International Accounting Standard Setting and its independent entity the IFRS Foundation
History of IASB
On April 2001, the International Accounting Standards Board (refer to IASB in the following context) took over its predecessor known as IASC (Board of the International Standards Committee) in order to lay out a set of international accounting standards needed for international accounting coordination. At the first meeting of IASB in London, UK, the main highlighted statement was that “any existing standards issued by IASC would remain being adopted by ISAB until amended or withdrawn and still named as International Accounting Standards” (April, 2001), but all new issued standards thereafter should be designated as International Financial Reporting Standards (abbreviate as IFRS). IASC was initially established in 1997 by Austrian, Canada, France, Germany, Japan, Mexico, Netherlands, English and USA and 16 major professional accounting bodies. After that, the number of countries has been increasing at a rapid pace. Right before the IASC was taken over; there were in total 112 countries and 153 accounting professional parties involved.
ISAB’s first IFRS-1was ssued in June, 2003. So far, there are 41 IASs which were initially issued by IASC from 1993 to 2001 and 9 IFRSs after the successor.
Structure of IASB
The IASB has a parent independent entity, which is called the IFRS Foundation. IFRS Foundation was incorporated as a non-profit organization in the state of Delaware, although the Board’s headquarter is located now in London, UK.
There are 22 trustees in the Foundation (initially was only 19 trustees). Their jobs are not involved in any setting of IFRSs, which solely under IASB’s responsibility, but to oversee the work done by IASB, review effectiveness of standard-settings, appoint the council’s and board’s new members, and to finance the Foundation by raising funds. (See Illustration 1.)
Illustration 1 IFRS Structure (source: IFRS Foundation, Who we are, 2011)
Under IFRS Foundation, there are three branches: IFRS advisory council, IASB and Interpretations Committee who take care of the standard-setting.
The advisory council has approximate 40 members. Their jobs include providing any strategic advises to the IASB and informing the Foundation.
“The upper level Monitoring Board approves, appoints the new trustees of IASB Foundation and oversees them. Monitoring Board was formatted of public capital market authorities by the meeting in Mid-Jan, 2009” (Byatt, 2009).
International Accounting Standards Board
The objective of IASB is “to set up one whole set of financial reporting standards which is high-qualify, understandable, enforceable and internationally acceptable on the basis of clearly articulated principles” (IFRS Foundation, 2011).
So far, there are 15 board members in the IASB. Each member has a voting right. “But to achieve a more fair geographical distribution, the number might expand to 16 members by July, 2012 according to foundations proposal” (IFRS Foundation, 2010).
Generally speaking, the Board’s everyday work is to set a relevant agenda, to administer and plan projects. The deliver the discussion papers and approved new standards to be communicated to the public. They discuss exposure drafts and interpretations. In May 2002, the IASB published the final version of Preface to International Financial Reporting Standards. In this document, the Due Process was regulated involving the following steps:
Identify and review all the problems and issues that are pertinent;
Research on different nations requirements and practices;
Get advices from the Advisory Committee, whether to issue the agenda;
Form a advisory team to provide information on this project;
Publish the discussion draft and gather all the comments;
Publish a exposure draft approved by at least nine members;
Consider the comments received within the time of discussion;
Consider the need to hold a hearing and the need for field tests;
Approve the final draft voted by at least nine members (IASCF, 2010).
In the mid 1990’s, some people were more critical of international accounting standards. Criticism focused on international accounting standards that gave too much choice on accounting practices. It harmed the comparability of accounting reports, and thus would not be conducive to improving the quality of accounting information.
But today, the convergence of IFRS is the trend, especially after the new formation of IASB. With great efforts of IASB and of course many other accounting organizations, more and more countries join the effort to converge IFRS.
In 2006, China has announced the roadmap of convergence of China Accounting Standards and IFRS. The international financial crisis of 2008 is likely to accelerate this situation.
In August 2008, U.S. Securities and Exchange Commission (SEC) offered a Proposed Roadmap for the potential use of financial statement regarding “how to transition to IFRS from current Generally Accepted Accounting Principles (U.S. GAAP). Eventually, if achieved, all US capital markets should issue files under IFRS in 2014” (SEC, 2008). Furthermore, the commission statement in February 2010 reiterated “the support of establishing a set of global high-quality accounting standards, developed a work plan on adopting the IFRS, and said that the SEC would make a final formal decision on whether to adopt the IFRS” (SEC, 2010). At the working level, the convergence of FASB and IASB for rapid process is on schedule.
In December 2009, the Japan Financial Service Agency officially released a roadmap on adoption of IFRS, “providing a reliable framework for part of voluntary companies’ early usages of IFRS. Around 2012, Japan will also make a final decision on whether to force all the companies use IFRS by the end of 2016” (FSA, 2009).
Apparently, the convergence of international accounting standards is becoming the consensus of the world and is being transformed into practical actions.
However, based on economic, political, and cultural backgrounds, the acceptance on current international accounting standards would still vary. The different levels of economic development will continue to be a major constraint factor.
Pros and Cons
The pros and cons of IFRS are somewhat speculative. Some examples towards the success received in perusing a widespread set of high-quality standards and in persuading nearly 100 countries to adopt them will be shown to support the cons of IFRS. The most important part of the drawbacks of IFRS is coming from the concern of the differences in financial reporting quality that could not be avoided among different countries that have been forced to implement.
We shall discuss the advantages of IFRS for investors first. The adoption of IFRS internationally provides investors a variety of potential superiorities, both directly and indirectly.
1. IFRS is said to be more accurate, comprehensive and provides on-time financial statement information, relative to the standards which were taking the place of the public financial reporting in most of the adopting nations including Continental Europe. Some financial statement information is unknown, IFRS has standard guidelines to predict this, leading to better informed valuation in the equity market, and therefore lowering the risk to investors.
2. In the market, there are plenty of small investors who are less qualified than professional investors to be able to antedate financial statement information from other sources. This will give these small investors with higher financial quality a better chance to perform compared to professionals in the industry. Also, it reduces the risk small investors face since now they will have more information.
3. By eliminating differences in accounting standards around the world, and standardizing reporting formats, the IFRS eradicates many of the changes or adjustments made by analysts in the past to compare companies’ financials and values internationally. Therefore, adoption of IFRS could decrease the cost of processing financial information for investors. The most outstanding benefit would be to the institutions that create large, standardized-format financial databases.
4. An additional advantage is that people can probably increase the efficiency while decreasing the cost of analyzing financial information. Efficiency of an organization is often captured in the stock prices. Irrespective whether small or professional, both investors will benefit from increasing their efficiency.
5. Reducing the amount of international differences in accounting standards somehow help to eliminate barriers to cross-border acquisitions and divestitures, which in theory will benefit investors with increased takeover premiums (Ball, 2005).
Generally, IFRS provides increased comparability and therefore decreased information costs, reduced formation risk to investors. In addition, IFRS offers indirect advantages to investors. Since higher information quality would definitely lessen both the risk to all investors from owning shares and the risk to less-informed investors according to adverse selection, theoretically, it should lead to a decrease in firms’ cost of equity capital. This would raise the price of per share, and would make new investments more attractive, other things remaining the same.
“People find more indirect advantages to investors of IFRS from promoting the level of use of financial statement information in contracting between firms and variety kinds of parts of the trade, especially lenders and managers” (Watts, 1977; Watts and Zimmerman, 1986). Growing transparency makes managers act favorably to shareholders. Former financial reporting standards have some very specific rules for variety kinds of economic events while the new IFRS layout the principles. For instance, the standards towards investment divide investment movements into short term and long term, and in long-term category there were credits and stocks investment due to the time period and form of the investment. IFRS just manage one part of the investment with guidelines of the long-term equity investment law and the other with the guidelines of the financial instrument law. Financial assets could be divided into assets measured at their fair value through profit or loss, investments held to maturity, loans and receivables, and financial assets available for sale. When one investing assets was put into different category, there are different laws and rules towards its initial measurement, subsequent measurement, and processing impairment, which will have different effects on the current and future periods on the balance sheet and income statement. More importantly, a true reflection of the capabilities and intentions of the asset should be held or reported by the enterprises. The old standards required a high degree of professional accounting personnel judgments. IFRS on the other hand is not as specific as the old standards but lays out principles on how to treat an investment asset and suggest which category it should fall into. From the perspective of historical cost and fair value accounting, the old standards treated long-term equity investments using the cost method rather than equity method accounting. “The investment real estate inventory and fixed assets from separate, allowing development costs capitalized as intangible asset, employee shares shall be paid waiting period will be measure at fair value at the grant date. And share price reasonably allocate the costs, the goodwill of a business combination is tested for impairment annually rather than the gradual spread marketing. For these changes, it is to make the accounting information reflect the true value of enterprise assets, the true state of business, so that decision-making accounting information is useful” (Damant, 2006). In addition, the new Article 13 of IFRS clearly defined that accounting information should be provided by the enterprises. “Users of the financial reports need information about decision-making which would help them to understand the company’s past, present or future evaluation of the situation and make predictions. In conclusion, there are a variety of direct and indirect ways in which IFRS deliver benefits to investors” (Ball, 2005).
Generally, the response from the market towards the adoption of IFRS seems good, therefore IFRS seems to reach its goal which its Board, companies, firms and investors were expecting. However, with a more profound analysis, the situation becomes more delicate. Why would some quoted companies voluntarily choose to adopt IFRS while others waited until they were forced to apply? The research results indicates that, positive influence on the value of the company and negotiability started to appear to those companies and forms which choose to adopt IFRS at the very beginning. This is a very fundamental point since to these companies, transferring to IFRS makes them better off or they wouldn’t do so. However, this reason could not explain why the other companies choose to wait until IFRS were made compulsive to adopt them. It raised the question that if these companies could not earn more or benefit, why would they change their balance of cost and profit suddenly and leave themselves no other choice? Of course, compared to the period before they adopted IFRS, there must have been some advantages such as the increasing correlatability and the reduction of the risks between small investors and well-informed professionals. Actually, the unbalanced spread of profit increased the necessity to analyze the motive of reporting. “Practically, after a research towards the negotiability after adopting IFRS in different countries, we found that not everyone was better off or benefited from IFRS. Only those countries with comparably stricter operating system or environment, more transparent in income could benefit or get improvements from negotiability, values and capital costs. For those who could not operate strictly or have bad reporting motivation, adopting IFRS didn’t make them any good” (Daske & Hail, 2008).
Like other standards towards accounting or financial reporting, IFRS give companies and firms enough room to judge by themselves. From one aspect, it is a progress, since people make a lot of judgments in financial reports, managers should be allowed to deliver advanced information to their investors outside the company or keep them secret due to the competition. However, the right to make judgments is heavily based upon the motive of reporting which due to the country’s law, different market forces, characteristics of the company’s operation and the personal goal of the manger differs. In the end, although more advanced information was asked to be reported by IFRS, the ability of people to actually influence the companies to turn it in was uncertain.
The world is trying to come together in accounting and financing aspects. Presently, the US is under U.S. GAAP; the rest of the world has their own GAAPs with lots of language as related to accounting standards. Companies and investors need to read the financial statements from Europe and from the U.S., and understand the similarities between those two. This is not possible right now. The world is moving towards a global set of standards, so international standards would impact every public company in the U.S. The majority of the world has already begun to accept IFRS. SEC has already mandate US companies to adopt IFRS by 2014. Companies need to work towards accepting IFRS much before this deadline. Still a lot companies wanted to wait and watch. The most intriguing part of this roadmap right now is a five-year conversion plan which theoretically allows a significant amount of time to let companies adopt it. It is a huge process, and it is not just a accounting issues. It will affect the whole company, affect information systems, affect supply chains and affect human resources.
The companies should understand what its strategy will be for the next four years and start implementing with their own roadmaps, keeping in mind that the clock is kicking.