International Accounting Standards and Global Convergence Chapter 7 International Accounting Standards and Global Convergence

Strategic Decision Point Rules-based or principles-based standards? Rules-based Detailed and complex standards Resulted in transaction manipulation Enlarged gap between managers and owners Principles-based Reflects “true” underlying economic substance Provides increased protection for companies Makes comparability across companies difficult International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Comparability of Accounting Information International pressure exists for comparability, especially with MNEs Different approaches to comparability Harmonization is more flexible Standardization suggests a state of uniformity International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Which groups are interested? Governments Trade Unions Investors (including financial analysts) Bankers and lenders Accountants and Auditors International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Pressures for Harmonization International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Governments Government involvement in accounting determination varies across the world Do governments really use corporate reports? Information needed by governments is often too extensive to include in the report Governments can demand whatever information they need Information needs are extensive and confidential These things suggest governments may not be important users of corporate reports Is this a paradox? Explained by situations where governments might be users International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Government use of annual reports Use reports, along with segmental information, to check performance of local subsidiaries of MNEs Governments wish to monitor MNE operations as a whole Governmental needs in differing departments can be accommodated by an annual report Developing countries would have more information without bargaining for it with increased corporate disclosure International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Governmental use of annual reports Interest in extranational operations of MNEs Intergovernmental organizations use this information for policy formulation (UN, EU). Many governments desire increased bargaining power for information as members of intergovernmental organizations International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations United Nations 1976 study revealed lack of information 1979 – Working Group of Experts established Emphasis on developing countries Have different interests from those of OECD and IFRS Major aim is international disclosure standards Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) established in 1983 Current issues deal with corporate governance Monitoring role in endorsing desirable standards UNCTAD – represented in Standards Advisory Council of the IASB Advisory Panel of Small and Medium-sized Entities of the IASB International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations Organization for Economic Cooperation and Development (OECD) Represents industrialized nations Issued Guidelines for Multinational Enterprises Aimed at strengthening confidence between MNEs and governments Not required by law Guidelines are becoming more of a benchmark Aim is to promote improvements in comparability and harmonization of standards International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Involved in international harmonization of standards as part of company law harmonization Goal is to promote European economic integration and development No company should be at a disadvantage because of legal differences between countries International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

International Organizations – European Union Interests of shareholders, lenders, suppliers, and other parties are protected Directives in the EU have the force of law and must be ratified by member nations Regulations become law without national ratification International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Fourth Directive – approved in 1978 Requirements relate to Disclosure Classification and presentation of information Methods of valuation Compromise between European and Anglo-American systems Contains detailed requirements for historical cost accounting with some flexibility International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Fourth Directive Level of disclosure and transparency increased “true and fair view” concept adopted Does not adequately address Foreign currency translation Leases and funds Cash flow statement International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Seventh Directive – adopted in 1983 Control criteria other than ownership is applied on an optional basis Requirements Worldwide consolidations “Fair value” approach for assets purchased through acquisitions Equity treatment of associated corporations Segmental disclosures of turnover by line of business and geographical area Disclosure has been substantially improved International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Additional Directives Eighth Directive – adopted in 1984 Deals with qualification and work of auditors Includes minimum educational requirements Encourages mobility of professional auditors Proposed directive for employee disclosure was put aside due to MNE and government opposition Issues readdressed in Charter of Fundamental Social Rights International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Intergovernmental Organizations – European Union Harmonization of stock exchange regulations and securities laws is also a prerogative Ensure investor access to sufficient information Promote capital market and stock exchanges No plans for new directives “Mutual Recognition” approach was once considered more effective IFRS adopted in 2005 International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Trade Unions and Employees International Trade Union Confederations European Trade Unions Confederation International Confederation of Free Trade Unions World Confederation of Labor Industry-specific trade unions Deal with individual MNEs National Trade Unions Influence MNEs on a variety of levels Information needs depend on contact with MNEs and purpose of information International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Trade Unions and Employees Power exists in the nation where they operate Unions have not grown beyond national boundaries as MNEs have Trade union pronouncements are aimed at establishing policies concerning MNEs Main concern centers on subsidiaries Transfer pricing policies are a major concern MNE subsidiary transactions have received little attention to date by regulatory bodies Information about the terms, conditions, scale, security, and location of employment are of concern International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Investors Owners or potential owners of shares in the MNE parent corp. or a subsidiary Interests are represented by international financial analyst organizations and IOSCO Concerned with current lack of comparability Some want information approach rather than a market approach to disclosure International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Investors International organizations Want comparable information ICCFAA and IOSCO IOSCO - works for multilisting and international trading IOSCO is closely associated with the IASB Want comparable information Interested in segmental information of MNEs Interested in consolidated results International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Bankers and Lenders Information needs are focused on financial positions, performance, and future prospects Concerned with security of loans advanced Significant impact in France, Germany, Japan Have more direct access to required info International banks are involved in harmonization and often require special financial reports (IFC, World Bank, etc.) International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors International Accounting Standards Board Formerly the IASC Governed by 14 board members Objectives Propose international standards and promote their acceptance Work toward improvement and harmonization of standards Works for comparability of accounting standards International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors IASB Adopted 41 IAS standards, completed 5 new standards, and revised 15 existing standards Achievements Completed a core set of standards in 2000 as agreed with IOSCO for cross-board and national listings Recent efforts are focused on EU compliance with IFRS in 2005 Endorsement by IOSCO was limited Members of IOSCO are permitted to require reconciliation of certain items, supplementary information, and eliminate some options existing in IAS Members will individually determine whether or not to endorse IFRS for cross-boarder listings International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Figure 7.2: The IASB’s Governance Structure International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors IFRS and U.S. GAAP IASB and FASB are working toward similar accounting standards FASB is researching international convergence Objectives include Identify every substantive difference between U.S. GAAP and IFRS Catalog those differences according to the strategy for resolving them Recommend further agenda decisions to the Board to further the objective of convergence with IFRS International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors IFRS and U.S. GAAP Benefits of convergence according to the FASB Increased efficiency in capital markets by increased comparability and transparency from nation to nation Reducing the administrative burden for MNEs by allowing only one set of financials to be prepared Enable U.S. companies access to capital markets throughout the world without reconciling U.S. GAAP to IFRS International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors IFRS and U.S. GAAP Street, Nichols, and Gray (2000) suggest the gap is narrowing Major differences are in the areas of Property, plant and equipment revaluations Deferred taxes Goodwill Capitalized borrowing costs SEC desires enforcement of international standards if they are in place International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors Rules versus Principles Recent scandals and aftermath perhaps show a need for principle-based standards Sarbanes-Oxley requires the SEC to examine the feasibility of principles-based standards Problems with principles-based standards Guidance for application Comparability No guidance for complex transactions International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors Rules versus Principles Survey by Mike Ng (2004) 93% of companies surveyed reported that is was possible to apply rules-based standards but not reflect the economic substance of the transaction Only 7% of companies surveyed believed principles-based standards would lead to a better reflection of economic reality Results show that neither approach will ensure that companies report the economic reality of transactions International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors Noncompliance with IFRS is problematic IASI states that compliance means following IFRS and each interpretation of IFRS Improper accounting treatment is not condoned by explaining accounting treatments applied or by footnotes (paraphrase IASI). Street and Gray (2000) found that only 775 of the companies in their sample stated they were fully compliant with IAS. International accounting firms are not supporting the enforcement of IAS New structure of the IASB should help with compliance International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors International Federation of Accountants Sets international auditing guidelines Promotes international convergence of standards International Auditing and Assurance Standards Board Independent body under the IFAC that creates International Auditing Standards (ISA) International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accounting and Auditors Reforms by the IFAC in cooperation with accounting firms, member bodies, regulators, and accounting organizations include: Establishment of the Public Interest Oversight Board to oversee IFAC’s standard setting process Increased transparency with regard to IFAC governance and international standard setting Public participation in the standard-setting process A more formal process of communicating with international regulators International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors International Forum on Accountancy Development (IFAD) Created after the Asian financial crisis to aid developing nations Encourages conformity with IFRS Developed the International Financial Framework to aid in improving standards within national financial frameworks Conducted a GAAP Convergence Survey (2002) 90% of countries surveyed plan to convert to IFRS Majority of countries surveyed plan to converge with IFRS by establishing a government regulation or a standard-setting body Half of the countries surveyed see a barrier to convergence in the complication of standards International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

Accountants and Auditors International Association for Accounting Education and Research Promotes excellence in accounting education Contributes to development of international standards International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

The International Harmonization and Disclosure Debate Some see harmonization and disclosure as a means to create a balance of power between MNEs and domestic corporations More industrialized nations will not be totally supportive of increased regulation Regional integration Long-term goal to remove market imperfections and eliminate regulatory barriers (EU) Many countries are more concerned with protecting their own business community at the expense of others International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

The International Harmonization and Disclosure Debate Differences in reporting are due to differences in domestic needs With domestic corporations, there is little concern for international standards Natural accounting coordination will be a lengthy process according to research Regional economic groupings (EU) and intergovernmental organizations (UN) will help Is the third bullet Okay, or do we need a citation? International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black

The International Harmonization and Disclosure Debate Future developments will be centered on MNEs May be less disclosure now in practice because of the complex nature of MNEs National reporting requirements may limit disclosure International Accounting and Multinational Enterprises – Chapter 7 – Radebaugh, Gray, Black