International Accounting, 6/e Frederick D.S. Choi Gary K. Meek Chapter 8: Global Accounting and Auditing Standards
Learning Objectives • Define and understand the distinction between “harmonization” and “convergence” as they apply to accounting standards. • State the pros and cons of adopting international accounting standards. • Understand what is meant by “reconciliation” and “mutual recognition” of different sets of accounting standards. • Identify the six organizations that have leading roles in setting international accounting standards and promoting international accounting convergence. • Describe the structure of the International Accounting Standards Board and how it sets International Financial Reporting Standards. • Understand the major provisions of the U.S. Sarbanes-Oxley Act and why similar legislation is being enacted in other countries.
Standardization, Harmonization, and Convergence • Standardization • Rigid, narrow set of rules • One-size-fits-all approach • Less flexible than harmonization or convergence • Not the current thinking • Harmonization • Standards that are compatible – no logical conflicts • Means the elimination of differences among existing accounting standards • Convergence • Means the gradual elimination of differences in accounting standards • But might also involve a new accounting treatment not in any current standard • Involves cooperative efforts of IASB and national standard-setters • Now the preferred term over harmonization
A Survey of International Convergence • Advantages of international convergence • Investor understanding and confidence is improved. • Investor decision making is improved. • Capital is allocated more efficiently around the world. • Financial risk and cost of capital are reduced. • Strategic decision making in mergers and acquisition is improved. • Criticisms of international standards • Solution is too simple for such a complex problem. • Strips accounting of its flexibility to adapt to different situations. • Challenges national sovereignty. • A tactic of large accounting firms to expand their market share. • May create standards overload.
A Survey of International Convergence (contin) • Reconciliation and mutual recognition • Reconciliation • Financial statements based on home GAAP, but net income and stockholders’ equity reconciled to another GAAP. • This is the SEC requirement for foreign filers. • Less costly than preparing complete financial statements based on another GAAP. • But a summarized, incomplete picture. • Mutual recognition (reciprocity) • Jurisdictions accept financial statements based on each other’s GAAP. • Does not improve comparability. • Can create an unlevel playing field. • Evaluation • Arguments on both sides have merit. • But convergence and international standards are a reality.
Some Significant Events in the History of International Accounting Standard Setting • 1959 – Jacob Kraayenhof issues first significant proclamation that work on international standards should begin • 1973 – IASC created • 1977 – IFAC founded • 1978 – EU Fourth Directive issued • 1987 – IOSCO resolves to promote common, international accounting and auditing standards • 1989 – IASC issues Exposure Draft 32 • 1995 – IASC and IOSCO agree on core standards work plan • 1995 – EU adopts New Accounting Strategy • 2000 – IOSCO accepts IASC’s core standards • 2001 – EC proposes that EU-listed companies use IAS by 2005 • 2001 – IASB succeeds IASC • 2002 – Norwalk Agreement signed between IASB and FASB • 2005 – SEC “roadmap” to eliminate IFRS reconciliation requirement
International Accounting Standards Board • Overview • Independent private-sector standard-setting body • Objectives • To develop, in the public interest, a single set of high-quality, understandable, and enforceable global accounting standards that require high-quality, transparent, and comparable information in financial statements and other financial reporting to help participants in the world’s capital markets and other users make economic decisions • To promote the use and rigorous application of those standards • In fulfilling the objectives associated with (1) and (2), to take account of, as appropriate, the special needs of small and medium-sized entities and emerging economies • To bring about convergence of national accounting standards, and International Accounting Standards and International Financial Reporting Standards to high-quality solutions • Represents accounting organizations from approximately 100 countries • Standards follow fair presentation and full disclosure • Standards are principles-based
International Accounting Standards Board (contin) • IASC’s core standards and the IOSCO agreement • IOSCO agreed to IASC’s core standards plan in 1995 • IOSCO’s agreement was a major boost to IASC’s credibility • Core standards completed in 1998 • IOSCO approved core standards in 2000
International Accounting Standards Board (contin) • The new IASB structure • IASC was restructured as IASB in 2001 • Bodies • Trustees • Representatives from entire world • Appoints members of Board • Raises funds and oversees IASB activities • IASB Board • Issues International Financial Reporting Standards • 14 members – 12 full-time and 2 part-time • Actively partners with national standard setters to promote convergence • Follows due process in setting IFRS • Standards Advisory Council • Advises IASB Board on agenda and priorities • International Financial Reporting Interpretations Committee • Issues interpretations of IFRS
International Accounting Standards Board (contin) • Recognition and support for IASB • IFRS are widely accepted around the world • Significant events that boosted IASB’s credibility • IOSCO endorsement of (IASC’s) work plan • EC proposal that EU-listed companies use IFRS by 2005 • Norwalk Agreement between IASB and FASB • SEC response to IFRS • Supports work of IASB but does not yet accept IFRS filings by foreign companies • 2005 – Issued “roadmap” setting out the steps for eliminating requirement to reconcile IFRS to US GAAP • 2007 – Proposed eliminating reconciliation requirement by 2009
European Union • Overview • Company law harmonization designed to integrate European financial markets • European Commission has full enforcement powers for accounting directives
European Union (contin) • Fourth, Seventh, and Eighth Directives • Fourth Directive (1978) • Broad, comprehensive set of accounting rules • Valuation rules • Disclosure requirements • Format rules for financial statements • Individual company accounts • Applies to public and private companies • True and fair view is overriding requirement • Requires audits of financial statements • Seventh Directive (1983) • Consolidated financial statements • Required for groups of companies above a certain size • Specifies • Note disclosures • Director’s report • Requires audits of financial statements • Member states have wide latitude in incorporating provisions • Eighth Directive (1984) • Specifies qualifications for statutory auditors • Revised in 2006 and now called Statutory Audit Directive • Requirements for appointment and removal of auditors • Audit standards • Continuing professional education • Auditor rotation • Public oversight • Audits must follow International Standards on Auditing • Established European Group of Oversight Bodies • A response to European accounting scandals similar to those in the U.S.
European Union (contin) • Have EU harmonization efforts been successful? • Yes: • Directives improved financial reporting practices and brought about harmonization • Directives accelerated accounting development in many EU countries • No: • EU countries mostly adapted the new rules to their existing ones • Enforcement was uneven • Some difficult issues weren’t dealt with
European Union (contin) • The EU’s new approach and the integration of European financial markets • Requirement that EU companies listed on regulated markets prepare consolidated financial statements using IFRS • To become legally binding, IFRS must be adopted by the European Commission • European Financial Reporting Advisory Group (EFRAG) • Provides technical review and opinion of the IFRS • Standards Advice Review Group • Assesses whether EFRAG’s advice is well balanced and objective • Accounting Regulatory Committee • Recommends that the IFRS be adopted (or not) • Is the IFRS compatible with European directives? • Is the IFRS conducive to the European public interest? • European Commission • Adoption completes the process
International Organization of Securities Commissions (IOSCO) • Securities regulators from over 100 countries • Responsible for over 90 percent of global securities markets • Objectives of member agencies • To cooperate together to promote high standards of regulation in order to maintain just, efficient, and sound markets • To exchange information on their respective experiences in order to promote the development of domestic markets • To unite their efforts to establish standards and an effective surveillance of international securities transactions • To provide mutual assistance to promote the integrity of the markets by a rigorous application of the standards and by effective enforcement against offenses • Extensive work on international accounting and disclosure standards • Cooperates with IASB • Has endorsed IFRS for cross-border securities offerings
International Federation of Accountants • Worldwide organization representing the accountancy profession • 160 member organizations • 120 countries • 2.5 million accountants • Mission • To strengthen the accountancy profession worldwide • To contribute to the development of strong international economies by establishing and promoting adherence to high-quality professional standards, furthering the international convergence of such standards • To speak out on public interest issues where the profession’s expertise is most relevant • Aim is to harmonize and converge auditing standards and professional practice worldwide • Auditing adds credibility to external financial reports • High-quality auditing standards are necessary to ensure that accounting standards are rigorously interpreted and applied • If auditor training and audit standards vary, the reliability of financial statements will also vary
International Federation of Accountants (contin) • Organizational structure • IFAC council elects the IFAC board • IFAC board sets policies and oversees IFAC operations • Public Interest Oversight Board provides additional oversight • Work done through standard-setting boards and standing committees • Standard-setting boards • International Accounting Education Standards Board • International Auditing and Assurance Standards Board • Issues International Standards on Auditing • International Ethics Standards Board for Accountants • International Public Sector Accounting Standards Board • Standing committees • Compliance Advisory Panel • Developing Nations Committee • Nominating Committee • Professional Accountants in Business Committee • Small and Medium Practices Committee • Transnational Auditors Committee
UN Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) • Only intergovernmental working group devoted to corporate accounting and auditing • Objective • To promote the transparency, reliability, and comparability of corporate accounting and reporting • To improve disclosures on corporate governance by enterprises in developing countries and countries with economies in transition • Discusses and publishes worldwide best practices • Recent initiatives • Corporate governance • Accounting by small and medium-sized businesses • Technical assistance in emerging economies
Organization for Economic Cooperation and Development (OECD) • International organization of 30 (mostly industrialized) market-economy countries • Promotes good governance in public and private sectors • A voice for larger, industrialized countries
Conclusion • Debate is no longer whether to converge, nor even how to converge • Financial reporting systems are converging, as international capital markets become more investor oriented • International Accounting Standards Board is at the center of the convergence movement