International Financial Accounting

The establishment of international financial accounting standards has proven critical in a worldwide economy that is increasingly eschewing national borders in order to conduct global commercial enterprise. Such standards provide uniformity in practice from industry to industry and region to region; an important characteristic in a world that is becoming more interconnected. This paper will explore the ways uniformity may be created among financial accounting practices, outlining the global standards that have been established in this arena and the areas in which those standards are applicable. The reader will glean a more comprehensive understanding of the benefits and intricacies of international financial accounting practices.

Keywords: Balance Sheet; Cash Flow Statement; International Accounting Standards Board (IASB); International Financial Accounting Standards (IFAS); International Financial Reporting Standards (IFRS); Income Statement; Transparency

Overview

The famed American writer and humorist James Thurber was once called into his bank to speak with the manager about his account, which was overdrawn. After some discussion, Thurber confessed that he did not keep a record of the checks he paid. Confused, the bank manager asked Thurber if he knew how much money was in his account. Thurber simply responded, "I thought that was your business" (Anecdotage.com).

There are countless methodologies by which businesses manage their books; thankfully, the majority of these methods are not nearly as lax as the system employed by Thurber. In fact, financial accounting is one of the most important aspects of a successful business, providing a detailed report on the true fiscal status of the company.

Adding to the diversity of financial accounting is the 21st century global economy. Over the last several decades, aided by state of the art technology such as the Internet and cellular telecommunications, businesses from virtually every industry have made connections around the globe. This new environment seems to thrive outside of the traditional purview of the nation-state, locating a lack of uniformity among accounting practices.

This paper will explore the ways uniformity may be created among financial accounting practices, outlining the global standards that have been established in this arena and the areas in which those standards are applicable. The reader will glean a more comprehensive understanding of the benefits and intricacies of international financial accounting practices.

Accounting Organization & Uniformity in Europe

In the mid-18th century, the Industrial Revolution brought a new era of development, as advances in agriculture, transportation and manufacturing technology helped increase production and the speed by which the products of that output could be delivered. As these industries continuously and quickly evolved, so too did their marketability. However, although the Industrial Revolution began in Europe in the mid- to late-1700s, the field of accounting did not see full development until the latter years of the era, when that marketability led to the formation of publicly-shared joint stock companies.

Prior to the mid-1850s, the field of accounting was limited to bankruptcy work; the creation of detailed reports of the failings of businesses so that assets could be distributed and debts paid. In 1856, however, the British government introduced what was known as "the Companies Act," which helped increase the power and relevance of accountancy companies while establishing regulations for those in business and stock trading to follow in uniform fashion. Provision 69 of that Act mandated that Boards of Directors keep "true accounts" of stock trades, profits, expenses, credits and liabilities (Joint Stock Companies Act, 1856).

By the time the Companies Act became law, organizations comprised of accounting firms and professionals began taking shape, primarily in Edinburgh and Glasgow, Scotland. In 1870, the landscape changed significantly, however, when the first local accounting societies formed in England. Within two years, those groups joined together to form a national body, the Institute of Accountants in England. At the same time, another group, the Society of Accountants, also came into being. Other groups, most notably the Chartered Institutes of England and Wales (ICAEW) and the Chartered Institutes of Scotland (ICAS), would join them soon after (MacDonald, 1995).

Although accounting and bookkeeping had been prevalent throughout history, the formal practice of accounting was largely specific to individual businesses and certain political systems. Even as accounting associations began to jell in Europe by the late 19th century, accounting as a collective industry still had not formally taken shape. One exception was Argentina, which in 1886 legally recognized the profession of accountant, applying government standard qualifications to those individuals who sought to enter the field (Brown, et al., 1905). Argentina stood out, however, as accounting remained fragmented in industrialized countries. The ICAEW was one of the few organizations of accounting professionals that worked to create some regional connectivity and even industry standards.

Prior to World War I, the ICAEW led the charge to create recognition for the industry under the law. The war, however, rendered moot the debate over the dozens of bills filed to that end. In the meantime, commerce continued to expand and international trade crossed borders, continents and oceans. In 1966, the efforts initiated by the ICAEW were reinitiated, as a proposal was offered to create a international study group comprised of that organization, the American Institute of Certified Public Accountants and the Canadian Institute of Chartered Accountants. The study group, which was finally approved a year later, began to offer a number of position papers and research materials, many of which would later become the standards of international financial accounting.

International Financial Accounting Standards

In 1973, the push for international financial accounting standards was furthered with the establishment of the International Accounting Standards Committee (IASC). For 27 years, that organization crafted a wide range of standards that were designed to reverse the countless variations of the practice of accounting. In 2001, the IASC was replaced with the International Accounting Standards Board (IASB). During that time, the standards that were introduced by the IASC and its successors were becoming increasingly popular throughout the industry. In 2000, the U.S. Securities and Exchange Commission endorsed the acceptability of establishing international accounting standards (Institute of Chartered Accountants, 2009). The central vehicle for delivery of such standards would be the International Financial Reporting Standards (IFRS), which are a series of benchmarks created by the IASB that create universally accepted public company financial statements.

The establishment of international financial accounting standards has proven critical in a worldwide economy that is increasingly eschewing national borders in order to conduct global commercial enterprise. It provides uniformity in practice from industry to industry and region to region; an important characteristic in a world that is becoming more interconnected. Many areas of international financial accounting have been updated and rendered in-tune with accounting practices around the world.

Further Insights

In the Interest of Transparency

The rationale behind the establishment of uniform international financial accounting standards is to foster transparency in business profiles. Previously, accounting was focused on assessing the fiscal health of a company for the purposes of offsetting debt and/or bankruptcy. However, since the advent of the publicly traded company and the joint stock venture, accounting is seen as a vital tool in creating a full illustration of a company's strengths and weaknesses that could be easily reviewed by would-be investors from all over the world.

Income Statements

One of the first areas of attention in this regard is the income statement. An income statement is, in essence, a report on the financial operational health of the company. It is a review of a business's performance over a certain period of time. This document reviews revenues and weighs them against expenses, creating a clear assessment of whether the company is operating at a profit or a loss. By establishing this profile, investors are given a useful tool in understanding the profitability of the company.

Balance Sheets

Another important document for the purposes of international financial accounting is the balance sheet. A balance sheet is similar to an income statement, identifying revenues received and taking into account expenses. The difference between the two reports is timing — whereas an income statement measures a company's profitability over a certain period of time, such as a month, quarter or year, a balance sheet is more of an immediate snapshot, taken at a specific time. Balance sheets are useful for providing an immediate illustration of the status of a company instead of analyzing trends that may have been reversed with alternate financial planning.

Balance sheets and income statements are of great use in the 21st century global economy. As more and more companies are developing in the current landscape, they are relying on foreign-based capital to fund their enterprises. Likewise, American investors are getting involved in international securities markets for the same reason — to help develop potentially profitable businesses in the global environment. The potential returns on investment are, to be sure speculative, but the data provided in income statements and balance sheets prove invaluable to better understanding the status of the company.

In fact, such information is considered vital for the integrity of the market as well, providing accurate information about publicly traded businesses. In 1988, the US Securities and Exchange Commission (SEC) recognized this fact, calling upon regulators to develop uniform standards of reporting, stating that "all securities regulators should work together diligently to create sound international regulatory frameworks that will enhance the vitality of capital markets" (cited in "SEC concept release," 2000). In that statement, the SEC endorsed the work of the IASC in this endeavor.

Cash Flow Statements

Another important aspect of accounting is the cash flow statement. Cash flow statements are reports that delineate how changes in balance sheets and income statements affect a company's available cash and assets. A cash flow statement is arguably one of the most sensitive documents produced by a company, as it demonstrates a company's ability to cover its bills, repay debts and pay employee salaries. Simply put, a cash flow statement provides clear data for external and internal shareholders and investors to evaluate whether that company is financially sound.

Because of the sensitivity of the cash flow statement, many companies have opted to keep such reports close to the vest. Local and national accounting standards on the subject have varied with regard to requiring companies to include cash flow statements in their annual reports, enabling those who wish to keep such information private protected from any unintended access to their records.

Then again, the promise of new sources of capital and/or other forms of investment from sources around the world has led some systems to consider (if not mandate) cash flow reporting as part of a financial report. In some European countries, for example, the idea of creating a system in which cash flow statements are included in overall financial reports was initially met with some skepticism at the end of the 20th century. However, a 2000 study of the European Union's largest member, Germany, revealed two major points: capital market forces motivate voluntary cash flow statement reporting and the development of international accounting standards facilitates the development and distribution of universally accepted cash flow statements (Leuz, 2000).

The development of international financial accounting standards for cash flow statements, balance sheets and income statements has facilitated the increased connectivity of businesses to capital and investment sources in the global economy. Accounting continues to diversify along these uniform lines. This paper will next review some of the areas under discussion for future standardization and how that uniformity will benefit business.

From Country-Specific to Global

Over the last 35 years, the push for uniform international accounting standards has largely transformed the accounting landscape from one that is fractured and country-specific to one that universal. This development stems predominantly from potential gains from capital sources in the international system. However, the system was still limited by national boundaries and government systems. The global economy, which does not necessarily recognize national borders, is helping modify the international political system so that it may continue to develop.

In Europe, for example, the consistently integrating European Union recognized in 2005 that in order to foster openness in commerce, it must adopt uniform standards. As a result, a rule was issued that most publicly-traded European Union-based companies must use the standardized systems of the IFRS (Hines, 2007). Such policies are reflective of the popularity of IFRS — although specific accounting practices indubitably differ from system to system, the flexible, general application of standards are seen as a way to open doors for business and the international community as a whole.

There have been latent concerns, however, that a standardized international financial accounting system may not benefit a given economic and commercial environment. A 2009 study revealed that despite the increased integration of American and European accounting standards (and the aforementioned endorsement by the SEC of the endeavors of IFRS), there remains a wide gulf on a number of issue areas that have created barriers for further adoptions of IASB standards. In fact, the study revealed, the United States, by virtue of the fact that its preeminence in international business has fostered a demand for unparalleled transparency in accounting. As such, the US accounting system is one of the more comprehensive environments in the world — the adoption of further IFRS standards might actually weaken a comparatively strong American accounting system ("Mind the GAAP," 2009).

Nevertheless, the IASB continues to work on standardization projects on a number of fronts. In some cases, the effort is based on the recent global recession of 2007-2009, which prompted the IASB to develop standardization projects on a number of areas that are considered contributing factors to the recession. Such projects include credit risk in liability measurement, fair value measurement and hedging. Other projects are geared toward employment benefits reporting, income taxes, leases and rate regulations (IASB, 2009). These efforts are representative of an IASB effort to stave off future recessions, address a number of political and economic issues and create greater connectivity among countries around the world.

Like the rest of the globalizing economy, international financial accounting remains in a state of evolution. This evolution is in part due to the conditions and trends of each system, as well as the conditions of the international environment.

Conclusions

In 1494, a Franciscan monk named Luca Pacioli wrote a book on mathematics. The piece might have disappeared into literary history if not for a chapter he wrote on the practical use of mathematics in business. He wrote that three factors would make a businessman successful:

• Sufficient cash or credit,
• An accounting system to show his status and
• A bookkeeper to manage that system (LaMoine, 2004).

Pacioli's recipe for a strong business would become the basis for modern accounting, a practice that depends on detailed information in order to ensure a true portrait of a business is created.

For centuries, the field of accounting was focused on businesses that were suffering from poor financial health. However, in the modern economy, accounting has evolved into a vehicle by which business may be conducted. In fact, the global business environment offers operational and burgeoning enterprises greater potential resources for capital investment, mergers and partnerships.

International financial accounting is therefore dedicated to creating comprehensive illustrations of a company's health so that investors and potential partners may demonstrate willingness to work with them. Then again, in the international setting, how those portraits are created has traditionally varied from nation to nation.

Because such diversity in financial reports can create confusion, the effort that began in the early 20th century to foster accounting standards has seen considerable support. This paper has provided a detailed analysis not only of the various aspects of international financial accounting but how those types of reports and information have increasingly become standardized in the interest of taking advantage of the global economy. It is likely that, as the field of accounting continues to seek new elements by which a company's financial health may be assessed, the manner by which such elements are reported will be given careful consideration for international standardization.

Terms & Concepts

Balance Sheet: A financial report that covers revenues versus expenses at a given time.

Cash Flow Statement: A report that delineates how changes in balance sheets and income statements affect a company's available cash and assets.

Income Statement: A financial report in which revenues are weighed against expenses over a certain period of time.

Bibliography

Brown, R., Ed. (1905). A History of Accounting and Accountants. Edinburgh: T.C. & E.C. Jack.

CFO? (2009). Retrieved September 28, 2009 from Anecdotage.com. http://www.anecdotage.com/index.php?aid=8783.

Hines, T. (2007). International financial report standards: A guide for sources for international accounting standards. Journal of Business and Finance Librarianship, 12, 3-26. Retrieved October 2, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=25894643&site=ehost-live.

Institute of Chartered Accountants in England and Wales. (2009). Knowledge guide to international accounting standards. Retrieved October 1, 2009 from website http://www.icaew.com/index.cfm/route/156901/icaew%5fga/en/Technical%5fand%5fBusiness%5fTopics/Guides%5fand%5fpublications/Knowledge%5fguides/Knowledge%5fGuide%5fto%5fIAS%5fIFRS.

Joint Stock Companies Act 1856. (1856). Retrieved September 30, 2009 from British Companies House, http://www.companieshouse.gov.uk/about/tableA/comm14July1856JointStockCoAct%5fP1.pdf.

Lemoine, J. (2004, September 7). History of accounting. Retrieved October 3, 2009 from http://www.lemoineandjames.com/gaap/11history.html.

Lin, J., & Fink, P. (2013). International financial reporting standards: Are they right for the United States?. Journal of Global Business Issues, 7, 59-67. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91814144&site=ehost-live

Leuz, C. (2000). The development of voluntary cash flow statements in Germany and the influence of international reporting standards. Scmalenbach Business Review, 52, 182-207. Retrieved October 1, 2009 from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=15097442&site=ehost-live.

MacDonald, K. M. (1995). The Sociology of the Professions. Thousand Oaks, CA: SAGE.

Nour, A., AbuSabha, S., Al Kubeise, A., & Nour, M. (2013). The fundamental issues with financial derivatives within the framework of international accounting standard no. and their relative responsibility for the current global financial crisis. Journal of Business Studies Quarterly, 4, 173-222. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=86874030&site=ehost-live

Pounder, B. (2013). Have we lost our ability to improve financial reporting?. Strategic Finance, 95, 16-18. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90611638&site=ehost-live

SEC concept release: International accounting standards. (2000). International Series 1215, Release 33-7801, 34-42430. Retrieved October 2, 2009 from US Securities and Exchange Commission. http://www.sec.gov/rules/concept/34-42430.htm.

Mind the GAAP: Analyzing the proposed switch to international accounting standards. (2009, April 1). Knowledge@Wharton. Retrieved October 3, 2009 from Wharton/University of Pennsylvania. http://knowledge.wharton.upenn.edu/article.cfm?articleid=2192#.

Suggested Reading

Cain, M. (2008). FASB and IASB propose a complete change to financial reporting. RMA Journal, 90, 84-88.

Cortesi, A., Montani, E. & Tettamanzi, P. (2008). Family business in Italy: An empirical study on the effects of the transition from the Italian to the international accounting standards. World of Accounting Science,1, 219-236. Retrieved October 5, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=37130585&site=ehost-live.

Rozycka, G. (2000). Financial reporting: International accounting solutions. Accountancy, 126(1284), 113.

Spengel, C. (2003). International accounting standards, tax accounting and effective levels of company tax burdens in the European Union. European Taxation, 43(7/8), 253-266.

The treatment in the income statement of unusual items and changes in accounting estimates and accounting policies. (1976). Accountancy, 87, 82-86.

Wallace, R. & Choudury, M. (1997). Cash flow statements: An international comparison of regulatory positions. International Journal of Accounting, 32, 1-22. Retrieved October 5, 2009 from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9708243635&site=ehost-live.