The Concept Of Convergence Of The International Accounting Standards

Convergence of Accounting Standards 1

The Concept of Convergence of the International Accounting Standards

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Convergence of Accounting Standards 2

The Concept of Convergence of the International Accounting Standards

Introduction

Convergence in financial reporting can be defined as the process of matching accounting

standards allotted by various accounting principles regulatory bodies. The International

convergence of accounting systems is not something new in the Accounting and Finance

industry as it arose back in the 1950s. According to Munter (2011), “it was due to World War II

economic integration and capital flow within the cross-border." The convergence major initial

efforts concentrated on harmonizing the accounting standards used in the major capital markets

all over the world.

It succeeded in the early 1990s leading to the rise of the unified set of standards that

would be used in almost all the main capital markets as it was intended (Amoreaux 2011). The

first international accounting standard committee was set up in the year 1973, and it was later

reorganized in the year 2001 to become an independent body known as, the International

Accounting Standard Board (IASB). The report is reflecting the concept of convergence, its

merits and demerits in the financial market, and how major capital markets have adopted it. The

primary objective of this report is to elaborate on the context of convergence about financial

reporting and to help in understanding its role in the financial, accounting, and the business

industry as a whole.

The concept of Convergence of the Accounting Standards.

The convergence of the accounting standards has transformed over a long period.

According to Tschopp and Nastanski (2014), it has formed a chronology of key events in its

evolution. Some of these key events can be divided into four sections, namely; the 1960s events.

They called for the international standards, and some early steps which were taken, the 1980s

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events that saw the commencement of a Standard-Setting body which operated internationally,

the 1990s events that formalize FASB and enlarges its international activities, and then the 2000s

events where the convergence pace accelerates and many capital markets merge in it.

The 1960s Events that Called for the International Standards

These are the period typically known as the birth of the convergence in the international

accounting standards. Many of the financial markets saw the need for the internationally agreed

upon accounting and auditing standards hence leading to the congress meeting. The 8

international congress of accounts was held in the same period by the American Institute of

Public Accounts (AICPA) (Tschopp & Nastanski 2014). The main agenda was the world’s

economy in conjunction to accounting, with many participants crying out loud that the

appropriate measures should be established to help in the accounting, development, auditing, and

financial reporting standards internationally. The reactions to that Congress lead to AICPA

reactivating its committee on international relations.

In around the year 1966, AICPA and its associates from Canada and the U K formed a

group to check in the differences in their standards to help in the way forward of the convergence

of those differences. It also drove to the publication of the first textbook on international

accounting standards by the (New York: Macmillan, 1967). According to Araya-Leandro (2016),

the book was written by Professor Gerhard G. Mueller who after some time after his publication

become a member of FASB.

The 1970 and 1980 Events - Commencement of a Standard-Setting Body

During this period the first body which sets standards of accounts internationally was

formed and gradual increase in the understanding among the FASB, IASC and many more

national standard setters. The FASB is also witnessed to be forming a task force that included

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international standard setters. The AICPA and its partners from eight other countries also

established the IASC which was a predecessor body to the IASB. It is eminent to note that many

countries denied using the IASC standards until 2002 when some started to use it

(Bandyopadhyay & McGee 2012). The IASC returns on its comparability and the improvement

projects. FASB joins the IASC consultative group and participates as a non-voting member

during the meetings. They then later in the 1980s show their support for the internalization of

standards.

The 1990s Events that Formalizes FASB

The FASB expands its international activities and issues their first strategic plan.

According to Garmong (2012), FISB together with the accounting standard board of Canada,

they then took a joint project of what was termed as segment reporting. They joined with other

standard setters to for a G4. G4 was a group which was formed to do research and proposes

solutions for the general accounting and reporting issues.

In the mid-1990s, the IASC and FASB and commence their first convergence standard-

setting effort. FASB amended its plans and decided to undertake a project which would see them

compare IASC and GAAP standards. It encourages the US to support high-quality international

standards and announces its intent in using of IASC standards.

The 2000s Events - Convergence Pace Accelerates

The convergence of the accounting standards was at its peak and grows fast. The FASB

and IASB become in agreement to work together, and even the US uploads the adoption of

international accounting standards. In the year 2001, IASC is transformed into the IASB in

response to the need of improving the governance, funding, and also the independence of IASC.

(Mala & Chand 2012). In the year 2002, the European Union (EU) decides to adopt the

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international financial reporting standards which required all the registered companies to prepare

consolidated financial statements using the IFRS from the year 2005. It is the period which the

Norwalk agreement was made, the FASB and the IASB came into one tone and agreed to work

together to strengthen the financial reporting standards.

Benefits of convergence of Accounting Standards

One of the benefits associated with the convergence of the accounting standards is low

transaction cost. It comes about as the set of rules to be followed when making the financial are

specific, and therefore you don't have to comply with various standards but only the

internationally agreed-upon ones. It saves time and eases the work to be done during such

preparations as some of them may need complex calculations which might be tiresome.

Another benefit is that it facilitates network externalities. It is a phenomenon where many

people benefit from using one set of standards in the same way. According to Betancourt and

Baril (2013), it increases the aggregate benefit of all of them as compared to the individual

benefit. It is agreed that network externalities apply to accounting standards hence benefiting in

also reducing the cost of training employees in each firm the different ways of making financial

reports as per the firm's standards, all the standards are the same.

Comparability is also another major benefit of convergence of the accounting standards.

It enhances the comparison between investors and managers. It is said that investors have a

difficult time in evaluating entities when they adopt different financial standards (Fischer &

Marsh 2012). It is therefore wise for the organization to subscribe to one set of converged

accounting standards as this will also assist managers when making the financial decisions in the

capital market.

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Limitations of convergence of Accounting Standards

The main limitation of the convergence of accounting systems is that it negatively affects

small business. Small organizations and companies spend comparatively more on regulatory

compliance as opposed to large organizations Yapa et al., (2015). These costs harm small

companies and diminish their ability to grow generally. Integrating accounting standards results

into the higher operational cost to these entities due to additional compliance mandates which

have been laid down by the standards.

Restriction of foreign laws is also a demerit of convergence. It implies that all the

countries around the world must adapt to a specific standard regardless of tax issues in the

country or economic situations. Accountants are also restricted to obtaining authority to practice

from a central point authorized by the set standards something which is sometimes costly as it is

renewed almost annually. These have led to the back fall of some few countries in the capital

market.

The Adoption of IFRS in EU

In the year 2002, the E U passed legislation demanding all their listed companies to impose the

use of International Financial Reporting Standards (IFRS) when preparing financial statements

starting from the year 2005. By doing so, the E U became the first capital market to adopt the

International Financial Reporting Standards. According to McEnroe & Sullivan (2014), after a

period, they decided to carve out a section of the international standards for what was termed as

financial instruments. These lead to the emergence of the European version of the International

Financial Reporting Standards (IFRS).

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The accounting regime of the European Union demands that IFRSs should be adopted

specifically for use in the European Union (Hail et al., 2010). In most scenario, the adoption

process is referred to an endorsement. The process follows a specific hierarchy which as

discussed below;

1. The first step is the issuance of the standard by the International Accounting

Standards Board (IASB)

2. After the issuance of the standards by the IASB, the E U Financial Reporting

Advisory Group (EFRAG) holds some consultations with the interested group to

enlighten then on the significant issues they should know before getting into it

fully.

3. At this level, the EFRAG communicates to the body on whether the standards

meet the criteria of adoption or in other words endorsement. In conjunction with

the commission, they also prepare a report showing the potential economic

effects of the given standard (s) to be adopted in the European Union.

4. At the fourth stage of endorsement, a draft report containing the endorsement

regulations is prepared by the commission based on the advice they receive from

the EFRAG. The endorsement of the regulations follows a regulatory procedure

and scrutiny under Articles 5a and eight of the Council Decision 1999/468. It

leads to the next three levels of the adoption.

5. The Accounting Regulatory Committee (ARC) set up the voting process on the

commission’s proposal accordance with by Article 6 of the AIS regulations. The

rule elaborates clearly that the majority voice prevails if the vote is favorable.

Convergence of Accounting Standards 8

6. The council of the European Union and the European Parliament are then

allowed three months to oppose the endorsement of the draft regulation by the

commission.

7. If they give a favorable opinion backing up the proposed regulation or the three

months period elapsed and the council and or the Parliament does not comment

on it, the commission eventually adopts the regulation.

8. Once it is adopted, the regulation is published in the “Official Journal” and

commence operation on the date stipulated in the regulation itself.

Convergence of IFRS and US GAAP

These two accounting standards convergence have been periodically examined in mostly

P2 exams (Khaira & Chakraborty 2015). It has witnessed a précised form of convergence, and a

lot of changes have also occurred over time. This section also elaborates on the key changes to

group accounting which is a victim of the convergence process.

The IASB and the FASB came into agreement and published a memorandum of

understanding MoU popularly known as the Roadmap in February 2006. They identified

different projects of convergence projects which was based on three main principles. According

to Guillaume and Pierre (2016), one of the primary principles in the memorandum of

understanding was that the convergence of accounting standards could helpfully be

accomplished by establishing quality standards which are common over time. Another principle

was trying to do away with the two accounting standards that require improvement. It stipulates

that a new financial reporting standard is initiated which improves the financial information

communicated to the investors. The last main principle in the (MoU) states that "to save the

Convergence of Accounting Standards 9

investor's need, the board should replace the standards which are highly in need of change and

converge into the new standards that can save the situation."

As a result of the MoU, priorities were established, they include some short-term

priorities which were included convergence which could be easily accomplished. According to

Guillaume and Pierre (2016), One of them was that the IAS 23 allowed for the borrowing costs

on the construction of an asset to be capitalized or written off, whereas, US GAAP required for

such cost only capitalized in the statement of financial performance. The AIS 23 was converted

in March 2007 and is now in line with the GAAP.

IAS 14 has also over time been outdated by IFRS 8 which engage in segment reporting.

The IFRS pin points the reportable segments based on the managerial perspective. It is in line

with the kind of approach adopted by the US GAAP instead of the risk and returns type of

approach adopted by the IAS 14 (Amoreaux 2011). The IAS was further revised in September

2007 which saw changes like the balance sheet being renamed as the statement of financial

position and the statement of comprehensive income replacing the income statement or the

former trading profit and loss account. It also in-cooperated the items of income and expense that

are not recognized for profit or loss but use to be directly recognized as equity. An example is

the revaluation gains.

The IFRS and the AIS 27 amendments occurred in January 2008. According to

Betancourt and Baril (2013), the introduced new standards changes the treatment of piecemeal

acquisition and goodwill calculations. In convergence to the US GAAP, the amendments which

were made bring the goodwill calculation into close line even though some few differences still

existed by then. The review which was done in 2012 converged them, and the calculation is

currently in line with one single standard.

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A second roadmap of the convergence was established in November 2008. The main

objective of the agreement was to allow organizations to file yearly financial statements which

are prepared categorically in line with IFRS GAAP for such statement to be accepted by the

Security and Exchange Commission (SEC) in the United States. According to Tschopp and

Nastanski (2014), the convergence was followed by a memo in 2007 which categorically stated

that the SEC would no longer demand IFRS compliant financial statement filled with them. It

also includes a reconciliation to the United States GAAP.

IFRS 15 – Revenues from Contracts with Customers

Objective

The aim of IFRS 15 is to identify the principles that a company shall use when reporting

significant financial information such as cash flow and revenue arising from a contract between

the company and the customer (Hail et al., 2010). Starting from the first day of January 2018, the

application of the IFRS 15 standard will be mandatory for all entities. It is eminent also to note

that earlier applications are permitted.

The Scope of IFRS 15

The contract is a binding agreement between two or more persons that promotes

enforceable right and obligations to the parties involved and has consequences if broken. In the

context of financial reporting, a customer can be defined as a party to a contract with the entity

providing him or her with good and or services that the entity produces. On the other hand,

revenues can be defined as the income earned from the normal activities of a given organization.

IFRS 15 revenue from contracts with customer applies to all the contracts an entity enters

with the customer. It only excludes leases within the specified scope of IAS 17 Leases, financial

instruments and any other contracts right stipulated in the scope of IFRS 9 Financial Instruments,

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IFRS 10 Consolidated Financial Statements, AIS 27 Separate Financial Statements, IAS 28

Investments in Associates and Joint Ventures, and IFRS 11 Joint Arrangements.

In some cases, one will realize that the contract an entity enters with a customer is

partially within the scope of the IFRS 15 and partially within a different standard (Mala & Chand

2012). In such a scenario: if the other standards clarify on how to initiate measures on one or

more parts of such a contract, then those measures should be taken into consideration first during

the transaction then the difference to be deducted on the original cost of the contract under the

standards. If nether of the standards gives clear guidelines on how to separate and or initiate the

measures of the contract, the IFRS 15 will be applied.

The Five Steps Model Framework of the IFRS 15

The principle of IFRS 15 is divided into five categories which include the following:

Identification of the contract with the customer; a contract is only within the scope of the IFRS if

the specific guidelines within the IFRS are met. Another model is identifying the performance

obligations in the contract. The entity should assess the goods or services they want to provide to

the customer and to identify performance obligation. The third model is to determine the

transaction price. It is the amount an entity requires to be entitled upon the issuance of the goods

and or services to the customer. According to Guillaume and Pierre (2016), an entity is required

to consider the previous market trends and customary business practices of IFRS 15:47. The

fourth model is to allocate the determined transaction price to the performance obligation which

was established in the contract. In a situation where the contract demonstrates to have more than

one performance obligation, the entity will have to reference their standard selling price in line

with the IFRS 15:75 Guillaume and Pierre (2016). The last model is for the entity to recognize

revenues after satisfying the performance obligation in the contract. It merely states that revenues

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should only be recognized when received. In line with IFRS 15:32, it is recognized as control is

passed, this can be over time or at the point of sale.

Conclusion

In conclusion, it is clear that the internationally agreed accounting standards effectively

and efficiently control the financial reporting. According to Guillaume and Pierre (2016), if the

international accounting standards can be implemented correctly, financial reports will be easy to

understand, and the capital market will eminently grow. The convergence of accounting

standards have promoted the growth of the economy since the standards being followed in

making the financial report like the statement of financial performance, and the statement of

financial position of an entity cannot be easily manipulated. Investors, either foreign or domestic

can easily understand the financial reports of a given organization they would like to invest in as

the standards are the same worldwide. The converged accounting standards have made learning

to account and finance easy as the principles are the same across the board. An accountant or

finance officer can work in any company in the world without fear of difference in the

accounting standards used in financial reporting. According to McEnroe & Sullivan (2014),

“there is nothing good in the business industry like having the financial intelligence."

Convergence of Accounting Standards 13

References

Guillaume, O, & Pierre, D 2016, 'The Convergence of U.S. GAAP with IFRS: A Comparative

Analysis of Principles-based and Rules-based Accounting Standards', Scholedge

International Journal Of Business Policy & Governance, 3, 5, pp. 63-72

Khaira, S, & Chakraborty, J 2015, 'Convergence with IFRS: The Case of Infosys Limited', IUP

Journal Of Accounting Research & Audit Practices, 14, 4, pp. 23-42

Hail, L, Leuz, C, & Wysocki, P 2010, 'Global Accounting Convergence and the Potential

Adoption of IFRS by the U.S. (Part II): Political Factors and Future Scenarios for U.S.

Accounting Standards', Accounting Horizons, 24, 4, pp. 567-588

McEnroe, J, & Sullivan, M 2014, 'The Rise and Stall of the U.S. GAAP and IFRS Convergence

Movement', CPA Journal, 84, 1, pp. 14-19

Yapa, P, Kraal, D, & Joshi, M 2015, 'The adoption of 'International Accounting Standard (IAS)

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ASEAN countries?', Australasian Accounting Business & Finance Journal, 9, 1, pp. 3-24

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CONVERGENCE', International Journal Of The Academic Business World, 6, 1, pp. 1-

Betancourt, L, & Baril, C 2013, 'Accounting for Joint Ventures Moves Closer to

Convergence', CPA Journal, 83, 2, pp. 26-31

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American countries to International Accounting Standards', RAP: Revista Brasileira De

Administração Pública, 50, 2, pp. 265-283

Convergence of Accounting Standards 14

Mala, R, & Chand, P 2012, 'Effect of the global financial crisis on accounting

convergence', Accounting & Finance, 52, 1, pp. 21-46

Garmong, SK 2012, 'The State of Major FASB IASB Convergence Projects', Financial

Executive, 28, 7, pp. 24-27

Bandyopadhyay, J, & McGee, P 2012, 'A PROGRESS REPORT: IFRS-U.S. GAAP

CONVERGENCE AND ITS CURRICULUM IMPACT', Advances In Competitiveness

Research, 20, 1/2, pp. 78-89

Tschopp, D, & Nastanski, M 2014, 'The Harmonization and Convergence of Corporate Social

Responsibility Reporting Standards', Journal Of Business Ethics, 125, 1, pp. 147-162

Amoreaux, MG 2011, 'Beyond Convergence', Journal Of Accountancy, 212, 2, pp. 46-51

Munter, P 2011, 'Accounting Standard-Setting: CONVERGENCE Drives More Change. (cover

story)', Financial Executive, 27, 1, pp. 22-25

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