International Harmonization of Accounting Standards

Introduction

Harmonization of accounting standards means the matching of accounting standards and practices implemented in domestic jurisdictions, such as the Generally Accepted Accounting Principles (US GAAP) in the United States, with International Financial Reporting Standards (IFRS), or formerly the International Accounting Standards (IAS). The IFRS is adopted by the London based IASB (International Accounting Standards Board) and has been adopted across member European Union member states in order to guarantee the protection of investors (International Accounting Standards Board, 2007)

The US GAAPs are adopted by the Financial Accounting Standards Board (FASB), which is the organization tasked with establishing financial reporting standards in the US. By harmonizing financial statements, the European Union is able to maintain investor confidence by setting out a “level playing field” for listed companies. The objective of the harmonization of the accounting standards process is to converge the various accounting standards used by different nations through the adoption of the international financial reporting standards (IFRS).

Arguments for the need for the harmonization of accounting standards point out some of the effects that globalization has had on businesses. International trade has increased, which calls for greater transparency and harmony of accounting and reporting standards. Multinational corporations have branches, headquarters and distribution outlets in different jurisdictions, and face the challenge of preparing financial statements in accordance with domestic standards of accounting (Radebaugh, Gray and Black, 2006). Such companies are affected by fluctuating exchange rates, commodity prices and interest rates, hence global standards of accounting are needed in order to ensure the accuracy of such information. “A harmonization of global accounting policies would enable an effective evaluation process since regulators, auditors and analysts would be receiving the same information.” Alexander and Britton, 2004.

Multinational companies tend to shun countries with strict regulations; hence countries that impose such regulations are likely to lose out on foreign capital from these multinationals. As a result, such countries will be less competitive in attracting capital, and may also witness the transfer of capital from their economies to countries that are friendlier in terms of accounting standards, and the subsequent decline in international market share (Sale 2004, 2007)

Multinational companies could target countries with lenient regulatory and reporting standards, and seek to exploit the weak reporting standards in order to repatriate more profits to their headquarters. International financial reporting standards, once adopted, would ensure that there is uniformity of standards across the world, hence countries that had inadequate accounting policies would be protected from companies that wish to exploit their regulations, in the end being able to claim more from the multinationals in form of tax revenues.

The major objective of IFRS in its aim to harmonize international accounting standards is that of protecting investors. Companies are forced to prepare different financial statements in the multiple economies that they conduct business in, hence it would be possible for a foreign investor to misinterpret performance reports of the same company from various locations (Alexander and Britton, 2004). Investors may be misguided as to the performance of an international firm due to the size of its reported profits from international subsidiaries, while the reality could be that such profits could be lower if financial statements were harmonized or translated in accordance with the home country’s accounting policies and practices. The need for harmonization, in this case, is to help investors make decisions based on the same type of information and the same standards of financial statements.

With the adoption of harmonization of accounting standards, investors will be able to better compare financial reports of companies based in different nations. This would greatly reduce the risks that arise from the interpretation of foreign financial reports, and maintain the consistency of accounting standards across the world. The end result is the facilitation of international trade in an international business-friendly environment, and free movement of capital across borders with little or no restrictions due to the harmony of accounting financial reporting standards.

Advantages of harmonizing standards

The major advantage of ensuring the harmonization of international accounting standards is the comparability of financial statements. Investors will be allowed to compare different reports since all companies will follow the same procedures and accounting principles in the preparation of their financial statements. By ensuring harmony of accounting principles, markets will be able to maintain investor confidence since similar transactions will be accounted for in a common manner, and thereby be more credible than in the current system where similar transactions are recorded in different ways. Investors may lose confidence in the financial markets when different regulations adopted by different countries account for similar transactions in different ways. Harmonization of accounting standards will therefore allow for greater comparability of financial statements, hence investors will be able to make informed decisions as to where their capital will generate the best returns.

Another advantage of harmonizing international accounting standards is that investors and analysts would save time and money spent on consolidating financial information from different nations into a form that allows for comparability. In the current system whereby most countries have their own set of accounting standards, more sets of records are required in order to comply with domestic regulations and subsequent reports that would be relayed to their home countries, making it expensive for the companies. Investors may have to purchase financial reports from analysts who carry out translation and conversion services when different accounting standards are used in a world where accounting policies differ from one nation to another.

Investors may not be in a position to understand all the differences between the various accounting standards, and may therefore fail to translate important financial data. Valuable time and money may be used in the translation of foreign financial statements, which may slow down or restrict the movement of labor and capital (Roberts, Weetman and Gordon, 2005). Such risks deter the investors from investing in foreign nations in which they don’t fully comprehend the financial reporting standards used. Financial reports on multinationals can also be collected from one central location since the information contained is prepared in a common procedure.

Companies with subsidies in foreign countries have to adopt foreign accounting policies when preparing their financial statements for tax purposes. With the harmonization of accounting statements, will see a reduction in statements that these companies have to prepare. Also, harmonization will enable subsidies to maintain the same set of accounting policies as the parent company, thereby facilitating ease of communication and compliance with headquarter specifications since they will be in the same accounting system as the parent company. The headquarters will be in a better position to control and follow up on the performance of their subsidiaries located in foreign countries, as opposed to only interpreting quarterly information received from the subsidiaries.

The multinational company will save on time and costs of translating or converting the financial reports of its subsidies in various countries in order to compare their performance, and therefore make decisions as to which countries to increase investments, and which countries to disinvest in. Harmonization will therefore allow for comparability of the performance of various subsidies that fall in different countries. The multinational company will also experience relative ease in floating its shares in a foreign stock exchange since disclosure requirements match those of its country of origin (Ryan, 2007). Without the harmonization of accounting standards, multinational companies would have to incur the costs of keeping different sets of records in order to comply with foreign financial reporting policies.

International harmonization of accounting standards will be advantageous to international auditing and accountancy firms. The harmonization will facilitate the free movement of staff across foreign countries, saving costs and valuable time that would have been forfeited in training staff on foreign accounting policies whenever they moved transferred to a new country. Auditing and accounting firms that have branches in foreign counties may also save on labor costs through the employment of local professionals rather than importing expensive labor from their home countries since all accountants follow the same accounting policies. Auditing and accounting firms would also have ease in servicing clients that have more than one foreign subsidiary due to the consistency of accounting policies in different nations.

Harmonization of international accounting standards will enable for consistency of financial information from different sources, thereby raising standards of accounting progressively in all countries around the world. Countries with inadequate accounting standards and regulatory bodies will benefit from the adoption of globally harmonized accounting standards, meaning that the country’s accounting policies meet global standards, which will increase the competitiveness of such a country in the global setting.

Countries with inadequate accounting standards will also benefit from increased tax revenues since multinational corporations in their nations could be exploiting their weak domestic accounting policies and repatriating huge profits back to their home country. Developing countries could save on the costs of setting up accountancy boards that would be tasked with the formulation and modernization of their own unique domestic accounting standards. All the country has to do is implement internationally agreed accounting standards and policies, therefore maintaining its competitiveness with relative ease.

International transactions will be facilitated with the harmonization of accounting policies due to increased transparency and increased government accountability (lewis and Pendrill, 2004). Exchange costs will be minimized as a result as the world moves towards perfect information, which will be reflected by better efficiency by multinational companies, increased profits and increased revenues for governments in form of taxes. Previts (2008) notes “with improved information standards, trade tariffs and quotas will be more accurate since governments will have to follow internationally accepted standards in the formulation and disclosure of tariffs and quotas.” Investors and companies would therefore benefit from the clarity of information on such government trade restriction policies and subsequently make informed decisions.

Since harmonized accounting standards will apply to all countries that have consented to follow them, the countries will have to abide by the IFRS. Such countries will be able to resist political pressures that may pile up due to the changes in political and economic landscapes. The International Financial Reporting Standards will ensure that there is dominance on the part of the government to implement policies that suit its own objectives, instead of business-friendly policies. The IFRS will ensure transparency and fairness of reporting standards, hence ascertaining accountability as per global standards. The advantage of this is that IFRSs are developed collaboratively by independent bodies, which is better than a system that is developed and enforced by the government. Once adopted, the government of a nation will bear the same responsibility of enforcing accounting policies, which will be in this case the International Financial Reporting Standards.

Financial markets and stock exchanges are also likely to benefit due to increased international trade and the quality of information. Companies will be required to report the same set of financial information, thereby making it easier for foreign companies to list their stock on domestic stock exchanges, in the process increasing the value of the stock exchange. Perfect information will lead to the efficient allocation of resources and transfer of capital around the world, increasing the performance of financial markets. Countries that implement internationally accepted reporting standards are able to improve their competitiveness due to the performance of their financial markets and stock exchanges, thereby attracting foreign capital and foreign currency. In this case, harmonization of accounting standards may increase international trade, and improve the world economy.

Criticism

Harmonization of international accounting standards will not be an easy task due to the numerous obstacles in place. Nationalism is perhaps the biggest obstacle in this case, as individual countries try to maintain authority over their own reporting standards rather than relying on recommendations by the IASB (International Accounting and Standards Board). A majority of countries would prefer to implement their own accounting standards based on their specific and unique economic and political conditions, which could not be considered by the IASB in the formulation of International Financial Reporting Standards (IFRS).

Political interference is another major obstacle as most regulatory bodies in different countries depend on the government as the major source of funding. This creates a dependency on the government by these bodies, resulting in the government having an influence on the regulatory bodies. Governments that are reluctant to forego control of their country’s accounting policies may abstain from committing their countries to the implementation of the international financial reporting standards (Previts, 2008). The problem is more pronounced in countries where the government establishes and enforces accounting and reporting standards than in countries where an independent body of professionals formulates the accounting policies. Political interference may also be experienced when a government does not want to improve transparency in its operations.

Multinational corporations that benefit from the lack of harmonization of accounting policies are likely to resist adopting internationally agreed accounting standards. Such multinationals could be benefiting from information arbitrage due to discrepancies in reporting standards in different countries. Due to their size and scale, multinational companies have influence over the adoption of the IFRSs and could use their power and influence to lobby against its implementation.

The process of harmonization of accounting standards faces other challenges such as translation. When the IFRS are translated into a form useable by a nation, for instance from English to Chinese, some statements or transactions could lose meaning in the form of valuable information, thus making the implementation process more difficult for countries that do not have English as their official language. This could add to the costs of implementation and compliance with the international financial reporting standards.

Other costs of compliance that are likely to rise to involve the amount of time and resources used in the planning, training and education processes. Professional accountants have to be updated on the differences between their former accounting structures and the new system. Educational institutions will not only have to change their syllabus but also have to train their staff on the IFRS, which could prove to be costly (Fischer, Taylor and Cheng, 2008).

Companies that have implemented the IFRS may also require their accounting and finance staff to learn the new system, and may have to offer incentives to their employees in order to retain the talent, skills and experiences, and save the expenses of recruiting new staff. Companies may also have to change prior period financial statements to match current statements in order to allow for comparability, and also enable meet shareholder requirements.

Differences in political and economic systems around the world could mean that accounting policies that apply to one region may not necessarily apply to another nation. Such differences could be brought about by differences in culture and social backgrounds, and the level of government involvement in the business. Socialist and communist countries differ significantly from capitalist states; therefore it would be challenging to formulate accounting policies that are workable in both systems (Elliot, B. and Elliot, J., 2006).

The divergence of accounting principles in light of globalization led to the formulation and development of efforts toward the harmonization of accounting standards internationally (Godfrey and Chalmers, 2007). With globalization, both companies and individual investors have transferred their capital beyond their national borders, and hence came the need for improving communication and increasing the value of information. Multinationals are tasked with translating consolidated financial statements from their subsidiaries located in different countries which is challenging given the fact that multiple countries have different reporting requirements. Multinational companies, therefore, have to retrieve financial statements from their subsidiaries and translate them into a form that matches the standards used by the parent company without losing valuable information or diluting the relevance of certain accounting items in the process.

Internationally harmonized accounting standards are likely to lose the flexibility enjoyed by domestically formulated, implemented and controlled national accounting policies. National accounting policies are usually designed to be responsive to changes in the political, regulatory and economic environments, which serves as a major advantage for the domestic system. Internationally harmonized financial reporting standards on the other hand would be slow to adapt to changes in the environment. Harmonized standards would be rigid because all contributing parties to the International Financial Reporting Standards (IFRS) would have to agree on any changes before they can be made to the set standards, a process that could take a considerable amount of time.

If accounting standards have been harmonized internationally, then changes in one part of the world may not warrant changes in the IFRS, which could be detrimental to the affected countries. Updating or further developing the IFRS would be a slow process because all countries have to agree to any changes in the international accounting standards (Saudagaran, 2009) and a majority of countries could therefore lose out on the benefits that would have accrued had they reacted in a timely manner. Harmonization will also not cater to the wide range of national characteristics that make countries unique and competitive, so countries that rely on their policies to attract foreign investors will lose a degree of their competitiveness when they adopt the IFRS.

Although harmonization of accounting standards could benefit developing countries by making them at par with international accounting standards, the move could be viewed as an attempt to impose a given level of accounting policies on developing nations by economic superpowers. The current debate on the adoption of the IFRSs lies with economically superior countries in the form of the European Union, the United States, and other developed nations while developing countries have been left out of the debate and have little say over the adoption of the IFRSs.

The implication of harmonizing accounting standards is that developing countries will be forced, rather than choose, to adopt the harmonized accounting standards in order to retain their competitiveness. Since developing countries may not contribute or may not be consulted by the International Accounting Standards Board in the formulation and development of the IFRSs, domestic accounting standard-setting bodies may collapse. Country unique accounting policies that were formerly in place in their domestic accounting standards may be lost. Accounting professionals that initially used their expertise to develop national accounting standards will also be left without work.

The International Accounting Standards Board may be biased in the formulation of IFRSs due to its heavy involvement with the UK and the EU. As a result, the IFRSs have a high probability of reflecting the accounting standards that favor European countries. The US is the biggest and strongest economy in the world, meaning that it would have significant influence and may take advantage of its position to have its way with certain accounting policies. The implication is that the IFRSs will not be balanced to reflect the proposals of the entire international community. Countries that have smaller economies will subsequently have little impact on the formulation of international financial reporting standards.

As countries are uniquely different, the IASB may find it difficult to arrive at a common agreement among all countries, which is likely to slow down the development process and future improvements altogether. Due to the differences in legal, political and economic environments, the International Accounting Standards Board may have to compromise on certain standards in order to attain consensus (Rodgers, 2007). This may dilute the fundamental benefits and values of the international financial reporting standards, in the end making the IFRS inadequate which defeats the purpose of suggesting the harmonization of accounting standards in the first place. Due to the compromise, countries that had adequate accounting policies may feel that the IFRSs fall below their standards, and may subsequently choose to withdraw from the harmonization process.

Harmonization of accounting standards can also be criticized for its implications on small and medium enterprises. A majority of SMEs have their activities limited within their national boundaries, and could also have a limited set of accounting records. SMEs already have to comply with national regulations and adapt to economic and social environments (Black, 2003). Adoption of the International Financial Reporting Standards in their case only puts additional pressure on the small and medium-sized enterprises to comply with the complex and often costly international reporting standards which could be overwhelming for the SMEs. The SMEs could already be satisfied with national accounting policies and may not see the need of incurring expenses and spending valuable time in the changeover from their current accounting systems to the IFRSs.

Conclusion

Harmonization of accounting standards implies the convergence of accounting policies and standards implemented in countries all over the world. This means the elimination of differences in various national accounting standards, and the matching of domestic accounting policies with the International Financial Reporting Standards (IFRS), as adopted by the International Accounting Standards Board (IASB). The main objective of the IASB, through the formulation of the IFRSs, is to provide an internationally agreed-upon accounting and reporting framework. Nations that agree to the IFRS are required to either replace their domestic accounting standards with those provided by the IASB or alternatively work progressively towards the convergence of their accounting policies with the IFRSs (Mirza, Holt and Orrell, 2006).

The adoption of the international financial reporting standards would ascertain the consistency of accounting policies, thereby providing a level playing field for all companies. Policies implemented to protect economies from the risk of future financial crises would be efficient due to the cooperation in the formulation and enforcement of financial reporting policies. Decreased risks of translating and consolidating financial information may increase investor confidence and market performance is likely to increase. This would be more effective than the case where each country adopted its own domestic reporting standards, the reason being that poorly performing multinational companies and weak financial markets may not be easily identified in countries that have lax financial reporting standards. On the other hand, a harmonized and efficient international financial reporting system would enable such companies or financial markets to be quickly identified and corrective action taken in a timely manner.

Harmonization of accounting standards would greatly benefit investors by making financial reports of companies from different countries more comparable, without having to convert or translate the financial statements (Nobes and Parker, 2006). The tendency of the world towards perfect information across boundaries would reduce the risks associated with interpreting foreign financial statements, in the process allowing for the free movement of capital in the international markets.

Harmonization of accounting standards eliminates regulatory arbitrage that exists when different nations implement different accounting policies (Blake and Lunt, 2001). In the current setting, multinational companies could identify mismatching accounting standards principles in different nations, especially weak standards, and exploit such standards in a manner that would solely benefit such companies. International accounting financial reporting standards would not enable companies to take advantage of such arbitrage opportunities.

Consistency of financial reporting standards would also reduce the compliance costs for multinational companies wishing to list their shares no foreign stock markets since the disclosure requirements are the same as those in their countries of origin (Greuning and Koen, 2001). Some multinational corporations have noticed that is unnecessary, and uneconomical, to maintain different sets of accounting records, for example, US GAAPs (Generally Accepted Accounting Principles) when complying with SEC (Securities and Exchange Commission), and IFRS when trading their shares on foreign stock markets, especially in the European countries. Multinational companies based in Europe do not have to go through the same hurdle as their US since use IFRS for filing their reports in both Europe and in the US since the SEC has removed the reconciliation requirement that instructed them to translate their financial statements to comply with US GAAPs (Tweedie, 2011).

Harmonization of accounting standards should not be confused with the standardization of accounting. Standardization requires the complete matching of accounting principles, leaving no room for variation between the various accounting standards implemented by various countries. Harmonization on the other hand means the convergence of accounting standards to a common point of agreement. Therefore, this implies that the main difference between the two concepts is that harmonization tries to reduce the differences between various accounting standards while standardization aims to eliminate all variations altogether, meaning that all countries use the same set of accounting and financial reporting principles.

Progress is being made in the convergence of international accounting policies, meaning that the harmonization of accounting standards will indeed become a reality in the near future. Currently, more than 100 countries have required or otherwise permitted the use of International Financial Reporting Standards for publicly traded companies, according to the IASB. The European Union made the decision in 2005 requiring all EU-listed companies to comply with IFRS (International Financial Reporting Standards, 2007), while other countries have suggested that they might follow suit. Some countries have expressed to adopt the IFRS once the US has complied since they feel a truly international accounting system should include the commitment of the world’s biggest economy. With international pressure building up, it is a matter of time before the world embraces the international financial reporting standards.

Therefore as indicated, there are also political advantages and disadvantages of internationally harmonized accounting standards, For example, the US has been resisting the harmonized standards over its own standard system bringing forth the ideology of nationalism. Greuning and Koen (2001) note “everyone who seriously considers global accounting harmonization as a potential method affirms that nationalism is one of the top constraints to becoming a reality.”

Therefore as globalization takes place, companies around the world will choose either to adopt the international accounting standards or not depending on the advantages that they see in them hence those that make a wrong decision on the issue are likely to suffer financial constraints arising from their accounting methods. Nevertheless, a harmonized accounting standard will be more beneficial to companies, especially multinational companies around the world as they will have a standard framework to work on. Also, the system will favor the government as they will be in a position to have legislation or an accounting policy that doesn’t contradict will international companies, hence making it easier for both the Multinational companies and the government to conduct business on one platform.

Apart from the government and multinational companies, the harmonized framework will also benefit the small scale or individual businesses as they too will enjoy the benefits of a global accounting standard that is tailored to make business operation easier since they too will have an effective financial reporting standard.

Reference list

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