Accounting 6570

Introduction to International Financial Reporting Standards

(IFRS) and Framework

International Harmonization and Convergence

Harmonization is the process of increasing the level of agreement in accounting standards and practices between countries. It means everyone has the same choices .

• Harmonization is NOT standardization or uniformity; standardization is similar to uniformity

• Convergence is everyone agreeing to use the same set of standards.

Arguments for Convergence

• Comparability • Reduce financial reporting costs• Reduce cost of capital• Raise the quality level of accounting practices• Increase credibility of financial information• Allow developing nations to have highly

qualified standard setters • Easier to transfer accounting staff

internationally

Arguments Against Convergence

• Nationalism• Culture will still influence interpretation and

selection of choices• Different environments may call for different

accounting systems• Politics may rule whose accounting systems are

chosen• Developing nations may not need as complex an

accounting system.

Major Convergence Efforts

• Investors and Regulators– IOSCO

• Accountants and Auditors – IFAC– IFAD– IASB

• Regional Organizations– European Union

Investors

• International Organization of Securities Commissions (IOSCO) – – Securities regulators around the world– Around 135 members from about 100 countries– SEC is a member– Aims to ensure a better regulation of the markets worldwide– Global coordination of stock exchange rules to encourage

multiple listings– Supports more disclosure and one set of high quality

standards

Accountants and Auditors

• International Federation of Accountants (IFAC) – Formed in 1977– Concerned with international auditing guidelines and

standards, ethics, education and training

• International Forum on Accountancy Development (IFAD)– Formed in June 1999 to enhance the accounting

profession in emerging countries– Formed Forum of Firms to increase quality of financial

reporting and auditing standards for all nations

Governments

• European Union - common framework of law, taxation, and financial resources

• 27 European countries currently– Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark,

Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and United Kingdom

• Euro currency - used by 16 countries including Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain MAJOR EXCEPTIONS: Denmark, Sweden, and the U.K.

European Union

• Goal is to have comparable, reliable financial information provided by all E.U. companies

• As of 2007, ALL E.U. listed (publicly-held) companies must follow International Acct. Standards

International Accounting Standards Committee (IASC)

• Formed June 29, 1973 by representative bodies from 9 countries including:– Australia, Canada, France, Germany, Japan,

Mexico, Netherlands, U.K./Ireland, and U.S

• Headquartered in London, England

• Representatives from 112 countries and more than 153 organizations

Board Restructuring

• Restructured April 1, 2001• New structure

– Now called International Accounting Standards Board (IASB)

– IASB is an independent organization with two main bodies

• Trustees• Board• Also has a a Standards Advisory Council (about 50 members),

miscellaneous Advisory Committees and an International Financial Reporting Interpretations Committee (12 members appointed by the Foundation)

What is the structure of the international standard setters?

InternationalAccountingStandards

Board (IASB)

IFRS and

IFRS for SMEs

IFRSAdvisory Council

IFRSFoundation

IFRSInterpretations

Committee

Information provided by www.IFRS.org

Monitoring Board

Board Restructuring

• Trustees– 22 highly respected experienced members

– Chairman – Tommaso Padoa-Schioppa, Former Italian Minister of Economy and Finance, Italy

– Vice Chairman – Tsuguoki Fujinuma, Former President of IFAC, JICPA, and Senior Partner of Ernst & Young

– Main duties• Appoint Board, Committee, and Council Members

• Exercise oversight of Board

• Raise funds

Board Restructuring

• Board– Sole responsibility for setting accounting standards– 14 voting members, 1 nonvoting member– CHANGING TO 16 MEMBERS!!!!– Have best available combination of technical skills and

international business experience– Seven must have a formal liaison with one or more national

standard setters– Minimum: 5 practicing auditors, 3 preparers, 3 users, 1 academic– First chairman of the IASC Board

• Sir David Tweetie, former U.K. Accounting Standards Board Chairman

– List of members (www.iasb.org)

Mission Statement

• The International Accounting Standards Board is an independent, privately-funded accounting standard setter based in London, United Kingdom. Board Members come from eleven 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.

How are international standards set?Agenda

Discussion paper

(DP)

Post-implementation meetings

Exposure draft

(ED)

IFRS Feedback statement

Input is received from:

► IFRS Advisory Council

► Working Group

► International groups such as analysts, preparers, audit technical partners

► Special interest groups

► Local standard setters

► Regulators

► Political groups

Public consultation

Public consultation

Research

Information provided by www.IFRS.org

Standard Setting Process

• 1. The Board establishes an Advisory Committee to give advice on the issues arising in the project. Consultation with the Advisory Committee and the Standards Advisory Council occurs throughout the project.

• 2. IASB may develop and publish Discussion Documents for public comment.

• 3. Following the receipt and review of comments, IASB would develop and publish an Exposure Draft for public comment

Standard Setting Process

• 4. Following the receipt and review of comments, IASB would issue a final International Financial Reporting Standard.

• 5. Publication of a Standard, Exposure Draft, or final SIC Interpretation requires approval by 8 of the 15 members (simple majority). Other decisions, including the issuance of a Draft Statement of Principles or a Discussion Paper and agenda decisions, requires a simple majority of the Board Members present at a meeting attended by 50% or more of the board members.

IFRS required or permitted

No action taken/date set for adoption

Local GAAP based on legacy IAS

In process of adopting or converting to IFRS

Currently, there are 117 countries that either adopted or signed to adopt IFRS:

► Brazil – 2010

► Canada – 2011

► Chile – 2009/2010/2011

► India – 2011/2012

► Japan – 2010 (optional)

► Mexico – 2012

The predominance of usage of IFRS around the world provides even greater motivation for IFRS adoption in the US.

What is the outlook for IFRS adoption?Global snapshot

Use of IFRS

• IFRS is required for all companies in 76 countries.• European Union – All listed companies must use IFRS • Some countries allow IFRS for foreign companies only –

U.S. • Application of IFRS among the Global 5500 companies

increased from 29 in 2004 to 159 in 2007• AICPA’s Governing Council recognizes IFRS as

authoritative for financial reporting for members of AICPA• Private U.S. domiciled companies may now choose freely

between U.S. GAAP, IFRS, and IFRS for Small, Medium Enterprises (IFRS SMEs - simpler than IFRS)

Principles-Based Approach

• Standards are vague guidelines instead of step by step rules (as in the U.S.)

• Guidance is limited (ON PURPOSE!)

• Judgment is encouraged to apply the standards; over-reliance on detailed rules is discouraged

• “True and fair” view overrides– If following a standard would be misleading, you

do not have to follow the standard

Is IFRS better than US GAAP?The following example is a simple illustration of a principles-oriented approach compared to a rules-oriented approach.

Rules oriented:

► Your parents tell you to get a 3.2 GPA or above.

► They provide you with 15 contingencies that might justify acceptance of anything lower than a 3.2 GPA.

Principles oriented:

► Your parents tell you to do your best to get good grades.

► If you do not get good grades, they will consider the substance of your reasons.

IASB Framework

• Investors are primarily the main user group.• Primary objective is to provide information useful for

decision making.• Underlying assumptions include accrual basis and going

concern.• Understandability, relevance, reliability, and comparability

are the main characteristics.• The elements – assets, liabilities, income, expenses and

capital are defined.• No one measurement basis is prescribed.• The IASB Framework is being revised with several other

country’s standard setters.

Framework Update

• There are eight phases of update: Objectives, Elements, Measurement, Reporting entity, Presentation and disclose, Purpose and status, Non-profit sector, Remaining issues

• Red = currently working on.

• Objective - “Provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.”

Framework Update

• Fundamental Qualitative Characteristics

– Relevance (capable of making a difference)

– Faithful representation (replaces reliability)

• Enhancing Qualitative Characteristics

– Comparability, Verifiability, Timeliness, Understandability

• Pervasive Constraints

– Cost

– Materiality

• No “matching”

• No “conservatism/prudence

Framework Update

• Working definition of asset:

• “An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have.”

• Economic resource

• Entity has rights or means to access resource

• Rights exist at the financial statement date

Framework Update

• Working definition of liability:• “A liability of an entity is a present economic

obligation for which the entity is the obligor.”

• Derived from working definition of an asset• No need to specify probability, past event• Only an unconditional obligation to an external party• Distinguishes liabilities from equity

Framework Update

• Measurement – still working on this

• Reporting Entity – “circumscribed area of business activity of interest to some users”

• Time table:– Objective & QCs – Q3 2010– Reporting entity – ED March 11, 2010– Measurement – DP 2010– Elements

Main Differences Between U.S. GAAP and IFRS

• Revaluation of tangible assets – allows fair market valuation of property, plant and equipment

• Development costs can be capitalized

• LIFO inventory not permitted

• No extraordinary items allowed

Differences from U.S. GAAP

• IFRS have no enforceability internationally; only enforceable by the local country adopting them.

• IFRSs deemed less rigorous

• IFRSs do not cover as many issues as US GAAP

Acceptance of IAS

• FASB/IASB Memorandum of Understanding – MoU (Norwalk Agreement)– Both pledged to use their best efforts to converge

standards– Coordinate future work programs– FASB is increasing its size back to 7.– Originally wanted to “converge” by June 30,

2011.– Not feasible.

GAAP Convergence

• Boards have achieved “high-level” convergence in some areas– Business combinations

– Share-based payments

– Income taxes

– Fair value option

– EPS

– Statement of cash flows

– Pensions

GAAP Convergence

• In other areas, models are very different:– Debt/equity classification

– Derecognition

– Consolidation

– Impairment of long-lived assets

• June 2010 – announced areas of “priority”– Financial instruments, Revenue recognition, Financial

statement presentation, consolidation, leases, financial instruments with characteristics of equity and fair value measurement

IFRSs Acceptance

• Securities and Exchange Commission (SEC) – As of November 15, 2007, foreign listed companies

using IFRS no longer have to reconcile to U.S. GAAP.

– Currently there are around 1,230 foreign private issuers from more than 57 countries listing with the SEC.

• Around 143 companies filed their 2007 20-F with no U.S. GAAP reconciliation

– Proposal to switch to IFRS under consideration

What is the outlook for IFRS adoption?• In 2008, the SEC released a proposed Roadmap that laid out a timeline and

milestones for continuing US progress toward acceptance of IFRS for public companies.

• In February 2010, the SEC reaffirmed its commitment to IFRS and continued convergence activities. It also set forth a transparent work plan (the Work Plan) to allow the SEC to make its decision on IFRS adoption in 2011.

– The Work Plan will address the specific factors and areas of concern that were noted by the SEC and by the comment letters on the Roadmap.

– In executing the Work Plan, the SEC staff will gather information by performing its own research as well as by seeking comment from, holding discussions with, and analyzing information from constituents. The SEC staff will also consider the experiences of jurisdictions that have successfully incorporated or plan to incorporate IFRS into their financial reporting systems.

– The SEC staff stated that it will provide public progress reports on the Work Plan beginning in October 2010.

What is the outlook for IFRS adoption?The following are the specific areas of focus within the Work Plan:

• Sufficient development and consistent application of IFRS:

• The SEC staff will evaluate the comprehensiveness and enforceability of IFRS as well the auditability and comparability of financial statements prepared using IFRS, both in concept and in practice. These efforts will include consideration of the IASB’s efforts to improve IFRS through its conversion efforts with the FASB.

• Independence of the standard-setting process:

• The SEC staff will consider the extent to which the IASB’s governance (including its Monitoring Board), composition, funding and standard-setting process continue to promote the reporting of full, fair and reliable financial information to support investors in their capital allocation decision making.

• Investor understanding and education:

– The SEC staff will consider investor understanding and education regarding IFRS, including the current familiarity with IFRS, the actions needed to facilitate further understanding and the time frame to do so.

What is the outlook for IFRS adoption?

• There has been some concern expressed about following standards developed by a standard-setting body over which the SEC has no control.

– James Kroeker, SEC Chief Account, has pointed out the following in addressing these concerns:

• The US representation on the Monitoring Board will allow for influence over the international standard setting actions of the IASB.

• The FASB will play a key role in further aligning US GAAP with IFRS and will have an ongoing and substantive role post-adoption similar to national standard setters in other post-adoption jurisdictions.

– This could include exerting influence on IFRS, maintaining US GAAP as necessary and representing the US on the international stage in areas of research and thought leadership.

Impediments to Convergence

• Resistance to change

• European Union wanted changes in IAS 32 and 39 and forced the IASB to change its IFRS

• No more rigorous than the FASB

• U.S. Congress

Impediments to Change

IASB setup – Currently 4-U.S., 2, U.K, 1each from Australia, Brazil, China, France, Germany, India, Japan, South Africa, and Sweden

• Too political?• Still too large?

– 15 now, expanding to 16 people by July 2012 (4 – North America, 4 Europe, 4 Asia/Oceania, 1 Africa, 1

South America, 2 other for geographical balance)

Impediments to Change

• Is it really independent? – There is now a MONITORING BOARD for the Trustees

• Composed of Emerging Markets and Technical Committees of IOSCO

• Financial Services Agency of Japan• U.S. SEC• Basel Committee on Banking Supervision is an observer.

• Are constituents biased toward their own national standards?

• Constituents often appear Anti-U.S.• Other differences?

Websites

• IASB (www.iasb.org)

• IAS Plus (www.iasplus.com)– Website sponsored by Deloitte– Lists differences between IFRSs and different

country’s GAAP

Homework for September 30

• 1-1, 1-4 (Abdulaziz Alsayyari)

• 2-1, 2-4 (Weerapat Attachot)

• 3-2, 3-3 (Dr. Harrington)

• 4-1, 4-2 (Michele Bouton)

• 5-3, 5-5 (Stephanie Braden)

• 6-1, 6-2 (Heather Brown)

• All homework problems 2 points each. DUE OCTOBER 7