International Accounting Standards: Convergence and IFRS

Posted on Jan 22, 2025 in Public Administration, Management, and Governance

Chapter 3

  1. Convergence and Harmonization of Accounting Standards
  • Harmonization: Reducing alternatives while maintaining flexibility in accounting practices. Allows different standards if no logical conflicts.
  • Convergence: Adopting one set of standards internationally. Main objective of IASB.
  1. Arguments For and Against International Convergence

Pros

  • Expedite global capital market integration, easier cross-listing.
  • Facilitate mergers and acquisitions.
  • Reduce investor uncertainty and cost of capital.
  • Reduce financial reporting costs.
  • Allow easy and cost-effective adoption of high-quality standards in developing countries.
  • Easier transfer of accounting staff internationally.

Cons

  • Significant differences in standards currently exist.
  • Political costs.
  • Overcoming nationalism and traditions.
  • May not provide significant benefits.
  • Diverse standards for diverse places are acceptable.
  • Will cause standards overload for some firms.
  1. Major Harmonization Efforts

IOSCO

  • Advocates for the development and adoption of a single set of high-quality accounting standards.

IFAC

  • Started the forum of firms to raise global standards of accounting and auditing.

EU

  • Worked to harmonize accounting standards within the EU, primarily through two directives.

IASB

  • Develops IFRS and exposure drafts, approves IFRIC (interpretations).
  • Comparability project (1989-1993): Review of existing IAS, eliminate choices permitted.
  • IOSCO agreement (1993-2001): 30 accounting standards for companies involved in cross-listing.
  1. IASB’s Principles-Based Approach

Accounting standards are grounded in the IASB framework. Limits guidance and encourages professional judgment in applying general principles to entities or industries.

  1. IASB Framework: Purpose and Main Parts
  1. Created to develop accounting standards systematically. Provides the basis for financial statements presented in accordance with IFRS.
    1. Parts:
      1. Objective (information useful for decision making) and underlying assumptions (accrual basis and going concern).
      2. Qualitative characteristics of information (understandability, comparability, relevance, and reliability).
      3. Definition (assets, liabilities, etc.), recognition (revenues and expenses), and measurement (historical cost, current, realizable, present value) of elements in financial statements.
      4. Concepts of capital (financial and physical) and capital maintenance.
  1. Support and Use of IFRS Across Countries
  • Adoption by the EU in 2005.
  • IOSCO’s endorsement for cross-listing.
  • IFAC G20 accountancy summit July 2009 renewed mandate for adopting global accounting standards.
  • Used by 116 countries.
    1. All companies.
    2. Consolidation.
    3. Public companies only.
    4. Foreign companies listed on stock exchange.
    5. Domestic companies listed on foreign stock exchanges.
  1. Issues Related to International Convergence (2002 Survey)
  • Complicated nature of some standards like financial instruments and fair value.
  • Tax-driven nature of national accounting regimes.
  • Disagreement with significant IFRS, such as financial instruments and fair value.
  • Insufficient guidance on first-time application.
  • Limited capital markets have little benefit.
  • Investor satisfaction with national standards.
  • IFRS difficulties in language translation.
  1. IASB/FASB Convergence Project (Norwalk Agreement)

Norwalk Agreement (2002)

  • Joint projects: Boards will work together to address some issues.
  • Short-term convergence: To remove differences for issues where convergence is deemed most likely.
  • IASB liaison: IASB member in residence at FASB.
  • Monitoring IASB projects: FASB monitors IASB projects.
  • Convergence research project: Identification of all major differences.
  • Convergence potential: FASB assesses agenda items for possible cooperation.

Chapter 4

  1. Differences Between IFRS and US GAAP
  • Definitions: Can lead to recognition or measurement differences.
  • Recognition: Whether, how, and when.
  • Measurement: Different method or different application.
  • Alternatives: Choice vs. one method.
  • Lack of requirements or guidance: IFRS may not cover an issue addressed by US GAAP and vice versa.
  • Presentation: In financial statements.
  • Disclosure: Whether and manner (notes).
  1. IFRS Requirements for Inventories
  • Costs included: Purchase (price, direct acquisition costs), conversion (labor & production overhead), other (design, interest if time to sale).
  • Costs excluded: Abnormal use, storage beyond production, administrative overhead, selling.
  • Cost formula: No LIFO, same formula for similar items.
  • Balance sheet value: Lower of cost or NRV.
  • Reversal allowed up to historic cost.
  1. IFRS Requirements for Property, Plant, and Equipment
  • Recognition of initial costs: When 1) yield probable future benefit, and 2) can be measured.
  • Recognition of subsequent costs: Follow initial recognition rules, then remove cost and accumulated depreciation of replaced part.
  • Measurement at initial recognition: 1) Purchase price, 2) costs to put into service, and 3) dismantling costs.
  • Measurement after initial recognition: 1) Cost or 2) revaluation.
  • Depreciation: Review annually estimated life, residual value, and method. Separate significant components.
  • Derecognition: 1) Retirements and disposals, or 2) no more future benefit.
  1. IFRS Revaluation Model
  • Fair value at date of revaluation less subsequent accumulated depreciation or impairment loss.
  • Often enough so carrying value does not materially differ from fair value.
  • Entire class.
  • Increases credited to other comprehensive income (OCI).
  • Subsequent decreases reduce previous OCI, then expense.
  • Report at gross and revalued or net.
  • Transfer surplus to retained earnings on sale/disposal.
  1. IFRS Treatment for Impairment of Assets
  • Test annually.
  • PP&E, intangible, goodwill, investments in subsidiaries.
  • Not: inventory, construction in progress, deferred tax, employee benefit, or financial assets.
  • Indicators: External (economic, legal, technological) or internal (damage, obsolescence).
  • Test: Carrying amount > recoverable amount (greater of net selling price and value in use – present value of future cash flows).
  • Reversal: Up to original carrying amount, immediately.
  1. IFRS Requirements for Intangibles
  • Applies to: purchased, acquired in business combinations, and internally generated.
  • Definition: Identifiable, non-monetary, no physical substance, held for production, rent, or administrative purposes, controlled with future economic benefit.
  • Purchased: Cost, life finite (amortize, assume no residual value unless market or buyer) or infinite.
  • Acquired: Patents, trademarks, customer lists. Finite or infinite. Special situation: target’s development costs not capitalized: capitalize or include in goodwill if fair value can’t be measured.
  • Internally generated: Development costs (if can be separated from research). Not goodwill internally generated. 6 criteria. Considerations: management judgment, direct costs, indirect costs, interest, use appropriate depreciation method reflecting pattern of benefits.
  • Revaluation: For finite lived with active market (taxi, fishing, production quota).
  • Impairment: Test annually. Reversal: except goodwill.
  1. IFRS Requirements for Goodwill
  • Recognition: Only in business combinations.
  • Measurement: Payment plus noncontrolling interest less fair value of net assets. Noncontrolling 2 options: proportionate share of fair value of net assets excluding goodwill, or including goodwill.
  • Negative goodwill: Income.
  • Not amortized.
  • Impairment: Test annually, at level of cash-generating unit, butt-up & top-down test, compare with recoverable amount.
  1. IFRS Requirements for Borrowing Costs
  • Recognition: Capitalize if: attributable to acquisition, construction, or production of qualifying assets. Expense: rest.
  • Asset: Substantial time to get ready for use/sale (inventories may qualify).
  • Measurement: Interest plus other costs incurred in connection with borrowing (foreign exchange gain/loss).
  • Multiply weighted average accumulated expenses by appropriate interest rate.
  • Net interest income on invested borrowed fund against interest cost.