acceleration of global integration in the world's capital markets as more developing countries are opening their doors to foreign investors, gaining economic strength, creating new markets and raising capital in foreign countries.
Particularly in Asia, this trend can be seen from the emerging economies of China, India and most recently, Vietnam, which have attracted many foreign investors from the United States, Europe and Japan in recent years.
In addition, companies within these booming Asian economies are also crossing borders to seek listings and raise capital in foreign financial markets (for example, Chinese companies seeking listing on the Singapore and Hong Kong stock exchanges).
As capital markets continue to expand across national borders, there is a need for investors to compare investments on a global basis. International stock exchanges need their issuers to report in globally accepted financial reporting standards.
Converging a single set of high-quality accounting standards contributes to greater investor understanding and confidence, which is necessary for a thriving and efficient capital market anywhere in the world.
International Financial Reporting Standards (IFRS) have gained wide acceptance by many countries across the globe. More than 100 countries, including Australia, Hong Kong, Singapore and the 27 European Union (EU) member states, require or permit the use of IFRS.
The major emerging economies - Brazil, China, India and Russia - are adopting or considering the adoption of IFRS. Similarly, Canada, Chile, Israel, Korea and Japan have all recently announced their plans to replace their national standards for IFRS.
While IFRS gains acceptance globally, there is another set of accounting standards that has dominated the world's capital markets long before IFRS were introduced: US GAAP, which is notably different from IFRS and is set and issued by the Financial Accounting Standards Board (FASB).
Currently, foreign companies listed in the US are required to file their financial statements with reconciliation to US GAAP. In order to achieve true global convergence of accounting standards, US GAAP and IFRS need to adapt, compromise or somehow accommodate each other in order to be compatible, comparable and useful, an aim that the FASB and IASB have been actively striving to achieve.
The SEC's recent proposal to allow foreign private issuers to file financial statements according to IFRS beginning in 2009 was welcomed by many. The SEC's rules currently require foreign private issuers that report in IFRS, or any other non-US GAAP, to provide a reconciliation of those financial statements to US GAAP.
The purpose of the proposed rule change would be to give foreign private issuers a choice between IFRS and US GAAP. However, the SEC emphasised that this proposal applies only to those companies filing financial statements according to full IFRS.
In addition, the SEC plans a concept release relating to the possibility of treating US and foreign issuers similarly by also providing US issuers with the choice to use IFRS.
On the SEC proposal, IASB's chairman Sir David Tweedie commented that: 'The SEC's proposal is an important step in achieving [our] goal [of convergence between US GAAP and IFRS], but much work remains to be done.'
This is an indication that the IASB and FASB convergence will be ongoing, and there are clear signs that the two standard-setters have been actively sharing their resources together to make steady progress. In a recent interview on the progress of convergence, Sir David responded that, 'It is probably going to take a long time to remove every difference.'
The IASB and FASB agreed that the way forward is not to over-emphasise the details, but rather converge by agreeing on the principles and jointly write new ones on those areas where both standards need significant improvement.
US GAAP has been known to be a set of rule-based standards while IFRS is relatively principle-based. Both systems have pros and cons. Today, the global capital markets appear to favour accounting standards that are simpler to apply and permit judgement. This explains the shift towards IFRS rather than US GAAP. However, it is interesting to note that, even with IFRS taking centre stage, the recent accounting standards and interpretations issued by the IASB are converging with certain existing US GAAP practices.
Take, for example, the new standard IFRS 8 Operating Segments issued in 2006. It was issued with the objective to converge with US GAAP practice, and, likewise, for the recent amendment to eliminate the option of expensing borrowing costs. Perhaps, with the FASB's significant participation on IFRS projects going forward, IFRS adopters should keep US GAAP in view as their practices are expected to be integrated into IFRS eventually.
Future benefits?
True convergence is a long-term process that may take years to reach the ultimate goal of a single set of accounting standards and may take even longer to see quantifiable results. This lengthy timeline is due to the different stages, timing of adoption, and the commitments to education and training that precede the transition to a truly high-quality financial reporting environment.
Despite the slow process towards true convergence, the benefits of having unified financial reporting can be immediately noticed.
The convergence of accounting standards removes differences so that investors can understand different financial statements and make confident investment decisions regardless of which countries the accounts are prepared in.
Although there are many other factors (political, cultural, legal or tax environment) that will affect investment decisions, having a unified set of accounting standards facilitates free flow of global investment and helps to achieve substantial benefit for all capital market stakeholders.
Cross-border capital raising or mergers and acquisitions will be easier and less time consuming if the financial reporting platform is comparable. A standard financial reporting system can also help increase access to foreign investment opportunities. Accepting IFRS without reconciliation in the US capital markets will bring more openness to capital markets and facilitate access for third country issuers to US financial markets.
Ultimately, by allowing investors to compare investments on a unified basis, it lowers their risk of error in judgment, thus giving them more confidence to invest in foreign markets.
The process of convergence is not about replacing one system for a better system, but rather it strives to achieve one 'gold' financial reporting standard for the world. This new reporting model would be built on principle-based standards that can be applied in a cost-effective manner.
Future challenges?
IFRS has made great strides since they were adopted by approximately 7000 listed companies in the EU in 2005.
Despite many countries claim to be converging to IFRS, they may never achieve 100 per cent compliance. Even major developed countries reserve the right to selectively carve out or modify standards they do not consider to be in their national interests.
With the EU's adaptation of IFRS, it chose a version of the rules endorsed by the European Parliament, instead of the one issued by the IASB. The IFRS as adopted by the EU has one 'carve-out' to remove certain hedge accounting restrictions.
European banks argued that IAS 39 in its original form would force them into disproportionate and costly changes to both their asset/liability management and to their xisting accounting systems, thus producing unwarranted volatility.
Culture and national interests do pose obstacles for full compliance. The concern is that if enough countries seek to tailor IFRS to their liking,
'[There could be] hundreds of different versions of IFRS instead of one set of international rules, which is the whole point,' says Sir David. This could result in confusing messages sent to investors and that is definitely not the desired outcome of all these convergence efforts.
What does this mean for auditors?
While the primary responsibility of quality corporate reporting rests with the preparers and those charged with governance, the market continues to look to the auditors as enforcers too. Besides taking active steps to declare the adoption of globally recognised accounting standards, many countries are also starting to review their accreditation and supervision process for accountants and auditors.
As a result, auditors are likely to face more regulatory pressure to keep their accounting knowledge up to speed.
Addressing the issue of global shortage of skilled accountants/auditors, a unified accreditation program for accounting education could help to enlarge the pool of auditors in the market and give more recruitment choices to the audit profession in every country.
US convergence timeline
pre 2001 Old IASC, 'Harmonisation Efforts'
establishment of IASB with support of FASB and US Securities and Exchange Commission (SEC)
2002 Norwalk Agreement between FASB and IASB
official support from the US SEC, Congress, others
2006 Memorandum of Understanding
2007 SEC proposed to allow non-US companies to file financial results according to full IFRS
Reference: November 2007, volume 77:10, p. 69-71 (Asia edition)
