International Financial Reporting Standards (IFRS)

Abstract

Accountants provide public records concerning the financial status, internal operations, and ongoing transactions of all publicly traded companies—that is, those companies that are financed through investors. This data is of interest to customers and potential investors seeking to assess the financial status of a company before doing business with it. In an increasingly global marketplace, the International Financial Reporting Standards (IFRS), drafted by an international committee of financiers in the early 2000s, now provides a single, broad universal system for measuring a business's financial status that, in turn, facilitates transnational operations and the global flow of capital.

Overview

In the decade immediately following World War II, the global economic market was significantly and seriously fractured into small, largely competing consumer markets. Given the tensions generated by the Cold War and in turn by the sharp divide between developing countries and so-called Third World countries, few businesses, American or otherwise, focused on developing transnational markets. Given its prominent military status after the war and the fact that United States was not impacted by a world war that had reduced much of Europe and Asia to rubble, the United States was largely seen as the dominant consumer market. To provide a public record of the financial status of its businesses and to help regulate the operations of these businesses (in part to prevent a repeat of the sort of financial meltdown that had triggered the Great Depression), the federal government, under the auspices of the Securities and Exchange Commission (SEC) and under the direct control of the American Institute of Accountants, drafted the first what would become a series of accounting principles to which American companies would comply as a way to provide the public with a reliable profile of all of a company's financials.

Over the next two decades these principals would become a standard for the accounting industry worldwide—the principles would come to be termed Generally Accepted Accounting Practices (GAAP). A generation of entrepreneurs as well as business executives followed the guidelines established by GAAP, including a record of profits and losses, changes in earnings, and ongoing transactions. The goal was to provide the public (and government watchdog agencies) with accurate records.

Within any company there is inevitably something of an information gap—that is, the perception of the company's financial status by those on the outside and the perception of the company's financial status by those within the company. Often businesses seek to promote a rosier-than-reality public image. The goal of GAAP was to close that gap. Problems emerged as one by one nations rebuilt and created new business opportunities and new markets. By the late 1970s, thirty-seven countries were widely recognized as developed industrial nations (Ball, 2007). The problem was that governing these thirty-seven independent nation-states were thirty-seven sets of financial reporting standards. This inevitably delayed any attempts by countries to expand beyond their own borders and to invest in other nations without risking considerable sums of money and resources.

The situation grew more perilous with the advent of computer technology. Beginning in the late 1980s, the emergence of digital technology and the realities of a global marketplace, linked by satellites and through the unprecedented reach of the Internet, radically altered the perception of the marketplace itself. With the collapse of the Soviet Union and the opening of broad new markets in both Europe and Asia, as well as the emergence of new and untapped consumer populations in Africa and South America, serious talks began to create a system of accounting principles that would not be restricted to the conventions and the protocols, biases and politics of individual countries.

A concrete and asphalt business headquartered in New Jersey, for example, might consider pursuing contracts with companies in Ghana and in Peru as part of an ambitious global expansion. The company would need accurate and current and reliable information about potential business partners in these countries. The information would come through each particular country's financial disclosure laws. Without a comprehensive international set of metrics, what Judge and colleagues (2010) term "harmonization," the decision to involve a company in overseas expansions, would be precarious and even ill-advised. As investors began to consider financial opportunities in the larger global marketplace, in fact, these potential investors needed to rely on clear and accurate financials. The problem was that the principles guiding such public records varied vastly, shaped by culture, politics, wealth, and industrial development, from country to country. "Such increasing complexity of business operations and globalization of capital markets [made] mandatory a single set of high quality reporting standards" (Kumar, 2014).

Information became the most important resource in the new international financial world (Ward & Lowe, 2017), and it needed to be readily available and reliable. Companies increasingly involved in multimillion dollar dealings that crossed borders needed to provide completely transparent records that would speak to this new global market. With the emergence in the late 1990s of the new European Union, financiers in Europe met to create a more international set of accounting standards. The International Financial Standards Board (IFSB), made up of fifteen members representing nine countries and headquartered in London, drew up what would become the IFRS (pronounced "iffers" by industry insiders).

Officially released in 2001, the IFRS supplanted the International Accounting Standards, which had directed the accounting activities of international financial organizations since the mid-1970s. The goal for the IFRS was to provide the international financial community with a sort of common language—that is, establish basic metrics for defining an accurate and stable financial profile of a company and then direct these company's financial officers, most often accountants, wherever their headquarter nation might be, to abide by these standards as a way to create a universal vocabulary for reporting and maintaining a company's financial statements within the new global marketplace. The IFSB had no authority to impose these standards; however, companies interested in expansion and cross-border business would need to comply.

In just over twenty years, more than 120 nations agreed to abide by the IFRS. Indeed, ninety countries have legislated complete compliance to the international guidelines as a way to make economic development in their countries more attractive to outside investment. The most notable exception to this rapid global embrace of the IFRS is the United States. Despite repeated calls by segments of American businesses leaders and despite repeated reassurances by the SEC, the adoption of the international guidelines, promised by 2015, has been delayed by influential conservative sectors of the American financial world, hesitant to hand over control of any element of the American markets to any international control.

Applications

The concept behind the emergence of the IFRS was basic, sound economics: An entity, whether a person or a bank or a corporation, is far more likely to invest significant sums of monies into a company, regardless of its geopolitical location, whose financial operations are available, current, and transparent. By defining a series of what were termed standard and fundamental economic profiles, the IFRS provided exactly that data. These public records, in turn, facilitated communications between countries and created open lines of transaction that, in turn, encouraged financial expansion and capital growth project that crossed conventional old school political and national borders (Weaver & Woods, 2015).

Although the IFRS commits companies to providing a broad amount of current financial data, the standards can be categorized into four major areas that are crucial to any investment decisions. First, the IFRS provides for a Statement of Financial Position, a kind of balance sheet that presents the company's big picture financial standing, a kind of general thumbs up or thumbs down. In addition, accountants provide a Statement of Company Income, a far more detailed ledger-styled report that provides a record of both gains and losses. More important, the IFRS provides that accountants present a Statement in Changes in Equity, a particular summary of any changes during a specific period of time in the company's earnings as a way to project potential financial health. Last, the IFRS provides for a Statement of Cash Flow, a public record of any ongoing transactions that might impact the company's short- or long-term financial status. The assumption behind these financial disclosures is that the company's accountants involved in the preparation of these informational reports work with reliable data and provide, in turn, complete transparency into company operations. "One of the main purposes of IFRS is to introduce greater transparency, improve quality, and comparability, thereby, facilitating access to investment capital on an international basis" (Rixon & Lightstone, 2016).

Once countries agree to comply with these international expectations, the transactions between nations can work far more efficiently and far more cheaply. As Forbes' board of editors argued in 2006, "[I]n the age of a global economy, capital is going to flow where it finds the fewest barriers to entry." Companies no longer have to submit financial records requests; companies no longer have to weigh the potential impact of national politics and current events in the determination of critical business decisions—rather these decisions can be shaped by reliable, accurate, and current financial records.

Indeed, within the IFRS system, companies review the same financial information against the same expectations whether the business operations are expanding into China or India, Mexico or Norway. Economists who specialize in international business law project that within a single generation, given the vast potential of technology and the digital age, the IFRS will by necessity become the vocabulary for international business operations. Indeed, these standards reflect fundamentals of capitalism and the values of "capitalist society…equality, independence, and security" (Youssef & Rachid, 2015).

Issues

Ball (2006) argues that it is common sense and sound economic growth policy for nations to abide by an international set of economic standards as a way to encourage and even facilitate investment in their nation's economy by other nations, a way to enhance their economic fortune by welcoming the monies as well as resources of other countries. Even as the adoption of IFRS has come to include more than 120 nations, the biggest roadblock to global acceptance of these standards is the United States itself. I may seem ironic that the world's largest and most expansive economy would hesitate to adopt international standards that would make such expansion far easier and far cheaper. Certain agencies of the U.S. government have, in fact, expressed interest in the eventual adoption of the IFRS, most notably the SEC, as has the American Institute of Accountants. Nevertheless, the movement toward acceptance has been slow and such reticence is largely due to the radically different economic culture in the United States.

The business world within the United States is litigation-centric, that is it is run, governed, and policed by a very developed code of rules designed to address (and in most cases close) potential loopholes within the system for financial disclosure. Generations of precedence as well as countless lawsuits have created a dense system for defining financial disclosures by businesses. Since the 1970s, GAAP has expanded to more than seven thousand pages. Two generations of lawyers, accountants, public agencies, and banks and financial institutions have worked out a massive system of rules intended to create clear lines of accountability and responsibility in the event of any misperceptions or fraud in the public record of a company's financials. The litigious nature of the American economy has evolved this system, and with each new case of apparent fraud or malfeasance, GAAP is further revised in an effort to create new levels of accountability and additional structures of responsibility.

By contrast the IFRS is perceived to be not so much a set of specific rules designed to thwart potential criminal activity but rather as a set of generally held, broadly stated principles designed to promote ease of accessing and interpreting accounting data and financial records. IFRS presumes that the viability of reporting must rely on flexibility and the ability to be applied to wide variety of national economies. Flexible guidelines and interpretable expectations, however, almost inevitably invites fraud or at least the opportunity for loopholes. Thus, the American economy, dependent as it has always been on the processes of law to govern market expansion and to police any business dealings, is reluctant to embrace a code that so obviously values flexibility and anticipates generous interpretation. GAAP is designed to regulate business expansion; IFRS is designed to promote business expansion.

National integrity, however, is perhaps far more fundamental an explanation for the American reluctance to embrace an international code devised by a coterie of nations. Much of the American business community and its political representatives lean conservative and are wary of internationalism. Despite the growing pressure of embracing a global marketplace, the American financial culture values its tradition of independence and is most reluctant to abandon GAAP, which for more than sixty years has been viewed as a landmark achievement in business evolution. Much as European nations dragged their feet in the emergence of the economic entity known as the European Union, the traditional of national spirit and national pride is difficult to entirely abandon, as evidenced by the 2016 referendum in the United Kingdom to summarily withdraw from a union in which "foreigners" were perceived to be running the nation's economy. Resistance in the United States, however, can be argued to be more practical than nationalistic. GAAP has long directed American business, including those that do not and have no plans to pursue opportunities overseas or across borders. For these domestic businesses to abide by an international code of accounting conduct would seem counter-indicated and even counterproductive.

The bottom line is that the global embrace of the IFRS is viewed by the international economic community as inevitable. The question of getting individual countries such as the United States on board is seen as a question of when not if. The advantages—transparency of operations, accessibility of financial records, and efficient data recovery—offer the emerging global marketplace a common language for evaluating the financial health of what is becoming a world of multinational companies.

Terms & Concepts

Accounting: The process through which a company maintains financial records.

Framework-based: A system based on and designed to be sustained by broad concepts rather than by specific and particular rules.

GAAP: Generally Accepted Accounting Principles, the guidelines that direct the reporting of the financial status of publicly owned companies in the United States.

Great Depression: Name given to the period (1929–1939) in which the American economy suffered catastrophic downturns that resulted in national economic distress and a long-term slump.

Harmonization: A term, borrowed from music theory, in which national economies at different levels of economic development share the same principles for reporting financial profiles of companies.

Transnational: A business concept in which companies seek to expand and/or invest in projects, companies, or institutions in different nations.

Transparency: In accounting, the need for a company to monitor the gap between the private perception of its operations and the public record of those operations.

Bibliography

Ball, Ray. (2006). International Financial Reporting Standards: Pros and cons for investors. Accounting & Business Research, 36, 5–27. Retrieved November 15, 3017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=23860578&site=ehost-live

Going global with accounting. (March 3, 2007). Forbes.

Judge, W., Li, S., & Pinsker, R. (2010). National adoption of International Financial Reporting Standards: An institutional perspective. Corporate Governance: An International Review. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=51248663&site=ehost-live

Kumar, K. (2014). International Financial Reporting Standards: Prospects and challenges. Accounting & Marketing, 3(1), 2–4.

Rixon, D., & Lightstone, K. (2016). Impact of International Financial Recording Standards on Canadian credit unions. International Journal of Business, Accounting, & Finance, 10(1), 90–102. Retrieved on November 15, 2017, from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=118052114&site=ehost-live

Ward, C., & Lowe, S. K. (2017). Cultural impact of International Financial Recording Standards on the comparability of financial statements. International Journal of Business, Accounting, & Finance, 11(1), 46–56. Retrieved on November 15, 0187 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=123754484&site=ehost-live

Weaver, L., & Woods, M. (2015). The challenges faced by reporting entities on their transition to International Financial Reporting Standards. Accounting in Europe, 12(7), 197–221. Retrieved November 15, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=111729256&site=ehost-live

Youssef, A., & Rachid, O. (2015). Ethical basis of the International Financial Review Standards. Malaysian Accounting Review, 14(1), 1–25. Retrieved November 15, 2017 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=120451659&site=ehost-live

Suggested Reading

Burton, G., & Jermakowicz, E. (2015) International Financial Reporting Standards: A framework-based perspective. New York, NY: Routledge.

Cowley, A. (2018). FRS 101: comparing accounting treatment under FRS 102—part 4. Accountancy, (1494), 1–6. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=127125121&site=ehost-live

Lu, J., & Shi, Z. (2018). Does improved disclosure lead to higher executive compensation? Evidence from the conversion to IFRS and the dual-class share system in China. Journal of Corporate Finance, 48, 244–260. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=127284930&site=ehost-live

Needles, B., & Powers, M. (2012). International Financial Reporting Standards: An introduction. Boston, MA: Cengage.

Nello, S. (2011). The European Union: Economics, policy and history. 3rd. ed. New York: McGraw-Hill.

Pinder, J., & Usherwood, S. (2013). European Union: A very short introduction. 3rd ed. New York: Oxford University Press.

Van Doorsselaere, J. (2018). International reporting: What's new in IFRS in 2018? Accountancy, (1494), 1–3. Retrieved January 1, 2018 from EBSCO Online Database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=127125127&site=ehost-live