Wednesday, February 27, 2013

Importance of IFRS


Introduction

International Financial Reporting Standards (IFRS) provides a set of principles to be followed while accounting for transaction and events in financial statements. Unlike US GAAP it provides management greater discretion and flexibility in preparing financial statement. IFRS was adopted by International Accounting Standards Board (IASB) with the objective to have uniform accounting standard across all countries.

Need for global Accounting Standard

In mid 1990, the trading relation between Canadian and US companies were improving, and more and more Canadian companies began raising funds from US. So, to facilitate smooth business operation, the Canadian Accounting Standard Board began aligning its accounting standards with U.S. GAAP (Generally Accepted Accounting Practice). So, in present scenario, when companies located in any country are trading globally, there is a need for global accounting standard.

Conceptual Framework of IFRS

The IFRS conceptual framework is an attempt to determine nature and purpose of accounting. The conceptual framework provides assumption and principles that underlie financial reporting.  The purpose of IFRS is to provide information to determine how a particular transaction should be accounted. Historical evidence indicates that in absence of conceptual framework, some accounting standard were in conflict with accounting principle of prudence and accrual, many standards were internally inconsistent and few standards were not consistent with other accounting standard. In many cases, the standard setting was based on individual concept of each participant of standard setting board. This led to development of rule based accounting, which is regarded as prescriptive and inflexible. So, to ensure that ‘principle based standard’ is developed, a detailed conceptual framework must be laid down (ACCA, 2011). Further, the conceptual framework would provide consistent accounting pronouncement over time.

Role of GAAP

US GAAP is a set of guideline provided by FASB (Financial Accounting Standard Board) to record and report transaction for companies and non-for- profit organization. Further, the GAAP are accounting convention involved over a period of time and designed to provide information to user of financial statement. However, each country follow their own GAAP, like India has IGAAP, UK countries followed UK GAAP.  Though the basic accounting principles are same, there are number of difference with respect to comparability and relevance of accounting standard across GAAP.

Benefits of Global Accounting Standard

Reduction in information cost to economy: Today, there are many opportunities for companies to trade across border and raise capital globally. If the company is following local GAAP, the foreign investors perceive the presence of accounting risk in such statement. Accounting risk refers to risk involved in analyzing and interpreting financial statement that follows different GAAP (Epstein 2009 p.26). Thus, the financial statement prepared in different GAAP, affects the financial ratio, which is a key factors in lending decision by bankers and for compliance with debt covenant.  In such cases, the companies restate its financial statement as per local GAAP of foreign country, so as to fasten the process of raising funds. If IFRS based standard are adopted, capital market regulators must be aware of only one set of accounting standard and the companies will experience efficiency in raising capital and reduced information processing cost (Barth 2008 pp.1159-1179).    
Presentation of Financial Statement: If IFRS is adopted, then it would provide consistent presentation of financial statement along with uniform measures for recognition, measurement and disclosures of financial transaction. It will lower complication in taxing global income, as the taxes are levied on the total income of the companies, and the company along with its foreign subsidiary follow similar accounting principle and practice (Paul, 2006).
Comparison:  Following different set of accounting standard, comparing financial statement of companies operating in same industry in different country difficult, as the same transaction may be treated in different way.  With IFRS, MNCs and analyst community would experience ease in comparing financial statement of companies located and functioning in different geography.
Listing on foreign stock exchange:  The Companies following local accounting standard are facing problems in getting its stock listed on cross- border stock exchange. With adoption of IFRS, the Companies will no longer required to prepare its financial statement under different GAAP and make the task of listing shares on foreign stock exchange easier.

Challenges towards implementation of IFRS

Transition Cost: The companies have to incur one time transition cost towards adjusting its accounting systems, updating internal control procedure and documenting it. Further, IFRS require companies to provide financial statement for at least one prior year or may be up to three years for SEC listed companies. In addition, the companies have to hire external consultant to train their employees and familiarize analysts and investors with IFRS.

International Convergence

The listed companies of European Union State including UK, France and Germany, have adopted IFRS since 2005. Developed country like US has given an option its companies to voluntarily adopt IFRS Standard; Whereas Canada requires all listed entities to follow IFRS from January 01, 2011. Asian countries like China has converged its national standard to IFRS standard. The process of converging towards IFRS is still going on in India.  Japan has permitted multinational companies in its region to prepare its financial statement as per IFRS. 

Compliance with IFRS

IFRS is a method of reporting financial transaction and presenting financial statement. Compliance with IFRS will reduce accounting risk associated with preparing financial statement as per local GAAP. However, the fair value concept advocated in IFRS may increase the subjectivity in accounting the value of asset that is not traded freely. So, if the value of such asset is not correctly arrived, the financial statement may distort its purpose. 

Conclusion  

Sufficient efforts by local accounting body are required to enable companies to adopt IFRS and the companies have to incur substantial cost in first year of preparing statement as per IFRS. However, the Companies will derive long term benefit from using IFRS standard for reporting its financial transaction