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Home > Accountancy Best Practice > Origins and Rationale for IFRS Convergence

Accountancy Best Practice

Origins and Rationale for IFRS Convergence

by Peter Walton

Executive Summary

  • Worldwide convergence on international standards for financial reporting will make investment and financial reporting more efficient.

  • Investors gain access to more investment opportunities and the cost of capital comes down.

  • As more countries use International Financial Reporting Standards (IFRS), so international groups can use them for subsidiary reporting and group reporting.

  • The International Accounting Standards Committee, the international standard-setter, came into existence in 1973 as an initiative by the accounting profession to address the emerging needs of cross-border business.

  • The standard-setter negotiated a role with the international co-ordinator of stock exchange regulators as a supplier of rules for secondary listings.

  • The International Accounting Standards Board, the successor body, was created in 2000 at the time when the European Union announced it would adopt IFRS for listed companies.

  • IFRS are now mandatory or permitted in more than 100 countries. China, Japan, India, Canada, Brazil, and South Korea are set to adopt IFRS in 2011.

  • Companies using IFRS can list in the United States without preparing a costly reconciliation of their numbers to US GAAP.

Introduction

How did an internal phone call in a Sydney hotel in 1972 lead 40 years later to a worldwide movement that is changing financial reporting radically and opening up international investment?

Thanks to that conversation, companies can more and more easily access different stock markets, and investors can step across national and cultural boundaries. Investment should be getting more efficient. Since 2001, International Financial Reporting Standards (IFRS) have been set in London by the International Accounting Standards Board (IASB), a privately financed independent body. Their standards are used for listed companies within the European Union and in many other places. In 2011 China, Japan, India, Brazil, and South Korea will start using them. Even the United States is considering abandoning its rules in favor of the international ones.

Why Convergence Is Necessary

Evidently, having different national accounting systems is costly for companies and investors. Companies have to keep duplicate accounting systems, and investors are wary about buying shares of companies whose accounts they do not understand. The problem arises because accounting regulation has developed over a couple of centuries in national economies whose needs have differed from each other, and whose ways of regulating people’s activities have also differed. What people are looking for from accounting is often different.

Much accounting regulation is contingent: you get an accounting failure, then you get rules to shut the stable door; so, for example, the Enron debacle was followed by the Sarbanes–Oxley Act. This has been going on ever since there were accounting rules. The first government requirements were developed because of a spate of bankruptcies in Paris in the seventeenth century. Consequently, while much of the basic methodology (double entry bookkeeping, balance sheet, etc.) is the same everywhere, the details can differ—especially when it comes to the more complex situations where there is no obvious best solution.

This has a number of consequences, which in turn bring costs. Internally within a multinational group there is usually a network of national subsidiaries (e.g. Nestlé has more than a thousand) spread across the world. They have to report nationally using their national GAAP (Generally Accepted Accounting Principles) and also have to report to the parent, which has to prepare consolidated statements using parent company GAAP. This means that either the subsidiary has dual accounting systems, or the parent has to maintain a special team to adjust the accounts of subsidiaries to parent GAAP. This is costly, and it also means that it is not that easy to transfer accounting staff around the world because of the different local requirements, and it is more expensive to train them.

The group consolidated financial statements are then used to communicate to present and potential shareholders. If the company is listed on several stock exchanges, this means the possibility of having to provide information adjusted to the requirements of the individual foreign stock exchanges—as in the case of the SEC reconciliation to US GAAP. Investors are not comfortable with financial statements that are not prepared under the GAAP they are used to. Consequently they either do not invest, or they will require a higher risk premium to do so.

This situation has the effect of limiting the extent to which international capital markets are truly international. A company may choose not to list in a major market because of the reporting costs, and therefore cuts itself off from investors based there who for legal, cultural, and other reasons will not invest outside that market. Equally there is a cost for investors because their choice is restricted. The US investor cannot directly compare Whirlpool with Electrolux or Siemens. If they could directly compare all washing machine manufacturers around the globe, they could choose the most efficient, and global wealth would increase.

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Further reading

Books:

  • Camfferman, Kees, and Stephen A. Zeff. Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973–2000. Oxford: Oxford University Press, 2007.
  • Canadian Institute of Chartered Accountants. The CICA’s Guide to IFRS in Canada. Toronto, ON: CICA, 2009. Online at: www.cica.ca/ifrsguide [PDF download].
  • Walton, Peter. An Executive’s Guide for Moving from US GAAP to IFRS. New York: Business Expert Press, 2009.

Articles:

  • Soderstrom, Naomi S., and Kevin Jialin Sun. “IFRS adoption and accounting quality: A review.” European Accounting Review 16:4 (December 2007): 675–702. Online at: dx.doi.org/10.1080/09638180701706732
  • Tokar, Mary. “Convergence and the implementation of a single set of global standards: The real-life challenge.” Accounting in Europe 2 (2005): 47–68. Online at: dx.doi.org/10.1080/09638180500379079

Reports:

  • Institute of Chartered Accountants in England and Wales. “EU implementation of IFRS and the Fair Value Directive. A report for the European Commission.” London: ICAEW, 2007. Online at: tinyurl.com/y92mjyb
  • US Securities and Exchange Commission. “Roadmap for the potential use of financial statements prepared in accordance with International Financial Reporting Standards by US issuers.” SEC Release 33-8982, November 14, 2008. Online at: www.sec.gov/spotlight/ifrsroadmap.htm

Websites:

  • European Financial Reporting Advisory Group, the advisory body on IFRS for the European Commission: www.efrag.org
  • Financial Accounting Standards Board, the US standard-setter: www.fasb.org
  • IAS Plus, an IFRS information site run by Deloitte: www.iasplus.com
  • IFRS help site by the Canadian Institute of Chartered Accountants: www.cica.ca/ifrs
  • IFRS resources provided by the American Institute of Certified Public Accountants: www.ifrs.com
  • IFRS News, a monthly newsletter on the development of global standards: www.ifrsnews.net
  • International Accounting Standards Board, the international standard-setter: www.iasb.org
  • International Organization of Securities Commissions, the international body for stock exchange regulators: www.iosco.org
  • US Securities and Exchange Commission: www.sec.gov

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