If you are studying accounting, you will learn in-depth details about the international accounting standards that must be followed by all professionals in the field. As the economy becomes more global, so do the activities of companies and lenders as well. This means that the need is greater than ever for a globally accepted framework where financial records and reports are consistent, comparable, reliable and transparent at international and domestic levels. If you would like to learn more about these international standards before you attend school, read on and find out the purpose of these standards and what they entail.
The Purpose of International Standards in Accounting
The purpose of these standards is to ensure that the financial centers of the world, which have become more interconnected than ever, can use a global financial reporting framework that ensures effective regulation of financial markets. The growing volume of cross-border capital flows makes having international standards, that are high in quality and testable across the board, a priority. By having these standards in place, capital markets that are located in different jurisdictions can create the most efficient capital flows that are beneficial to regulators, organizations, and the market as a whole.
Who is In Charge of These Standards?
Until recently, the International Accounting Standards (IAS) were created and issued by the Board of the International Accounting Standards Committee (IASC). These standards were put in place to advise companies how to report financial events in a financial statement. In 2001, a new set of standards was developed and these new standards are referred to as the International Financial Reporting Standards (IFRS). The IFRS were issued by the International Accounting Standards Board (IASB), which ultimately has no authority over whether or not a company adopts the standards. While this is true, many countries have financial laws requiring all publicly traded companies to prepare financial statements in compliance with the IAS to protect investors, stakeholders and creditors. The IFRS are currently not being adopted in the US, which has led to a lot of criticism.
The Red Book, the Blue Book and the Green Book
There are three different editions of the standards that are printed today. The first edition was the Red Book, which is the original set of standards that has not been superseded or replaced. While this version is still published, it does not contain some updated information. The Blue Book, printed in 2010, consolidates standards that were put in place before January 1 of that year. The Green Book, which is the latest version to be printed, consolidates all of the current standards. It is important to also have current interpretations of these standards.
History of International Auditing Governance
The term “ international auditing governance” sounds pretentious, and there are easier ways to express the concept of regulating the auditing principles of industrial countries. One might term the idea a “universal finance language” but the concept must also include teaching the language and enforcing its use. Plus, something cannot be universal if everyone in the “universe” does not participate. Still, simply put, these principles are the methods and standards companies use to record their financial wellness. Before international standards were set, companies created their financial statements using the principles of the countries where they were located. This worked well in a world where most trade was conducted within that country’s boundaries or with “next-door-neighbors.”
As economies grew, and industry became larger and more complicated, issues arose in financial reporting that centered on expanded business domains, cultural and linguistic differences and even in the types of currencies involved in trade. In the United States, for instance, the growth of companies like Standard Oil and US Steel made existing accounting principles antiquated merely because of the amount of capital involved in production and sales and the number of people and organizations investing in them.
After WWI, the US replaced Britain as the number one economy in the world during an economic boom. Hundreds of corporations began and found eager investors. Many investors, who were sometimes part of the organizations in which they invested, realized huge profits through insider trading, stock manipulation and other schemes that may, or may not, have been legal. Of course, there were financial audits, but the auditors usually worked for the companies they audited. Then, in 1929, the bottom fell out of the economy with the Depression. On Black Friday investors and banks lost fortunes. Workers lost jobs, people committed suicide in desperation, and the nation lost faith in its financial institutions. Before that time, there was little interest in financial reporting reform, but after “the crash,” there was a demand for change.
Responding to the demand of its citizens , the US Securities Exchange Commission was formed as an enforcer of newly created financial laws. They were given the authority to govern accounting principles, but they stopped short at creating them. That was left to the private sector. That board was largely unsuccessful. In 1971, people were afraid that the government would assume responsibility, so a commission was formed to study accounting principles. Called the Wheat Commission after its chairperson, the commission was composed of three components that issued several documents, one of which was GAAP. That acronym stands for generally accepted accounting principles. GAAP is still used in the US, although much of the rest of the world uses the International Accounting Standards. The reason for US reluctance may be because, according to the Harvard Business School, more powerful nations are less likely to adopt the policies since they do not want to cede the standard-setting authority to an international organization.
Why Update the Standards
Today, any start-up with access to the Internet can become a global “player.” Additionally, companies are expanding beyond the boundaries of their base countries to have global presences. International supply chains and markets have pushed the amount of capital being exchanged to almost unbelievable limits. New forms of exchange, such as digital currency , complicate the already-difficult issue of changing, and volatile, monetary systems. The intent of auditing and financial reporting is to present a picture of a company in its financial position and health. Using that portrayal, investors can compare companies and opportunities and evaluate the financial well-being of corporations. That picture can be altered, and fraud perpetrated. While this has always been true, the impact of such deception on a global economy would be immense. This fraud largely derives from finding “loopholes” and inadequacies in financial laws or misrepresenting financial statements. What was true and legal yesterday may not be tomorrow. Consider these two American frauds.
Enron was a company that resulted from a merger of Houston Natural Gas and InterNorth. The combination of the two smaller companies resulted in an energy industry giant. Because of trickery in their accounting system and deceptive practices such as hiding debts in shell companies the company was forced into bankruptcy. Many people were left without jobs and lost their retirement savings. The scandal also took down one of the biggest accounting firms in the world.
Cendant Corporation, 1997
The Cendant Company was part of the hospitality industry. Just three months after the corporation’s inception, rumors surfaced about abnormal accounting practices. The company had reported $640 million of profit that never existed.
Although the purpose of accounting standards is not solely to identify fraud, the transparency such standards seek to employ helps detect such discrepancies.
Why the US Does Not Participate
Again, most countries either require the IFRS or allow corporations to use it. The United States is not one of these countries. As obvious as it may seem to apply the latest principles and guides to global financial reporting, there are some caveats. According to an essay on the website CipCommunity, some of these are:
• The GAAP is more detailed and principles-based. The IFRS is open to interpretation. Accountants have to make value judgements. That means an accountant may be influenced by company incentives.
• There is significant difference in wording on several issues. For instance, the IFRS is not clear on whether some expenses must be listed, and how much of the expense must be accounted for.
• Transition to the system is expensive. The estimate for the US to convert is “at least $8 billion for the entire US economy.” However, the one-time transition cost for a small firm could be as much as $420,000.
• Ceding power to the IFRS would weaken the control of the American Financial Accounting Board. Some people believe that the US should maintain control because American equity “accounts for almost half of the global capitalization.”
• The IFRS is funded by contributions from member countries. That makes it subject to political manipulation,
• Indeed, the Securities Exchange Commission admits that the goal is to achieve one set of standards that are endorsed by all countries. They add that this may not be achievable. One reason given for this thought is that the US is a litigious country. In the event of a financial failure, the accountants are often blamed ( and sued). It is not surprising that American accountants are holding out for a more specific set of rules.
• Additionally, many financial issues are inherently subject to a “range” of estimates rather than one specific figure, and so allow for lee-way. The IFRS adjusts for this by creating room for judgement. The GAAP becomes more stringent considering this issue. It keeps adding more rules that have no match in the IFRS system. That means the gap between the two accounting systems is widening.
Many people believe that the primary reason for the conflict, however, is political. The US is protecting American investor interests first and foremost. The SEC has stated that the US “does not believe that high quality standards should be compromised for the sake of uniformity. ”
What Kind of Standards are Included
The focus of this article is on a definition of international accounting standards. Therefore, there should be some attempt at looking at those standards. One exposition includes 41 of these separate standards such as:
• Presentation of Financial Statements : This details how the financial statements should look. It also presents a minimum requirement for content.
• Statement of Cash Flow: This integral part of the statement includes operation expenses and activities that are entered using “ the direct or indirect method.”
Other topics of the standards include Income Tax, Revenue, Leases, Employee Benefits, Effects of Changes in Foreign Exchange Rates and several others. It seems that, while everybody is “on board” with building a set of standardized accounting practices that are recognized globally, and while most countries have accepted the standards set forth in the International Financial Reporting Standards, there are a few holdouts. These abstainers, however, are some of the major global economy players.
Future of the IFRS
Most people agree that the global economy would benefit from a “universal financial language.” Some of those benefits include a healthier global economy, greater efficiency in the market and less expensive operating costs. There is some evidence, however, that not all countries would benefit equally, or at all. No third world country can be a global economic leader without using strong accounting standards because no one would invest in industries that are not secure, not transparent that cannot be quantified because of differences in currencies and practices. That means countries invested in the IFRS must enforce the practices and allow for administration of consequences for violations. More than 100 countries have bought into the idea. The momentum has slowed, though, because of the reluctance of the United States to sign on. In short, everyone wants to go there, but some people want to take a different route.
While the progress of attaining a universal set of accounting practices has slowed, globalization has not. That, in itself, may obstruct the process of financial unification. That is because technology has not slowed either. With new processes and greater access to greater data, IT may outpace the initiative by making some not-yet-accepted principles outdated. Plus, if—as some have said—a universal financial language is unobtainable, the world will spin its wheels for a long time trying to come up with an alternative to the International Accounting Standards.
In a global environment it is important to have a global set of standards that can be adopted and used by every country. This makes the framework much more reliable and consistent. While the US currently adopts the GAAP standards that were created by the Federal Accounting Standards Board, some companies that operate on a multi-national level have adopted international standards. The worldwide adoption of the IFRS will make the reading and analysis of financial statements much easier for all investors. While the international accounting standards are not used by all listed and unlisted companies, more and more countries are making adoption a priority.