Faculty for Economy, Communication and IT
Faculty for economy, communication and IT
Elsa Bengtsson 850222-7120
IFRS
-what experience has been gained after the European adoption in the year of 2005
International Financial Accounting
7,5hp
2009-10-22
Kursansvarig: Berndt Andersson
Index
1 Introduction 3
1.1 Question of issue 3
1.2 Purpose 4
2 Method 5
3 Theory 6
3.1 Harmonization 6
3.2 Standard 6
3.3 IASB 6
3.4 IASC Foundation 7
3.5 IFRS 7
4 Why IFRS and experience after adopting it 8
4.1 Background to IFRS 8
4.2 Experiences with adopting IFRS 9
4.3 Pros and cons with IFRS 11
4.4 Auditors work 12
4.5 IFRS in US 13
5 Discussion and conclusions 15
5.1 Conclusion 17
References 18
1 Introduction
In September 2002 the biggest change to financial reporting in 30 years was introduced by the Parliament and the Council of the European Union (EU). It was a new accounting Regulation that required all listed companies in EU to follow International Financial Reporting Standards (IFRS) in their consolidated financial Statements as of 2005[1]. This decision affects thousands of companies in all the 28 countries of the European Economic Area (Jermakowicz & Gornik-Tomaszewski 2006). The compelling reason for the Regulation was a need to develop an incorporated financial services market in the EU. The change to IFRS will ultimately lead to transparency in financial statements, which should increase market efficiency, reduce the cost of raising capital, and thereby eliminate barriers to cross-border trading (Jermakowicz & Gornik-Tomaszewski 2006). IFRS leads to a greater comparability between companies’ financial statements from different countries and this comparability is now successive increasing (Bäckström, A. 2009). The IASB hopes to get US in line with IFRS by 2018 (Faith, Jo. 2009). Adopters in the US will have an advantage compared to adopters in Europe because US companies that adopt IFRS can learn a lot from European adopters (Graziano & Heffes 2009). This is because listed companies that have adopted IFRS have learnt that they have underestimated the complexities, effects and costs of IFRS (Hoogendoom, M. 2009).
1.1 Question of issue
When Europe adopted IFRS in 2005 they gained a lot of experience about the IFRS. There have been a lot of issues and questions about IFRS. Lots of companies have experienced that adopting IFRS is time-consuming, cost-full and so on. Now when the US is about to adopt IFRS they can learn a lot from Europe. A question I ask is what Europe has learnt from this adoption. Is IFRS still the best way to go or are there other ways we can gain comparability.
To fully understand IFRS I also want to know the background of it and when the whole idea started. I also want to know what experienced people think about IFRS now when we have the experience after the adoption. With all this knowledge is it still a good idea to use IFRS or can there be another option to IFRS?
I ask my self these three questions:
· What is the purpose of IFRS?
· What experiences was gained when adopting IFRS?
· Is IFRS here to stay?
1.2 Purpose
The purpose of this paper is to find out why IFRS exists, what experiences has been gained when adopting IFRS and if IFRS is here to stay.
2 Method
This paper is a literature study made by articles and the main book from the course. I found the articles by searching in the database Business Source Premier and the articles I have used are scientific. When I did the search I used keywords such as: IFRS, IASB, IAS. There are a lot of articles from the late 2000 so I have used only articles that are as new as possible because IFRS is a quite new term and it develops constantly. I have also searched for literature in the library and its database for books. I have also used IASB´s official webpage as well as for Swedish articles in the Swedish magazine in economics named “Balans”.
The questions I will try to answer by using articles made by different experienced and knowledgeable people in the area of IFRS. There are articles discussing what experience we have made and if we should continue using IFRS.
3 Theory
Because a lot of terms are used in the paper I have chosen to put a summery of them here to make an understanding for the reader and to prepare for the next chapter to come.
3.1 Harmonization
It is a process where bounds are set to their degree of variation to increase the comparability of accounting practices (Alexander et al. 2009).
3.2 Standard
A standard is a form of rule that tell us what to do in different situations. A rule tells us what is allowed and suitable. Brunsson Jacobsson (1998) explains several arguments to use Standards. Standards are an effektivt instrument when transfer information and standards work as a coordination method (Brunsson & Jacobsson (1998). Both harmonization and standardization are often used interchangeably (Alexander et al. 2009).
3.3 IASB
The International Accounting Standards Board (IASB) is the independent standard-setting body of the International Accounting Standards Committee Foundation (IASC Foundation), which the IFRS is set by (seen below). IASB is appointed and overseen by a geographically and professionally diverse group ofTrustees of the IASC Foundation. Currently the Trustees consist of 15 members from nine countries. A decision at the January 2009 Trustees meeting, the IASB will be expanded to 16 members by 2012. The members are a group of people representing the best available combination of technical skills and background experience of relevant international business and market conditions. It is important in order to contribute to the development of high quality, global accounting standards.
IASB is supported by an interpretations committee (IFRIC) and an external advisory council (SAC) to offer guidance where divergence in practice occurs. The IASBcooperates with national accounting standard-setters to achieve convergence in accounting standards around the world (IASB 1 2009). IASB´s predecessor is the International Accounting Standards Committee (IASC) (Jermakowicz & Gornik-Tomaszewski 2006).
3.4 IASC Foundation
The International Accounting Standards Committee (IASC) Foundation is a not-for-profit, independent and private sector organization. The foundation is dedicated to developing a single set of high quality international financial reporting standards for general purpose financial statements. It promotes the use and rigorous application of International Financial Reporting Standards (IFRS) (IASB 2 2009). It also takes account of the special needs of small and medium-sized entities (IFRS for SMEs)[2] and emerging economies related documents (IASB 2 2009).
IASC Foundation rests with 22 Trustees, which are individuals with senior executive experience from diverse geographical and professional backgrounds, in both the private and public sectors. Thefunding of the IASC Foundation is based on four principles. (IASB 2 2009)
3.5 IFRS
International Financial Reporting Standards (IFRS) encompasses all standards and interpretations issued or adopted by IASB (Alexander et al. 2009). IFRS was first discussed in 1972 by Englishmen[3], but was created in 2001 with a mandate to develop a single set of high-quality global accounting standards and to encourage convergence on these standards (Jermakowicz & Gornik-Tomaszewski 2006). Applicability of IFRS is that it should be able for a wide range of users like shareholders and employees and you should not have to be an expert to be able to read a IFRS standards company. IFRS should be prepared for at least annually[4].
4 Why IFRS and experience after adopting it
Here I put the reader in perspective of the background of IFRS, and the purpose of IFRS, why IFRS exist. Later I use articles that discuss what Europe experienced when adopting IFRS and the pros and cones about the international standards.
4.1 Background to IFRS
There is a historical difference between accounting thinking and practice across the world (Alexander et al. 2009). For example the EU includes countries with extreme diverse economics. Even countries such as Germany and the UK, which are highly industrialized member states, have sharp contrasts in orientation and style when it comes to their accounting and financial reporting practices (Jermakowicz & Gornik-Tomaszewski 2006). Accounting is mainly a communication process and through those differences it makes it more difficult internationally and in the context of multinational business. Because of this, businesses need to prepare multiple sets of financial statements under different bases, or users need to learn and understand a variety of different accounting preparation systems. These two alternatives are very costly and time consuming. It can also easily lead to errors and confusions (Alexander et al. 2009).
An elimination, or at least a reduction, of such differences is wanted (Alexander et al. 2009). For listed companies the harmonization process, on a global scale, is well on its way. On regional bases, and which of perhaps EU is the most significantly, have done attempts to reduce country differences. The International Accounting Standard Board (IASB) and its forerunner the International Accounting Standards Committee (IASC) pursue harmonization at global level (Alexander et al. 2009).
In 1976 Henry Benson, then chairman of the IASB Committee, explained the lack of accounting standards. He was speaking towards a group of Dutch and European accountants and Benson delivered a scathing attack on the lack of accounting standards. He said there has not been enough attention to maintenance of professional standards. Benson reaffirmed his belief in international accounting standards and refuted on criticism that international standards were to loose (Collins, S. 1976). Sir Henry Benson foresaw the importance of international accounting standards by about the year 2000. (Nobes & Zeff).
In May 1990 the European Commission agreed on a Financial Services Action Plan. To create a single large capital market within EU was one of the objectives of this plan. To make this creation possible the European Commission proposed in 2000 that all listed companies should use one set of accounting standards for financial statement purposes. Chosen to be that set of standards was International Finance Reporting Standard (IFRS). On the application of IFRS the Regulation (EC) no 1606/2002 was approved by the European Parliament in 2002 (Alexander et al. 2009). It was the biggest change to financial reporting in 30 years (Jermakowicz & Gornik-Tomaszewski 2006). The compelling reason for the Regulation was a need to develop an incorporated financial services market in the EU. The change to IFRS will ultimately lead to transparency in financial statements, which should increase market efficiency, reduce the cost of raising capital, and thereby eliminate barriers to cross-border trading (Jermakowicz & Gornik-Tomaszewski 2006). And as mentioned above this Regulation applies in all member states plus Iceland, Norway and Liechtenstein (Alexander et al. 2009). In other words it affects thousands of companies in all the 28 countries of the European Economic Area (Jermakowicz & Gornik-Tomaszewski 2006). It requires all listed companies in EU to follow International Financial Reporting Standards (IFRS) in their consolidated financial Statements as of 2005 (Jermakowicz & Gornik-Tomaszewski 2006). The European Union's (EU's) regulation concerning this compulsory use of IFRS from 2005 was a major step toward Sir Henry Benson’s goal. With announcements in 2007 from the Securities and Exchange Commission (SEC) accepting international standards (IFRS) for foreign registrants, and perhaps for all registrants, Benson's dream is coming true. (Nobes & Zeff) Member states could by that time allow a two year extension for companies that have their securities publicly traded outside the EU, and had already been using international accepted standards since a financial year that started before the Regulation was published. A two year extension was also allowed for companies that had only debt securities listed on a regulated market. There extensions are no longer accepted and all listed companies now have to follow IFRS (Alexander et al. 2009).
4.2 Experiences with adopting IFRS
Nobes and Zeff (2009) say in their article that the central purpose of IFRS, as posited by the IASB and some commentators, is that users all around the world can compare companies´ financial statements better, so information risks are reduced which leads to a reduce of cost of capital (Nobes & Zeff 2009). Martin Hoogendoom talks in an article, from 2006, about listed companies that have underestimated the complexities, effects and costs of IFRS. It has taken much more time than expected. The article made by Hoogendoom is a personal experience from a Dutch perspective, but colleges to Hoogendoom say having the same experience outside the Netherlands. Hoogendoom brings up his own experience when receiving the first drafts that were intended to be in compliance with IFRS, but he had about 300 points of comment. (Hoogendoom, M. 2006). The Journal of Accountancy from 2009 certifies this. The article “IFRS: Don´t Get Caught Short” from May 2009 stats that adoption of IFRS in Europe and Australia revealed that conversion often consumes a lot more time and resources than expected. The article mentions there is a troubling number of companies had to rush and risk mistakes or outsource more work than necessary (Street & Needles 2009).
Many companies around the world have found that IFRS conversion appeared to be not only an accounting change, it soon developed into a “multifaceted business initiative involving systems and process, people and change management, and other business consideration” (Street & Needles 2009). In a perfect world the move to IFRS would not affect stock prices or shareholder value. But conversion to IFRS for US companies need to understand the effect it has on their financial position and results of operations, so they can inform investors, analysts, and other key stockholders in a timely manner about the changes associated with a IFRS adoption. I, as the one writing this paper, can make an assumption this is the same for any European company. If the companies fail to communicate the impact of IFRS adoption there is a risk of having their financial performance misinterpreted and, more importantly, being penalized by markets and other financial statement users (Street & Needles 2009).
IFRS has eliminated many differences existing in the European countries and this is a huge contribution to comparability (Hoogendoom, M. 2006). But this comparability is not perfect. Comparability is significant impeded by the lack of balance sheet and income statements formats. According to Hoogendoom this is even a step backwards compared to the EU Directives. This is also an area where analysts will have trouble with comparing financial statements. Some companies will apply a current-non-current distinction, others not, balance sheet will differ, and some companies put cash and cash equivalents at the top of the balance sheet, others at the bottom. Also income statements will be prepared in variety of forms. IFRS is too complex, even for auditors and other specialists. Most users found financial statements difficult to read and understand. IFRS is unclear and unstable. Hoogendoom estimates, as a result of IFRS, financial statements has increased by at least 20 – 30 pages (Hoogendoom, M. 2009).