International standardization of financial accounting and reporting is driven by the process of economic integration, the development of capital markets, the increasing role of transnational corporations, and the increasing cost of financial reporting. It aims at forming an international accounting system, developing a single set of financial reporting standards applicable to companies in any country. Financial reporting standards are one of the most critical areas of accounting activity.
They do not include the following merely an estimate of the aggregate value of the enterprise’s assets and liabilities, but also the stages of presentation and preparation of international standards. At present, local and regional practices of compiling and presentation of accounting statements by financial reporting standards are based on international standards. However, at the same time based on traditional approaches, new methods are being formed, taking into account the current state of the economy and branch belonging of the enterprise. All this determines the necessity to study the fundamental bases, separate methodical approaches, specific methods and ways of accounting, and to report on financial reporting systems, which is the main objective of this course work.
The Necessity of Financial Reporting Standards
Financial reporting standards set out the principles for the preparation of financial statements, as well as the types and scope of information that should be provided to users of financial statements, including investors and creditors so that they can make informed decisions. Understanding the overall structure of financial reporting standards is much broader than knowledge of specific accounting rules (Flower and Ebbers, 2018). This understanding will enable a financial analyst to assess the implications of evaluating accounting reporting elements and transactions, including new products and transactions that are not prescribed by specific standards.
The company’s financial statements include reports and other additional disclosures that are necessary to evaluate the company’s financial position and periodic financial performance. The formulation of a single set of conceptual frameworks is an essential first step in the process of developing a set of interrelated standards. Previously, financial reporting standards were developed mainly independently by the standardization bodies of each country (Acharya and Ryan, 2016).
This independent standard-setting process has resulted in a wide range of standards, some of which were very comprehensive and integrated, while others were more general. The globalization of capital flows and the various discussions related to auditing has increased the public demand for more universal and quality international reporting standards and prompted greater coordination among major standard-setting organizations. Such coordination is also a natural consequence of the increased globalization of capital markets.
The development of financial reporting standards is complicated by the increasing complexity of the surrounding economic reality. The financial operations and financial position that a company wishes to present in its financial statements at this time are also complicated and non-universal (Nobes, 2014). Moreover, uncertainty about various aspects of transactions often results in accruals and estimates that require judgment. However, even with these standards, companies will generally not have a correct answer to the question of how to reflect economic reality in their financial statements. Nevertheless, financial reporting standards attempt to limit the range of acceptable responses to improve consistency in financial statements.
The Diversity of Financial Reporting Systems
All over the world, companies and enterprises must prepare and present their financial statements. The social, economic, and legal environment, as well as national accounting traditions and the orientation of national standards towards different users of financial reporting in different countries, have resulted in seemingly different forms of reporting in terms of the way economic indicators are generated and their content (Isidro, Nanda, and Wysocki, 2016). With the integration of national economies, the establishment of joint ventures, and the infiltration of capital abroad, there is a real need to level out these differences by bringing together accounting rules and procedures related to the preparation and presentation of financial statements.
It is essential to clarify that an international standard is an accounting standard whose application is customary in international business transactions regardless of the specific name of the standard. It is a standard familiar to all accountants of International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) in the US or the UK (Nobes, 2014). In other words, such standards are a set of accounting rules, methods, terms, and procedures that are advisory. The fundamental purpose of financial statements is to provide useful information to all potential users interested in obtaining information about the financial position, results of operations of the company or consolidated group of companies, management performance, and the degree of responsibility of managers for a given business.
Their structural differences determine the diversity of accounting systems. Standardization of financial accounting and financial reporting takes place at three levels: national, regional, and international (Flower and Ebbers, 2018). Each country has national standards for financial accounting and financial reporting that can be developed by professional accounting organizations and government agencies. Regional standards are in force in several countries in the same region: these include accounting directives, the provisions of which are subject to mandatory transposition into national legislation of EU member states.
International standardization of financial accounting and financial reporting is conditioned by the process of economic integration, development of capital markets, the increasing role of transnational corporations, increasing costs of financial reporting preparation. It is aimed at forming an international accounting system, developing a single set of financial reporting standards applicable to companies in any country.
While there are many similarities between the financial accounting policy options allowed under local and international accounting standards, these options are often based on different underlying principles, theories, and objectives.
Differences between accounting systems lead to significant differences between the financial statements prepared in countries. It is worth noting that the underlying differences between international accounting systems are related to historically determined differences in the ultimate use of financial information (Zeff, 2013). Financial statements prepared by IFRS are used by investors, as well as other enterprises and financial institutions. Since these user groups had different interests and different information needs, the principles underlying the preparation of financial statements have evolved in different directions.
Brief Historical Overview
The development of globalization of the economy has led, on the one hand, to the need to harmonize accounting approaches at the international level in order to ensure comparability of information contained in the reports of companies from different countries, but on the other hand, to the restructuring of international systems to the national format. The first World Congress of Accountants was held in Saint Louis, USA, in 1904 (Vidal-García and Vidal, 2020).
Already in the early 1930s, the United States began to develop a system of national accounting and reporting standards, which were applied by the largest enterprises voluntarily. This was the beginning of the GAAP system, which is still in use today (Moreira, 2019). Professional accountancy bodies developed these standards: in addition to the United States, they have been used in Canada, England, Italy, Mexico, and several other countries. Although uniform accounting and reporting concepts have been maintained in each of these countries, national accounting and reporting specificities have not been overlooked when legislation is enacted.
In the second half of the twentieth century, a new period of international standardization began in accounting history. Under the conditions of the growing necessity of unification and standardization of accounting the preconditions for its going beyond the national principles and rules were formed. In the 1960s, the development of international standards began under the leadership of the UN Centre for Transnational Corporation (Alon and Dwyer, 2016). This gesture could be seen as an attempt to create a common universal language for accountants and financial agents around the world.
IASB Model and Concept
Only by the second half of the last century did the world realize the need for a unified international system. International Accounting Standards Committee (IASC) was established on June 29, 1973, by representatives of professional organizations of the largest developed countries of the world, which included Austria, Canada, France, Germany, Japan, Mexico, Netherlands, Great Britain, Ireland, and the USA (Zeff, 2013). In 2001, the Committee was reorganized into International Accounting Standards Board (IASB) — thus, the IASB is a non-governmental professional organization. The ideas set out in the Statutes of the Board are embodied in the goals pursued by IASB (Bragg, 2018).
- Development of a unified system of high quality, understandable and applicable in practice global accounting standards that provide for the formation of high-quality, transparent, and comparable information in financial statements to assist participants of the world capital markets and other users of information in making economic decisions.
- Dissemination of standards and ensuring their uniform interpretation.
- Active work towards convergence of national standards with IFRS.
Since the IASB is not a government entity, the Board cannot require anyone to apply the international standards. IFRS are not regulations. Therefore, the obligation to apply the IFRS may arise if it is legislated by a national or supranational institution (Whittington, 2008). For example, some countries have legislation that provides for the obligation to prepare IFRS reports: The European Commission requires all listed companies, including credit and insurance institutions, to apply IFRS to prepare consolidated financial statements. In such circumstances, management is required to apply IFRS to the preparation of financial statements.
However, many companies and professional organizations voluntarily apply IFRS because they appreciate the quality of the useful information contained in the financial statements prepared under the standards. Many companies have voluntarily decided to prepare IFRS financial statements in the absence of such legislative requirements. It should be noted that in 2000, the International Organisation of Securities Commissions (IOSCO) approved the application of international standards for the preparation of financial statements for subsequent listing and sale on world stock markets (Pavić, 2019). This approval means that IOSCO recommends that its member financial market regulators allow companies to apply IFRS when preparing their financial statements.
FASB Model and Concept
In the opposite plane lies another model of financial reporting, which has become particularly popular in the United States. The Financial Accounting Standards Board (FASB) is an independent seven-member board of accounting professionals who set the standards for financial reporting in the United States (Jiang, Wang, and Wangerin, 2017). The FASB standards, known as GAAP, govern the preparation of corporate financial statements and are recognized by the authoritative Securities and Exchange Commission (SEC).
FASB was established in 1973 as a designated organization to protect financial standards governing the accounting and reporting practices of the private sector (Ong, 2018). It is the SEC that also gives FASB its governing authority (Baker, 2017). The SEC has the legal authority to set and manage financial reporting standards under the Securities Act of 1934 but has decided to grant this authority to a private FASB to manage the private sector independently.
FASB’s stated mission is to establish and improve financial reporting standards and to provide useful valuation information to investors and others who use financial statements. FASB strives to actively achieve this mission by promoting an open and independent reporting process that allows for broad stakeholder participation. According to Jiang, Wang, and Wangerin, (2017), FASB’s mission and operations are overseen by the Board of Trustees of the Financial Accounting Fund. As of 2016, FASB’s current and primary priority is to integrate US GAAP with IFRS (Christensen and Nikolaev, 2017). This allows for more transparent and transferable financial practices at the international level. In particular, FASB aims to eliminate differences in reporting between revenue recognition, leasing, financial instruments, and insurance.
Factors Determining the Differences between International Financial Systems
The adoption of international standards as a mandatory financial reporting system in the European Community and other countries has advanced the process of global convergence of financial reporting standards. However, there are still significant differences in financial reporting on international capital markets. Today, a considerable number of public companies worldwide use one of two reporting systems: either international or generally accepted principles.
In general, both international and national systems work together to coordinate changes in standards and reduce differences between them. However, as more and more countries adopt international standardization rules, there is less need for financial analysts to consider other reporting systems. In practice, analysts have to deal with financial statements prepared on a basis other than the international one. The emerging differences between the general and US systems remain and affect both the Conceptual Framework and many financial reporting standards (Sanko, H. and Koldovskyi, 2017). It is most appropriate to depict the difference between the models described using the table below.
|Factor for comparison||IFRS||GAAP|
|Stock Assessment||Weighted average cost method, FIFO method||Weighted average cost method, FIFO and LIFO method|
|Extraordinary income and expense items||Not shown separately in the profit or loss statement||Shown separately in the report|
|Development costs (R&D)||Capitalized only if certain conditions are met||To be considered as expenses|
|Recovery of written off stocks||Acceptable if the following conditions are met||Forbidden|
|Profit and loss statement||Has a single-stage or multistage form||Not strictly formatted has two approaches to cost classification by function and entity|
|Accounting for fixed assets||Revaluation is not permitted except for securities and at fair value||Historical cost is used in accounting and property, plant and equipment may be subject to revaluation|
|The first-time application of standards||All standards are valid from the first date of preparation. Exceptions can be made only for buildings, structures and equipment, business combinations, and pension plans accounting. All adjustments made at the time of adoption are to be reflected in the financial result of the first year of application||The principles require the application of all standards for prior periods. However, there are transitional rules and exceptional standards that apply to newly established companies|
|Comparison of information||A balance sheet, profit, and loss statement, cash flow statement for the two preceding years should be presented||For listed companies, all reporting components are presented for the preceding three years and the balance sheet for two years.|
|Changes in accounting policies||It is shown retrospectively, i.e. in the current and all previous periods. Changes in prior periods are reflected as changes in the opening balance of profit/loss of prior years||Changes are reflected in the financial results of the current period in which the changes occurred. Changes in prior periods are required to be reflected if they occur: |
Comparative analysis shows that the national system is primarily focused on the creditors and potential investors of the enterprise, while international standards establish a common approach to the preparation of financial statements and offer different methods for accounting for business transactions, accounting for individual items, and the preparation of financial statements. All of them are fundamentally advisory and are, therefore, not binding (Naito, 2018). Based on these data, international systems are more flexible than national systems.
Convergence of IFRS and GAAP
Convergence is a convergence towards convergence, sustainable balance, and development. Concerning financial accounting, this process involves a broader range of issues than harmonization, as it implies further development of the unified system. Thus, the processes of harmonization and convergence in financial accounting are inevitably linked and have common objectives (Whittington, 2008).
The purpose of convergence is to ensure that different standard-setting organizations come up with the highest quality and most likely similar national or international standards on the same issue. The convergence process involves making every effort to reach such a consensus. For a long time, there was no consensus on whether global accounting and reporting standards were needed or whether the benefits of having uniform rules for the preparation of business accounting records in different countries were so high.
The imminent convergence of two opposing systems was only a matter of time. As early as the beginning of the twenty-first century, FASB, which develops international standards in the United States, stated the need for convergence of standards (Ortega, 2017).
The introduction of many high-quality international standards is necessary because their use would improve the international comparability of financial documentation. This, in turn, would reduce costs for auditors, users, and creators of financial statements and could ultimately lead to maximum efficiency in capital markets. The Committee is of the view that, in the long term, global costs for implementing and maintaining the standards would also be reduced. At the same time, it should be borne in mind that there is an ever-increasing demand for high-quality international standards from existing market forces.
The US Securities and Exchange Commission was interested in international standards as an acceptable alternative to US GAAP and as a result, made a rather revolutionary decision for the US. Starting with the 2007 reports, foreign registrants were officially allowed to use IFRS on the US exchanges without the requirement to ensure the reconstruction with US GAAP (Tan et al., 2016). However, the convergence of the two global accounting standardization systems, IFRS and GAAP, which the G20 leaders have been talking about for so long, has been inefficient. The timing of mutual improvement projects has been pushed back, and on many critical accounting issues, standardized has been dragged into tedious discussions without compromise.
Revision of the Conceptual Framework
There was a need for a single or harmonized financial accounting system. Beginning in 2009, G20 leaders at their annual meetings called for the use of a single system of standards in group countries, which should lead to more excellent financial stability, transparency of company information, and reliability of forecasting in financial markets (Ortega, 2017). Thus, the successful implementation of the project would have resolved both technical and political challenges, to which standard setters have paid much attention since the 2008 crisis.
The convergence project was formed over a long period and was divided into sub-projects on working with specific standards. In general, IASB and FASB work together to coordinate changes in standards and reduce differences between standards. Their joint project began in 2004 and was aimed at developing an improved common framework for financial reporting. For example, according to the IFRS Conceptual Framework, which was published in 2018, the purpose of financial reporting is to provide financial information that will be useful to current and potential suppliers of resources in making decisions (Barker and Teixeira, 2018). All other aspects of the Conceptual Framework are derived from this primary objective.
The Concept Framework on Preparation and Presentation of Financial Statements is the foundational document that establishes the general principles for preparing IFRS financial statements. Although the Concept Paper replaced it by the IASB in September 2010, the Concept Framework remains relevant, defines the accounting methodology, and is used to understand the accounting principles of both small and medium-sized businesses and large companies whose shares or debt are traded in regional or international capital markets (Murphy and O’Connell, 2013).
The main change in the 2010 Conceptual Framework was the definition of the financial reporting purpose. It was the question of defining the primary purpose of financial reporting that became a turning point in the convergence of the two systems. To ensure convergence between IFRS and GAAP, the IASB and FASB Council Leaders in September 2010 defined valuation utility as the primary and sole purpose of reporting as such (Pelger, 2016).
According to their updated concept, the purpose of general financial statements is to provide financial information about the reporting entity that is useful for existing and potential investors, lenders, and other creditors in their decisions about providing resources to the entity. Other users may also find financial information useful in making economic decisions. Information useful to users in assessing future net cash inflows to the company includes information about the economic resources and claims on the company, and how well management and the strategic management body have used the company’s resources. While the financial statements do not show the value of the company, they are useful in assessing the value of the company.
It is difficult to note, however, that the real debate between two different accounting systems was limited to the idea of using as the primary objective. The recognition of the usefulness of information prepared under IFRS or GAAP has generated debate on governance as a primary objective (Burke, 2019). In other words, there was an unambiguous reorientation of priorities from already developed ways and objectives to new ones. This, in turn, paved the way for additional discussions for convergence.
Current Convergence Issues between IASB and FASB
Useful information – as a new, informal purpose of financial reporting, helps to highlight earlier convergence issues between IASB and FASB. Importantly, the purpose of financial reporting is to provide financial information that will be useful to current and potential resource providers in making decisions, and that all other aspects derive from this purpose. For this reason, in order to assess the importance of the changed purpose in convergence and disagreement, it is necessary to focus on the points of convergence. Users of IFRS express concern about the fact that the convergence of IFRS and GAAP means that the GAAP principles are actually adopted by IFRS (Ong, 2018).
The problem is that IFRS and GAAP are two completely different systems for preparing financial statements. The GAAP system is built on detailed rules that in some cases focus on the legal form of transactions and agreements rather than on the economic substance. By contrast, IFRSs are built on a set of principles and are less detailed, focusing on the economic substance and application of judgment. For example, many global economists believe that the convergence between the two systems should be aimed at developing new standards and common interpretation mechanisms, rather than ruling out the specific differences between existing IFRS and GAAP.
In December 2010, Paul Beswick, Deputy Chief Accountant at the SEC, at a conference of the American Institute of Certified Chartered Accountants, for the first time suggested a hybrid approach in the US (Roybark, 2016). This approach implied that US GAAP would continue to exist, but changes would be made to existing standards to eliminate differences from IFRS. It was suggested that the new standards of the IFRS system should be incorporated into US GAAP without modification, as the participation of the US SFU in their development entailed the harmonization of concepts and approaches. The transition was not intended to take place overnight; the entire convergence phase could take five to seven years.
It has already been stated that the goal of the most respected accounting and reporting standards bodies in the business world – IASB and FASB – is to achieve a single set of globally accepted standards. Therefore, it seems rather strange that after thirteen years of hard work by the world’s top accounting experts, there is still no understanding of when the convergence process will end and what role the combined goal will play in this. Neither does the Norwalk Agreement on the Convergence of IFRS and US GAAP, signed in 2002, add to the understanding (Hughes et al., 2017).
It is likely that the harmonization of the financial reporting mission between the two different systems will strengthen convergence, but the reality at the moment is that despite the completion or near-completion of all joint IASB/FASB convergence projects, a real merger of the two systems has not yet been achieved (Agostini, 2018). In addition, for the time being, IFRS is only permitted to be used in the US for the reporting of foreign, but not domestic, US companies. Therefore, it is not clear that the creation of an informal joint objective between the IASB and FASB is in some way conducive to convergence.
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