REASONS FOR HARMONISATION
IASB'S AND EU'S APPROACH TO HARMONISATION
OBSTACLES TO HARMONISATION
DEVELOPMENTS TOWARDS THE IASB'S GOAL
CURRENT STATE OF HARMONISATION
References and Bibliography
Harmonisation is the “process of increasing the compatibility of accounting practices by setting bounds to their degree of variation” (Deegan and Unerman, 2011). On an international scale, harmonisation aims to update, align or even replace domestic standards with a high quality set of international accounting standards issued by the IASB. Reducing differences in financial reporting between various countries would benefit a wide variety of users in understanding and comparing accounts on a much larger geographical scale.
Reasons for harmonisation
Globalisation and the increase in investing/borrowing from diverse countries is an additional reason for harmonisation (Mogul, 2003); especially as investment decisions are based upon financial reports. More meaningful comparisons and increased confidence, due to the reliability of these high quality standards produced, will aid globalisation as investors can make informed decisions concerning investment alternatives (Deegan and Unerman, 2011). Consolidating foreign subsidiaries’ accounts will become easier and cheaper, as will the ability to evaluate foreign companies for takeover purposes (Nobes and Parker, 2010).
Additionally, a single set of internationally recognised standards acknowledged by all stock exchanges would save time and costs spent on preparing national reports required by foreign stock exchanges who wish to protect their investors (Deegan and Unerman, 2011). This is advantageous for companies seeking finance larger than what domestic lenders can provide. Harmonisation could also benefit developing countries who cannot afford setting their own standards, thus the popularity of IASs with developing countries (Ampofo and Sellani, 2005).
Furthermore, research found that reporting exactly the same transactions under IAS and US GAAP produces totally different results (Deegan and Unerman, 2011). Harmonisation could prevent this unfair disadvantage felt by different countries purely because of differences in their GAAPs (Mogul, 2003).
IASB’s and EU’s approach to harmonisation
The main body trying to achieve global harmonisation is the IASB formed in 1973, then known as the IASC, to tackle the “problem of differing accounting systems in the global market” (Alves and Antunes, 2011). The IASC began a project of reducing its options within standards and trying to increase comparability by 1999, which enabled companies to list themselves with any IOSCO member in the world (Deegan and Unerman, 2011). This was a step towards increasing the recognition of IASs as quality standards as any stock exchange regulated by IOSCO members allowed these.
The IASB replaced the IASC in 2001 with the main objective of creating and promoting a set of high quality standards derived from best accounting practices used at a global level (Alves and Antunes, 2011). The EU also plays a major role in harmonising accounting standards; it required all EU listed companies to comply with IASB standards from 2005. This allows investors to understand and compare accounts from all EU member states, encouraging them to invest across borders. Effectively this will “increase market efficiency and reduce the cost of capital for companies, ultimately improving competitiveness and helping boost growth” (Europa press releases, 2002). Thus the EU benefits substantially from requiring companies to comply with approved IASs. The EU also managed to lobby the IASB into creating a simplified standard for SMEs (Nobes and Parker, 2010).
However harmonisation cannot be restricted to European members, the needs of all countries who have relations with the EU must be acknowledged (Alves and Antunes, 2011). Furthermore whilst the FASB is setting rules for US markets, the IASB cannot claim to have achieved harmonisation or be the global standard setter, thus true global harmonisation requires the inclusion of the USA (PriceWaterhouseCoopers, 2011).
There is increased pressure on the FASB and the IASB, the most influential accounting standard boards in the world, to converge in order to achieve global harmonisation (Mogul, 2003). The first crucial step was taken in 2002 when they signed the Norwalk Agreement ensuring the development of high quality comparable standards derived from improvements and reducing major differences between their respective standards (Sweetman, 2009). This was a significant move as there are major differences between FASB and IASB standards set due to their conflicting rules-based and principles-based approaches.
The USA doesn’t employ IFRSs because they feel their rules-based approach is superior to the IASB’s principles-based approach (Deegan and Unerman, 2011). However their belief was weakened following numerous scandals, including Enron in 2002 (ibid). This demonstrates a major disadvantage of rules-based standards; providing rigid rules allows companies to circumvent these in such a way and justify compliance. This criticised approach eliminates the need for professional judgement. Enron controlled ‘subsidiaries’ into borrowing money, yet kept them off their balance sheet as their shareholding was less than the 50% rule.
The US’s response to Enron was the Sarbanes-Oxley Act 2002. However, even after being established for six years, it didn’t prevent the creative accounting of Lehman Brothers which filed for bankruptcy in 2008 (Lanchester, 2010). The way in which they hid their liabilities was legal but ethically dishonest. “Lehman’s bankruptcy was the trigger for the global financial collapse” (Davis, 2010); highlighting the impact accounting regulations can have on the entire economy. This stresses the need for the US to change its rigid approach to standards. Many European accounting professionals argue that Enron couldn’t have hid such liabilities as off balance sheet finance under European practices (Deegan and Unerman, 2011). If harmonisation is achieved and all companies adopt standards issued by the IASB reporting differences across countries would disappear.
Obstacles to harmonisation
However numerous obstacles, existing due to the natural differences between countries, hinder the speed and completion of harmonisation. One set of standards may not suit everyone’s needs, requirements and characteristics. The main elements influencing national GAAP are culture, legal systems, religion, tax systems, business ownership, financing systems, influence of the accounting profession and the rules v principles-based approach to standards.
A predominant obstacle between the FASB and IASB harmonising is their contrasting approaches; whereby rules-based standards are very detailed, complex and rigid rules compared to principles-based standards which provide guidance and encourages professional judgement. The intricacy of rules-based standards allows manipulation which can be justified as compliance (Nobes and Parker, 2010), whereas the principle approach focuses on portraying the economic substance of a transaction.
The Norwalk agreement was a significant step towards harmonisation highlighting the FASBs attempt to move towards the principles-based approach of the EU (Mogul, 2003). This satisfies a Sarbanes-Oxley objective whereby the SEC was obliged to consider a principles-based system operating in the US environment, after Enron damaged the perception of the US having high quality standards (Deegan and Unerman, 2011).
However the fear is that the IASB may be lobbied by the heavily influential US into complicating their standards as they harmonise. For 70 years the US has created detailed standards responding to its complex business environment (PriceWaterhouse Coopers, 2011). These may suit the US, however they may be unsuitable if imported and enforced on all countries adopting IASs (ibid). The Hong Kong Stock Exchange worries that the new standards are too complex and costly (Jones, 2011). The IASB must consider the needs of its varied users, setting additional hurdles for harmonisation.
During this process financial statements in Europe have grown considerably in length (Zeff, 2007), highlighting the detailed requirements of the revised IAS. This may indicate that IASs are moving slightly towards a rules-based approach, with several becoming somewhat Americanised. Certain EU members are not habituated to this and are familiar with using judgement and guidance in portraying a fair view of their company, rather than following such rigid rules which can prevent this. Hence the reason for controversy over (the rules-based) IAS39 which was drawn from US GAAP (Elliot and Elliot, 2011). The EU stood as a barrier against the full implementation of IAS39 as certain provisions placed European banks at a disadvantage to American banks (ibid). Adopting a rules-based approach could become a barrier as well as needing to satisfy the growing members in issuing new standards.
IAS23 was amended to be consistent with US GAAP further exemplifying US influence; the option to write-off borrowing costs is now prohibited once certain criterion is met (Sweetman, 2009). IFRS8 also follows the US approach, in addition to terminology amendments under IAS1. These changes are reducing differences; however they may not be suitable to all environments in which they are enforced.