A Non-Technical Guide to International Accounting

Roger Hussey, Audra Ong

• Publisher: Business Expert Press
• Year: 2019
• ISBN:
  9781946646873
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

Business has become more international and more complex. Whether you are a manager, a student, or someone generally interested in corporate financial information, you want information and you want to understand that information. Companies in all countries are required to generate financial information, if for no other reason than to settle their tax obligations.

If you are interested in the larger companies, such as those listed on a stock exchange, they must make financial information public, and the nature and type of that information is strictly regulated. Companies must comply with accounting standards. Many countries use the International Accounting Standards issued by the IFRS Foundation. This is a not-for-profit international organization that has developed a single set of high-quality global accounting standards. These standards can be complex, but this book explains clearly the main requirements.

CHAPTER 1

The Growth of International Accounting

About This Chapter

The basic process of accounting, known as double entry ­bookkeeping can be traced back for many centuries. The first formal book of ­instruction on the use of this method appeared in 1494 (Pacioli). An explanation of the history can be found in Sangster (2016). Every organization now keeps some form of financial records. Even with the smallest business, the owners, the tax authorities and possibly the bank, will want to know its financial performance and its financial strengths and weaknesses.

When we consider large companies, particularly those with shares publicly traded on a stock exchange, there will be national legislation compelling them to disclose financial information publicly. Companies comply by issuing a document that will contain financial statements and other corporate information. There may even be the requirement for limited financial information to be published half-yearly or quarterly.

The annual documents are lengthy, usually more than 200 pages. They include the financial statements and accompanying Notes required by accounting standards. This takes up roughly 50 pages. There will also be information required by government legislation and that which the company decides to include, such as product details. Over recent years there have been moves in many countries for companies to provide information on various topics that come loosely under the general heading of “Corporate Governance.” The main headings you may find that make up the total contents of present “Annual Report and Accounts” document are:

Strategic Report

Governance Report

Corporate Social Responsibility

Management Report

Report of the Chairman

Financial Statements (or Annual Report and Accounts)

One can obtain a company’s annual report and accounts by contacting them. You will also find that most companies have a website and you can download the annual report and accounts for several years. Take care! The sheer volume of the information available can be intimidating, with financial information being only one part of it.

Legislation is necessary to ensure that companies are properly run but is a very unwieldy system for determining the detailed financial information companies should disclose in the annual report and accounts. Another process is required. In this chapter, we discuss the development of regulations in the form of national accounting standards. We identify the limitations of such an approach and explain the birth of international accounting standards and the development of international financial reporting standards.

Many countries now use international financial reporting standards including Australia, Canada and all member states of the European Union. One country that started to converge its own standards with international accounting standards was the U.S. We describe that process as well as the reasons that full convergence did not take place.

Problems with National Accounting

On a personal basis, most of us do some simple form of accounting. We need to ensure that we do not spend more money than we possess or we can borrow. We keep a record of how much money we have in the bank and we may have to decide whether we need a loan and, if so, whether we can pay it back.

The owners and managers of a business need to conduct more detailed accounting. They require financial information to make decisions and monitor business activities. They may also have to keep shareholders and other lenders informed. There may be various groups of people and individuals, not employed by the company, who require financial information or are legally entitled to receive it. The purpose of financial accounting is to provide that information. The larger the business, the more complex the accounting system will be.

In most countries there are usually regulations that specify the types of organizations that must produce financial information. This regulation may be part of the law of the country, but is usually in the form of accounting standards, also known as financial reporting standards. These are issued usually by a professional accounting body, or some organization specifically established for the purpose within that country.

Accounting standards are concerned with specific economic transactions, arrangements and events conducted by a business. For example, you will have one standard that is concerned only with identifying and measuring the revenue that a company receives. Another standard will set out the procedures for purchasing buildings and machinery. Other standards apply to such topics as accounting for valuing goods you have in stock and recording transactions in a foreign currency.

A standard usually focuses on the following three topics:

1. 1.Recognition. This specifies the transactions and events that should to be incorporated into the financial statements. The Chief Executive having a heart attack may be interesting and impact the share price of the company, but it is not shown on the financial statements. The factory burning down will be.
2. 2.Measurement. The method used to determine the financial value of transactions and events. This can be tricky. Everything a company does has to be converted into financial measures. With many items there are no problems, but we need to know how entities do their calculations and to have confidence in their methods. Accounting standards provide this reliability. With some transactions and events there must be estimations and we will discuss these when we consider the individual standards.
3. 3.Disclosure. Companies do not “open their books” to anybody who asks. Not only are there concerns over privacy, but the volume of information is huge. Information must be extracted and disclosed in a useful way. There is a standard that specifies the content and structure of the main financial statements. We explain these statements in detail in the following chapters.

In early times there were no accounting standards. Companies decided themselves how to account for their activities and, frequently, would not give investors and lenders a complete picture. Not surprisingly, shareholders relying on this financial information could “scarcely avoid arriving at erroneous conclusions” (Naylor 1960). To protect those who use the financial statements of companies for investment decisions, many countries began to develop their own accounting standards. Frequently, it was an organization of professional accountants in a particular country that began to recommend to its members how to account for financial transactions and activities.

In the U.S. the Securities and Exchange Commission (SEC) was established in 1934 by the Securities Exchange Act to remedy the poor corporate financial information that was available (Galbraith 2009). In 1973, The Financial Accounting Standards Board was established and is accountable to the SEC for setting accounting regulations. These were first issued as Statements of Financial Accounting Standards, and since 2009 there has been an online Accounting Standards Codification (ASC) in the U.S.

Accounting Standard Updates (ASUs) are issued to amend the codification. Updates are published for all authoritative U.S. GAAP released by the FASB, regardless of the form in which such guidance may have been issued prior to release of the FASB codification. Updates will also be issued for amendments to the SEC content in the FASB codification, as well as for editorial changes.

Other countries also have established their own methods requiring companies to provide publicly financial information. Unfortunately, the accounting techniques and methods of accounting can have strong national characteristics. In other words, one could not compare the information in the financial statements of companies in the U.S. with those in the U.K. or Japan, or any other country because they had different methods for recognizing, measuring and disclosing financial transactions and events.

Much has been written on the reasons for countries having different financial accounting and reporting regulations (Frank 1979; Mueller 1967; Nair and Frank 1980; Nobes 1983). The main reasons would appear to be:

1. 1.The different sources of external financing for companies. In some countries, companies rely on financing from wealthy private individuals. In other countries there is a stock exchange where a company can list its shares.
2. 2.The legal system in the country will reflect the values and procedures within that country including financial accounting.
3. 3.The types of business organizations and ownership differ.
4. 4.The culture of the country will influence the approach to regulating corporate activities.

Although national regulations for financial accounting greatly improved financial reporting in one country, there were substantial problems at the international level. If you wanted to do business, buy shares, or make loans with a company in another country you could not refer to their nationally produced financial statements, unless you “translated” them to your own methods.

When countries use different accounting standards to regulate the financial statements of companies operating within their borders, there is difficulty in comparing a company in one country with one in another country. As businesses and investors have become more international in their activities, this has caused problems.

To compare the financial statements of a foreign company to that of a U.S. company, the financial statements had to be redrawn according to the U.S. method of accounting to give the “profit or loss” ­according to U.S. regulations. This was not only a laborious task, but the amount of profit shown under the two different country systems could vary considerably. The worrying question was “Which one is the ­correct figure?”

The Start of International Accounting

After the Second World War, international trade began to increase. Companies were buying and selling in different parts of the world, and investors and lenders of finance were also taking an international approach. The problem of being unable to compare financial statements drawn up under different national procedures was a major obstacle to an increase in international activity. Some form of action was required.

In 1973 the national accountancy bodies, not governments, from Australia, Canada, France, Germany, Mexico, the Netherlands, the United Kingdom, Ireland, and the United States met and agreed to form the International Accounting Standards Committee (IASC). This was to be based in London, U.K. with the task of establishing international accounting standards. These would be used by companies, whatever their country of origin.

Unfortunately, progress was slow. The (IASC) was a private sector, non-governmental organization. It received modest funding and had only a part-time body of standard-setters who met 3 or 4 times annually to agree on a uniform way of accounting.

In its early years, with scarce resources and little power, the IASC concentrated mainly on the harmonization of financial reporting on a worldwide basis. It issued its first International Accounting Standard, IAS 1 Disclosure of Accounting Policies, in January 1975 and in October 1975 issued IAS 2 Inventories. This standard, although it has been amended, is still in force.

There were external factors that assisted the work of the IASC. Many emerging economies were attempting to establish themselves in international trade. The IASC offered a way for following an appropriate and acceptable accounting regime. A company’s financial statements could be understood by interested parties in other countries.

A second factor assisting the IASC was the increased involvement from several organizations in developing international business activities. The European Union (EU) for many years had been seeking accounting harmonization throughout the EU. This was achieved by issuing “Directives” that were binding to all member states. Towards the end of the 1980s, the European Commission gave increasing support to the efforts of the IASC.

Although the IASC made progress, it was under resourced. It was heavily reliant on the support of national accounting bodies as well as other parties who sometimes argued for international standards that best met their own national interests. The aim was international accounting regulations, but the question was whether the IASC could achieve that aim. Either a complete overhaul of all aspects of the IASC was required or a new body must be formed. The latter was the course of action chosen.

In 1992, the three standard setting bodies of Canada, the United Kingdom, and the United States met to discuss ways for making greater progress. Australia and New Zealand later joined the working group, and this became the group known as the G4+1.

In January 2001, it was agreed that G4+1 group would disband and a newly constructed organization, the International Accounting Standards Board would replace the IASC. The IASB, with a highly experienced accountant, David Tweedie, as its Chair was established in April 2001. It had more substantial financial support than the IASC and a reorganized structure.

The IASB kept several of the IASs issued by the IASC and commenced issuing its own standards entitled International Financial Reporting Standards (IFRSs) starting with IFRS First-time Adoption of International Financial Reporting Standards followed by IFRS 2 Share-based Payments.

The numbering of individual standards is somewhat confusing. The present position is that the IASC issued 41 standards between 1975 and 2000. The standards were numbered consecutively starting with number 1. Each standard also had a descriptive title, for example, IAS 7 Cash Flow Statements. Most of the IASC standards are still in effect.

When the IASB took over from the IASC it “adopted” the IASs still in force and started to issue its own standards. These are named International Financial Reporting Standards (IFRSs). Once again, these standards are numbered consecutively, starting with number 1 and have a descriptive title, for example, IFRS 7 Financial Instruments: Disclosures.

When referring to all the standards that have been issued, we generally use the term international standards. It is essential, however, to use correctly the term IAS or IFRS when referring to a specific standard, for example, IAS 2 Inventories or IFRS 2 Share-Based Payment.

The Spread of Internationalization

The pressure for international accounting standards arose from the need for comparable financial statements. The financial reports of all companies would be prepared according to the same principles. Ideally, all companies would use the same accounting standards in their financial reports.

Several countries have adopted international accounting standards. This does not necessarily mean that those countries require all companies within its borders to comply with them. Normally, it is only major companies listed on its national stock exchange that must do so. ­Usually smaller companies will follow the national regulations for financial reporting or, if ...