Answers to Questions (Tutorial 2)

Chapter 3

1. The ultimate goal of both harmonization and convergence is to achieve international

comparability in financial reporting, and both are processes that take place over time.
However, while harmonization refers to the reduction of alternative accounting
practices in different countries, convergence refers to the process of developing a
set of high quality financial reporting standards for use internationally (the process of
global standard setting). Until the establishment of the IASB in 2001, the main
objective of the IASC was to achieve international harmonization in accounting
standards. Accordingly, the focus was to achieve consensus among different
countries with regard to accounting standards. In this process different countries
were allowed to have different accounting standards as long as they did not conflict
(for example, the harmonization program of the European Union). On the other hand,
convergence implies the adoption of one set of standards internationally.

2. The potential benefits for a multinational corporation from convergence of financial

reporting standards are derived mainly as a result of international comparability of
financial reporting standards and practices. Examples of such benefits include:
reduction of financial reporting costs for multinational corporations that seek to list
their stocks on foreign stock exchanges; reduction of cost of preparing worldwide
consolidated financial statements; and ability to transfer accounting staff to other
subsidiaries overseas more easily.

3. The EU Directives were not completely effective in generating comparability across

EU member nations because the Directives:

a. Allowed countries to choose among available options in many areas and

b. Did not cover many accounting issues, such as leases and translation of foreign
currency financial statements.

4. The three phases in the life of the IASC were:

a. 1973-1988 – lowest common denominator approach to standard setting
b. 1988-1993 – reduction of existing options in IASs through the Comparability of
Financial Statements Project
c. 1993-2001 – development of core set of standards under the IOSCO Agreement

5. IOSCO’s endorsement of IASs legitimized the IASC’s claim as “the” international

accounting standard setter. This also helped in addressing, at least partly, the
problem of IASC’s lack of enforcement power.

6. Twelve of 14 members of the IASB are full-time. In order to establish their

independence they are required to sever all ties to former employers. The most
important criterion for selection of IASB members is technical competence. These
aspects of the Board’s structure confirm the IASB’s commitment to develop the
highest quality standards possible. In addition, the IASB follows an open process in
which constituents are able to provide input and feedback on IASB projects and
proposed standards. The geographical representation is achieved through the
method of appointing the IASC Foundation Trustees.

7. A principles-based approach to accounting standard setting refers to the

development of standards that provide the basic guidelines for accounting in a
 particular area without getting bogged down in detailed rules. The IASB uses a
principles-based approach in developing IFRS. Traditionally, the U.K. and the
member countries of the British Commonwealth have adopted this approach.
9. The IASB has adopted a principles-based approach to develop a set of accounting
standards that constitute the “highest common denominator” of financial reporting.
This approach is in sharp contrast to the approach adopted by the IASC in its early
years. Also, unlike the IASC, the IASB is now formally linked to national standard
setters. Seven of the 14 Board members have a direct liaison relationship with
influential national standard setters. The major change is in the emphasis of the role
of the IASB, from harmonization to global standard setting.

10. The different ways in which IFRS might be used within a country include:
 Required for all companies domiciled within the country.
 Required for parent companies in preparing consolidated financial statements;
national GAAP used in parent company-only financial statements.
 Required for all companies (both domestic and foreign) publicly traded within the
country; non-listed companies use national GAAP.
 Required for foreign companies that are publicly traded within the country.
Domestic companies use national GAAP.
 Required for domestic companies with foreign operations and/or foreign stock
exchange listings. Domestic companies without a foreign presence use national
GAAP.
 Instead of requiring the use of IFRS in each example above, a country could allow
the use of IFRS in lieu of domestic GAAP in each situation.

11. There are several factors that might inhibit worldwide comparability of financial
statements even if IFRS are required in every country. First, even though the
Comparability Project of the 1990s reduced the number of alternative methods
allowed, several IFRS continue to allow companies to choose between a benchmark
and an allowed alternative treatment. Strict comparability will not exist if the
benchmark is adopted by one company and the allowed alternative is adopted by
another company. (It should be noted that this is also true within a country if domestic
GAAP allows choice among alternatives, for example, in depreciation and inventory
valuation methods.) Second, even if the same treatments are selected, cross-
national comparability could be harmed if accountants apply the principles-based
IFRS differently. Differences in cultural values across countries could cause
accountants to have biases, for example, with respect to conservatism that could
influence their judgment in applying IFRS.

12. The IASB’s Framework intends to assist firms in preparing IFRS-based financial
statements in several ways, for example:
 Firms will have consistent accounting standards.
 The Framework reflects agreement on the scope and objectives of financial
reporting, the type of entities that should provide financial reports, recognition
and measurement rules, and qualitative characteristics of financial information.
 By adding rigor and discipline, the Framework enhances public confidence in
financial reports.
 Firms (including auditors) can use the Framework as a point of reference to
resolve an accounting issue in the absence of a standard that specifically deals
with that issue.”

13. IAS 1 indicates that the overriding principle is fair presentation, which means
financial statements should present fairly the financial position, financial
performance and cash flows of an entity.
14. If an entity claims that it has satisfied IFRS in preparing its financial statements, IFRS
1 requires that it should comply with each IFRS effective at the reporting date of its
first IFRS financial statements. However, IFRS 1 also provides exemptions to this
rule where the cost of complying with this requirement would likely exceed the benefit
to users.

15. Over 170 countries have either adopted or allowed the use of IFRS.

16. The SEC has ruled that beginning in 2007, foreign companies that have prepared
their financial statements on the basis of IFRS need not include a reconciliation to
U.S. GAAP in filing the Form 20-F. A possible reason for this rule is that it would help
better serve investors. The AICPA, FASB and senior finance professional supported
this view. Taking a step further, the SEC has considered allowing U.S. domestic
companies also to use IFRS and developed a “Roadmap for the Potential Use of
Financial Statements Prepared in Accordance with International Financial Reporting
Standards by US Issuers”. However, the future of U.S. policy towards IFRS seems
uncertain at the moment.

17. The main difference is in the approaches taken by IASB and FASB for accounting
standard setting. The IASB has taken a ‘principles based’ approach whereas FASB
has taken a ‘rules based’ approach. According to the IASB’s approach, theoretical
aspects of an accounting problem are first considered, then the possible alternative
solutions are chosen, and finally the solutions, which are consistent with the current
regulatory guidance, are determined. According to the FASB’s approach, accounting
exercises have “right” and “wrong” solutions, and there exists a “correct” way to
account for a certain transaction. A much lesser importance is placed on the
theoretical aspects of accounting problems.

18. Currently, U.S. GAAP and IFRS convergence remains an elusive dream. No longer
the IASB does not seem to take the view that a failure to converge with U.S. GAAP
will be fatal for the IFRS project. The international weight of IFRS has grown so much
and worldwide IFRS adoption has picked up dramatically over the past few years. As
a result, it has become increasingly imperative for the IASB to listen to the voices of
that constituency. However, the formal end to convergence between U.S. GAAP and
IFRS does not mean the project is completely dead. Regular consultations between
the FASB and IASB are likely to continue.