International accounting – Lectures 7, 8 & 9

Chapter 2. Financial reporting of large (listed) entities: economic context, implications for
accounting, accounting models (cont.)

2.4. IFRS – context, evolution, perspectives

- IFRSs comprise 17 IFRSs, 28 IASs, 23 IFRICs and 8 SICs, along with the conceptual
framework (http://www.ifrs.org/issued-standards/list-of-standards/);
- the first framework dates from 1989; however, it is under revision (a common project with
FASB to revise the framework (first phase completed and published), followed by a separate ED
by the IASB)1;

- due process and transparency in standard setting

Example: The conceptual framework project

- exposure draft - http://www.ifrs.org/projects/work-plan/conceptual-framework/comment-letters-
projects/ed-conceptual-framework/#consultation
- comment letters - http://www.ifrs.org/projects/work-plan/conceptual-framework/comment-
letters-projects/ed-conceptual-framework/#comment-letters
- analysis of feedback received - http://www.ifrs.org/projects/work-plan/conceptual-
framework/#consultation
- discussions (including audio available) - http://www.ifrs.org/projects/work-plan/conceptual-
framework/#project-history
„As a private organization, input legitimacy, being achieved when inputs received reflect the
opinions of all stakeholders involved, is a key issue for the IASB’s acceptance as global standard
setter. To study this input legitimacy, this paper examines the evolution of constituent
participation in international accounting standard setting in terms of geographic diversity over
the period 1995– 2007 and examines whether biases (due to differences in institutional regimes)
or unequal access (due to differences in participation costs) are present in this process. Based on
an analysis of 7442 comment letters we observe an increase in participation over time. However,
we also find distortions in the geographic representation of constituents, due to differences in the
institutional regimes of countries and due to differences in participation costs, proxied by the
level of familiarity with the accounting values embedded in IFRS, with the system of private
standard setting, and with the English language.”2

1
http://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Pages/Conceptual-
Framework-Summary.aspx
2
Jorissen, A., Lyabaert, N., Orens, R., van der Tas, L. (2013) A geographic analysis of constituents’ formal
participation in the process of international accounting standard setting: Do we have a level playing field?,
Journal of Accounting and Public Policy, vol. 32: 237-270

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 International accounting – Lectures 7, 8 & 9

- IASB’s legitimacy increased after 2001, since more and more countries realized or intend to
realize total or partial convergence with IFRS.
- IFRS are in a continuous modernization process, especially after 2001, process in which the
IASB – FASB convergence plan played a key role.

The convergence process

- examples of standards issued by IASB influenced by FASB: IFRS 5 (2004), IFRS 8 (2006), IAS
23 revised (2007), IFRS 13 (2011);
- examples of standards issued by FASB influenced by IASB: SFAS 154 (2005) accounting
policies, SFAS 159 (2007) (Fair value option).
- common projects (some delayed) (IFRS 15, IFRS 16, conceptual framework, presentation of
financial statements)
- the initial plan for convergence was to have a single set of accounting standards (the direct
implication was the use of IFRS in the US).
Details about the convergence projects:
http://www.journalofaccountancy.com/content/dam/jofa/archive/issues/2013/02/fasb-
iasb-convergence.pdf

Q1: Discuss the challenges and benefits of the convergence process, and the intentions of various
stakeholders involved.

- there was much economic pressure (from G20 – “which are growing increasingly
impatient and further stepping up pressure on the IASB and FASB to achieve a single set
of high quality accounting standards”3)
- the IASB was looking for tangible evidence of a U.S. commitment to IFRS, the new
IASB’s chairman Hoogervorst declaring that: “Growing adoption of IFRS worldwide
shows that the standards are strong and not in danger of unraveling. But there are
concerns about continued U.S. leadership in IASB work and projects if the United States
is not going to come on board.” (2012)4 and “This inability to deliver compatible
outcomes with the FASB clearly demonstrates the inherent instability of convergence as a
means to achieve a single set of global accounting standards. For this reason, our Trustees
wisely concluded that convergence can never be a substitute for adoption of IFRS.”
(Hoogervorst’s speech in 2014)

Cohen & Co. (2014)5 „Comparability to replace convergence”

Since 2002, the Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) have been working on converging U.S. Generally Accepted Accounting
Principles (GAAP) and International Financial Reporting Standards (IFRS). There have been
successes and failures along the way, but now the convergence effort appears to have run its
course. Going forward, U.S. standard setters propose an informal, collaborative model that will
minimize differences in financial reporting, in lieu of the IASB’s one-size-fits-all approach.
Rise and stall of global convergence
In 2002, FASB and the IASB agreed to quickly develop a single set of high-quality, compatible
accounting standards that could be used for both domestic and cross-border financial reporting.
The goal of the Norwalk Agreement was to remove individual differences between U.S. GAAP
and IFRS to improve the consistency and comparability of financial statements worldwide.

3
Street (2012) (Idem): p. 271.
4
http://www.journalofaccountancy.com/News/20126951.htm
5
http://www.cohencpa.com/insights/articles/u-s-gaap-ifrs-comparability-to-replace-convergen

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 International accounting – Lectures 7, 8 & 9
Convergence proved difficult, however. The standard setters couldn’t agree on what’s best for
stakeholders, and the approval process took much longer than anticipated. Eventually, the
boards’ efforts focused on four specific joint projects: revenue recognition, insurance, financial
instruments and leases.
Mixed results
Of the four projects, revenue recognition stands out as a success story. Conversely, convergence
projects on insurance and financial assets have failed.
Comparability replaces convergence
At this point, FASB and the IASB agree that a one-size-fits-all global financial reporting model is
a good idea in theory doesn’t necessarily work in practice. So, where do we go from here?

The split over convergence, CFO Newsletter (2014)6

Who killed convergence? To Christopher Cox, the chairman of the Securities and Exchange
Commission from 2005 to 2009—a period of peak optimism about reaching the goal of a single
set of global accounting standards—the answer isn’t a mystery. It was the International
Accounting Standards Board who did it, enabled by an increasingly obedient Financial
Accounting Standards Board and a lack of interest in accounting convergence on the part of U.S.
investors and corporations.
“Convergence was a limited-scope project,” he wrote in an e-mail to CFO. Like any program,
it’s had its successes, such as the converged standard on revenue recognition, and “some
challenges,” especially the inability to come to agreement on how companies should report
results involving their financial-instrument holdings, Hoogervorst wrote.
The major goals on the agenda were to fix deficiencies in both U.S. GAAP and in IFRS, and
eliminate certain differences between the two sets of standards. It was an ambitious agenda, and
the pace of accomplishments was brisk, if sporadic. “Business combinations, noncontrolling
interests, fair value measurements, borrowing costs, segment reporting, stock compensation, and
nonmonetary exchanges are just some of the other areas where we’ve improved and aligned
standards,” Golden said in a September e-mail to CFO.
Both Hoogervorst and Golden now seem to regard the joint standard on revenue recognition
issued on May 28 as the crowning achievement of convergence, however. In the United States, the
new standard, which starts becoming effective for annual reporting periods beginning after
December 2016, will replace more than 200 ad hoc pronouncements on revenue recognition (see
“Harder to Recognize,” April).
The recent divergence “requires us to recognize that differences in the cultural, business, legal,
and regulatory environments in different jurisdictions inevitably will result in some differences in
those standards,” wrote Golden.
Perhaps the clearest example of how such differences led to a breakdown in convergence is the
leasing project. After a half decade of deliberations, having reached a fundamental agreement
that leases longer than 12 months should be reported on corporate balance sheets, the two
boards announced their decision at an August 27 joint meeting to approach lease reporting
differently.

IFRS application
- over 100 countries require or allow IFRS application, using various strategies (adoption,
endorsement, convergence). Research suggests that there are differences in the manner in which
IFRS are applied:
1) Kvaal and Nobes (2009)7 propose some hypothesis based on the previous national regulations:
- entities in Spain are more inclined to present an income statement by nature;
- entities from UK are more inclined to present a balance sheet showing net assets;
- entities from UK are more inclined than others to use fair values;

6
http://ww2.cfo.com/gaap-ifrs/2014/10/split-convergence/
7
Kvaal, E., Nobes, C. (2009) International differences in IFRS policy choice, working paper, Electronic
copy available at: http://ssrn.com/abstract=1466693

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 International accounting – Lectures 7, 8 & 9
- German entities are more inclined to use weighted average cost, while UK entities are more
inclined to use FIFO.

2) Chen et al. (2010)8 identifies an increase in the quality of the accounting information in
Europe, but the quality level is not the same in EU countries. The institutional context (users,
politics, auditors, capital market) is important.

3) Example – the application of IAS 40 in EU9

The authors of this study analyzed the model used for the measurement of investment property by
125 European listed companies (15 countries). Their results show that the factors affecting the
choice of a certain model are: prior accounting standards, the auditor (Big 4 or not), the
commitment to increase transparency and the characteristics of their market.

Country Firms IAS 40 Pre-IFRS domestic GAAP

Cost Fair Cost Revaluated PPE Notes
value
Austria 5 1 4 x x
Belgium 9 1 8 x x x Revaluations allowed under
certain circumstances
Denmark 4 0 4 x Revaluation is required
Finland 4 0 4 x
France 16 9 7 x x Revaluation is permitted, but rare
in practice
Germany 13 8 5 x x
Greece 1 0 1 x
Italy 5 3 2 x While depreciation is not
mandatory, fair value is
prohibited
Netherlands 6 1 5 x x Disclosure of fair value
Norway 3 0 3 x x
Poland 2 0 2 x x x
Spain 1 0 1 x x
Sweden 11 0 11 x x Disclosure of fair value
Switzerland 5 0 5 x x x
UK 40 0 40 x
Total 125 23 102

Q2. Which do you think are the factors leading to different IFRS practices? What do you think the
implications of such a different practice are?

Q3. Which are the sources (related to IFRS) for these differences?

Issues related to the IFRS application

- benefits and effects
Previous studies suggest that benefits are related to increased trust of users, increased
comparability, increased transparency (on past performance and risk), capital market
development, cross-border investing, lowering the cost of capital. In terms of effects, studies
indicate that IFRS are related to a decreased degree of prudence, increased volatility of results, an

8
Chen, H., Tang, Q., Jiang, Y., Lin, Z. (2010) The role of IFRS in accounting quality: Evidence from the
EU, Journal of International Financial Management and Accounting, vol. 21, no. 3: 220- 278.
9
Sellhorn & Riedl (2008) – Choosing cost versus fair value – international evidence from the European
real estate industry upon adoption of IFRS, EAA Congress

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 International accounting – Lectures 7, 8 & 9
integration of financial reporting and managerial accounting (with impacts upon the organization
of the accounting system of the company).

ICAEW (2014) „The effects of mandatory IFRS adoption in the EU: A review of
empirical reserach”
The research evidence on the potential benefits of mandatory IFRS adoption in the EU is
generally not conclusive. But on balance it seems likely that there were overall benefits to
transparency, comparability, the cost of capital, market liquidity, corporate investment efficiency
and international capital flows. The research evidence also clearly shows that these benefits were
unevenly distributed among different firms and different countries. Due to differences in
institutions and incentives, there may have been either negligible benefits or even costs rather
than benefits for particular firms or countries. (p. 9)

- compliance and enforcement

There are differences between countries in terms of the compliance and enforcement levels.
“Scandinavian and Anglo-Saxon companies display above-average compliance, whereas
companies from Middle-Eastern Europe display below-average compliance. In-depth
investigations indicate that the strength of countries’ enforcement systems, the importance of the
national stock market as well as cultural factors are associated with compliance”10.

“Enforcement of financial reporting rules can be seen as a three-part process: (i) effective
company control systems and management dedicated to good reporting, (ii) independent auditors
who are expert in the rules, and (iii) an oversight mechanism with sufficient expertise and power
to achieve effective enforcement.”11
“Even if it is possible to craft a single set of high-quality standards, can they be consistently
enforced? […] A common accounting system needs a common enforcement system. Having the
most intelligently crafted rules means nothing if companies feel they can simply ignore them
without fear of any meaningful consequence. Yet there is no global enforcement mechanism.”12

“There are considerable challenges to be faced in the effective enforcement of IFRS in Europe.
The structure and organisation of entities responsible for the oversight of financial reporting
requirements differ between EU countries, with both public and private sector bodies being used.
Furthermore, some countries have no institutional oversight of financial reporting (FEE, 2001a,
p. 10). The EU Regulation mandating the use of IFRS stipulates that member states are required
to take appropriate measures to ensure compliance with IFRS (European Commission [EC],
2002, n.16). Consequently EU countries are presently evaluating existing enforcement strategies
and proposals to introduce enforcement bodies.13

Q4. What it is understood by enforcement? Name a few enforcement mechanisms. How the level
of enforcement influences the level of compliance?

The political lobbying over IASB

Considering the so-called ‘economic consequences’ of accounting standards, those with a vested
interest intervene by writing letters, comments, overt or covert threats, attacks at the setter’s
reputation or independence, powers or existence, withdrawals of funding etc.

10
Glaum et al. (2012) Compliance with IFRS 3 and IAS 36 required disclosures across 17 European
countries: company and country level determinants, Accounting and Business Research, in press.
11
Brown, P., Tarca, A. (2005) A commentary on issues relating to the enforcement of IFRS in the EU,
European Accounting Review, vol. 14, no. 1: 181-212
12
Reilly, D. (2011) Commentary: Convergence Flaws, Accounting Horizons, vol. 23, no.4: 873-877
13
Brown and Tarca (2005).

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 International accounting – Lectures 7, 8 & 9
14
Examples
- elimination of LIFO in 1992: delegations of countries (Germany, Italy, Japan and South Korea)
where it could be used for tax purposes opposed. LIFO was then finally eliminated in 2003;
- in 2001, IASB begins working at a standard related to employee stock options; it proposed that
share options be expensed in each period in which employee services were performed. Even
before IASB had even composed the exposure draft, 15 European companies (amongst which
Nokia, Lafarge, Nestle, Saint-Gobain, Pirelli, ING etc.) complained (probably concerted) about
them being placed in a competitive disadvantage compared with companies applying US GAAP.
Still, IFRS 2 was issued in 2004, endorsed by the EC in 2005, while FASB had issued SFAS 123
revised to converge with IFRS 2 (with opposition from the congress);
- IAS 39 in EU – the loudest complaint came from especially French banks, that the standard
would afflict them with unacceptable earnings volatility and require they change their risk
management practices to their disadvantage. In July 2003, President J. Chirac even wrote to
Commission President Romano Prodi that the proposed standard would have ‘disastrous
consequences for financial stability’. In 2004 the Commission endorsed IAS 39 but with two
carve-outs: full fair value of some liabilities and portfolio hedging on core deposits. In 2005 the
IASB amended IAS 39 to eliminate the fair value option, thus solving the first carve-out. The
second still remains.

Exercises and questions

1. Provide examples of treatments in IFRS which may be applied differently in the UK and Italy.
2. Which IASs/IFRSs do you believe to be the most difficult to be applied by European
continental companies? Please explain.
3. Which do you believe to be effective ways to reduce differences in IFRS practice around the
world?
4. How successful is IASC/IASB as a standard-setter?

14
Nobes and Parker (2008), pages 224-227.

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