The Convergence of International Accounting Standards and Practices

1. The Convergence of International Accounting Standards and Practices Cynthia Jeffrey Iowa State University

2. How different is accounting internationally (across countries)? • What historical factors have contributed to these differences?

3. Each nation has its own accounting rules that tend to mirror certain elements in that nation. • A country's economic, legal, and political systems; stages of technological development or sophistication; culture and tradition; and various other socioeconomic factors all influence the development of accounting standards and the accounting profession in that nation.

4. These differences have led to significant diversity in accounting standards from one nation to another. • Given the growth of international business activity, and especially international investment, comparability of accounting standards has a high priority. • International diversity in national accounting standards has the potential to diminish the international flow of investment capital and thereby hinder economic development and the efficient international allocation of resources.

5. What are the international responses to across-country accounting differences? • Reconciliations versus mutual acceptance versus one set of global accounting standards and practices.

6. Convergence of Accounting Standards • It is useful to think about a continuum ranging from total flexibility and diversity to total uniformity. • Convergence implies a more flexible approach whereby a limited set of alternatives are acceptable, compared to standardization, which implies a state of uniformity.

7. What kinds of problems are allegedly caused by international accounting differences? • Potential inefficient allocation of scare resources.

8. Convergence of Accounting Standards • Arguments for convergence: • Not only can convergence help with resource allocation, but a multinational accounting firm and the preparers of financial information, can make a strong argument for increased convergence. • The burden of financial reporting would be lessened with increased convergence, which would simplify the process of preparing individual and group financial statements.

9. How Different is Different? • Example: The News Corporation (an Australian firm) reported 1992 earnings of $502 million (Australian dollars). Under US GAAP, earnings would have been about $421 million (Australian dollars). The difference is about 16% of income under Australian GAAP.

10. Potential Costs? • As an example of the financial cost of complying with the differing accounting rules in different countries, an article in WSJ described the costs incurred by an international firm which sought to sell an offering of securities in the US, Canada, and the UK. • The offering required three sets of financial statements and finally cost $2.8 million to get the $55.5 million offering registered.

11. Difficulties • In general, there are difficulties in comparing income, net assets, and shareholders equity across countries.

12. International Barriers to Convergence 1. Accounting itself is a judgmental and social discipline, reflecting the needs of its particular business environment 2. National traditions, educational opportunities, and business and accounting attitude differences among nations 3. Legal and economic differences among the nations 4. State sovereignty 5. Economic gaps between developed and developing nations.

13. Recognition Criteria Differ • What items are recorded in the financial statements, at what times? • Intangible assets, certain leases, goodwill

14. Measurement Criteria Differ • Historical cost versus inflation adjustments versus fair values

15. Disclosure Rules Differ • What should be reported in the notes and supporting schedules? • Management compensation

16. TYPE A True and fair view Shareholder orientation Disclosure emphasized Tax rules separate Professional Standards TYPE B Legal-oriented view Creditor orientation Secrecy is emphasized Linked to tax rules Government rules Broad Categorizations

17. Depreciation over useful lives Limited or no use of legal reserves Lease capitalization Cash flow or funds statement Depreciation by tax rules Extensive use of legal reserves No leases capitalized No cash flow or funds statement Example of Specific Policies

18. United Kingdom United States Australia Canada France Germany Spain Italy Examples of Countries

19. Historical Reasons for Differences • Predominant modes of financing and ownership. • Banks, and small groups of owners • Government • Shareholders • Each of these different types of financing arrangements implies differences in what accounting information is needed for decision making.

20. Legal system • English common law versus codified law systems • Differences in approaches to securities regulation • Use of financial reports for taxation • Audited reports for capital markets versus for tax calculations

21. What kinds of issues are allegedly raised by International Accounting Differences? • The holding of shares across international boundaries is becoming more common, so more users are confronting noncomparabilty of financial statements • It is sometimes alleged that international capital flows are needlessly hampered by the need for users (investors) to develop their own comparability adjustments.

22. Multinational firms are expanding their operations cross-nationally, so more preparers are confronting noncomparable accounting standards and rules

23. What is viewed as acceptable or even desirable accounting practice in one country might be viewed as unacceptable or even misleading in another country. • Example: LIF|O inventory valuation in the United States.

24. Internal performance evaluation in large multinational firms might be affected by the use of different accounting and measurement systems

25. Large CPA firms are expanding their wold-wide operations and facing attestation engagements under widely varying accounting and reporting systems. What does an audit report mean if there are divergent practices across countries?

26. The US accounting system (part of the overall US securities regulation system) is allegedly needlessly stringent and discouraging to international capital flows • Worldwide equity capitalization (one measure of the demand for capital) is current estimated at about $17 trillion. (Privatizations in China, Europe coming)

27. There is intense competition for non-domestic listings, particularly among the NYSE, NASD, and the LSE. This competition could increase to the extent the European exchanges develop new alliances (remember the proposed alliance between the LSE and the Frankfurt exchange--derailed because of an unfriendly takeover bid for the LSE)

28. Convergence • Convergence refers to the process of increasing the consistency and comparability of accounting across countries, with the goal of removing (alleged) impediments to international capital flows.

29. Is it Possible? Or Desirable? • To the extent that accounting differences result from underlying differences in economic, legal, social, and other environmental factors, accounting convergence may simply not be appropriate.

30. The differences in accounting are so deep and numerous that they are structural in nature and it would take extremely strong actions to remove them. • Some countries do not have a long tradition of a strong accounting profession while others do. Government intervention would be necessary to achieve convergence, and this raises problems of nationalism.

31. Two Approaches to Convergence 1. Evolution in the development of accounting principles. • This approach recognizes the reasons for the differences in accounting principles: countries with different economic and legal systems should have different accounting principles. • Time and the natural development of the countries' economies would be necessary to bring accounting principles into closer harmony. • That is, the natural evolution of accounting principles within each nation would tend to narrow the alternatives, and this would reduce the degree of diversity from country to country. • Other forces, including international competition for investment and loan, would also work to reduce diversity.

32. Two Approaches to Convergence 2. The more dominant view posits that formal action should be taken to reduce diversity. • This view looks to organizations for standard setting with multi-country authority. • This is the problem! Enforcement? • For a country to voluntarily give up their own accounting destinies and delegate to others the power to set accounting standards represents a reduction in the national sovereignty.

33. Some who interpret convergence as implying the use of a single set of financial reporting standards worldwide favor the use of International Accounting Standards, as promulgated by the International Accounting Standards Board (IASB)

34. IASC International Accounting Standards Committee • The concept was introduced as early as 1904 with the First International Congress of Accountants in St. Louis. • But it wasn't until 1973 that the International Accounting Standards Committee (IASC) was founded by the leading professional accounting bodies in 9 nations: • Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the UK, and the US. • Members are not nations, but rather accounting bodies within nations are members. • In the US, the AICPA is a member, not the FASB or the SEC. • In this way, no nation completely surrenders its accounting sovereignty to the IASC. • Now, accounting bodies from over 91 nations are members.

35. Recently, the IASC was restructured. The IASC is the foundation that oversees the International Accounting Standards Board IASB.

36. IASB • The International Accounting Standards Board is an independent, privately-funded accounting standard setter based in London, UK. Board Members come from nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the Board cooperates with national accounting standard setters to achieve convergence in accounting standards around the world.

37. IASC was be established as an independent foundation. The foundation has two main bodies, the Trustees and the Board, as well as a Standing Interpretations Committee and Standards Advisory Council. The Trustees would appoint the Board members, exercise oversight and raise the funds needed, whereas the Board would have sole responsibility for setting accounting standards.

38. IASC, IASB Objectives: 1. To formulate and publish international financial standards 2. To promote worldwide acceptance and observation 3. To facilitate a "common international approach" to the harmonization of accounting principles

39. Develop and aid the implementation of international accounting standards that satisfy the needs of developing and newly industrialized countries; • Narrow the differences between international accounting standards and the various national accounting requirements with a goal of developing greater compatibility and easier comparability of financial reporting.

40. The IAS Standards tend to follow the principles of “true and fair” value and full disclosure, consistent with the “Type A” view above.

41. IASC • A conceptual framework (Framework for the Preparation and Presentation of Financial Statements) is being developed for guidance. • objectives of financial statements, • qualitative factors of financial information, • the elements and the recognition criteria of financial statements. • By the beginning of 1993, IASC had produced 31 statements which are very similar in content and format to FASB statements. • Member organizations have pledged to use their best efforts to have the standards adopted by their national authoritative standard setting bodies.

42. IOSCO Charge: • In July 1995, the IOSCO Technical Committee stated its agreement with the work plan, as follows: • The [IASC] Board has developed a work plan that the Technical Committee agrees will result, upon successful completion, in IAS comprising a comprehensive core set of standards.

43. Completion of the comprehensive core standards that are acceptable to the [IOSCO] Technical Committee to recommend endorsement of IAS for cross-border capital raising an listing purposes in all global markets. • The goal is for 40 “core standards.”

44. The project was completed late in 1998. • IOSCO, the International Organization of Securities Commissions, has agreed to consider these standards for registering and listing shares.Within IOSCO, the key commissions are those in Canada, Japan, and the US. These countries are the most restrictive with regard to to the use of (or reconciliation to) domestic GAAP.

45. IOSCO • May 30, 2002--IOSCO Annual Conference encourages cooperation to achieve convergence • http://www.iasc.org.uk/cmt/0001.asp?s=896113&sc={75E9A0E3-85F3-4F1C-B03E-5C65B88F506D}&n=4083

46. Adopters of IASCs • Some countries have adopted IASC standards with few amendments (Nigeria, Malaysia, Russia). Such adoptions can be advantageous to countries with developing market economies. • Stock exchanges in more than 30 countires (but not the US) allow international standards, at least for foreign registrants.

47. US POLICIES • Under current US regulations, any issuer who wishes to access the US equity market must conform to SEC rules, including filing reconciliations of income and shareholders equity with US GAAP on Form 20-F. • IF the SEC were to accept IAS for cross-border listings, these form 20-F reconciliations would presumably disappear for IAS users.

48. Why Would a Non-US Issuer Object to Reconciliations? • Out of pocket costs to prepare • Disclosure of proprietary information, including reserves, segment data, and Form 10-Q

49. Why might the SEC insist? • Possible belief that US GAAP is superior • Investor protection under US securities laws, accounting rules and enforcement mechanisms • Emphasis on individual investor. IS this important any more? Funds, and the effects of online brokerages. 65% of trades are individual investors.

50. SEC Decision • The SEC is a voting member of the IOSCO Technical Committee that endorsed the IASC core standard project.