ACCOUNTING ISSUES

Accounting issues

Accounting issues

Introduction

The harmonization of accounting standards has made considerable progress within a relatively short period of time (Camfferman and Zeff, 2006). In 1993, Daimler Benz AG aimed to list on the New York Stock Exchange (NYSE); hence, it needed to reconcile its financial statements to comply with US Generally Accepted Accounting Principles (US GAAP). Under German GAAP, the firm had reported a net income of 615 million Deutschmarks (DM) for the 1992 year, which turned into a net loss of DM1, 839 million under US GAAP (see also Ball (2004)). On November 15, 2007, the US Securities and Exchange Commission (SEC) allowed the operation of foreign private firms using International Financial Reporting Standards1 on the NYSE without first reconciling their financial statements to US GAAP. The financial press enthusiastically greeted this move; on November 19, 2007, the Financial Times wrote: “The goal of a single worldwide accounting language has long been a dream. Today it is fast becoming a reality—and the pace is picking up.”

A number of forces have driven acceptance towards a common set of accounting standards. Processes of political integration, exemplified by the European Union, as well as the globalization of financial markets and firms' operations in different jurisdictions are among the driving forces ([Flower, 2004a] and [Flower, 2004b]; see also Ball (2006)). In the global arena, the stock of foreign direct investment increased from US$1.7 trillion in 1990 to US$6.6 trillion in 2001 (UNCTAD, 2002). Nevertheless, these forces do not suffice in explaining how accounting standards have gained widespread acceptance. Arguably, harmonized accounting standards need to meet some technical features to enable acceptance by countries with diverse cultures and reporting traditions. In the current article, we examine the logic of IAS/IFRS that facilitated its widespread acceptance and adoption in more than 100 countries, as well as the implications of these standards for the accounting and auditing professions. Furthermore, we discuss the extent to which the adoption of IAS/IFRS accounting standards have driven convergence and, hence, removed substantial reporting and measurement differences across countries.

Principles-based vs. rules-based systems

A distinctive feature of the IAS/IFRS standards is that they are “principles-based” instead of “rules-based”. As noted by Nelson (2003, p. 91), “…rules include specific criteria, 'bright line' thresholds, examples, scope restrictions, exceptions, subsequent precedents, implementation guidance, etc.” In contrast, “principles-based” standards refer to fundamental understandings that inform transactions and economic events. Under a principles-based system, these understandings dominate any other rule established in the standard. In the case of consolidation, for example, IAS 27 states that full consolidation should be enforced whenever a firm exerts “control” over another firm. As a governing measure of consolidation, the “principles-based” notion of control, IAS 27, par. 4, states: “…the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities”. In turn, this superimposes any specific rule, such as the percentage of voting rights owned by the controlling company vis-à-vis the controlled firm. If a firm actually exerts control over another company, the “principles-based” system ...