Issues in Financial Reporting

What is Meant by Convergence?

In a financial reporting context, convergence is the process of harmonising accounting
standards issued by different regulatory bodies. One example might be the convergence of
International Accounting Standards (IAS) and US Standards. The objective is to produce a
common set of high quality accounting standards to enhance the consistency, comparability
and efficiency of financial statements.
There are two aspects to the current convergence debate.
International Convergence – the process within which the International Accounting Standards
Board (IASB) and National Standard-Setters (NSS) are converging their respective financial
reporting standards into one global set of accounting regulations.
National GAAP Convergence – the adoption of International Standards as national GAAP.
For example, the Accounting Standards Board (ASB) in the UK is working to converge its
own financial reporting standards with those of the IASB.
The two aspects are clearly intertwined: the IASB works with the NSS in one country to
converge IAS and local Generally Accepted Accounting Practice (GAAP), which has
implications for the convergence of local GAAP in another country with IAS.
Define GAAP?
Generally accepted accounting principles (GAAP) refer to a common set of accepted
accounting principles, standards, and procedures that companies and their accountants must
follow when they compile their financial statements. GAAP is a combination of authoritative
standards (set by policy boards) and the commonly accepted ways of recording and reporting
accounting information. GAAP improves the clarity of the communication of financial
information.
GAAP is meant to ensure a minimum level of consistency in a company's financial
statements, which makes it easier for investors to analyze and extract useful information.
GAAP also facilitates the cross comparison of financial information across different
companies.
These 10 general principles can help you remember the main mission and direction of the
GAAP system.
1.) Principle of Regularity

The accountant has adhered to GAAP rules and regulations as a standard.

2.) Principle of Consistency

Professionals commit to applying the same standards throughout the reporting process to
prevent errors or discrepancies. Accountants are expected to fully disclose and explain the
reasons behind any changed or updated standards.
3.) Principle of Sincerity

The accountant strives to provide an accurate depiction of a company’s financial situation.

4.) Principle of Permanence of Methods

The procedures used in financial reporting should be consistent.

5.) Principle of Non-Compensation

Both negatives and positives should be fully reported with transparency and without the
expectation of debt compensation.

6.) Principle of Prudence

Emphasizing fact-based financial data representation that is not clouded by speculation.

7.) Principle of Continuity

While valuing assets, it should be assumed the business will continue to operate.

8.) Principle of Periodicity

Entries should be distributed across the appropriate periods of time. For example, revenue
should be divided by its relevant periods.

9.) Principle of Materiality / Good Faith

Accountants must strive for full disclosure in financial reports.

10.) Principle of Utmost Good Faith

Derived from the Latin phrase “uberrimae fidei” used within the insurance industry. It
presupposes that parties remain honest in transactions.

Define IFRS?

International Financial Reporting Standards (IFRS) are a set of international accounting

standards stating how particular types of transactions and other events should be reported in
financial statements. IFRS are issued by the International Accounting Standards Board
(IASB), and they specify exactly how accountants must maintain and report their accounts.
IFRS were established in order to have a common accounting language, so business and
accounts can be understood from company to company and country to country.
Similarities of IFRS compared to GAAP reporting standards:

There are many similarities in US GAAP and IFRS guidance on financial statement
presentation. Under both sets of standards, the components of a complete set of financial
statements include: a statement of financial position, a statement of profit and loss (i.e.,
income statement) and a statement of comprehensive income (either a single continuous
statement or two consecutive statements), a statement of cash flows and accompanying notes
to the financial statements. Both US GAAP and IFRS also require the changes in
shareholders’ equity to be presented. However, US GAAP allows the changes in
shareholders’ equity to be presented in the notes to the financial statements, while IFRS
requires the changes in shareholders’ equity to be presented as a separate statement. Further,
both require that the financial statements be prepared on the accrual basis of accounting (with
the exception of the cash flow statement) except for rare circumstances. IFRS and the
conceptual framework in US GAAP have similar concepts regarding materiality and
consistency that entities have to consider in preparing their financial statements. Differences
between the two sets of standards tend to arise in the level of specific guidance provided.

Differences of IFRS compared to GAAP reporting standards

1. Locally vs. Globally

As mentioned, the IFRS is a globally accepted standard for accounting, and is used in more
than 110 countries. On the other hand, GAAP is exclusively used within the United States
and has a different set of rules for accounting than most of the world. This can make it more
complicated when doing business internationally.

2. Rules vs. Principles

A major difference between IFRS and GAAP accounting is the methodology used to assess
the accounting process. GAAP focuses on research and is rule-based, whereas IFRS looks at
the overall patterns and is based on principle.

With GAAP accounting, there’s little room for exceptions or interpretation, as all transactions
must abide by a specific set of rules. With a principle-based accounting method, such as the
IFRS, there’s potential for different interpretations of the same tax-related situations.

3. Inventory Methods

Under GAAP, a company is allowed to use the Last In, First Out (LIFO) method for
inventory estimates. However, under IFRS, the LIFO method for inventory is not allowed.
The Last In, First Out valuation for inventory does not reflect an accurate flow of inventory
in most cases, and thus results in reports of unusually low-income levels.

4. Inventory Reversal

In addition to having different methods for tracking inventory, IFRS and GAAP accounting
also differ when it comes to inventory write-down reversals. GAAP specifies that if the
market value of the asset increases, the amount of the write-down cannot be reversed. Under
IFRS, however, in this same situation, the amount of the write-down can be reversed. In other
words, GAAP is overly cautious of inventory reversal and does not reflect any positive
changes in the marketplace.

5. Development Costs

A company’s development costs can be capitalized under IFRS, as long as certain criteria are
met. This allows a business to leverage depreciation on fixed assets. With GAAP,
development costs must be expensed the year they occur and are not allowed to be
capitalized.

6. Intangible Assets

When it comes to intangible assets, such as research and development or advertising costs,
IFRS accounting really shines as a principle-based method. It takes into account whether an
asset will have a future economic benefit as a way of assessing the value. Intangible assets
measured under GAAP are recognized at the fair market value and nothing more.

7. Income Statements

Under IFRS, extraordinary or unusual items are included in the income statement and not
segregated. Meanwhile, under GAAP, they are separated and shown below the net income
portion of the income statement.

8. Classification of Liabilities

The classification of debts under GAAP is split between current liabilities, where a company
expects to settle a debt within 12 months, and noncurrent liabilities, which are debts that will
not be repaid within 12 months. With IFRS, there is no differentiation made between the
classification of liabilities, as all debts are considered noncurrent on the balance sheet.

9. Fixed Assets

When it comes to fixed assets, such as property, furniture and equipment, companies using
GAAP accounting must value these assets using the cost model. The cost model takes into
account the historical value of an asset minus any accumulated depreciation. IFRS allows a
different model for fixed assets called the revaluation model, which is based on the fair value
at the current date minus any accumulated depreciation and impairment losses.

10. Quality Characteristics

Finally, one of the main differentiating factors between IFRS and GAAP is the qualitative
characteristics to how the accounting methods function. GAAP works within a hierarchy of
characteristics, such as relevance, reliability, comparability and understandability, to make
informed decisions based on user-specific circumstances. IFRS also works with the same
characteristics, with the exception that decisions cannot be made on the specific
circumstances of an individual. It’s important to understand these top differences between
IFRS and GAAP accounting, so that your company can accurately do business
internationally. U.S.-based companies must abide by specific accounting regulations, even if
they plan to do business internationally.

Advantages of IFRS compared to GAAP reporting standards

1-Focus on investors

2-Loss recognition timeliness

3-Comparability
4-Standardization of accounting and financial reporting
5-Improved consistency and transparency of financial reporting
6-Better access to foreign capital markets and investments
7-Improved comparability of financial information with global competitors
8-Relevance
Disadvantages of IFRS compared to GAAP reporting standards

The most noteworthy disadvantage of IFRS relate to the costs related to the application by
multinational companies which comprise of changing the internal systems to make it
compatible with the new reporting standards, training costs and etc.

The issue of regulating IFRS in all countries, as it will not be possible due to various reasons
beyond IASB or IASC control as they cannot enforce the application of IFRS by all countries
of the world.
Issues such as extraordinary loss/gain which are not allowed in the new IFRS still remain an
issue
Another major disadvantage of converting to IFRS makes the IASB the monopolist in terms
of setting the standards. And this will be strengthened if IFRS is adopted by the US
companies. And if there is competition, such IFRS vs. GAAP, there is more chance of having
reliable and useful information that will be produced during the course of competition.
The total cost of transition costs for the US companies will be over $8 billion and one-off
transition costs for small and medium sized companies will be in average $420,000, which is
quite a huge amount of money to absorb by companies.
And even though the companies and countries are incurring huge transitional costs, the
benefits of IFRS cannot be seen until later point due to the fact that it takes some years for the
harmonization and to have sufficient years of financial statements to be prepared under IFRS
to improve consistency.
They key problem in conversion to IFRS that has stressed with high importance is the use of
fair value as the primary basis of asset and liability measurements. And the interviewers think
that this principle will bring increased volatility as the assets are reported.
And another disadvantage of IFRS is that IFRS is quite complex and costly, and if the
adoption of IFRS needed or required by small and medium sized businesses, it will be a big
disadvantage for SMEs as they will be hit by the large transition costs and the level of
complexity of IFRS may not be absorbed by SMEs.

The End