The effort towards a more widely applicable accounting standards got a boost in October 1998, when the Group of Seven (G7) finance ministers and central bank governors called on the International Accounting Standards Committee (IASC), predecessor to IASB, to make further improvements to its accounting standard.
In return, they promised to promote its national use within their jurisdictions.
Both the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) have assessed the original draft of an International Accounting Standard (IAS), each from its own particular per- spective. The BCBS thought that IAS has been generally suitable for prudential supervisory purposes, although it felt that two of its standards, IAS 30 and IAS 39, required further comment.
IOSCO accepted the IAS accounting rules, and in May 2000 it recommended that its member organizations generally allow the use of IAS in their jurisdictions, as a
criterion for gaining access to their national stock exchanges. However, the ques- tion about homogeneity between IAS (now IFRS) and US GAAP remained open for some time. Eventually the need for rapprochement between accounting rules led to a closer collaboration between IASB, the United States Financial Accounting Standards Board (FASB), and the Securities and Exchange Commission (SEC).
SEC’s co-involvement is welcome for two reasons. First, it is the overarching US government agency for FASB. Second, one of the main purposes of accounting standards is investor and creditor protection. It is wise that the rules governing this process do not vary from one jurisdiction to the next, even if specific ways and means to implement investor protection might differ.
● National standards enshrine codified accounting legislation, all the way to penalties imposed for breaking the rules.
● By contrast, international accounting standards contain no universally applicable, legally protected regulations, unless their rules are voted by parliaments.
The members of the EU intend to do just this with IFRS. Its rules will be endorsed EU-wide by means of a special legislative procedure known as comi- tology. In procedural terms, the European Commission presents its proposal to endorse (or reject) IFRS to the Accounting Regulatory Committee (ARC), a body consisting of representatives of member states and chaired by the Commission.
● Ifthe ARC accepts the Commission’s endorsement proposal,
● Then, the Commission prepares the legal framework for applying the new accounting principles in the EU.
There is also the European Financial Reporting Advisory Group (EFRAG), a tech- nical committee consisting of experts from the member states, to advise the Commission on the introduction of IFRS. EFRAG has a Technical Expert Group (TEG). Another player is the Subcommittee on Accounting and Auditing of the EU’s Banking Advisory Committee (BAC), which consults the Commission in all issues regarding banking and banking supervision.
Underlying the co-involvement of all these different committees is the fact that the creation of a single European financial market means that accounting prac- tices have to be harmonized more extensively than has been achieved thus far by means of the EU’s different accounting directives. In this sense, IFRS is an appro- priate instrument for achieving that goal.
Until the advent of IFRS, the accounting standard with the most widespread international appeal has been the US GAAP, developed by the FASB. The appli- cation of US GAAP is mandatory for:
● All American companies, and
● All foreign companies wishing to be listed on a US stock exchange.
For internationally operating credit institutions and other industrial companies, some jurisdictions have permitted that they make a choice in financial reporting between their national accounting standards, and US GAAP. An example of a country which has allowed that choice is France. Basically, that permission con- cerns companies which are listed in the United States and therefore have to use US GAAP in their reporting in the United States.
In late 2005, European regulators tentatively concluded that some entities that use accounting rules developed in the United States, Canada, and Japan should be required to provide additional information to investors if they want their securities to continue trading in Europe. This is contained in a recent report by a working group of the Committee of European Securities Regulators (CESR) which states that:
● Accounting standards in the aforementioned three countries are close enough to international standards to not require complete restatements,
● But, at the same time, there are several areas where investors need infor- mation that may not be available in those countries.
The most important area where CESR called for additional disclosures regards Japanese rules on mergers, and on consolidating the operations of subsidiaries. In such cases, CESR said, Japanese companies should be required to disclose how both their:
● Balance sheet and
● Earnings statement
would be different if the international accounting standards were used. CESR also stated that additional calculations of earnings might be needed by some companies, regarding the use of special purpose vehicles (SPVs) that are not con- solidated. Twisting the rules to avoid consolidation is one of the elements which played a role in the Enron scandal.
While standards cannot be expected to be failproof and foolproof at the same time, the way to bet is that rigorous accounting rules and greater transparency
reduce the likelihood of fraud. This is of course a relative statement, not an absolute one. The frauds of Enron, Adelphia Communications, WorldCom, and so many others (see section 6), have happened under US GAAP, which is one of the best and toughest standards.
Contrary to US GAAP, which applies in America and is not an internationally recognized accounting standard, at the present time IFRS has been adopted across many borders, an example being the countries of the European Union (EU); but it is not a global accounting standard. The use of internationally uniform and appropriately rigorous accounting standards can clearly be instrumental in:
● Enhancing transparency in enterprise finances, and
● Promoting the stability of the financial system as a whole.
The first step in achieving these goals is to properly reflect the right value of assets and liabilities, and help in determining profits in an accurate and unam- biguous manner. Going beyond investors, this is protecting creditors, and it also assists in preserving capital. Basically, the rules of accounting standards vary according to the principle which is applied. A main dichotomy is between:
● The accrual principle reflecting historical cost, and
● Marking to market, which provides an estimate of current fair value.
The essence of the accrual concept is that income arises from operating events, and only from such events. The sale of a product is one such event, with two operations in the background. A sale of the product for $1000 is an increasein the owner’s equity; but taking such product from the inventory, where it had been marked $600 because of accrued costs, is a decrease in the owner’s equity.
● An increase in equity is a revenue
● A decrease in equity is an expense.
If the expense exceeds the revenue, thenthe owner suffers a loss; but the owner realizes a profit in the opposite case. Income is associated with changes in the owner’s equity, and such changes are conditioned by what has accruedin the books – the $600 in the inventoried position of the product being sold being an example.
Marking to market is a different ball game. In this case, what counts is not the accrued cost of the product but its fair value under current market conditions.
This is the value a willing buyer would pay a willing vendor, under other than fire sale conditions. (A complete discussion on fair value vsaccruals is presented in Chapter 4, in connection to IAS 39.)
One of the main differences between accounting standards regards the options being provided. Several national accounting standards, the German being an example, have allowed for options under commercial law. By contrast, US GAAP contains no explicit options, and with IFRS options are limited.
US GAAP lacks explicit options mainly because of the plurality of its individual provisions and density of specific regulations. Experts say US GAAP is a case-based system rather than a code-based system, reflecting the fact that US law is based on case law. Moreover US GAAP is characterized by fluidity, its rules being constantly amended or supplemented. This may be difficult to match through accounting standards where many interests necessarily converge.