International Financial Reporting Standards - Essay Example

About U.S. Companies Switching To International Financial Reporting Standards (IFRS) Beginning In TABLE OF CONTENT: PAGES 1) Executive Summary 02 2) Introduction 02 3) Similarities and Differences 03 4) IAS-2 (Inventories) 03 5) IAS-11 (Construction & Contract) 04 6) IAS-16 (Property Plant & Equipment) 05 7) IAS-36 (Impairment Losses) 06 8) IAS-39 (Intangible Assets) 06 9) Diversification into IFRS from GAAP and its Impact 07 10) Conclusion 09 11) Bibliography 09 12) References 10 Executive Summary: The IASB has a conceptual framework underlying its financial reporting standards and interpretations, the Framework for the Preparation and Presentation of Financial Statements (the Framework). The Framework sets out the concepts that underlie the preparation and presentation of financial statements for external users Introduction: This Essay provides an adequate knowledge of International Accounting Standard (IAS) and General Accepted Accounting Principle (GAAP) and their comparison. Mainly we only emphasize on the 5 IAS and compare their similarities and differences with the GAAP. It includes the diversification from GAAP to IFRS which have to be adopted by the US in order to compliance with the Security and Exchange Commission, also provides knowledge why and how conversion enhances the reporting quality. The framework for the preparation and presentation of the financial statements adopted by the International Accounting Standard Board (IASB) is known as International Financial Reporting Standard, IFRS provides a procedure norms, rules and regulation that how to prepare and present the financial statements, what data must be included and what should be omitted. Most of the standards which come under the umbrella of IFRS are previously known as the International Accounting Standard (IAS). IAS was issued between 1973 and 2001 by the International Accounting Standard Committee. While General Accepted Accounting Principles (GAAP) is also a standard framework of financial reporting, it includes the standard, convention, rules and regulation an accountant must follow in recording and summarizing transactions and in the making of financial statements. IFRS and GAAP have some similarities and differences which we will discuss later. Similarities and Differences: There are a number of similarities and difference in every IAS and GAAP, but we will mainly emphasize on the mentioned below 5 IAS. IAS 2 (Inventories): IAS 2 elaborates the accounting treatment for inventories. The issue which arises often in this standard is when we intend to recognize the cost as an asset and carried forward it until related revenues are recognize. The cost formula assign for the cost of inventory is also prescribed in IAS-2. Basically there are two main methods of inventory valuation. i) First In First out (FIFO) which means the organization has to utilize its stocks which they have first in line. ii) Last In First out (LIFO) which means organizations have to use the last purchase stock first. Generally FIFO is for low Cost of Good Sold (COGS), high ending inventory so ultimately the bottom line will show a high net profit, while as far as LIFO is concerned, is for high COGS , low ending inventory and low net profit. Darrell Mullis and Judith Orloff elaborates practical examples of FIFO and LIFO in their book namely "The Accounting Game" which shows how FIFO leaves a positive impact over the net income and LIFO condensed the net profit or the profit after tax (PAT), Usually Companies uses LIFO method in order to save the Taxes. Differences are there between IFRS and GAAP, like adoption of LIFO method in IFRS is prohibited while under U.S GAAP, companies have the choice between LIFO and FIFO method. Some sort of similarities are also there between IFRS and GAAP, (like in measuring inventory at net realizable value even if cost above), the IFRS permitted only for producers, inventories of agriculture and forecast products and mineral ores ad for broker-dealers while in GAAP these all are permitted, but based on a specific product. IAS 11 (Construction & Contract): The objective of the International Accounting Standard 11 (IAS 11) namely "Construction and Contracts" is to elaborate the accounting treatment of revenue and cost pertains with construction contract. It furthers prescribed that when the cost should be treated as an expense or a revenue in an income statement. It prescribed the method of accounting for construction contracts when the percentage of competition can not be determined, various method can be use to do the accounting for construction & contract. The two methods which are mainly use in IFRS and GAAP are mentioned below. (i) Cost Recovery Method (ii) Completed Contract Method. IFRS tends to use the cost recovery method which prescribes that no gross profit is recognized until all the cost of merchandising has been recovered. Once the cost has been recovered then the remaining collection will ultimately become the part of gross profit. On the contrary GAAP uses Completed Contract method which prescribed the recognizing revenues and cost from, a long term project in which profit is recorded only when the project has been completed. Even the payment are received during the project completion then the said payment will not be recorded as revenue in the income statement until and unless the project has been completed. IAS 16 (Property, Plant & Equipment): The objective of the International Accounting Standard 16(IAS 16) namely "Property Plant & Equipment" is to elaborate the treatment for property plant and equipment from which the users of financial statements discern and idea regarding the investment of the entity in property, plant and equipment and their changes which influences the Return on Asset (ROA) ratio. Determination if the carrying amounts, depreciation rates and charges and impairment losses are also describe in IAS 16, we can say that IAS 16 is a basis of measurement for property, plant and equipment. Revalued amount and historical cost is the measurement tool in IFRS. Residual amount is the fair value at date of revaluation less subsequent accumulated depreciation and impairment losses, while historical cost is the only measurement tool in GAAP and revaluation is prohibited in GAAP. As per the IAS 16 it generally accounted for as part of the cost of an asset while accounted for either expense as incurred, deferred and amortized over the period are the part of the cost of an asset. Residual value may be fluctuated upward or downward in IFRS but only be adjusted downward if it associated with GAAP. IAS 36 (Impairment Losses): Now comes to the standard which deals with the impairment losses prescribed the procedure that an entity applies on their assets which are carried out at no more than their recoverable amount. More laymen approach if I opt, than I can say that an entity to recognize an impairment loss if the carrying amount exceeds the amount to be recovered through use and sale of an asset. Measurement of impairment loss for long term assets are varies from standard to standard. In IFRS it based on the recoverable amount, while in GAAP it based on the fair value, which generally based on discounted cash flow. Calculation of impairment and goodwill consist of one step in IFRS and of two steps in GAAP. Subsequent reversal of an asset impairment loss is required for all assets, other than goodwill in IFRS while it's strictly prohibited in GAAP. IAS 39 (Intangible Assets): IAS 39 namely Intangible Assets dealt with the measurement of the carrying amount of intangible assets and require specific disclosure about Intangible Assets, The objective of this standard is to prescribe the accounting treatment for intangible assets. Revaluations of Intangible Assets are permitted in IFRS if asset is traded in active market while it is prohibited in GAAP. Impact of Diversification to IFRS From Gaap In Us. Things are changing so rapidly in the world as IFRS is still unfamiliar to most of the peoples. As I mentioned earlier IFRS is the new name of pronouncement of the International Accounting Standard Board (IASB), the movement towards IFRS as the worldwide accounting yardstick affect the environment in which all companies operates including USA. Adoption of IFRS definitely enhances the quality of financial information because IFRS will require companies to assess their compensation philosophy and design. Diversification in IFRS from GAAP would bring certain outcomes. (i) Efficiency in financial reporting (ii) Cost saving (iii) Help to reduce the Compensation packages. (iv) Greater access to foreign capital markets and investment. (v) Chance of investing in foreign countries. (vi) It will help to fight against the financial crisis. The conversation of GAAP in IFRS in US helps organization to abate their cost, it would bring efficiency and cost saving to a multinational company lets say "Proctor & Gamble" who's foreign sister concern are already using IFRS. According to Melton, (CFO.com) "The new rules will affect specific levels of executive compensation as well as the impact on broader employee compensation scheme", Recently Obama administration intervene between the bonuses awarded among the employees and the Executive(s) of American International Group (AIG) and say why should they awarded bonuses and perks as they are the causes to push the Group towards the brink of bankruptcy. As per the credit rating agencies, Investment Banks and accounting firms U.S companies could get benefit of European counterparts' experience of transitioning to IFRS. Mostly European Countries and countries like China, India, were also converted their Accounting principal to IFRS and enjoying its benefits. According to Security and Exchange Commission (SEC), "Although diversification to IFRS is helpful to enhance the quality of reporting in U.S but it will require some time to manipulate, as not many U.S accountants are knowledgeable enough about IFRS, but the U.S have to do it before 2014. I want to quote here the words of MR. Gary Illiano, (who is the partner at Grant Thornton), called "The conversion fairly traumatic but with good results". Public Companies in at least 100 countries prepare financial statements using International Financial Reporting Standard (IFRS) and in view of recent SEC action, US Companies may soon be permitted to do the same. As per Christopher coz (SEC Chairman), SEC allow some big multinational companies to report according to international accounting standard beginning in 2010, He also estimates that around 110 US companies would qualify on their market capitalization and would switch to International Financial Reporting standard beginning in 2014. Christopher further elaborates that the conversion will help US to compete globally. IFRS tends to lead to higher earnings and the conversion will hike the earnings graph in US, which helps to meltdown the affect of Global Financial Crisis. Conclusion: From all this controversial issue we can say that diversification in IFRS from GAAP will enhance the quality of reporting in US, as an enormous quantity of the companies are now report as per the International Financial Reporting Standard (IFRS). Apart from a number of benefits of the diversification as mentioned above it also helps to create greater access to foreign capital markets and investments and facilitate cross-border acquisition and ventures. IFRS will indulge in one time cost association with enterprise wide conversion, including the audit effort and other external cost. Books References: (1) International Financial and Reporting Standard (IFRS) 2007 VOLUME 1 AND 2. (2) The Accounting Game by "Darrell Mullis and Judith Orloff". (3) Advance Financial Accounting 7th Edition by "Richard Lewis and David Pendrill" Websites References: (1) http://www.kpmgifrsinstitute.com (2) http://www.ifrs.com (3) http://www.ifrs.com/overview/General/differences.html (4)http://www.pwc.com/extweb/pwcpublications.nsf/docid/0926233008C4060380256AE 700566123 (5) www.ifrs.org (6) http://www.gaap-ifrs.com (7) www.sss.ias.edu/community/faculty-cv/geertzcv.pdf Read More