The emergence of the accounting standards has been beneficial for the companies and the investors of the companies. The accounting standards help in the presentation of the financial information of the company in a format that can be understood by the investors of the companies. The investors of the companies are interested in the performance of the company and the financial results are referred to analyze the results. Therefore, the companies must be able to communicate information that is useful for the investors and the other related parties.
The emergence of the standards has been helpful in introducing uniformity of the presentation in the companies. The investors have been benefited by the clarity of the information and the scope of the information. In the case of the companies, the management is able to garner more investments form the investors because of the clarity of the information. The clarity of the information in the case of the companies helps in attracting more capital. Therefore, in the true sense, the cost of capital decreases.
The accounting world follows different kind of standards and formats in the case of the presentation of the financial information. With the globalization of the economy, it was felt evident to have a uniform standard all over the world. The existing standards of the different parts of the world are in the process of converging to make a globalized standard. The process is going on till now. In Europe, with the emergence of EU, the rules and regulations in the case of the business have been more stringent. The IAS/IFRS controls the presentation of the accounts in the case of the business houses in Europe. In the case of the US and the North American countries, the US GAAP is the most accepted standard. Therefore, there will be a difference in the presentation of the accounting and the financial information of the companies in these two spheres.
There are differences between the US GAAP and the IAS that hinders the presentation of the financial statements of the company. In some cases, there is difference in the valuation of some of the items in the company. The difference in the valuations of some of the items will be confusing for the investors. In the case of the measurement of the non-controlling interests of the company, the IAS allows it to be valued at fair value or at the proportionate value in the company. In the case of the US GAAP, the standard allows the valuation at fair values. This leads to the differences in the valuation of the companies.
The structure of the presentation of the financial statements differs in the case of the IAS and the US GAAP. In the case of the IAS, the report should consist of the various divisions of the changes of the equity and the comprehensive income. However, in the case of the US GAAP, the comprehensive income will report all the changes. In the case of the IAS/IFRS, the comparison between the different years is required while in the case of the US GAAP, the comparison is “desirable”. Deferred tax is always recognized in the case of the US GAAP while in the case of the IAS/IFRS, the deferred tax is recognized if the income is probable.
The reporting for the segments also differs in the case of the standards. In the case of the US GAAP, one basis of segmentation is required while in the case of the IAS/IFRS, the whole segmentation has to be done. The segment must report the results in the case of the IAS/IFRS while in the case of the US GAAP it is not needed. These are the key differences in the case of the presentation of the financial statements.
With the globalization of economy, the reporting of the accounts of the company became a problem. The EU became bigger and engulfed newer countries in its fold. About 7000 companies registered in the EU are required to comply by the IFRS. This is a problem as most of the companies are incorporated in the US. In the US, the companies can report in the IFRS from but they have to prepare reconciliation in the GAAP format. Therefore, the companies essentially have to prepare accounts twice. Moreover, the implications of the Sarbanes-Oxley Act require the preparation of the accounts in the best interest of the international business environment. Therefore, in October 2002, the board of the IFSB and the FASB (US GAAP) entered into a contract to converge the different accounting principles to prepare a global system. The bodies take short-term projects to converge the different points of the standards. This will help the global business organizations. Also, finance analysts made fewer mistakes forecasting future earnings, and that the accuracy was enhanced after the adoption of IFRS by the European Union.
Principles-Based System (IAS/IFRS) Vs Rules-Based System (GAAP)
Before the convergence, and even in the process of it, debates over which set of standards is superior never stopped. The biggest issue rests with the essence of the two different accounting styles. Many scholars assert that IFRS is principles-based while US GAAP is rules-based. However, this distinction is futile, because the only distinction is in the degree of professional judgement required for the implementation of the two systems. In a global economy, accounting harmonization is getting more attention. Principles-based system is advocated by both academia and practical circles as a principles-based system i.e. IFRS provides flexibility for countries with diverse accounting traditions to comply with, while preserve its spirit to ensure a ‘true and fair’ presentation. While the spirit of principles-based system is appreciated, there are cases indicating the failure of such system. The success of a principles-based system depends more on human factors such as willingness of auditors to comply, capacity of regulators to monitor, factors that rules-based system ignores because of its rigidity. The rigidity of rules-based system is also a curse. The rigid rules leave more loopholes for accounting manipulation as manifested in the Enron scandal, in which the management managed to keep off-balance sheet transactions within the GAAP rules. Also cultural differences lead to different accounting styles which might render the convergence ineffective.
Fair Value Vs Historical Costs
The IFRS advocates the use of fair value as fair value provides relevance and decision-usefulness. Historical cost is used in the US GAAP for its prudence and reliability. Problems that the convergence must counter focus largely on the adoption of costing system. Since historical cost is still being used in many countries, it has its inherent advantages. Nowadays, scholars argue that fair value costing might provide more accurate thus relevant information. Only with the exception in financial crisis, fair value causes fluctuations in accounting figures which makes it less dependable. Moreover, it introduces volatility even when economy is stable, although it on certain level prompts early reaction to control risks.