CHAPTER 6
Responding to
based approach might state that you should apply basic principles to ensure fi- nancial statements are not misleading. The burden is then put on the preparer of the financial statements and the auditors to ensure that the financial statements are not misleading. A rules-based approach would state that if you follow spe- cific rules when issuing financial statements, they will not be misleading.
There are arguments both for and against the two approaches. The main ar- gument against the principles-based approach is that it may not give sufficient direction to the preparer of accounts and relies too much on judgment. The ar- gument against the rules-based approach is that it encourages preparers to find loopholes in the rules or to use accounting treatments that are not covered by the rules. The financial statements can therefore still be considered as complying with the regulations, although they may not be as transparent as they should be.
At one time, it seemed that there would be no agreement between the IASB and the FASB on these two approaches. However, a number of major finan- cial scandals, such as the collapse of Enron and WorldCom in the United States, encouraged a review of the approach to standard setting. In 2003, it was decided to move toward a more principles-based approach. Robert H.
Herz, the FASB Chairman, described it thus. “Under a principles-based ap- proach one lays out the key objectives of good reporting in the subject area and then provides guidance explaining the objectives and relating it to some common examples. While rules are sometimes unavoidable, the intent is not to try to provide specific guidance or rules for every possible situation. Rather, if in doubt, the reader is directed back to the principles.”1
The IASB has attempted to meet the FASB partway by holding various meet- ings and publicly making statements of support. Its resources, however, are be- ginning to look overextended. The understandable attention of the IASB on those major countries in the process of converging with international standards and its work with the FASB may divert much of the needed guidance and sup- port for other parts of the world. The main conduit for information and influ- ence in the Far East is the Accounting Standards Board of Japan. They have been long-term supporters of internationalization but have expressed some reservations on the focus of interest of the IASB, although at the end of 2004 there appeared to be greater rapport than previously. In the EU, the opinion has been expressed by EFRAG that more attention needs to be paid to the issues facing those countries that have decided to adopt international standards.
There are also questions on the perceived users of financial statements and their needs. The International Accounting Standards Board (IASB) has con- centrated on the interests of the capital markets, and this has led to criticism
1Quoted by Linda A. MacDonald in “Right in Principle.” Accountancy U.K., Janu- ary 2003, p. 89.
that the needs of other groups of potential users of financial statements are not being considered. The IASB’s Framework for the Preparation and Presen- tation of Financial Statements lists several potential users of financial state- ments such as employees, customers, suppliers, and the public. Perhaps it is expecting too much of a general-purpose document that all the needs of these diverse users can be satisfied.
A further major difficulty that confronted the IASC also confronts the IASB: it has, by itself, no direct recourse to a statutory body to make interna- tional accounting standards mandatory. It is difficult to envisage a time when the IASB will have the powers to enforce its standards, and the Board must therefore work through other agencies to obtain compliance and enforce- ment. It must rely on national governments, standard setting bodies, and se- curity regulators to require organizations to prepare financial statements in accordance with IFRSs. The support and encouragement of professional ac- counting bodies throughout the world undoubtedly assists in establishing the credibility of international accounting standards, but it is the cooperation of the national standard setters that ensure their adoption.
Finally, the IASB needs a funding base that is certain and transparent. The major part of its current funding comes from contributors with each of the major accounting firms donating approximately US$1 million annually. There are also approximately 200 other corporations, associations, and other insti- tutions providing financial support. Comments have been made that the IASB may not always have the necessary independence in setting standards because of the importance of these contributions to its existence. There is also the pos- sibility that some major contributors may cease their support either because they are unhappy with the path being taken by the IASB or for other reasons.
For example, the demise of Arthur Andersen following the Enron scandal re- sulted in the cessation of a US$1 million contribution.
EFFECTS AND ACTION
Globalization of business has been with us for many years and, in the main, has been managed successfully by organizations. This is because many of the problems have been concerned with practices, not policies, and working within regulations in other countries. It has not involved changes to the finan- cial regulations affecting domestic operations. When the issue becomes one of international regulations and policies affecting domestic arrangements, the impact is much greater and pervasive.
Undoubtedly, organizations are going to be involved in a significant amount of work, but it will be gradual. However, the complete and the long- term impact on all aspects of accounting have yet to be realized. The effects Responding to Internationalization • 43
can be grouped under four headings of education and training, professional accounting bodies, regulators, and companies.
Education and Training
In 2000, the American Accounting Association (AAA) published the results of a joint research project with the AICPA, the Institute of Management Ac- countants (IMA), and a number of international accounting firms. Authored by W. Steve Albrecht and Robert J. Sack, the report makes a critical examina- tion and analysis of accounting education in the United States. It is not sur- prising that these prestigious bodies were able to agree on the findings of the research. Their conclusions extend and reinforce previous studies and opin- ions expressed in other countries. The main message is that accounting educa- tion needs to change and it needs to change soon.
The authors of the report argue that accounting educators “have spent too much time resting on our traditions and looking into the rearview mirror when we should have been teaching for the future.” To reach that conclusion, they conducted a thorough analysis of the factors that have led to that position.
They also point out that improvements have taken place in some institutions and offer sound recommendations as to how further change can be brought about. With the increasing influence of international accounting standards, the present provides an opportunity for introducing and accelerating change.
Some of the fundamental issues revolve around perceptions of accounting, held by a number of accounting professors. The method of teaching has been based on the preparation of financial statements and not their use. Introduc- tory classes concentrate on the record-keeping aspect under the mistaken be- lief that it is both interesting and useful. Students whose career goal is to enter the accounting profession may find this approach useful, but the majority of students earning business degrees do not share this goal. They need to be able to understand, interpret, and use financial and statistical information, as well as deal with the conceptual issues such as recognition and measurement.
The authors of the American Accounting Association report propose how this may be achieved. The main points they make are the necessity for an ac- counting department to:
• Assess the environment and the programs the faculty faces
• Examine rigorously every degree offered
• Challenge curricula and content from the most introductory course to the most advanced course
• Consider carefully the pedagogy in every class
The AAA report is applicable to educational institutions in many coun- tries but it deals with the teaching of accounting per se and does not address
the special needs of teaching international accounting. Such needs have been energetically debated in international circles. Conferences and workshops held by the International Association for Accounting Education and Re- search (IAAER) constitute a prime force for linking the activities of standard setters and professional accounting bodies with the concerns of academic in- stitutions worldwide.
Professional Accounting Bodies
Those who are not accountants find it surprising how fragmented the ac- counting profession is in most countries. The dictionary and list of acronyms in this book describe some of the many different bodies that exist. At one stage, professional accounting bodies attempted to secure their position and to grow by arguing a special skill and knowledge in a particular subdiscipline.
Broadly speaking, this led to the division in most countries between those who claim expertise in financial accounting and those in managerial account- ing. As businesses and accounting have become more complex and integrated, some accountancy bodies have established routes to specializations within a subdiscipline. For example, taxation or auditing has been considered as dis- tinct career paths for some.
Recently, professional bodies have attempted to differentiate themselves by making geographic claims. Thus, there are claims to be the main account- ing body in Europe, the largest in the world, or the fastest growing in Asia.
Some, particularly the U.K. bodies, have also added international accounting as an alternative course or as a freestanding certificate or diploma in their portfolio. Such a strategy neatly fulfills a demand for knowledge and sup- ports global ambitions.
Another strategy for growth has been to allow mutual recognition or vari- ous forms of support. Thus a member of one accounting body can be ac- cepted as a member of another accounting body. This might require taking certain examinations, particularly taxation and regulatory requirements, when the qualification is to be used in another country.
This process of formal recognition and other working agreements has, to date, not resulted in national or international mergers. This is surprising, since the early twentieth century saw numerous mergers, often with regional bodies coming together to form a national body. The next logical stage would be for the accounting bodies in one country to combine to make it easier to achieve international presence and credibility. We would seem to be a long way from that final stage but the influence of international accounting stan- dards is accelerating change, and interest in mergers at the national level has begun to reappear. Canada and the United Kingdom are currently the main incubators for mergers, and, if they take place, this development could accel- Responding to Internationalization • 45
erate further movements in other countries. To date, however, negotiations between professional accounting bodies have yet to result in mergers.
It is apparent that there have been two levels of professional accountants for many years (the general practitioner and the specialist). The specialist is someone who is a general practitioner and either through experience, study or examination, has a higher level of specific knowledge and skills. Accounting bodies have formalized this by having separate streams, interest groups, or similar divisions. In some instances, courses have to be taken with, or with- out, an examination. There are also examples where the specialized qualifica- tion is obtained by acceptance into another professional body. It can be anticipated that mergers or some forms of mutual recognition agreements could take place at the specialized level.
National Standard Setters
The future of national accounting standard setters is uncertain as the influ- ence of the IASB increases. It is evident that there will be a decline or a change in the focus of their powers and responsibilities. Normally, their authority comes from legislation that recognizes the accounting standards issued. If in- ternational standards are recognized as valid for the preparation and presen- tation of financial statements, the question arises whether national accounting standard setters are required if the IASB is doing the task.
In the foreseeable future, the response must be in the affirmative. There is the process of negotiating and managing convergence and meeting the needs of organizations, mainly small and medium-sized, which at present are not covered by international standards. The IASB currently has a project on the standards appropriate for smaller and medium-sized entities. A standard such as the U.K.’s Financial Reporting Standard for Small Entities (FRSSE) could prove a useful model.
It is probable that national standard setters will maintain their existence through various activities on several levels. First, the IASB still has to main- tain an international consensus, and for this it needs national standard setting bodies. Political and interest groups are very powerful in some countries, and the IASB will have to rely on national bodies to reflect these and assist in forming opinion. Certainly, on the identification of issues for standards and emerging issues, national bodies will play a key role.
The matter of ensuring compliance has also not been addressed. The IASB does not have an appropriate mechanism whereas some national bodies have established means for monitoring financial statements. It would seem that the IASB would therefore depend on auditors, national standard setters, stock ex- changes, and independent bodies to ensure compliance. In addition, the iden-
tification of problems after implementation, the operation of standards, and the need for their revision have to be monitored.
Finally, a major role for national bodies will be in the area of education and research. This may be conducted either unilaterally or by various coali- tions working on common interests. The research papers produced by the G4+1 are excellent examples of the progress that can be made, and some na- tional standard setters are now working together to seek solutions to account- ing and financial reporting problems.
Companies and Accounting Firms
One conclusion from the above analysis is that the main impact on harmo- nization of accounting standards will be best managed by companies and ac- counting firms. Indeed, for the latter it could be contended that a marvelous opportunity has been presented for increasing their revenues through consult- ing and advisory services!
The argument that these two groups will be least affected is at variance with popular thinking, which tends to concentrate on organizations that publish fi- nancial statements. The reason for this is that the most immediate, visible, and easiest impact of international harmonization that can be identified is compli- ance by organizations with the standards. In reality, companies have had a long history and considerable experience in dealing with new and revised accounting standards. In some countries the national accounting standard setters have is- sued a plethora of pronouncements and interpretations in the same year. CFOs may not have enjoyed the experience, but they have managed it successfully.
Organizations that foresee moving to an international accounting regime are advised to start making plans early. Much initial planning can be done in anticipation of regulatory changes, even if these do not finally occur. One im- mediate action to take is the examination and analysis of the accounting pro- cedures and systems. This should reveal any weaknesses or areas where attention is required in the organization and, regardless of IFRSs, should im- prove the efficiency of the organization and its internal control system.
The next stage is to undertake a diagnostic appraisal of how IFRSs, if im- plemented, would affect accounting policies. The final stage is to design a plan for the transition to IFRSs. This should incorporate the following issues:
• The availability of suitably trained staff
• The adequacy of the internal control system
• The work of the internal audit department
• The knowledge of the directors and audit committee about the changes
• The likely impact on any covenants, agreements, and contracts that con- Responding to Internationalization • 47
tain key financial performance indicators, including incentive targets for employees and managers
Finally, it will be necessary to determine how to manage communications to various groups involved. There will be an impact on both the staff manag- ing the current system and the staff needed for the new system. Training may solve many of the problems, but there may be changes in job descriptions and these will have to be handled appropriately.
As well as those handling the practical change, it must be appreciated that financial performance indicators under IFRSs will differ from those reported previously. Communication must take place with interested parties before new financial indicators are published. Not only should the immediate impact be communicated, but it is also important to clarify what may be the long- term effects on managerial incentives and compensation plans. This may re- quire explanations of how ROI-based performance bonus and incentive plans may be affected as well as the renegotiation of agreements with external par- ties that are based on financial indicators.