The possible ways of global comparability of financial
statements in capital markets
Možné cesty k celosvětové srovnatelnosti finančních výkazů
na kapitálových trzích
Ing. Alžběta Srnová, Faculty of Business and Economics,
Mendel University, xsrnova1@node.mendelu.cz
Abstrakt
Tento článek se věnuje harmonizaci finančního výkaznictví a představuje detailně jednotlivé
možné cesty k dosažení celosvětové srovnatelnosti finančních výkazů na kapitálových trzích.
V úvodu je popsán v čase se měnící přístup zainteresovaných subjektů k jednotlivým
postupům vedoucích k naplnění harmonizačního cíle, včetně jejich výhod a nevýhod. Článek
poskytuje také vysvětlení tohoto měnícího se přístupu. Na základě komparace jednotlivých
harmonizačních postupů a pomocí metody analýzy a syntézy je navrhnuto možné řešení
k dosažení harmonizačního cíle.
Klíčová slova
Harmonizace, konvergence, endorsement, condorsement, IFRS, US GAAP
Abstract
This paper deals with the harmonization of financial reporting standards and presents possible
ways how to achieve global comparability of financial statements in capital markets. The
introduction describes the time-changing attitude of entities to the methods leading to the
harmonization, including their advantages and disadvantages. The paper provides an
explanation of this change. Based on comparison of possible ways of harmonization, analysis
and synthesis, the probable solution is suggested.
Key Words
Harmonization, convergence, endorsement, condorsement, IFRS, US GAAP
Introduction
The globalization of capital markets, the increase in the number of multinational companies,
the removal of institutional barriers, improvement of competitiveness and increasing amount
of cross-border trade of goods and services have made the financial world riskier for
investors. When taking into account the fact that individual states have their own national
accounting systems that provide external users with different information, there is a need to
create compatible and understandable information sources. The harmonization of financial
reporting standards of publicly traded companies could become the right source of
information for inventors.
Lack of quality, complete, comprehensive and comparable information may lead to the
investors’ bad decision with negative consequences not only for investors but also for the
capital markets, as well as the economy as a whole. Establishment of a harmonized high
quality, compatible set of financial standards which would be applicable to both national and
cross-border reporting is required solutions.
Development of a single - global system of financial reporting standards would help
investors to obtain reliable information about the financial situation of the enterprise,
eliminating the need for conversion of national standards and in the end it may lead to an
increase in the international capital flow which would give companies better access to capital
through lower interest rates. The introduction of harmonized reporting rules would allow
companies entering new foreign markets with lower costs and would lead to increasing
international competition in global markets. (Pologeorgis, 2013)
Objectives and methodology
The main goal of this paper is an evaluation of the changing attitude to harmonization of the
financial reporting system and introduction of the possible ways how to achieve the globally
accepted standards with their advantages and disadvantages in details. The article also
describes the cause of this change which is mainly visible by US entities. On the basis of the
analysis, the goal of the paper is to draw up the most probable solution which could aim at the
desired harmonization.
For introduction of the time varying approach to harmonization and presentation of the
possible ways how to achieve it, the description method is used in the article. The paper also
uses method of comparison which allows comparing each specific harmonizing procedure. On
the basis of this comparison, the analysis and the synthesis suggest a solution to achieve
harmonization objectives. During the work on this paper, the studies carried out by the
leading international consultancy companies PricewaterhouseCoopers (PwC), Ernst & Young
and Deloitte were used. Road Map of SEC, Work Plans, public statements and documents of
Financial Accounting Standards Board (FASB), International Accounting Standards Board
(IASB) and Securities and Exchange Commission (SEC) were also analyzed. The researches
of the PricewaterhouseCoopers (2011) and the American Institute of Certified Public
Accountants (2010) were important for the analysis.
Theoretical backgrounds
It is possible to identify several ways how to achieve the global harmonization of financial
reporting standards. There is a method of convergence of the most significant financial
reporting systems, endorsement – adoption of one type of standard to a second one and very
recently discussed condorsement that represents the merger of two previous methods. Each of
these ways has its strengths and weaknesses.
The convergence of two of the world's largest financial reporting standards IFRS
(International Financial Reporting Standards) and US GAAP (General Accepted Accounting
Principles) belonged to the fundamental ways of achieving the desired harmonization aimed
at international comparability of financial statements, undoubtedly. The International
Accounting Standards Board (IASB) is responsible for the development of IFRS. IFRS
represent world-wide standards applied across the continents. For US GAAP, reflecting the
unique American environment is a key institution Financial Accounting Standards Board
(FASB). It is important to remind the important role of the Securities and Exchange
Commission (SEC), the governing body of US financial markets and the American Institute
of Auditors (AICPA).
The mentioned systems of financial reporting, IFRS and US GAAP, are based on
different approaches. US GAAP is known as the rules-based system, supplemented by
detailed explanatory materials and IFRS can be considered an accounting system based on
common principles. Although it may seem at first glance that the financial reporting standards
IFRS and US GAAP are more different than similar, the opposite is true. The general
principles and conceptual framework are often the same or similar in both sets of standards,
leading to similar accounting results. The existence of any differences - and their materiality
to an entity's financial statements - depends on a variety of specific factors (Ernst & Young,
2011).
Need for a global system of financial reporting, the proximity of the two most widely
spread sets of financial reporting standards - IFRS and US GAAP and a large number of nonUS companies registered at the SEC was one of the main impulses leading to the initiation of
cooperation between the IASB and the FASB to develop a globally accepted financial
reporting system. The cooperation on the convergence of IFRS and US GAAP began in
October 2002 by Norwalk agreement. (FASB, 2002)
The signature of the Norwalk Agreement in 2002 was the beginning of cooperation
between the IASB and FASB with the aim to develop harmonized high-quality financial
reporting rules leading to comparability of disclosures in the financial statements of
companies around the world. This comparative information subsequently would help
investors to understand better investment opportunities. The desired goal should be achieved
through joint projects in the short and long term. Both Boards agreed to carry out these
projects in parallel and coordinated way. When signing Norwalk agreement, FASB also
emphasized that in case of significant differences between IFRS and US GAAP which are
many, it is expected that the solution would be obtained by choosing between current
US GAAP and IFRS. It should be a balanced cooperation of IASB and FASB towards
a common goal. At the beginning of the convergence process most professionals, participants
in the capital markets and companies themselves on both sides of the Atlantic Ocean found
the convergence as a positive and important step in meeting the desired goal - to simplify the
comparability of the financial statements based on globally accepted high quality standards. In
the case of international companies with a large number of branches and subsidiaries in
different countries, the idea of integrated accounting and reporting procedures for whole
company which enables them to reduce the costs associated with the transformation of the
financial statements was the driving force to support the convergence. Since 2005 all
companies listed at stock exchanges in the European Union have compulsory prepared their
financial statements in accordance with IFRS.
In Memorandum of Understanding in 2006, built on Norwalk agreement, the IASB
and FASB reaffirmed their commitment to continue in convergence of financial standards.
Their commitment was strengthen by creating a time schedule of the convergence process,
called as Road Map for 2006 - 2008. In the time schedule the specific "– milestones -" that
should be met by 2008, were set. An important consequence of the ongoing convergence
process was that the SEC, the US capital markets regulator, decided in 2007 that all non-US
company registered in the United States wouldn’t have to submit their financial statements to
US GAAP anymore if their financial statements were based on IFRS issued by the IASB. This
change was related to roughly 1,150 of 12,000 companies registered at the Securities and
Exchange Commission, (Delloite, 2008). At that time, the SEC published a Road Map
containing the potential adoption of IFRS for US companies with effective date 2014. In the
document, among other things, SEC explains that it has long expressed its support for a single
set of high - quality global financial standards as an important means of enhancing
comparability and believes that IFRS has the potential to provide the best common platform
on which companies can report and investors can compare financial information. (SEC, 2008)
The SEC also said that according to the Work plan from February 2010, it would make
a detailed analysis of IFRS. The results of the analysis would serve as a basis for the SEC's
final decision on adoption of IFRS to US GAAP or not. The analysis would focus on the
ability to IFRS become the only standards of financial reporting in the United States, the
continuity and development of IFRS, the influence of adoption on other areas of economic
and legal environment - for example, the Tax Code of the United States of America, the future
role of the FASB and the readiness of professionals and all stakeholders in the capital
markets. (KPMG, 2010)
The experts, investors and representatives of large multinational companies reacted to
the Road Map by sending Comment Letters to the SEC. In these letters they consistently
expressed their support to develop global high quality financial standards. However, there
were differences in future role of IFRS in the American environment. In several Comment
Letters the doubt about applicability of IFRS in USA, which is necessary for the continuation
of the harmonization efforts, appeared for the first time. The proposed timetable and costs
connected to transfer of US GAAP to IFRS were one of the most criticized points of the
Road Map. Other concerns directed to the establishment of the international body responsible
for issuing the standards also for USA in the future. There is a question if the body would be
able take into account the specifics of the American environment when issuing or modifying
standards. In parallel with the described activities of the SEC, FASB and IASB continued
work on joint projects. The most important projects with the greatest impact on reporting
became the leasing, financial instruments and income recognition (PricewaterhouseCoopers,
2011).
In response to the disclosure of the Road Map by the SEC in 2010 American Institute
of Certified Public Accountants (AICPA) made a survey of 1,620 companies - US Public and
Private Companies, Foreign Private and Public Companies, Non Profit Companies and Public
Companies Practice. The research was mainly focused on the familiarity of companies with
IFRS and the relationship to the SME (Small and Medium Enterprise). One of the questions
was whether the SEC should require the adoption of IFRS into the US environment. The
responses were nearly same across different types of companies. Most companies agreed with
the adoption of IFRS but only after the process of convergence between IFRS and US GAAP
would be finished (see Fig. 1). Speed of the changes was for 37% of respondents too fast but
only 5% of respondents considered the change too slow (see Fig. 2).
1: Adoption of IFRS to USA, Source: AICPA
What do you thing of the pace of
recent standard - setting activity?
Too fast
Just right
25%
Too slow
Not sure
37%
5%
33%
2: Pace of recent standard - setting activity 1, Source: AICPA
Less than a year later, in 2011, consultant - company PricewaterhousesCoopers made an
extensive research related to the convergence of IFRS and US GAAP among representatives
of companies differed in size, business and income. 85% of companies came from the United
States. Comment Letters sent to the SEC in response to the issue of the Road Map showed
criticism about the speed of the convergence which was considered very fast especially by
American small and medium - sized companies. The PricewaterhousesCoopers’s research
confirmed that almost half of the respondents found the convergence process too fast
(see Fig. 3). Compare to the numbers of AICPA’s research, it can be seen an increase in both
extreme responses. A big disadvantage of convergence effort was its cost effectiveness. 67 %
of respondents agreed in a study conducted by PwC that convergence may lead to an increase
in the quality of IFRS and US GAAP (see Fig. 4). Nevertheless excessive financial costs were
not expected to be offset by the benefits. This is a strong argument against convergence
process (see Fig. 4). Among correspondents substantially prevailed opinion that IFRS would
be adapted to the American environment in the future, only the date of adoption was different
(see Fig. 5).
What do you thing of the pace of
recent standard - setting activity?
Too fast
Just right
Too slow
Not sure
14%
15%
43%
28%
3: Pace of recent standard - setting activity 2, Source: PwC
Will convergence improve quality of US GAAP and IFRS and
achieve convergence?
The quality willy improve
10%
30%
23%
37%
The qualitywill improve but
cost does not justify the
improvements
No need for these projects US GAAP enough quality
4: Improvement of US GAAP and IFRS, Source: PwC
Do you believe IFRS will eventually
be adopted in the US?
8%
16%
YES - in 2015
12%
YES - in 2016
23%
YES - after 2016
No
41%
Not sure
5:Adoption of IFRS to USA Source:PwC
In May 2011 the SEC published staff paper "Exploring a Possible Method of Incorporation
which included a more detailed framework for the possible inclusion of IFRS into the US
reporting system but also for the first time presents officially the idea of "condorsement ". As
the name implies, the condorsement is link of endorsement approach and convergence. Mr.
Beswick (Deputy Chief Accountant, SEC) was the first one who introduced officially this
approach. Under this approach, US GAAP would continue to exist. The FASB and IASB
would work to finish their joint projects converge. After completing their joint projects, FASB
would work to converge US GAAP to IFRS over a period of time for standards that are not on
the IASB's Work plan. At the same time, FASB would have a process to consider new
standards issued by the IASB for incorporation into US GAAP. The new standards could be
incorporated into US GAAP with or without US modifications. The condorsement approach
would allow FASB to retain control over US GAAP. (Parks, 2011)
In the middle of July 2012, the SEC issued the document commenting the ongoing
convergence efforts. In this document, the SEC says that based on the analysis the differences
between IFRS and US GAAP are greater than initially was expected. It also confirmed that
IFRS could be generally considered as high quality standards of financial reporting but on the
other hand there are areas which are underdeveloped. So, it is impossible to say that IFRS are
so much better and more transparent standards than US GAAP. But what is missing in the
document is an expectation of the SEC about rejection or acceptance of IFRS (when) into the
US environment.
2002
Norwalk
agreement
2005
IFRS for
listed
companies
in EU
2007
SEC
non-US
companies
in USA financial
statements
under
IFRS
2011
SEC
Staff Paper
„condorsement“
2012
SEC
IFRS a US
GAAP bigger
differnces than
was supposed
2006
Memorandum of
Understanding
6: Timeline of harmonization process, Source: Own work
Discussion and Results
The analysis of the time changing approach to the global harmonization of financial reporting
standards clearly confirmed that the idea of global high quality standards providing the
required comparability of financial statements is still alive. The way how to achieve this goal
is changing mainly according to attitude of the important US entities to adoption process of
IFRS into the US environment.
And what are the current situation and the attitude of representatives? IASB and FASB
continue in the convergence process. The four most important current projects include
leasing, revenue recognition, financial instruments and insurance contracts. Each of these
projects is at a different level of preparation. Some of the projects are in the process of
Exposure draft or Re-exposure draft, another one is closed to release the final standard.
Nowadays, in the United States the most often mentioned approach is neither
convergence nor full adoption of IFRS into the US environment but it is condorsement.
Especially small local companies do not agree with adoption of IFRS in the USA because of
the high costs that would be associated with it. Contrary, large companies with international
branches see in it a way how to reduce the costs that otherwise would have to be spent on the
transformation of financial statements prepared in accordance with IFRS to meet the
requirements of US GAAP. Development of a single reporting language would bring
international companies significant benefits. If the language was IFRS, these benefits would
be even greater. In the context of costs of the endorsement, it is important to realize that
reporting under IFRS in the European Union applies only to the companies listed on stock
exchanges in the European Union, other companies can disclosure information in their
financial statements accordance with national standards. In the USA the situation is different.
All American companies regardless of their size are required to follow the rules set by
US GAAP. It is obvious that the adoption of IFRS would affect a huge number of companies,
including small and medium-sized enterprises.
Even if convergence is losing its supporters, there are several advantages that could
bring with. Firstly the convergence could help to increase the transparency, comparability,
clarity and possible simplification. Negative attitude to convergence may be based on
a general reluctance to take part in a collaborative process with someone who comes from
different cultural, political and economic system or from the society based on different values.
Convergence is also faulted for focusing only on the largest differences between current IFRS
and US GAAP and the smaller are overlooked. (Pologeorgis, 2013)
The opposition to the endorsement among key American institution could come from
the fear to lose power under issuing the standards of the USA. However, it is important that
these opponents realize that the other economically developed countries in the world have
slowly adopted IFRS as its financial reporting standards. It would probably be a mistake for
the USA as an important market remains isolated. In recent years, the IFRS, at least to some
extent, have been adopted by several large economies - such as China, Russia and Canada.
At this moment, the most likely way to achieve harmonization objective is
condorsement. It is possible to expect that the FASB and IASB will finish gradually the joint
projects and the USA will so far keep their standards with key role of FASB. After that, the
new possible common way to develop global standards will be looked for. Although the
convergence process has not been successful in all that it was set at the beginning - for
example in the conceptual framework, in other projects (e.g. leasing, revenues recognition and
financial instruments) have achieved some success. Despite the negative American attitude to
the adoption of IFRS to US GAAP, American environment will be strongly influenced by
IFRS standards incurred as a result of joint convergence projects in the coming years.
Conclusion
There is a general consensus that the development of global, high quality and internationally
accepted standards of financial reporting is very important but difficult task. The aim of
harmonization is to develop high quality and compatible international financial standards
applicable to both domestic and cross-border financial reporting to allow greater
comparability and transparency of financial reporting, better access to capital and reduce the
costs associated with the transformation of statements.
It has already been several years since cooperation began. During this period, intensity
of cooperation and an attitude of American institutions, professionals and the companies
themselves to the ways of harmonization have changed. Even though the convergence project
have been invested by large amounts of effort and money, it can’t be expected accordance to
present attitudes especially from US entities that the convergence will be fully filled, at least
to the extent and timeframe, which was initially expected. A similar situation exists in the
case of endorsement method. The opposition to adopt IFRS could come from, inter alia,
a general unwillingness to accept anything from other groups coming from different cultures
and values, which pays twice in USA.
The current most important task of harmonization efforts is to find a way to achieve all
desired harmonization objectives with minimal impact on the markets of the United States of
America and maintain the influence of the SEC and FASB so that this way could be
acceptable for the USA. Taking into account the last SEC’s document published in 2012,
current attitude of Americans representatives and the other facts, in my opinion we cannot
expect a global comparability of financial statements in the next five years but in the much
longer term.
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