1. Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 3: International Convergence of Financial Reporting

2. Learning Objectives  Explain the meaning of convergence  Identify the arguments for and against international convergence of financial reporting standards  Discuss major harmonization efforts under the IASC  Explain the principles-based approach used by the IASB in setting accounting standards  Describe the proposed changes to the IASB’s Framework  Discuss the IASB’s Standards related to the first-time adoption of IFRS and the presentation of financial statements  Describe the support for, and the use of, IFRS across countries 3-2

3. Learning Objectives  Examine the issues related to international convergence of financial reporting standards  Describe the progress made with regard to IASB/FASB convergence project  Explain the meaning of “Anglo-Saxon” accounting 3-3

4. International Accounting Standard-setting  Evolution of IASC and IASB shows international accounting standard-setting in the private sector:  With the support of the accounting bodies, standard-setters, capital market regulators, government authorities, and financial statement preparers  Harmonization allows countries to have different standards as long as they do not conflict  Accounting harmonization considered in two ways  Harmonization of accounting regulations or standards  Harmonization of accounting practices 3-4

5. International Accounting Standard-setting  Other factors leading to noncomparable accounting numbers despite similar accounting standards  Quality of audits  Enforcement mechanisms  Culture  legal requirements  Socioeconomic and political systems  International convergence of accounting standards refers to both a goal and the process adopted to achieve it 3-5

6. Harmonization and Convergence  Harmonization  Reduction of alternatives while maintaining a high degree of flexibility in accounting practices  Convergence  Enforcement of single set of accepted standards by several regulatory bodies 3-6

7. Harmonization  Can be considered in two ways  Harmonization of accounting regulations and standards  Harmonization of accounting practice  Ultimate goal of international harmonization efforts  Harmonization of standards may or may not result in harmonization of practice  Different from standardization  Standardization involves using the same standards in different countries  Allows for different standards in different countries as long as they do not conflict 3-7

8. Arguments for Convergence  Facilitate better comparability of financial statements  Easier evaluation of companies  Facilitate international mergers and acquisitions  Reduce financial reporting costs  Cost-listing would allow access to less expensive capital  Reduce investor uncertainty and the cost of capital  Reduce cost of preparing worldwide consolidated financial statements  Simplify auditing  Easy transfer of accounting staff internationally 3-8

9. Arguments for Convergence  Raise the quality level of accounting practices internationally  Increase credibility of financial information  Enable developing countries to adopt a ready-made set of high-quality standards with minimum cost and effort 3-9

10. Arguments against Convergence  Significant differences in existing standards  Enormous political cost of eliminating differences  Nationalism and traditions  Arriving at universally accepted principles is difficult  Need for common standards is not universally accepted  Well-developed global capital market exists already  May cause standards overload  Differences in accounting across countries might be necessary 3-10

11. Harmonization Efforts  Several organizations were involved at global and regional levels  International Organization of Securities Commissions (IOSCO)  International Federation of Accountants (IFAC)  European Union (EU)  International Forum on Accountancy Development (IFAD)  International Accounting Standards Committee(IASC)  International Accounting Standard Board (IASB) 3-11

12. International Organization of Securities Commissions (IOSCO)  Established in 1974  Initially limited its membership to regulatory agencies in America  Opened membership to agencies in other parts of the world in 1986  Aims at ensuring a better regulation of markets on both domestic and international levels  Works to facilitate cross-border securities offering and listings by multinational issuers  Advocates the adoption of a set of high-quality accounting standards 3-12

13. International Federation of Accountants (IFAC)  Established in October1977 at 11th World Congress of Accountants in Munich  Promotes adherence to high-quality professional standards of auditing, ethics, education, and training  Launched International Forum on Accountancy Development (IFAD) to  Enhance the accounting profession in emerging nations  Promote transparent financial reporting  Established the Forum of Firms with an aim of  Protecting the interests of cross-border investors  Promoting international flows of capital 3-13

14. European Union (EU)  Founded in March 1957 with the signing of the Treaty of Rome by six European nations  Issued two directives aimed at harmonizing accounting  Fourth Directive: Dealt with valuation rules, disclosure requirements, and the format of financial statements  Established the true and fair view principle  Provided considerable flexibility  Allowed countries to choose from among acceptable alternatives  Opened the door for noncomparability in financial statements  Seventh Directive: Dealt with consolidated financial statements 3-14

15. European Union (EU)  Directives helped reduce differences in financial statements  Complete comparability was not achieved  European Commission decided not to issue additional accounting directives  Associated itself with efforts undertaken by the IASC toward a broader international harmonization of accounting standards 3-15

16. International Forum on Accountancy Development (IFAD)  Mission was to improve the market security and transparency, and financial stability on a global basis  Assists in defining expectations from accountancy profession  Encourages governments to focus on the needs of developing economies in transition  Harness funds and expertise to build accounting and auditing capacity in developing countries 3-16

17. International Accounting Standards Committee (IASC)  Established in 1973 by leading professional accounting bodies in 10 countries  Broad objective of formulating international accounting standards  Harmonization efforts evolved in three mail phases  Lowest-common-denominator approach  Issuance of 26 generic International Accounting Standards  Comparability project  Publication of Framework for the Preparation and Presentation of Financial Statements  Comparability of Financial Statements Project  IOSCO agreement 3-17

18. International Accounting Standards Board (IASB)  Replaced IASC in 2001  IFRS Foundation appoints board of 16 members  13 full and 3 part-time  Board approves standards, exposure drafts, and interpretations  Shift in emphasis from harmonization to global standard- setting or convergence  Main aim is to develop a set of high-quality financial reporting standards for global use 3-18

19. EXHIBIT 3.2—The Structure of the IASB 3-19

20. Principles-Based Approach to International Financial Reporting Standards  IASB follows a principles-based approach to standard setting vs a rules-based approach  Standards establish general principles for recognition, measurements, and reporting requirements for transactions  Limits guidance and encourages professional judgment in applying general principles to entities or industries 3-20

21. IASB Framework  Created to develop accounting standards systematically  Framework for Preparation and Presentation of Financial Statement adopted by IASB in 2001 from IASC  Scope of Framework  Objective of financial statements and underlying assumptions  Qualitative characteristics that affect the usefulness of financial statements  Definition, recognition, and measurement of the financial statements elements  Concepts of capital and capital maintenance 3-21

22. Qualitative Characteristics of Financial Statements  Understandability: Understandable to people with reasonable financial knowledge  Relevance: Useful for making predictions and confirming existing expectations  Affected by nature and materiality of information  Reliability: Neutral and represents faithfully what it purports to  Reflecting items based on economic substance rather than their legal form  Comparabilty 3-22

23. Proposed Changes to existing frameworks by IASB and FASB  IASB and FASB will work on existing frameworks to provide basis for developing future standards by boards  Phases of project  Objectives and qualitative characteristics  Elements and recognition  Measurement  Reporting entity  Presentation and disclosure  Purpose and status  Application to not-for-profits  Finalization 3-23

24. 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 3-24

25. The Norwalk Agreement  Proposed Changes as per the discussion paper published jointly by two boards:  Decision-useful objective encompassing information relevant to assessing stewardship  Stakeholder approach (vs. U.S. framework of shareholder approach) — users other than capital providers explicitly acknowledged  Asset of an entity would be present economic resource to which, through an enforceable right or other means, entity has access or can limit others’ access  Emphasis on principle and guidance development for fair value measurements in IFRS—exit price as measurement base, or, if not—develop additional guidance 3-25

26. Presentation of Financial Statements (IAS 1)  Single standard providing guidelines for the presentation of financial statements  Guidance areas  Purpose of financial statements  Components of financial statements  Overriding principle of fair presentation  Requires the faithful representation of the effects of transactions and events  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 3-26

27. Presentation of Financial Statements (IAS 1)  Basic principles and assumptions  Adds to the guidance provided in the Framework  Immaterial items should be aggregated  Assets and liabilities, and income and expenses should not be offset  Structure and content of financial statements  Current/noncurrent  Items to be included on face of financial statements  Items to be disclosed in the notes 3-27

28. First Time Adoptions of IFRS (IFRS 1)  Provides guidance to companies that are adopting IFRS for the first time  Requires compliance with all effective IFRS at the reporting date of an entity’s first IFRS financial statements  Allows exemptions when costs outweigh benefits 3-28

29. Use of IFRS  Evidence of support for IFRS  Adoption by the EU – public companies in the EU were required to begin using IFRS in 2005  IOSCO has endorsed IFRS for cross-listings  IFAC G20 accountancy summit in July 2009 issued renewed mandate for adoption of global accounting standards  Latest IFAC Global Leadership Survey—emphasized that investors and consumers deserve simpler and more useful information  Adoption of IFRS in 2011: Japan, Canada, India, Brazil and Korea 3-29

30. International Convergence Issues  The complicated nature of standards such as financial instruments and fair value accounting  The tax-driven nature of the national accounting regime  Disagreement with significant IFRS, such as financial statements and fair value accounting  Insufficient guidance on first time application of IFRS  Limited capital markets are less beneficial  Investor satisfaction with national accounting standards  IFRS difficulties in language translation 3-30

31. IASB/FASB Convergence  The Norwalk Agreement reached in 2002 between the IASB and FASB pledged  For compatible financial reporting standards  Proper coordination of work program to maintain compatibility 3-31

32. IASB/FASB Convergence  IASB’s and FASB’s key initiatives in the Norwalk Agreement  Joint projects – boards work jointly to address issues (e.g., revenue recognition)  Short-term convergence –remove differences between IFRS and U.S. GAAP for issues where convergence is deemed most likely  IASB liaison – IASB member in residence at FASB  Monitoring IASB projects – FASB monitors IASB projects of most interest  Convergence research project – identification of all major differences between IFRS and U.S. GAAP  Convergence potential – FASB assesses agenda items for possible cooperation with IASB 3-32

33. IASB/FASB Convergence  Following global financial crisis both groups formed Financial Crisis Advisory Group (FCAG)  July 2009 FCAG report addresses:  Effective financial reporting  Limitations of financial reporting  Convergence of accounting standards  Standard-setting independence and accountability 3-33

34. Anglo-Saxon Accounting  Accounting systems prevalent in English-speaking countries including U.S., U.K., Canada, Australia and New Zealand  Fundamental features:  Micro orientation (firm level) with emphasis on professional rules and self-regulation  Investor orientation  Primary aim is efficient operation of capital markets  Very transparent  Less emphasis on prudence and measurement of taxable income or distributable income  Substance over form 3-34

35. End of Chapter 3 3-35