McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 International Harmonization of Financial Reporting

3-2 International Harmonization of Financial Reporting Chapter Topics  Harmonization: Definition, pros and cons, efforts toward.  International Accounting Standards Board (IASB).  Other organizations involved in Harmonization.  Principles-based vs. Rules-based accounting.  IASB Framework and IFRSs.  Use of and support for IFRSs.  Convergence of IAS and U.S. GAAP.

3-3 International Harmonization of Financial Reporting Learning Objectives 1. Explain the meaning of harmonization. 2. Identify the arguments for and against international harmonization of accounting standards. 3. Discuss major harmonization efforts. 4.Explain the principles-based approach used by the International Accounting Standards Board (IASB).

3-4 International Harmonization of Financial Reporting Learning Objectives 5. Discuss the IASB’s Framework and Standards related to the adoption of International Financial Reporting Standards (IFRSs) and presentation of financial statements. 6. Examine the support for, and the use of, IFRSs across countries. 7. Describe the IASB/FASB convergence project.

3-5 Harmonization What is harmonization? Harmonization -- the process of increasing the level of agreement in accounting standards and practices between countries. Learning Objective 1

3-6 Harmonization The two “levels” of Harmonization  Harmonization in accounting standards, which is increased agreement in accounting rules.  Harmonization in practice, which is increased agreement in actual accounting practices.  Harmonization in standards may or may not result in harmonization in practice. Learning Objective 1

3-7 Harmonization  Is different from Standardization.  Harmonization allows for different standards in different countries as long as there are not logical conflicts.  Standardization involves using the same standards in different countries. Learning Objective 1

3-8 Harmonization: The Pros and Cons Pros:  Expedite the integration of global capital markets and make easier the cross-listing of securities.  Facilitate international mergers and acquisitions.  Reduce investor uncertainty and the cost of capital.  Reduce financial reporting costs.  Allow for easy adoption of high-quality standards by developing countries. Learning Objective 2

3-9 Harmonization: The Pros and Cons Cons:  Significant differences in standards currently exist.  The political cost of eliminating differences.  Overcoming “Nationalism” and traditions.  Perhaps it will not provide significant benefits.  Will cause “Standards Overload” for some firms.  Diverse standards for diverse places is acceptable. Learning Objective 2

3-10 Harmonization Efforts Organizations involved  Association of South East Asian Nations (ASEAN).  United Nations (UN) / European Union (EU).  International Organization of Securities Commissions (IOSCO).  International Federation of Accountants (IFAC).  IASB and FASB. Learning Objective 3

3-11 Harmonization Efforts Organizations involved  IOSCO – is essentially the international equivalent of the U.S. Securities and Exchange Commission (SEC).  IFAC – is similar, at the international level, to the American Institute of Certified Public Accountants (AICPA).  IASB – is essentially the international equivalent of FASB. Learning Objective 3

3-12 Harmonization Efforts IOSCO  Works to achieve improved market regulation internationally.  Works to facilitate cross-border listings.  Advocates for the development and adoption of a single-set of high quality accounting standards. Learning Objective 3

3-13 Harmonization Efforts IFAC  Works to develop international standards of auditing, ethics, and education.  Began International Forum on Accountancy Development (IFAD) to enhance the accounting profession in emerging countries.  Started the Forum of Firms to raise global standards of accounting and auditing. Learning Objective 3

3-14 Harmonization Efforts EU  Has worked to harmonize accounting standards within the EU, primarily by way of two directives.  Fourth Directive – a set of comprehensive accounting rules built on the principle of a “true and fair view.”  Seventh Directive – requires consolidated financial statements for company groups of a certain size. Learning Objective 3

3-15 Harmonization Efforts IASB  Preceded by the IASC (International Accounting Standards Committee).  Works toward harmonization of international accounting standards.  IASC was established in Learning Objective 3

3-16 Harmonization Efforts IASB  Comprised of 14 members (12 full, 2 part-time).  7 members are liaison with a national board.  Standard development process is open.  Standards are principles-based.  Since establishment of IASB, focus is on global standard-setting rather than harmonization per se. Learning Objective 3

3-17 Harmonization Efforts IASB – Major Initiatives Comparability Project  Comprehensive review of existing IAS (International Accounting Standards).  Begun in  In order to increase rigor of IAS. Learning Objective 3

3-18 Harmonization Efforts IASB – Major Initiatives IOSCO Agreement  Establishment of a core set of 30 accounting standards.  Standards agreed upon by IOSCO and IASC. Learning Objective 3

3-19 Harmonization Efforts IASB – Revised Structure The restructured IASB is overseen by the IASC Foundation which also oversees:  The International Financial Reporting Interpretations Committee (IFRIC).  The Standards Advisory Council (SAC).  Also, IFRSs are subject to due process and the IASC Foundation now periodically reviews its constitution. Learning Objective 3

3-20 Principles-Based Approach to Accounting Standard Setting IASB Perspective  IASB attempts to follow a Principles-Based approach to standard setting.  As such accounting standards are grounded in the the IASB Framework. Learning Objective 4

3-21 Principles-Based Approach to Accounting Standard Setting A Principles-Based approach  Represents a contrast to a Rules-Based Approach.  Attempts to limit additional accounting guidance (e.g., FASB EITFs, FASB Interpretations).  Is designed to encourage professional judgment and discourage over-reliance on detailed rules. Learning Objective 4

3-22 Principles-Based Approach to Accounting Standard Setting Support for a Principles-Based Approach from outside the IASB  FASB – has published a supportive proposal entitled, “Principles-Based Approach to U.S. Standard Setting” ( based_approach.pdf).  SEC – has recommended adoption of this approach ( d.htm). Learning Objective 4

3-23 IASB Framework and IFRSs IASB Framework  Provides the basis for financial statements presented in accordance with IFRS.  Similar to the relationship between U.S. GAAP financial statements and the FASB Conceptual Framework. Learning Objective 5

3-24 IASB Framework and IFRSs IASB Framework  The objective and underlying assumptions of financial statements.  Qualitative characteristics of information.  Definition, recognition, and measurement of elements in financial statements.  Concepts of capital maintenance. Learning Objective 5

3-25 IASB Framework and IFRSs IASB Framework  Possesses objective and underlying assumptions of financial statements.  Primary objective is to provide information useful to decision making.  Underlying assumptions include accrual-basis and going concern. Learning Objective 5

3-26 IASB Framework and IFRSs Qualitative characteristics of information  Understandability – should be understandable to people with reasonable financial knowledge.  Comparability – allows for meaningful comparisons to financial statements of previous periods and other companies. Learning Objective 5

3-27 IASB Framework and IFRSs Qualitative characteristics of information  Relevance – useful for making predictions and confirming existing expectations.  Reliability – free from bias (neutral) and represents that which it claims to represent (representational faithfulness). Learning Objective 5

3-28 IASB Framework and IFRSs Elements of Financial Statements  Definition – assets, liabilities, and other financial statement elements are defined.  Recognition – guidelines as to when to recognize revenues and expenses.  Measurement – various bases are allowed, historical cost, current cost, realizable value, and present value. Learning Objective 5

3-29 IASB Framework and IFRSs Concepts of Capital maintenance Financial capital maintenance  One approach to income measurement.  Net income represents the increase in net financial assets, excluding owner transactions.  The approach in U.S. GAAP. Learning Objective 5

3-30 IASB Framework and IFRSs Concepts of Capital maintenance Physical capital maintenance  Another approach to income measurement.  Net income represents increase in physical productive capacity.  Excluding owner transactions.  Requires current costs for measurement of certain physical assets. Learning Objective 5

3-31 Presentation of Financial Statements (IAS 1) This standard provides guidance in the following areas  Purpose of financial statements – to provide decision-useful information.  Components of financial statements – balance sheet, statements of income, cash flows, changes in equity, and notes to the financial statements. Learning Objective 5

3-32 Presentation of Financial Statements (IAS 1)  Fair presentation – the overriding principle of financial statement presentation.  Accounting policies  Should be consistent with all IASB standards.  When specific guidance is lacking, use standards on similar issues, and definitions of the financial statement elements. Learning Objective 5

3-33 Presentation of Financial Statements (IAS 1) Basic principles and assumptions  Reiteration of underlying assumptions.  Accrual basis/going concern/comparability. Structure and Content of Financial Statements  Provides information on presentation format:  Current/noncurrent.  Items to be included on face of financial statements.  Content of notes. Learning Objective 5

3-34 First Time Adoptions of IFRSs (IFRS 1)  Provides guidance for first time adoption.  Much used in 2005, particularly in EU.  Requires compliance with all effective IFRSs.  Allows exemptions when costs deemed to outweigh benefits. Learning Objective 5

3-35 Use of IFRSs Evidence of support for IFRSs  Adoption by the EU – public companies in the EU were required to begin using IFRSs in  IOSCO has endorsed IFRSs for cross-listings.  Many developing nations have adopted IFRSs.  Some countries disallow IFRSs for domestic firms but allow foreign companies to use them.  U.S. is a major exception, does not allow use of IFRSs. Learning Objective 6

3-36 IASB/FASB Convergence The Norwalk Agreement  Reached in  Between the IASB and FASB.  To work toward accounting standards convergence. Learning Objective 7

3-37 IASB/FASB Convergence FASB’s key initiatives in the Norwalk Agreement  Joint projects – boards will work together to address some issues (e.g., revenue recognition).  Short-term convergence – to remove differences between IFRSs and U.S. GAAP for issues where convergence is deemed most likely.  IASB liaison – IASB member in residence at FASB. Learning Objective 7

3-38 IASB/FASB Convergence  Monitoring IASB projects – FASB monitors IASB projects of most interest.  Convergence research project – identification of all major differences between IFRSs and U.S. GAAP.  Convergence potential – FASB assesses agenda items for possible cooperation with IASB. Learning Objective 7