Benefits and Drawbacks of International Financial Reporting Standards - Assignment Example

International Financial Reporting Standards Benefits and Drawbacks of International Financial Reporting Standards Introduction International Financial Reporting Standards (IFRC) are accounting standards that are used by organizations to determine how a business’s transactions are reported and disclosed. It defines how an organization’s financial statements are to be prepared and disclosed. This set of standards was designed to replace each country’s Generally Accepted Accounting Principals (GAAP). This makes it easy for all financial statements from any part of the world to be comparable and evaluated on the same set of accounting standards. Financial accounting and managerial accounting deal with the preparation of accounting reports that provide information for decision making. Financial accounting deals with the preparation of financial statements such as the balance sheets and the profit and loss accounts. These are disclosed to both internal and external users. The internal users include the management and employees. Management accounting deals with the preparation of accounts that are used internally by management for decision making. Financial accounting statements are subject to the scrutiny of outsiders; potential investors, financial institutions and economic analysts compared to managerial accounts that are used internally by management (Ramanna & Sletten, 2009). Financial accounts provide information on the financial position and position of the business whereas management accounts provide information for planning, budgets and controls for management decision making. This explains why financial accounts need to follow certain standards compared to managerial accounts. Due to globalization, countries need to speak the same language internationally so that the accounts produced can be understood and improve investor confidence regardless of the country concerned. This paper sets out to explain what IFRS is, the arguments for and against using uniform accounting standards in the preparation of financial statements and the flexibility of the preparation of management accounting reports (Caroline, 2010). History of International Financial Reporting Standards The International Accounting Standards Board (IASB) was formed to promote the adoption of the IFRS so that there is worldwide consistency in financial reporting regardless of where the organization was located. The International Accounting Standards Committee (IASC) was formed in 1973 to prepare standards that would be used by smaller nations in creating their own internal accounting standards. This was succeeded by the IASB in 2001. GAAP is an appropriate tool for financial reporting where organizations operate within a country’s borders with reason. With globalization a company may find it difficult to compare its financial statements using its GAAP without violating the GAAP of another. IFRS were developed due to the growth of global markets and the desire by multinationals and organizations to have one common set of financial statements that can be understood internationally. The IASB was mandated to develop high quality accounting standards that would reduce the cost of doing business, increase efficiency and provide information for potential investors. Currently, there are over 100 countries that have adopted the IFRS. There are many countries that are in the process of replacing the local standards with IFRS such as the US (Armstrong, Barth, Jagolinzer, & Riedl, 2010). Benefits of International Financial Reporting Standards There is greater comparability of financial statements. Companies from different countries can easily compare their accounts. Using different rules in the preparation would not be possible and good for investment. The statements can be compared in all the financial markets irrelevant of where they were prepared. Financial statements prepared using IFRS are more flexible as they are principle based compared to local accounting standards, the general accounting accepted principles (GAAP) that are rule based. IFRS allows a country to adapt to its situation and come up with a reasonable valuation. IFRS uses substance rather than criteria in reporting a business’s transaction. There is more professional judgment exercised which leads to better disclosure (Ramanna & Sletten, 2009). The IFRS’s main goal is to meet the needs of investors and all stakeholders. The standards provide a common global accounting language. The process of preparing the standards is transparent to maintain investor confidence and high quality. This process avoids political influence and is independent. Investors have better information to enable them make important decisions on their investments. Multinationals operate in different countries which lead to having multiple financial statements using different standards from the different countries. IFRS reduces the number of financial statements prepared and makes it easier for them to compare their performance. The multinationals are also able to compare financial statements from the countries they do not operate in to make decisions for expansion (Chen et al., 2009). The use of IFRS enable all levels of management to be more involved in the financial reporting and be aware of the nature of the transactions being reported. Companies are more efficient and a lot of saving is made in making one uniform set of accounts. Countries require more information due to globalization. The costs of acquiring this are greatly reduced when uniform accounting standards are used. Investors participating in the capital markets can use information that uses a common global language compared to different local standards from the different countries they operate in. Countries with high level of expected foreign investment and trade will find it in their interest to adopt IFRS. For an economy to attract foreign investment, it is easier to attract investors if the information required making that decision is easy to understand and compare with their own (Ramanna & Sletten, 2009). Investors are the biggest beneficiary to the use of IFRS. The standards ensure accurate, comprehensive and timely financial statements. IFRS ensures that smaller investors can compete on a level playing field with bigger investors who would otherwise be better informed without the uniformity of the standards. The use of uniform statements means that there is no need for the small investor to get more information from other sources which can be costly. Reduced costs mean increased market efficiency. Reduced international differences in accounting standards removes barriers that lead to increased profitability and premium margins for mergers and acquisition. In the modern world, many companies prefer forming mergers with other companies in the same field or related fields, so as to reduce the cost of production, which subsequently increases their profit margins. Basically, mergers usually enhance or facilitate economies of scale, which subsequently increase profits. These economies of scale include in marketing, production and human resource among others. This trend of mergers and acquisitions has therefore become very popular and fashionable in the modern business world (Katz & Shapi, 2000). Drawbacks of International Reporting Standards Although over 100 countries have implemented IFRS, it too has its disadvantages and drawbacks. There are countries using GAAP where the drawbacks are more significant and have valid reasons for not adopting IFRS. The most significant country is the US that has delayed the transition to IFRS. The use of principle based standards can lead to manipulation. Companies are free to adjust the information to achieve a certain desired result. For example a firm can be able to manipulate its profitability by adjusting the value of its inventory. It is easy to hide fraud and any financial problems that the organizations would have. Under the IFRS one can justify why it has to make certain adjustments. Stricter rules are needed to ensure that such manipulation does not occur (Ramanna & Sletten, 2009). The cost of changing to IFRS is high and has many implications. Smaller economies do not have the resources to implement the standards. It is difficult for foreign companies to do business in countries that do not use IFRS as there will be different multiple sets of accounts in use. There is the cost of re-education and training. Accountants, auditors and consultants need to be trained and relearn their jobs. This takes time and will lead to reduced profits during the transition period. IFRS lacks detail and there is a perception that it is inferior to what is in place in countries that use GAAP. Countries with low foreign investment interests would not benefit in the use of IFRS. Other countries do not fully adopt IFRS and partially use the international standards. This still makes it difficult for comparability in financial statements. The importance of financial markets is vital to a country’s decision to adopting the IFRS. Countries that do not have a vibrant financial market are less reluctant to do so (Kalbfleisch & Prentice, 1980). Cultural influences in many countries do not like to have outside influence in their operations. The idea of developing countries being controlled by developed countries if they adopt the international standards. They believe that the local standards are sufficient and they do not need external influence to change the accounting policies. IFRS is difficult to regulate when in operation in multiple countries (Ramanna & Sletten, 2009). The use of IFRS in Developing Countries Many developing countries have adopted IFRS in order to enjoy the benefits as outlined above. IFRS has attracted foreign investment in these countries. It is now common to see multiple multinationals operating in developing countries. This has improved the economies of the developing countries and boosted investor confidence. These economies have in turn made it easier for investors to operate in their economies. The challenge for developing countries is to establish the necessary legal and regulatory framework to create investor confidence and encourage foreign investment. Some developing countries have developed local institutions to ensure that the IFRS are implemented (Ramanna & Sletten, 2009). IFRS and the US GAAP The US has been using GAAP but is now working on making a transition to IFRS. The US GAAP was always known as the golden rule to accounting standards. This clearly shows that globalization has affected even leading economies such as the US to finally see the need for a globally accepted accounting language. The network effect also has played an important role in more countries adopting the IFRS. As more countries adopt the international standards, other countries are more willing to make the transition. They clearly see the advantages from examples of these countries and are more convinced of the need to change as compared to when they were initially introduced. The advantages of using IFRS far outweigh the disadvantages. There are various reasons why the US is reluctant to adopt the IFRS. There are many small companies in the US with no dealings internationally. There would be no direct benefit to them to changing to IFRS. The high costs of implementation are a major drawback. The US finds its GAAP more superior to the IFRS the costs not warranted. The global financial crisis being experienced is not a time to be making major financial changes. The cost of education and training was also a major factor for the reluctance to make the transition. There are also major differences between GAAP and IFRS such as the use of the LIFO method and allowance for the revaluation of assets under certain circumstances (Ramanna & Sletten, 2009). Conclusion The IFRS was created in order to deal with the creation of a globally accepted accounting language. Each country has its own GAAP that it uses to prepare financial statements. Due to globalization it has become crucial to use international accounting standards to enable investors to use financial information from different countries to make investment decision. IFRS enables comparability, flexibility, transparency and reduces the cost of doing business. Developing countries have benefitted from IFRS with increasing investor confidence and thus growing their economies. Although the IFRS has its benefits, there are also drawbacks especially for countries that have a well established GAAP such as the US. Countries that have low foreign investment interests are reluctant to adopting the standards. Other countries see their own GAAP being more superior to the IFRS and do not see any need to adopt them for the sake of globalization. With globalization, the growth of trade and capital markets it is vital for countries to speak one accounting language. This is especially in the preparation of financial statements which are used both internally and externally. Managerial accounting reports are more flexible in that they are used internally by management to make decisions. They do not need to be subject to international standards the decisions made are not directly affected by globalization and do affect other organizations. IFRS is key to financial statements due globalization. Countries like the US who have always used GAAP are now working at having a transition to IFRS for the sake of globalization. References Armstrong, C., Barth, M., Jagolinzer, A., & Riedl, E., 2010. Market reaction to the adoption of IFRS in Europe. The Accounting Review, 85 (1), pp. 31–61. Caroline, N. L., 2010. International Finacial Reporting Standards, Pros and Cons for Investors. Accounting and Business Research, pp. 5 -27. Chen, H., Tang, Q., Jiang, Y., & Lin, Z., 2009. The Role of IFRS in Accounting Quality: Evidence from European Union. Journal of International Financial Management & Accounting, 21 (3). Kalbfleisch, J. D., & Prentice, R.L., 1980. The statistical analysis of failure time data. New York: John Wiley. Katz, M.L., & Shapi, C., 2000. International Accounting Standards Committee (IASC) EU financial reporting strategy. London: IASC Insight UK. Ramanna, K., & Sletten, E., 2009. Countries adopt International Financial Reporting Standards. Harvard: Harvards Business School. Read More