ADDIS ABABA UNIVERSITY COLLEGE OF BUSINESS AND ECONOMICS DEPARTMENT OF ACCOUNTING AND FINANCE ADVANCED FINANCIAL ACCOUNTING ASSIGNMENT ON INTERNATIONAL CONVERGENCE OF FINANCIAL REPORTING AND INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) PREPARED BY: - EYOB DEMESEW ID: - GSE/1963/14 SUBMITTED TO: - DR. SEWALE(PhD) SUBMISSION DATE: - JANUARY,2022 International Convergence of Financial Reporting and International Financial Reporting Standards (IFRS) 3.1 Harmonization and Convergence Harmonization According to the Financial Accounting Standards Board, efforts to bring together U.S. and international accounting rules began in the 1950s, as the world economy was emerging from the shadow of World War II. These first efforts were based on the idea of harmonization -- minimizing the differences between accounting standards. With harmonization as the focus, there would continue to be GAAP in the U.S. and IFRS elsewhere, and there would still be areas of disagreement between them. The goal of harmonization was just to make those areas as minor as possible. Convergence In the 1990s, the focus shifted from harmonization to convergence. In convergence, the ultimate goal is for GAAP and IFRS to come together in a single set of standards that would apply everywhere. There would no longer be a distinct GAAP or IFRS. However, convergence doesn't just involve GAAP. Several other major economies do not follow IFRS, including Japan and China. International convergence efforts are intended to bring those countries into the same set of international standards as well. Harmonization -- the process of increasing the level of agreement in accounting standards and practices between countries. Convergence -- the adoption of one set of standards internationally. This is the main objective of the IASB Harmonization: The Pros and Cons Pros: Expedite the integration of global capital markets and make easier the cross-listing of securities. Facilitate international mergers and acquisitions. Reduce investor uncertainty and the cost of capital. Reduce financial reporting costs. Allow for easy and cost effective adoption of highquality standards by developing countries. Easier to transfer accounting staff internationally Cons: Significant differences in standards currently exist. The political cost of eliminating differences Overcoming “Nationalism” and traditions Perhaps it will not provide significant benefits. Will cause “Standards Overload” for some firms Diverse standards for diverse places is acceptable Organizations involved Association of South East Asian Nations (ASEAN) United Nations (UN) European Union (EU) International Organization of Securities Commissions (IOSCO) International Federation of Accountants (IFAC) IASB and FASB 3.2 IASB Framework And IFRS Conceptual Framework for Financial Reporting was issued by the International Accounting Standards Board in September 2010. It was revised in March 2018. The Conceptual Framework sets out the fundamental concepts for financial reporting that guide the Board in developing IFRS Standards. It helps to ensure that the Standards are conceptually consistent and that similar transactions are treated the same way, so as to provide useful information for investors, lenders and other creditors. The Conceptual Framework also assists companies in developing accounting policies when no IFRS Standard applies to a particular transaction, and more broadly, helps stakeholders to understand and interpret the Standards The Conceptual Framework has three levels: 1. First Level: - Objectives of financial reporting 2. Second Level: - Qualitative Characteristics 3. Third Level: - Recognition, Measurement and Disclosure 3.3 Principles-Based Vs. Rules-Based Accounting IASB Perspective IASB attempts to follow a principles-based approach to standard setting. As such, accounting standards are grounded in the IASB Framework A principlesbased approach Represents a contrast to a rules-based approach Attempts to limit additional accounting guidance (e.g., FASB, EITFs, FASB Interpretations) Is designed to encourage professional judgment and discourage over-reliance on detailed rules Principles-Based Accounting Principles-based accounting seems to be the most popular accounting method around the globe. Most countries opt for a principles-based system, as it is often better to adjust accounting principles to a company’s transactions rather than adjusting a company’s operations to accounting rules. The international financial reporting standards (IFRS) system—the most common international accounting standard—is not a rules-based system. The IFRS states that a company’s financial statements must be understandable, readable, comparable, and relevant to current financial transactions.2 Rules-Based Accounting Rules-based accounting is a standardized process of reporting financial statements. The Generally Accepted Accounting Principles (GAAP) system is the rules-based accounting method used in the United States. Companies and their accountants must adhere to the rules when they compile their financial statements. These allow investors an easy way to compare the financial information of different companies. Principles-Based vs. Rules-Based Accounting The fundamental advantage of principles-based accounting is that its broad guidelines can be practical for a variety of circumstances. Precise requirements can sometimes compel managers to manipulate the statements to fit what is compulsory. On the other hand, when there are strict rules that need to be followed, like those in the U.S. GAAP system, the possibility of lawsuits is diminished. Having a set of rules can increase accuracy and reduce the ambiguity that can trigger aggressive reporting decisions by management. Compliance to GAAP helps to ensure transparency in the financial reporting process by standardizing the various methods, terminology, definitions, and financial ratios. For example, GAAP allows investors to compare the financial statements of two companies by having standardized reporting methods. Companies must formulate their balance sheet, income statement, and cash flow statement in the same manner, so that they can be more easily evaluated. If companies were able to report their financial numbers in any manner they chose, investors would be open to risk. Without a rules-based accounting system, companies could report only the numbers that made them appear financially successful while avoiding reporting any negative news or losses. 3.4 Convergence of IAS And U.S. GAAP The convergence of accounting standards refers to the goal of establishing a single set of accounting standards that will be used internationally, and in particular the effort to reduce the differences between the US Generally Accepted Accounting Principles (US GAAP), and the International Financial Reporting Standards (IFRS). Convergence in some form has been taking place for several decades, and efforts today include projects that aim to reduce the differences between accounting standards. 3.5 Types Of Differences Between IFRS And US GAAP 1. Local vs. Global IFRS is used in more than 110 countries around the world, including the EU and many Asian and South American countries. GAAP, on the other hand, is only used in the United States. Companies that operate in the U.S. and overseas may have more complexities in their accounting. 2. Rules vs. Principles GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has principles that require judgment and interpretation to determine how they are to be applied in a given situation. However, convergence projects between FASB and IASB have resulted in new GAAP and IFRS standards that share more similarities than differences. For example, the recent GAAP standard for revenue from contracts with customers, Auditing Standards Update (ASU) No. 2014-09 (Topic 606) and the corresponding IFRS standard, IFRS 15, share a common principles-based approach. 3. Inventory Methods Both GAAP and IFRS allow First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. However, GAAP also allows the Last In, First Out (LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in artificially low net income and may not reflect the actual flow of inventory items through a company. 4. Inventory Write-Down Reversals Both methods allow inventories to be written down to market value. However, if the market value later increases, only IFRS allows the earlier write-down to be reversed. Under GAAP, reversal of earlier write-downs is prohibited. Inventory valuation may be more volatile under IFRS. 5. Fair Value Revaluations IFRS allows revaluation of the following assets to fair value if fair value can be measured reliably: inventories, property, plant & equipment, intangible assets, and investments in marketable securities. This revaluation may be either an increase or a decrease to the asset’s value. Under GAAP, revaluation is prohibited except for marketable securities. 6. Impairment Losses Both standards allow for the recognition of impairment losses on long-lived assets when the market value of an asset declines. When conditions change, IFRS allows impairment losses to be reversed for all types of assets except goodwill. GAAP takes a more conservative approach and prohibits reversals of impairment losses for all types of assets. 7. Intangible Assets Internal costs to create intangible assets, such as development costs, are capitalized under IFRS when certain criteria are met. These criteria include consideration of the future economic benefits. Under GAAP, development costs are expensed as incurred, with the exception of internally developed software. For software that will be used externally, costs are capitalized once technological feasibility has been demonstrated. If the software will only be used internally, GAAP requires capitalization only during the development stage. IFRS has no specific guidance for software. 8. Fixed Assets GAAP requires that long-lived assets, such as buildings, furniture and equipment, be valued at historic cost and depreciated appropriately. Under IFRS, these same assets are initially valued at cost, but can later be revalued up or down to market value. Any separate components of an asset with different useful lives are required to be depreciated separately under IFRS. GAAP allows for component depreciation, but it is not required. 9. Investment Property IFRS includes the distinct category of investment property, which is defined as property held for rental income or capital appreciation. Investment property is initially measured at cost, and can be subsequently revalued to market value. GAAP has no such separate category. 10. Lease Accounting While the approaches under GAAP and IFRS share a common framework, there are a few notable differences. IFRS has a de minimus exception, which allows lessees to exclude leases for lowvalued assets, while GAAP has no such exception. The IFRS standard includes leases for some kinds of intangible assets, while GAAP categorically excludes leases of all intangible assets from the scope of the lease accounting standard.
