IFRS and Accounting - Essay Example

?There are two forms of accounting typically taking place within an organisation, ly, financial accounting and management accounting. Financial accounting (FA) is mainly focused on provision of financial statements of interest to external stakeholders (e.g. investors, creditors and relevant tax authorities) while management accounting is majorly focused on provision of details important for decision making by the internal management structure of the organisation (IFAC, 2005). As Axel (2002) says, the European Union’s decision to require every listed company within the region to adopt the International Financial Reporting Standards (IFRS) from 2005 henceforth marks the initial peak in the internalization of financial reporting in Europe and beyond. Since then, financial accounting became subject to the IFRS but management accounting is still done with a great degree of flexibility and varies from one organisation to the other. This paper will then explore the degree to which the IFRS has been effective in harmonizing global financial accounting, and explore some of the drawbacks to this harmonization. Finally we’ll take a look at some of the issues with the currently unregulated nature of management accounting. IFRS and Accounting As Soderstrom and Jialin (2007) reports, the European Union (EU) parliament passed a regulation in the year 2002 that required all the companies listed in the EU to adopt a set of Generally Accepted Accounting Standards (GAAP) in their consolidated as well as simple accounts. These standards, referred to as International Financial Reporting standards (IFRS), were implemented beginning January 1st in 2005 and were targeted at financial accounting. Management accounting (sometimes referred to as managerial accounting) didn’t have to conform to any external standards since organizations are allowed independence in their management accounting structures. According to Axel (2002), the IFRS has very noticeably led to a great degree of internalization within this realm of financial accounting and has greatly accelerated to go beyond the region. The IFRS is usually administered by the International Accounting Standards Board (IASB), which is based in the UK and has been widely accepted in many EU countries and beyond, replacing the previously existing national accounting standards for the publicly listed companies within the respective countries. The IFRS has in recent times been working closely with the Financial Accounting Standards Board (FASB) which is mandated with the provision of the U.S. GAAP (an equivalent of IFRS) for implementation by the U.S. Securities and Exchange Commission (SEC) among all publicly listed corporations within the U.S. to harmonize the differences existing between the IFRS and the U.S. GAAP. This is very well demonstrated in the U.S. Security and Exchange Commission (SEC) move in 2007 to a adopt a policy that would permit non-U.S corporations that are listed on the U.S stock exchange to use IFRS in their financial statements instead of the U.S. GAAP. A year later, SEC further edged towards the use of IFRS completely by issuing a road map document that highlighted the steps towards full adoption of the IFRS among publicly traded companies by the year 2014. This move is targeted at publicly traded companies and The American Institute of CPAs has responded with a call for the formation of a separate entity or committee to govern the accounting standards for private corporations. The IFRS and U.S GAAP differ significantly in so far as inventory costs are concerned. It is greatly believed that as the two accounting standards continue being harmonized prior to full adoption of IFRS by 2014, a number of inventory cost methods currently in use under GAAP will cease to be applicable in financial reporting. This will have far reaching consequences in financial accounting for numerous publicly traded companies. But as G?unther and Zoltan (2011) argue, the degree of secondary effect on management accounting will be relatively limited. In spite of this, the company managers will still have to be keen on any significant changes in the financial accounting standards as it has a significant on how they report the results of their management decisions to their external parties such as the tax authorities and the shareholders. This is mainly because how management decisions are financially reports has overarching impacts on the earnings per share and typically has an impact on how the stocks of the company are valued. Financial Accounting versus Management Accounting As we have already mentioned, management accounting systems of publicly listed companies are imposed to no financial standards unlike the financial accounting systems. However financial accounting affects the management accounting to some extent. For instance, both management and financial accounting relies on the same the cost systems while accounting for inventory costs. Even then, financial accounting and management accounting differ in many ways. As IFAC (2005) highlights, financial accounting serves the interests of external stakeholders especially the shareholders, creditors and the tax regime, who are all interested in getting correct, standardized information about the company’ financial position and performance. On the other hand, management accounting is primarily focused on the internal management and is basically done to facilitate the internal decision making processes. In addition, while financial accounting is governed by national as well as international accounting standards (IFRC in most countries), which stipulate the way in which various financial items should be handled (e.g. which expenditures should be capitalized and which ones should be expensed? and how should reporting of given liabilities be approached?), management accounting is not subject to any national laws or international standards and an organization is free to determine its own management accounting standards and best practices based on its own principles, culture, goals and objective. On the same note, financial accounting focused purely on financial (monetary) information which gives the company outlook in so far as annual income and expenditures (income statement or profit and loss account); cash flow (financial statement); and assets, liabilities, and capital (balance sheet) are concerned. Management accounting on the other hand focuses on monetary as well as non-monetary information such as cost drivers e.g. raw materials and labor, with the overall goal of helping support the decision-making process through planning, budgeting, and facilitating for efficient utilization of company resources, thus maximizing the value of the company to the external stakeholders particularly the shareholders. Also while the sequence for financial reporting involves data collection, balancing and auditing of financial reports, and reporting to the external stakeholders, management accounting revolves around data collection followed by a regular and strategic review of the data using various techniques the likes of capital investment appraisal with the overall goal of solving and driving various management goals, need, and objectives (IFAC. 2005). Thus, while financial accounting deals with the information and review of financial statements whose main objective is to provide a reasonable return to investors, management accounting is mainly concerned with provision of tools that the managers require to satisfy the expectations of the external stakeholders of the organisation Bhimani and Bromwich (2010). Another major difference between financial and management accounting is that while financial accounting is normally concerned with the whole company, management accounting may focus on only various products or segments. Also, while management accounting may have reports generated on any time intervals e.g. weekly, daily, yearly etc, financial accounting usually involved reporting on fixed time interval which include fiscal yearly or quarterly, and as Cooper (1996) points out, while the confidential, financial accounting reports are based on historical facts on which recipients can make future predictions about the company, management accounting reports are based on publicly available, predictive reports with specific goals and values. Summary of the differences between financial accounting and managerial accounting Challenges and implications of current IFRS implementation The mandatory adoption and implementation of the IFRS has not been without its challenges and drawbacks. Schipper (2005) points out an increased demand for detailed implementation guidance as well as a single European securities regulator”. Also, as Soderstrom and Jialin (2007) argues, the extensive adoption of the IFRS within the EU is likely to result in some inter-country differences in the quality of accounting nevertheless since the quality of accounting prevalent in a company is a function of its overall institutional effectiveness with factors such as the political and legal system of specific countries plays a critical role in this. The mandatory IFRS implementation could have significant implications on the quality of banking and could have accelerated the recently experienced financial meltdown even when most debates focuses mostly on the role played by real value accounting (Song et al., 2010; Goh et al., 2009). But as G?unther and Zoltan (2011) maintains, IFRS could have played an equally significant role. To start with, the biggest portion of banks’ assets constitute of loans which are typically measured on a cost basis under local Generally Accepted Accounting Principles (GAAP) as well as under IFRS. Loan loss provision is important to banks in determining deterioration of the loans’ credit quality. Thus loan loss provision has a considerable effect on the reported earnings of a bank. The widespread implementation of IFRS in EU countries and beyond brings about a notable change in detection and quantification of loan loss provision. While IFRS introduces an incurred loss model, the loan loss provisioning regime previously practiced in Europe under local GAAP was more forward-looking and allowed for some degree of loss anticipation owning to future events where. But the rules were largely principle-based and managers were allowed room for use of discretion, that is, income-smoothing. In contrast, IAS 39 uses an incurred loss approach whereby managers provide only for the losses accrued as of the date of the balance sheet. On that note, it is not possible to account for future losses. The implications of this are best understood by analyzing the importance of loan loss provisioning and accounting. The importance of appropriate loan loss accounting is best demonstrated by the 19998 debate where SEC questioned the appropriateness of the approach of SunTrust Banks. As Wall and Koch (2000) reports, the bank had to reduce its loan allowances considerable before it could get its registration statement approved. As a follow up, SEC issued interagency letters alongside bank regulators that sought to guide banks on the appropriate loan loss accounting practices which was at that point gaining international attention at a fast paced rate. It led to various policy changes and proposals relating to accounting standards. To start with, the Joint Working Group of Standard Setters called for the introduction of fair value accounting to financial instruments (JWG, 2000). In addition, statistical provisioning was introduced in Spain (Fernandez de Lis et al., 2001). This ultimately led to IAS 39 in the same year which has undergone several revisions ever since. The overarching objective of IAS 39 has been the harmonization of U.S GAAP and IFRS. One key aim of the incurred loss approach was to relatively mitigate the judgment and discretion scope in determination of the loan loss provisions compared to the forward-looking regimes that precede the IFRS. Ethical challenges for management accounting According to Cooper (1996), managerial accounting is becoming ever so important as the global competition rises. Companies need to learn how to manage their costs more effectively and reduce costs and as more and more managers become involved in cost management systems, the position of management accounting can only become more central. Even then, management accounting is faced with numerous challenges in its presently uncontrolled structure unlike financial accounting which is administered under the IFRS and other local GAAPs. One notable challenge to management accounting is the subjective approach with which it is inevitably implemented. Management accounting usually involves a cost-benefit analysis whereby the aim is to have the perceived benefits exceed the implementation costs. In addition, although financial measures are typically used to inform management accounting decisions, other measures can as well be used e.g. time where money cannot be used to present events. for instance time can be used to express service quality for Amazon.com which values fast delivery of items to buyers, in airlines where timely departures and arrivals represent successful operations, and for fire brigades whereby prompt response to fire emergencies is translated to be a success in service delivery. Since no external standards are typically subjected to the management accounting process, it can be pretty subjective. Ethical issues may also be of concern to management accounting. Ethics are concerned with moral propriety and fitness of a chosen action path. Since transcends the stipulations of existing laws to moral qualities which are normally not well defined (subjective). Managers often have to deal with scenarios that do not clearly fall into either ethical or unethical brackets such as speeding up or slowing down the shipments ay the end of the first quarter to meet current earnings forecasts. Conclusion The introduction of IFRS regulations by the EU parliament paved way for the internalization of financial accounting. IFRS has since gained momentum and characterizes the financial accounting systems of most countries. Also plans are underway for the U.S. to drop its currently used U.S. GAAP for the IFRS by the year 2014. We have seen how financial accounting differs with management accounting and explored the extent to which international harmonization of accounting regulations in line with IFRs has been achieved. We have also discussed some of the drawbacks inherent in the hitherto unregulated management accounting. References Axel, H. 2002. “Financial accounting developments in the European Union: past events and future prospects.” European Accounting Review, 11, 1, 153-90. Bhimani, A. and Bromwich, M. 2010. Management Accounting: Retrospect and Prospect, London, Elsevier/CIMA Cooper, R. 1996. “Look Out, Management Accountants.” Management Accounting, 2, 20–26. Fernandez de Lis, S., Martinez P. and Saurina, J. 2001. “Credit Growth, Problem Loans and Credit Risk Provisioning in Spain’, in Bank for International Settlements, Marrying the Macro- and Micro-aspects of Financial Stability.” BIS Papers, 1, 331–53. Goh, B. W., Ng, J. and Young, K. O. 2009. Market Pricing of Banks Fair Value Assets Reported under SFAS 157 during the 2008 Economic Crisis, Working Paper, Singapore Management University. G?unther G. and Zoltan, N. 2011. “Mandatory IFRS Adoption and Accounting Quality of European Banks.” Journal of Business Finance & Accounting, 38, 3, 289–333 IFAC (International federation of accountants). 2005. Environmental Management Accounting: International Guidance Document, IFAC, New York. JWG (Joint Working Group of Standard Setters on Financial Instruments). 2000. Financial Instruments and Similar Items – Draft Standard & Basis for Conclusions. London (IASC), Norwalk (FASB). Laux, C. and Leuz, C. 2009. “The Crisis of Fair-Value Accounting: Making Sense of the Recent Debate.”Accounting, Organizations and Society, 34, 6&7, 826–34. Schipper, K. 2005. “The introduction of International Accounting Standards in Europe: Implications for international convergence.” European Accounting Review, 14(1), 101-26. Soderstrom, N. and Jialin, K. 2007. “IFRS Adoption and Accounting Quality: A Review.” European Accounting Review, 16, 4, 675-702. Song, C. J., Thomas, W. and Yi, H. 2010. “Value Relevance of FAS No. 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms.”The Accounting Review, 85, 4, 1375–410. Wall, L. D. and Koch, T.W. 2000. “Bank Loan-Loss Accounting: A Review of Theoretical and Empirical Evidence.” Economic Review – Federal Reserve Bank of Atlanta, 85, 2, 1–19. Read More