International accounting Chapter 4: International Harmonization

Learning objective: Assess the arguments for and against international harmonization or standardization of financial reporting; Illustrate how harmonization can be measured; Outline the history, purpose and activities of the International Accounting Standards Committee (IASC); Explain how the IASC had different effects in different types of country; summarize the relevance of other bodies for harmonization; Explain the structure and workings of the International Accounting Standards Board.

Introduction The preceding (and the following) chapters make it clear that there have been major differences in the financial reporting practices of companies around the world.

Introduction This had led to great complications for those preparing, consolidating, auditing and interpreting published financial statements.

Introduction As the preparation of internal financial information often overlaps with the preparation of published information, the complications spread to management accounting.

Introduction To combat these difficulties, several organizations throughout the world have been involved in attempts to harmonize or standardize accounting. Market forces also contribute to this, as will become clear.

Introduction Harmonization’ is a process of increasing the compatibility by setting bounds to their degree of variation. ‘Standardization’ appears to imply working towards a more rigid and narrow set of rules.

Introduction It is also important to distinguish between harmonization of rules (de jure) and harmonization of practices (de facto). Tay and Parker (1990) point out that de facto harmonization/standardization is more useful than de jure harmonization/standardization.

Reasons for, obstacles to and measurement of harmonization

Reasons for harmonization Standardization can reduce administrative costs, improve the quality of accounting and increase comparability. The pressure for international harmonization comes from those who use, regulate and prepare financial statements.

Reasons for harmonization Financial reports produced in one country are used in various other countries. Consequently, the reasons that make national accounting standards desirable also apply internationally.

Reasons for harmonization Investors and financial analysts need to be able to understand the financial statements of foreign companies whose shares they might wish to buy. They would like to be sure that statements from different countries are reliable and comparable, or at least to be clear about the nature and magnitude of the differences. They also need confidence in the soundness of the auditing.

Reasons for harmonization Those companies that wish to issue new shares more widely than on their domestic markets will see the advantages of harmonized practices in the promotion of their issues. International credit grantors such as the World Bank also face the difficulties of international comparison.

Reasons for harmonization The international accountancy firms support harmonization partly because it is good for their large clients. Also, the tax authorities throughout the world have their work greatly complicated, when assessing foreign incomes, by differences in the measurement of profit in different countries.

Reasons for harmonization Example of the need for harmonization Cost (FIFO, LIFO or weighted average) (e.g. some Japanese companies until 2007); The lower of FIFO and net realizable value (e.g. common IFRS practice); The lower of LIFO and current replacement cost (e.g. common US practice). Adding all the differences together, the effects on earnings or shareholders’ equity can be very large,