MA601 Current Issues in Accounting: Adopt the IFRS

Answer:

Introduction

Globalization of business operations requires universal accounting standard that will streamline financial reporting systems. This effort has seen the International Accounting Standard Board (IASB) develop a set of international accounting standards called the International Financial Reporting Standard (IFRS). The body gave guidelines of reporting particular transactions in the financial statements.  Currently, over one hundred countries are using the IFRS and questions are in the air why an economic giant like the United States of America (USA) is still hesitant to adopt the IFRS but still using Generally Accepted Accounting Standards (GAAP) (Horton, Serafeim & Serafeim, 2013).

The establishment of IFRS had a goal of having a common accounting language so that accountants and businesses can understand one another from country to country and company to company. Conversely, the Securities and Exchange Commission (SEC) who controls the financial markets in the US have the mandate of creating fair markets, ensuring true and fair corporate disclosure (Brown, 2007), looking towards the future, protecting investors and protecting the GAAP rules and regulations. SEC has given the mandate of improving and setting accounting standards on US GAAPs to Financial Accounting Standard Board (FASB) to work in the interest of the US companies (Brown, 1981). This has seen maintaining of the GAAPs despite calls from the European Union to have a single financial reporting standard. 

Significant financial reporting differences between IFRS and GAAP

The USA GAAPs portray significant differences to IFRS in reporting financial statements. As such, GAAP has a different way of calculating financial ratios. For example, IFRS has a flexible way of reporting revenue, in particular, companies can report revenue as soon as possible which may cause the balance sheet in this reporting system to reflect the higher stream of revenue (Lantto & Sahlström, 2009). Besides, when reporting expenses under IFRS, a company can capitalize monies used in developing investments for the future and does not necessarily regard that expenditure as an expense (Kvaal & Nobes, 2010).  Further, when accounting for inventory, GAAP acknowledges the use of first in first out (FIFO) and last in first out (LIFO). FIFO here means that selling of stocks is in the sequence of arrival, the stock that arrives first is sold after which the company can begin selling new arrivals, and LIFO means that the latest stock is given first priority when making sales. However, GAAP adopts FIFO and LIFO, IFRS does not allow the adoption of LIFO inventory management system. The existent of such differences have contributed to hesitations of US to adopt the IFRS. Among other factors are;

Fear of losing business

The US is an economic giant that has her way of financial statement reporting, which is the US GAAP. Succumbing to the pressure of adopting the IFRS will mean that there will be no comparison between financial reporting standards and even the IFRS itself will not have an edge over any strong financial reporting standard. Of note, adoption of the IFRS will harm investors in the US stock market as listings will shrink leading to losses.

Inconsistency of IFRS application

There are a lot of inconsistencies in the application of IFRS as it provides a leeway where individual accountants can make personal judgments unlike the US GAAP that have accepted and detailed guidance and established practice (Ball, 2006). Inconsistencies exist in industry accounting and reporting under the IFRS principles, whereas under GAAP, there is elaborate guidance on the presentation of many specific transactions such as cost related to revolving lines of credit.

Report by Securities and Exchange Commission in 2012 asserts that there was no need to replacing the US GAAP, a high-quality accounting standard, with a set of global standards to only achieve uniformity while disregarding quality and consistency.  The report further argued that the adoption of GAAP in the US financial reporting system under the authority of the FASB is far itself an  indication GAAP meet the sufficient quality necessary for maintaining and improving financial reporting system. This signifies that even if the US adopts the IFRS, then significant changes is necessary to meet US investors' expectations which will alter the general reporting principles of IFRS.

Litigious business environment in the US

The business environment in the US is highly litigious and when financial reporting system goes wrong, auditors and accountants are held responsible. Further, creditors or investors' problems are directly linked to the reporting. Under the US GAAP, there are adequate elaborations on the reporting rules due to a high professional liability of accountants and auditors compared to IFRS whose main goal is achieving uniformity in the global financial reporting system leaving accountants to make judgments on their own. Even though professional judgment is acceptable, there are chances of making biased judgment which may have a negative influence on the outcome. Because of this, US accountants require elaborate rules for all possible decisions to avoid liability if anything goes wrong. For this reason, USA is hesitant to adopt the IFRS. 

Benefits of adopting IFRS

Studies conducted on the viability of IFRS indicate significant improvement among the 100 countries who are currently using the financial reporting principle in their accounts (Horton, Serafeim & Serafeim, 2013). European Union countries who have already adopted the IFRS are enjoying some of the benefits across a range of economic phenomena such as international capital flows, corporate investment efficiency, market liquidity, reduced cost of capital, comparability, and transparency (Daske, 2006). Even though research evidence shows uneven distribution of these benefits among different countries and companies due to institutional differences in incentives and contexts, the overall benefits outweigh its disadvantages. The move to adopt IFRS has had important economic benefits for Europe.

Transparency

Financial reporting transparency is achieved when readers when readers are able to understand the financial position and financial performance of a company with ease. IFRS adoption across the over 100 countries have streamlined their financial system and brought transparency in areas such as accounting for share-based payments which were not addressed adequately in GAAPs of various countries. Besides, many countries had no comprehensive financial instrument standard which IFRS has now brought. Additionally, legal requirements and company law often have a limited representation of transactions elements in the financial statements such as the presentation of preference shares or non-equity, but the adoption of IFRS has introduced these elements. Standardization of accounting practice in form IFRS is making it easy for any individual to comprehend financial statements comparing it with multiple GAAPs used earlier.

Accounting equality

Adoption of IFRS has eliminated elements of poor accounting quality which were characterized by recognizing only good reporting news from untimely recognition of losses, and income smoothing (Barth, Landsman & Lang, 2008). Incorporation of IFRS into the financial reporting system has eliminated such practices which only ended hurting investors in the long run. Following the set IFRS principles mean that there is reporting of true and fair view of a company's state of affairs.

Comparability

The universal IFRS reporting system is making it easy for investors, creditors, financial institutions to easily compare the performance of a company over several years or different related companies to achieve a specific objective. The comparability aspect is quite evident in accounting for financial instruments, financial reporting, which is similar among the member countries.

The cost of capital

In-depth research on the adoption of IFRS shows that European Union companies are realizing a significant reduction in the cost of equity and debt capital. A majority of the companies are benefiting from the reduction of cost of bonds and equity capital. Moreover, raising capital, have become very easy due to increased transparency exhibited when accounting for derivative financial instruments (Lee et al. 2010). Further, the process of accessing international finances is quite easy with the adoption of IFRS compared to the previous United Kingdom GAAPs which were complex and consumed a lot of time during scrutiny. 

Cross-border investment and market liquidity

Cross-border investments are thriving in both foreign portfolio investment and foreign direct investments (Ramanna & Sletten, 2009). Investors across the member countries adopting IFRS in preparing financial reports are able to easily understand market technicalities in their target markets since they are familiar with the reporting system thus able to understand financial structures. It is no doubt that universal reporting system is friendly to investors in understanding different aspects of the market. Moreover, the adoption of IFRS has increased the liquidity of equity markets for the European Union members. 

Free market economy

In a free market economy, companies and businesses can produce and sell their goods and services with little or no control from any central government agency or international body as far reporting of their financial statements is concerned (Baumol, 2002). However, the accounting standards are set for financial accountability, different political aspects, economic and social factors is shaping the accounting regulations standards. Even though the majority of policy makers believe in regulations to caution investors on perceived market risks, there is a need to have a free market where companies can prepare their financial reports in a manner that suits them. This freedom in reporting of financial statements has both positive and negative effects on the business.

Positive effects

Promotes innovation

When companies have the freedom to prepare their financial statements in a manner that suits them, then there are aspects of promoting innovation in the financial reporting sector (Rigby & Zook, 2002). Different companies have the freedom to come up with ways that meet their financial goals thus they are free to incorporate different strategies. In the process, new viable ideas are created.

Cost reduction

The current accounting regulation standards such as the IFRS and the GAAPs have cost implications associated with them. Adhering to these standards require subscriptions to membership and monthly payouts to support the activities of the board. Therefore, having the freedom to prepare one's financial statement without subscribing to these regulation help cut these cost to the company (Bouët et al. 2010).

Negative effects

Dangers of profit motive

When companies have the freedom of preparing their own financial reports, they will be tempted to only portray the business as profitable which may have negative impacts on investors (Ball, Robin & Wu, 2003).. Investors will not be able to access true and fair view of the company's state of finances at a given time thereby making wrong investments decisions. 

Lack of transparency and comparability

Standard reporting principles and rules such as the IFRS and the GAAPs provide a platform where regulators, investors, and customers can compare the performance of different companies. An investor can easily compare the performance of the companies he or she is interested in, basic with parameters in mind. In addition, there is transparency when the universal standard is used among competing companies to verify and approve their performance. Overall, when there is free market regulation, these important aspects of transparency and comparability will be missing leaving investors at the mercy of unethical companies. 

Pro-Regulation Of Financial Reporting

Increased competition and the globalization of businesses require universal regulations to protect businesses and promote healthy competition in every sector. Many companies are expanding their operations to different countries and this has been possible because of their stable financial status. Achieving this status is pegged to IFRS or GAAP from which we can conclusively make decisions to expand or not. There, financial reporting regulations are necessary to eliminate unethical companies who might take advantage of unsuspecting investors by inflating their profits to lure them to their companies. It is also important to have a common reporting standard which promotes transparency, accountability, and comparability of different financial reports.

Regulations provide grounds for measuring accountability of accountants and managers. Where managers and accounts collude to fraudulently understate their sales, and assets and overstate their profits and purchases, then, available accounting rules will provide ways of detecting such malpractices (Liou & Yang, 2008). Profits being the major driving force for business, overstating of such by accountants and managers is punishable since investors make investments decision based on profits generated by a particular company (Cahan, Liu, & Sun, 2008). The auditing firm will also be held responsible if they approve of such fraudulent scheme to steal money from investors.

Financial statements of a company can guide our decision-making process when we want to invest in a particular sector (Healy & Palepu, 2012). Among the competing firms, we can make a judgement on which firm to choose when their financial statements are transparent and comparable. Accounting regulations provide a standardized format of preparing financial reports upon which investors can make easy and faster comparison on the same. It is, therefore, important for regulation to be in place to promote transparency and comparability of different financial statements reports. 

Conclusion

Both IFRS and GAAP are very important in maintaining sanity in the financial markets and reporting. Even though there are questions of about USA adopting the IFRS to have universal reporting standard, there are milestones that the US have achieved and some differences in business environments which has not made that a reality. As much as free markets are good for promoting innovation and help in cost cutting, the benefits of operating under regulations far much outweigh free market regulation for the benefit of investors and planning. Accounting principles are the only way through which global business can be transparent, accountable, and comparable.

References

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