Need for a Common Set of Accounting and Financial Reporting Standards
As the oft quoted verse from the world-renowned works of Shakespeare (Romeo and Juliet) goes: “What’s in a name? That which we call a rose by any other name would smell as sweet.” One wonders if the same can be said of financial statements prepared in different jurisdictions of the world. Not too far in the distant past, countries and economic regional blocs, such as Europe, would not be swayed by the thought of converging to a single set of global accounting standards and, due to nationalistic approaches to accounting standard setting, a financial statement issued in Japan (under the Japanese accounting standards) was vastly different in terms of accounting treatments and disclosures compared to a financial statement issued in other major parts of the world, say, in Germany where German accounting standards were used. In other words, the “name” that was given to the set of accounting standards used in the preparation of financial statements did matter for several countries since their national standard setters strongly believed that their own (national) accounting standards were suitable for their needs and were compatible to other globally preferred accounting standards.
However, due to the advent of globalization, the falling of the erstwhile insurmountable trade barriers between nations, and more recently the much-awaited response to the global financial crisis, together with calls by world leaders, things have changed dramatically in terms of the preferred set of standards of accounting globally. The accounting and financial world is now seriously considering the notion of using a single set of accounting and financial reporting standards that would be used by most, if not all, the nations around the globe, it appears that in all likelihood the name of that set of global accounting standards may be the International Financial Reporting Standards (IFRS®).
With this transformation of our world into a “flat world” (as some claim) the magical phenomenon of globalization has led to the emergence of a “global village” that we all live in now. The robust waves of globalization surging through the world seem to have transformed businesses across the globe as well as the manner in which they deal with each other across boundaries. If therefore, as the old adage goes, “accounting is the language of business,” then businesses around the world cannot afford to be speaking in different languages to each other while exchanging and sharing financial results of their international business activities with each other, and also while reporting the results of business and trade to their international stakeholders. As one school of thought believes, since business enterprises around the world are so highly globalized now and need to speak to each other in a common language of business, there is a real need for adopting a single set of accounting standards to unify the accounting world under one canvas and more importantly, solve the problem of diversity of accounting practices across borders.
Historically, countries around the world have had their own national accounting standards (which some countries have treasured for whatever reason, most likely due to the pride of national sovereignty). However, with such a compulsion to be part of the globalization movement, wherein businesses across national boundaries are realizing that it is an astute business strategy to embrace the world as their workplace and marketplace, having different rules (standards) of accounting for the purposes of reporting financial results would not help them at all (rather, it would serve as an impediment to smooth flows of information), and therefore, businesses have realized that they need to talk to each other in a common language. Thus, there is an urgent need for a common set of global, or even universal, accounting and financial reporting standards that are understood, used, and interpreted by different people around the world in the same manner.
The adoption of accounting standards that require high-quality, transparent, and comparable information is welcomed by investors, creditors, financial analysts, and other users of financial statements. Without a common set of accounting and financial reporting standards, it is difficult to compare financial information prepared by entities located in different parts of the world. In an increasingly global economy, the use of a single set of high-quality accounting standards facilitates investment and other economic decisions across borders, increases market efficiency, and reduces the cost of raising capital. International Financial Reporting Standards (IFRS) are increasingly becoming the set of globally accepted accounting standards that meet the needs of the world’s increasingly integrated global capital markets.
What Are IFRS?
IFRS is a set of standards promulgated by the International Accounting Standards Board (IASB), an international standard-setting body based in London, United Kingdom. The IASB places emphasis on developing standards based on sound, clearly-stated principles, on which interpretations may be required (sometimes referred to as principles-based standards). This contrasts with sets of standards, like US GAAP, the national accounting standards of the United States, which contain significantly more application guidance. These standards are sometimes referred to as rules-based standards, but that is really a misnomer as US standards also are based on principles—they just contain more application guidance (or “rules”). IFRS also generally do not provide “bright lines” in distinguishing between circumstances in which different accounting requirements are specified. This reduces the chances of ‘structuring’ transactions to achieve particular accounting effects.
According to one school of thought, since IFRS are primarily “principles-based” standards, the IFRS-approach to standard setting focuses more on the business or the economic purpose of a transaction and the underlying rights and obligations and therefore, instead of providing prescriptive rules (or guidance), IFRS promulgates Standards that lay down guidance in the form of “principles.”
This significant difference in approach to standard setting between IFRS and US GAAP is responsible for the limited number of pages that the IFRS Standards are spread over compared to US GAAP (US GAAP extends to over 20,000 pages of accounting literature as opposed to IFRS which presently is covered in approximately 2,000 to 3,000 pages).