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Summary Financial Accounting & Reporting
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Course IntroductionWhy do we need ‘international’ accounting standards? The
internationalization of accounting preceded by internationalization of
capital markets Substantial increase in net purchases of foreign equities
by local residents since the 1980s Substantial increase in the number of
cross-listings (i.e., listing in foreign countries) during the 1990s. The need
for ‘international’ accounting standards:
- Cross-listings. Cross-listed companies had to present separate
financial statements for each market costly and confusing (profit
of local GAAP is not the same as profit in US GAAP)
- Foreign investments. Foreign investors are not/less familiar with
local GAAP adopting international accounting standards to attract
foreign investors.
Both companies and investors had a strong interest in the international
harmonization of accounting standards and intensely lobbies for IAS.
Today, IFRS is the prevailing set of financial reporting standard around the
globe!
Potential advantages of harmonized accounting standards:
- Cuts compliance costs for firms
- Easier access for firms to international capital
- Increases the attractiveness of local capital markets for foreign firms
- Increases comparability of international financial statements
(understandability)
Potential disadvantages of harmonized accounting standards
- Lack of influence for local governments, particularly in small
countries
- IAS often allow firms more flexibility, because they must be
adaptable to numerous legal environments, and they cannot
consider country-specific situations
- Accounting quality does not only depend on accounting standards,
but also on the enforcement of the rule which is still a local
responsibility
- Different general objectives of financial accounting
IFRS Institutional Background
IFRS adoption in Europe EU regulation on the application of IAS (2002).
Starting for each member state for each financial year on or after 1
January 2005. It gives member states the option to prepare the individual
accounts in conformity with IFRS/IAS and permit non publicly traded
companies to prepare their accounts in conformity with IFRS/IAS. Listed
companies apply IFRS for group reports. For example, if a company itself
has no public listings or securities on a regulated market, it does not have
,to comply with IFRS, but if the firm is part of a group, it has to present IFRS
as a group.
The three pillars of IFRS in Europe
1. Standard setting International Accounting Standards Board (IASB)
to develop, in the public interest, a single set of high quality,
understandable, enforceable and globally accepted financial
reporting standards based upon clearly articulated principles. In
1973 establishment of the International Accounting Standards
Committee (IASC). Initiative to auditing companies. It was a private
standard-setting organization and developed International
Accounting Standards (IAS) 1 to 41. In 2001 new structure of IASC
as IASB. IFRS Foundation as organizational structure. IASB developed
International Financial Reporting Standards (IFRS) as of April 2022).
The IFRS Foundation has a three-tier structure:
Due process:
- Agenda consultation. Every 3-5 years: comprehensive review and
consultation to define international standard-setting priorities and
develop its project work plan
- Research program. Board explores the issues, identifies possible
solutions and decides whether standard setting is required. Ideas are
typically published in a discussion paper for public consultation.
- Standard-setting program. Proposal for a new Standard or an
amendment to a Standard are published in an exposure draft for
public consultation
- Maintenance program. Consultation on the implementation of a new
or amended Standard to identify any implementation or application
problems that may need to be addressed.
During the entire due process, there is consultation with a broad range
of stakeholders (including preparers, users, auditors, other standard
setting bodies, enforcement agencies, academic, etc.) from all over the
world. The IASB holds public hearings on proposed accounting
standards.
,2. Endorsement (goedkeuring). EU endorsement of IFRS standards.
Problems:
1. Legal requirement of IFRS EU regulation in 2002
2. Legislative authority of the IASB as a private organization
endorsement mechanism IAS can only be adopted if they are
not contrary to the (European true and fair view) principle and,
are conducive to the European public good and, meet criteria of
understandability, relevance, reliability and comparability
required of the financial information needed for making economic
decisions and assessing the stewardship of management.
The Accounting Regulatory Committee (ARC) votes on endorsement
of IFRS Standards in EU. When an endorsement procedure exists, the
question remains whether law-making is still a political process in
general, accounting standards are not altered during the
endorsement process. Only in a few specific situations of economic
significance, pollical institutions have successfully tried to influence
the standard-setting process.
3. Enforcement. Enforcement structure in the Netherlands:
, IFRS Conceptual Framework
Financial reporting has various purposes:
- Distribution function distribution of earnings and determination of
taxable income
- Information functions for investors, management and other
stakeholders
- Other functions assessment of (limited) liability, reporting
requirements (in case of losses/bankruptcy), and documentation
functions (court proceedings)
The objective of the general-purpose
financial reporting is to provide financial
information about the reporting entity
that is useful in making decisions. But
there is a fundamental problem
information asymmetry.
- Adverse selection is a type of
information asymmetry whereby
one or more parties to a (potential)
business transaction have an
information advantage.
- Moral hazard is a type of
information asymmetry whereby
one or more parties to a contract
can observe their actions in
fulfillment of the contract, but other
parties cannot.
The role of financial accounting:
- Information economics perspective. The higher the information
asymmetry, the higher the risk premium will be that risk-averse
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