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FBLT041 Advanced Financial Reporting

Published : 07-Oct,2021  |  Views : 10

Question:

Critically examine the regulatory, ethical and cultural dimensions in which financial reports are prepared.
 
The concept of convergence first arose in the late 1950s in response to post-World War II economic integration and related increases in cross-border capital flows. Initial efforts focused on harmonisation reducing differences among the accounting principles used in major capital markets around the world. By the 1990s, the notion of harmonisation was replaced by the concept of convergence the development of a unified set of high-quality, international accounting standards that would be used in at least all major capital markets (FASB, 2015).
 
In 2001, the EU announced its adoption of IFRSs for listed companies from 2005. Soon afterwards, the IASB and the FASB entered into a Memorandum of Understanding for the purpose of convergence and started a joint project for convergence between the two conceptual frameworks (Alexander et al., 2014: 140). This would then provide a sound foundation for developing future accounting standards which will be principles-based and internationally converged.
An example of such standards is IFRS 13 fair value measurement, which was jointly issued by the IASB and FASB in 2011 (effective from 2013) as part of the convergence project, and also as a response to the global financial crisis.
Furthermore, in 2014, the IASB and the FASB jointly issued a converged standard on the recognition of revenue from contracts with customers. The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally (FASB, 2016).
 
Distinguish between harmonisation and convergence, providing benefits and limitations of both concepts
Appraise the process of the convergence of IFRS and US GAAP, highlighting the need for such a convergence and providing examples of success and setbacks in the process.
 
Appraise the use of fair values in the preparation and presentation of financial statements. Your discussion must include comparisons to the historical cost convention.

Evaluate the converged standard, IFRS 15 Revenues from Contracts with Customers, contrasting it with the superceded IASB standard, IAS 18 Revenue.

Answer:

Introduction: 

The current report is based on the brief discussion of harmonization and convergence of accounting standards. The aim of this report is to provide a brief discussion of convergence between the IFRS and US GAAP and the highlights the success and setbacks. The report also emphasis on the use of fair values in the presentation and preparation of the financial statement and also provides discussion based on the historical cost by comparing the same with their respective advantage and disadvantage. The report considers the IFRS 15 revenue from contracts with customers and evaluates the superseded effects of IAS 18.    

Overview of Convergence:

The convergence of accounting standards can be defined as the objective of making a single set of bookkeeping standards that will be used internationally. Convergence is driven by numerous factors that includes the belief of a having a single set of accounting requirements that would increase the comparability of different entities accounting numbers, which will contribute to the flow of international investment by benefiting variety of stakeholders. The concept of convergence is particularly aimed to bring the US GAAP and IFRS closer. The major objective is based on having identical general principles along with the overall accounting standards in order to lay down the foundation for future accounting standard. The conceptual framework of convergence aims to make consistent project as the part of making constant update by refining the current concepts to highlight the changes in the market and business practices.

Overveiw of Harmonization:

 Harmonization on the other hand can be defined as the process of improving the compatibility of accounting practices by setting up the limits on large accounting practice (Wang 2014). Harmonization of standards will be not have any conflicts of logic and will ultimately improve the comparability of financial information from several different countries. The efforts of harmonizing the accounting standards have started long before the creation of the international accounting standards committee in 1973. Harmonization of international accounting is regarded as the utmost significant matters that is faced by the makers of accounting standards, capital market regulators, stock exchange and those preparing or using the financial statements (Tschopp and Nastanski2014).

Difference between Harmonization and Convergence: 

Below listed are the differences between the harmonization and convergence, which are as follows;

Harmonization

Convergence

International harmonization refers to the procedure that aims to eliminate the difference between the present accounting standards

Convergence refers to the working with other standard setting bodies in order to develop new or revised standards that will contribute in the development of single set of accounting standards (Wagenhofer 2014).

The process of harmonization is far more open and flexible

Convergence on the other hand is more difficult to implement internationally

Harmonization is regarded as slow procedure of modifying the present national accounting standards to be more aligned with the matching IFRS (McLeay 2014).

The process of convergence is flawed as retaining a wide range of existing standards of listed companies will be required to be complied with the IFRS standards and this turns out to be very confusing since comparison only has IFRS in place and nothing else.

Harmonization results in more complex accounting rules across the nations since the process of alignment is not perfect.

Convergence does not reflects the fair presentation of the organizations financial position and performance.

The benefits and limitations of Harmonisations and Convergence are as follows;

Harmonization

Advantage

  1. One of the advantage of harmonization is that it will constantly pursue the achievements of fair, liquid and efficient capital markets.
  2. Harmonization will provide investors with necessary information that is accurate, timely, easy to compare and reliable
  3. Harmonization will provide consistency throughout the international market

Disadvantage:

  1. Harmonization is a time consuming and will take will require long time to implement the new standards
  2. It is a costly process as managers, accountants, employees and investors will have to undergo vigorous education which involves large amount of cost
  3. There are some countries that are not willing to adopt the uniform code since many of the countries has issues related to political, economic and ethics.    

Benefits:

  1. Harmonization helps in improving the comparison of the financial statements particularly in the smaller companies
  2. Presents fair financial position of the organization and makes the accounting companies more dependable
  3. Helps in reducing the financial reporting cost for the multi-national companies

Drawbacks:

  1. Several countries might view the process of compliance with international accounting standards as the threat to their nationalism
  2. Underdeveloped companies may consider harmonization as the obligation placed on them by nations with superior economies
  3. Harmonization will not be regarded as flexible to deal with the problems faced by the nations under differing problems and circumstances (Chen, Ding and Xu 2014).

Convergence:

Advantages:

  1. Shifting to universal financial standards will provide the ease of expansion for organizations.
  2. Another biggest advantage of convergence is that it facilitates comparability between companies across different companies.
  3. Convergence will provide the owners of the small business to assess the international options of investment and cash management.

Disadvantage:

  1. Some small business will be forced to change the present accounting system and this will incur huge amount of cost on implementing new business system.
  2. The laws and other kinds of regulations would hamper the comparability of the financial statements across the countries despite the same accounting standards is used.    

Benefits:

  1. It provides benefits to the investors and reduce the cost of accessing the capital markets across the world
  2. The understanding of the investors and their confidence is improved which ultimately helps the investors in making better investment decisions
  3. Allocation of capital is more efficient across the world
  4. Portfolios are more diversified and financial risk is reduced
  5. There is a large number of transparency and comparability between the competitors in the global markets
  6. The process of strategic decision making in mergers and acquisition is improved

Drawbacks

  1. It takes into the considerations very simple solution for a complex problems
  2. It strips accounting of flexibility to adapt under different situations
  3. It is not suitable for small and medium sized companies
  4. It requires unnecessary and detailed disclosure

Convergence of IFRS and US GAAP:

The convergence of accounting standards is considered as the most decisive strategic importance for the future of the international capital markets. Information of higher quality is regarded as necessary for high quality markets. The valuable process of convergence of financial reporting and accounting standards contributes to the free flow of the global investment and attains the substantial benefits for all the capital markets stakeholders (Carneiro, Rodrigues and Craig 2017). Convergence of IFRS and US GAAP helps in improving the ability of the investors to compare the investment on the international basis and hence helps in lowering their risk of errors of judgement. Convergence helps in facilitating the accounting and reporting for organizations with international operations and cutting down the costly requirements.

Convergence has the potential to establish a new standard of responsibility with greater degree of transparency. These are valuable to the market participants along with the regulators since convergence helps in cutting down the operational challenges for an accounting firm and focuses on their value to increase their unified set of standards. Convergence of IFRS and US GAAP offers unfrequented opportunities for the standard setters and other stakeholders so that it can improve their reporting models (Angeloni 2016). Currently the financial accounting standard board and the international accounting standard board have jointly laid down the path of convergence, the scope and the nature of accounting and reporting standards will be changed.

The procedure of convergence in the area of conceptual framework requires the financial reporting system to be based on the common conceptual framework. It forms the fundamental prerequisite to reach the full compatibility of US GAAP and IFRS by providing best platforms for developing principle based standards (Chiuet al. 2016). The revised conceptual framework must replace the current IASB or FASB frameworks and must form the basis for standards setters. This will help in reducing the risk of reaching the difference conclusion concerning similar issues or events.

Success:

Considering the success of IASB and U.S GAAP convergence on the wider principles of capitalization of borrowing cost was improved due to the removal of the free choice option. Substantial success was experienced as convergence has resulted in improved disclosure of financial assets and liabilities (El-Gazzaret al. 2017). Another success that could be considered is the substantial success in the fair value measurement. The direction on the fair value in IFRS is much improved now and has made constant disclosure to enhance the standard.

Setbacks:

Ever since the commencement of convergence, there has been several setbacks and differences in the opinion, which have impeded the completion of new standards. According to Bohušová(2014) there are concerns regarding the preservation of FASB role in “Accounting Standard 11” since a healthy FASB hedges against the IASB represents a failure in adopting a high-quality standards that is appropriate for U.S capital markets. Another setback is the significant expenditure, which a company might incur after making a switch from GAAP to IFRS.

Use of fair value in the presentation and preparation of financial statement:

Fair value is useful in the preparation and presentation of the financial statements for investment funds or similar financial instrument in compliance with the IFRS. Fair value is useful in the preparation and presentation of financial statements since it requires the preparer to make the use of judgement in relation to the choice of the accounting policies. Fair value is necessary because it lays down the process of disclosure that must be tailored to meet the organizations specific circumstances. Materiality is relevant for the presentation and disclosure of the items in the financial statements. Preparers is required to take into the considerations whether the financial statements considers the information which is relevant to the understanding of the organization.  

The accounting standard certification 820 defines fair value as the price of an asset or transfer of a liability that is conceptually different from the contract price. Fair value is regarded as the price of exit in the standard market (Oliver 2014). The fair value measurement is useful in considering the sale of an asset or the transferability of the liability and not a business deal to counterbalance the risk that is linked with the asset or liability. By not attempting to eradicate the judgement that is concerned in the assessment of fair value, ASC 820 offers a structure that is proposed to encourage constancy and increasing the comparison in the assessment of the fair value that is used in the monetary reporting.

The accounting standard documentation offers an exemption to the main beliefs of the principles of fair value as it allows the business to measure a set of monetary instrument that is based on the cost to sell or its net position concerning a particular risk exposure, if the necessary criterions are met. The fair value measurement is useful in allowing for the features of assets and liabilities where the marketplace contributors takes into the considerations the pricing of assets and liability (Barniv and Myring 2015). While the theory of highest and best use concerning an asset might consider it putting into use under different circumstances but the motive of fair value measurement is to regulate the value of an asset in its current form. Therefore, the purpose of fair value measurement is to compute nearly the value at which an organised commercial deal is to sell the asset or to transfer the liability would take place amid the marketplace participants on the evaluation date under the present market circumstances. The valuation techniques are considered as a suitable approach of assessment that considers the accessibility of the information to expand the inputs.

Comparison of fair values and historical cost:

Choosing amongst the fair value and historical cost accounting is regarded as one of the most argued subjects in the accounting literature. On the beneficial side, it is predicted that the fair value accounting to be used is additionally to be assisted in the assessment of the performance and it is useful in evaluating the organizations management. Whether the fair value dominates the historical cost in this regard, it is more possibly to be dependent on the procedure involved in the usage of an asset (Christensen and Nikolaev 2013). If an organization generates substantial sum income from the dealing of an asset the fair value is more likely to provide a better measure of periodic income than the historical cost. In contrast to this, if an organization intends to hold the asset and to derive income from its use then under such circumstances historical cost is more likely to be preferred.

Historical cost and the fair value is considered as two key methods of recording non-current assets and financial instrument (Linsmeier 2013). The key differences between the historical cost and the fair value are that the value of the noncurrent assets is valued at price that is spent to acquire the assets. Under the historical cost, the assets are shown at estimate of the market value at the time of using the fair value.

Historical cost

Fair Value

Historical cost represents the original price that is spend to acquire the asset.

Fair value reflects the value at which the asset can be sold in the market

Guidance on the historical cost is available in IAS 16

Guidance on the fair value is available in IFRS 13

Historical cost is understated and obsolete

Fair value reflects that the price that is in line with the current market value (Blankespooret al. 2013).

Reasonably, the difference amongst the historical and fair value is primarily dependent on the accounting treatment. The management has the discretion to make a selection of the appropriate method (Ball, Li and Shivakumar 2013). They must be careful of not exaggerating the price of the assets if the fair value method is considered that will give asset an unrealistically high value. Even though the use of historical is fairly straightforward method it does not show the most recent value of the assets.

IFRS-15 Revenue from Contracts with customers:

In the month of May 2014, the IASB and the FASB collectively issued revenue recognition contracts with the customers under the US GAAP defining it as a converged benchmark of identifying revenue from contracts with customers (Palea 2014). IFRS 15 sets up a comprehensive framework for revenue acknowledgment from the contracts with the customer based on the core principles, which an entity must identify the revenue that represents the transfer of promised goods and service to the customers. It reflects a sum, which a business must expect to be authorised in exchange for the goods and service. In agreement with the IFRS 15, a business recognises the asset for incremental costs of procuring the contracts since the business expects recovering the cost with the help of upcoming fees for consulting services (Mrša 2014).

“IFRS 15 revenue from contracts with the consumers” is applied to all the contracts with the customers. A contract with customers might be partially within the scope of IFRS 15 and partially inside the range of another standard (Komninos and Cameron 2017). The fundamental objectives of IFRS 15 is that an organization will identify revenue to characterize the transmission of guaranteed goods and services to consumers as the quantity, which reflects the considerations to an extent where an organization anticipates to be allowed in exchange for the goods and services. The scope of IFRS 15 is applicable to all the contracts with the consumers in the industry with the exception of;

  1. Lease contracts
  2. Insurance contracts
  3. Financial instruments and other types of contractual right or obligations
  4. Non-monetary exchanges taking place amongst the businesses that are in similar line of industry in order to enable sales to consumers or possible consumers.

Unlike the current revenue guidance, IFRS 15 states the accounting for the incremental costs of getting the contract with the customers along with the cost that is incurred for completing a contract with the customers.

Comparison between IAS 18 and IFRS 15:

The IAS 18 states that an organization must consider the application of recognition criteria to separately identify the components of a single transaction (Silvia 2014). IAS 18 does not provide direction on recognising the constituents and distribution of selling price since there was diverse practice that was applied. Under the new IFRS 15, the transaction value should be apportioned to the performance of the duties in the contract and identifying the contracts when the duties are delivered or fulfilled.

The primary effect under the new IFRS 15 standard is that the organizations will be reporting the profits in diverse manner and the revenue from the reporting patterns would change (Tong, 2014). This is because there are some contracts that goes beyond one accounting period and reporting revenues incorrectly will result in incorrect taxation and different reporting to stock exchange.  

Five step Model: 

To recognize the revenue below listed are the five step model which must be applied:

Step 1: identifying the contracts with the customers:

A contract with purchaser will fall inside the standards if the below listed criteria are met;

  1. The parties to the agreement have accepted the contract
  2. The rights of the parties are recognised in terms of the goods and service to be transported
  3. The agreement possess the profitmaking substances
  4. The collection of an amount of consideration to which the entity is entitled, for exchange of goods and service that is payable

Step2: Identifying the performance obligations in the contract:

Upon the inception of the contract, an entity must assess the goods and service that is already promised to the customer and must recognize the performance obligation. These includes;

  1. A goods or service that is distinct
  2. A series of distinct goods or substances that are substantially identical and possess the identical pattern of transfer to the customer

Step 3: Determining the price of the transaction:

The transaction price refers to the amount of considerations which an entity anticipates to be entitled in exchange of goods and service. An entity is required to consider the terms of the contract and past customary business practice at the time of making this determination.

Step 4: Allocating the transfer price:

An entity must apportion the contract price to each of the performance obligations as the sum that depicts the amount of consideration to which the entity anticipates to be entitled in exchange of transferring the promised goods or service to the customer.

Step 5: Recognizing the revenue when the performance obligation is satisfied:

An entity must recognize the revenue when it fulfils the performance responsibility by transferring the promised goods or service to a specific customer, which is when the control is passed either over time or at the point of time.

Conclusion: 

The report has successfully provided a detailed explanation of the convergence between the IFRS and U S GAAP. The concept of convergence is aimed to bring the US GAAP and IFRS nearer. The major purpose of this report is based on having identical general principles along with the overall accounting standards to lay down the basis for future accounting standard. The report also successfully depicts that Fair value is useful in the preparation and presentation of financial statements as it enables the preparer to make the use of best judgement in relation to the choice of the accounting policies.

Reference:

Angeloni, S., 2016. Cautiousness on convergence of accounting standards across countries. Corporate Communications: An International Journal, 21(2), pp.246-267.

Ball, R., Li, X. and Shivakumar, L., 2013. Mandatory IFRS adoption, fair value accounting and accounting information in debt contracts. Fair Value Accounting and Accounting Information in Debt Contracts (September 11, 2013).

Barniv, R.R. and Myring, M., 2015. How would the differences between IFRS and US GAAP affect US analyst performance?. Journal of Accounting and Public Policy, 34(1), pp.28-51.

Blankespoor, E., Linsmeier, T.J., Petroni, K.R. and Shakespeare, C., 2013. Fair value accounting for financial instruments: Does it improve the association between bank leverage and credit risk?. The Accounting Review, 88(4), pp.1143-1177.

Bohušová, H., 2014. General aaproach to the IFRS and US GAAP convergence. ActaUniversitatisAgriculturaeetSilviculturaeMendelianaeBrunensis, 59(4), pp.27-36.

Carneiro, J., Rodrigues, L.L. and Craig, R., 2017, June. Assessing international accounting harmonization in Latin America. In Accounting Forum. Elsevier.

Chen, C.J., Ding, Y. and Xu, B., 2014. Convergence of accounting standards and foreign direct investment. The International Journal of Accounting, 49(1), pp.53-86.

Chiu, P.C., Pincus, M., Zhou, K. and PwC, L., 2016. Do Industry Differences Matter–IFRS Versus US GAAP?.

Christensen, H.B. and Nikolaev, V.V., 2013. Does fair value accounting for non-financial assets pass the market test?.

El-Gazzar, S.M., El-Gazzar, S.M., Finn, P.M. and Finn, P.M., 2017. Restatements and accounting quality: a comparison between IFRS and US-GAAP. Journal of Financial Reporting and Accounting, 15(1), pp.39-58.

Komninos, J. and Cameron, R.B., 2017. IMPACTS OF REVENUE RECOGNITION CHANGES IN THE CONSTRUCTION INDUSTRY.

Linsmeier, T.J., 2013. A Standard setter's framework for selecting between fair value and historical cost measurement attributes: a basis for discussion of" Does fair value accounting for nonfinancial assets pass the market test?". Review of Accounting Studies, 18(3), p.776.

McLeay, S., 2014. International Harmonization of Accounting Standards. Wiley Encyclopedia of Management.

Mrša, J., 2014. IFRS 15-Revenue recognition. Ra?unovodstvo, revizijaifinancije, 24, pp.136-140.

Oliver, K., 2014. Balance Sheet Presentation under IAS 1 and US GAAP.

Palea, V., 2014. Fair value accounting and its usefulness to financial statement users. Journal of Financial Reporting and Accounting, 12(2), pp.102-116.

Silvia, M., 2014. IFRS 15 vs. IAS 18: Huge Change Is Here.

Tong, T.L., 2014. A Review of IFRS 15 Revenue from Contracts with Customers.

Tschopp, D. and Nastanski, M., 2014. The harmonization and convergence of corporate social responsibility reporting standards. Journal of Business Ethics, 125(1), p.147.

Wagenhofer, A., 2014. Global convergence of accounting standards. The Routledge companion to accounting, reporting and regulation, pp.246-264.

Wang, C., 2014. Accounting standards harmonization and financial statement comparability: Evidence from transnational information transfer. Journal of Accounting Research, 52(4), pp.955-992.

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