ACC305 Accounting Theory

Introduction

Global standardization of accounting principles and standards formulated by IFRS issued by IASB is a veritable tool aimed at driving that all countries of the world come together to adopt accounting standards that will be generally acceptable all over the globe.

In as much as the accounting standards of IFRS issued by IASB is adopted by more than 100 countries in which this decision was spearheaded by the European Union which recognizes the implementation of IFRS standards in the preparation of consolidated financial statements of listed companies from 2005.

Prior to the adoption of IFRS in 2005, various countries implemented accounting standards that were typically developed on a domestic basis. However, with the adoption of IFRS issued by IASB in 2005 by most countries some other countries have declined to the adoption of IFRS and a particular country in question is the United States Of America which still up to date adopts the Generally Accepted Accounting Principles (GAAP) which is developed on a domestic basis and a particular reference will be made to KPMG which is a well known firm in the United States.

In the light of this, this essay/report tends to take a critical look at the global standardization which requires the United States (US) which will invariably extensively examine some of the influences/factors that might discourage the US from fully implementing or adopting the IFRS. It will also take a detailed and comprehensive look at some perceived benefits that would flow after a country implements or adopts the global standardization as represented in IFRS.

This essay/report will equally take a detailed look at the free market arguments in relation to the support of reducing or eliminating accounting regulations as well as in contrast to pro-regulation which tends to provide counter arguments in support of regulation and adequate conclusion will be drawn at the end of the essay/report.

Factors Discouraging Implementation of IFRS into the United States (US)

SEC (Securities Exchange Commission) is presently considering the adoption of IFRS (International Financial Reporting Standards) into the US GAAP for achieving a single set of high quality global accounting standards. However, SEC is receiving both support and discouragement from the people at a global level in relation of convergence of US accounting standards with that of IFRS (KPMG, 2015). In this context, the factors that are restricting the US to fully adopt the IFRS standards are stated as follows:

Higher Cost

The major reason that is discouraging the US from fully implementing IFRS is higher cost involved to convert the GAAP into the IFRS. This is because the conversion of GAAP into the IFRS requires business entities within the US to incur significant costs related to providing training to the accounting professionals. The training is required for improving their understanding of the IFRS and the changes that would occur in the financial reporting process of businesses with its adoption. In addition to this, there is requirement of implementing major changes in the accounting system processes by the business entities to fully integrate IFRS and this would also incur significant costs. The changes are also required to be implemented within the business operations and the technology systems further adding to the transitional cost involved. As such, it can be said that all the required changes that are to be done by the US to adopt IFRS will present major challenges before the businesses involving huge time and resources. The costs are largely outweighing the benefits the US is likely to receive with complying IFRS (Bayerlein & Farooque, 2012).

Superiority of GAAP over IFRS

It has also been cited in this context that the US GAAP is best accounting system till date and such is superior over IFRS. It has been stated by the FASB that US GAAP are superior to IFRS. GAAP have been widely used and implemented by the business entities for a long period of time as compared to the IFRS that have adopted only 10 years back. The quality of the financial statements that have been prepared with the use of US GAAP provides more relevant and high quality information as compared to the IFRS. Thus, it could be stated t o be irrational on the part of business companies within US to ingrate an accounting system that is inferior to their current set of system and processes (Hail, Leuz & Wysocki, 2010).

Principle Based Vs Rules-Based

The major reason that is cited in the context of non-compliance of US with the IFRS is due to large difference present between the GAAP and IFRS. USGAAP are rules-based set of accounting standards whereas IFRS is principles-based and this is restricting the US to comply with IFRS. This is because a present there is less flexibility in the rules-based standards of the US GAAP and the adoption of IFRS will provide more flexibility to the managers to report the information they want to disclose. This could eventually result in negatively impacting the quality of financial information disclosed as present rules-based standards have reduced the chances of error occurrence. Assuch, rules-based standardsproviding less flexibility to the managers for distorting the financial performance helps in improving the quality of financialreports developed. IFRS is more subjected to be interpreted and thus lacks reliability and accuracy in comparison to the US GAAP that is rigid set of accounting policies. The use of such rules-based standards leads in developing more quality financial reports and thus US is switching to IFRS (Bahnson, Paul & Paul, 2008). The rule based accounting standard contains high level of complexities and requires proper structuring of report that leads to increase in level of thresholdon the implication of rule based standards. On the other in IFRS, the standards are drafted in such way that it does lead to burden on companies applying it but motive is to improve the quality disclosures and reporting format. The difference between US GAAP and IFRS related to the basis of formation is very wide and it is very difficult to fill. The convergence procedure adopted by both IASB and FASB are trying to fill this gap but process is very slow due to major differences in accounting standards. As per information available on the IASB and FASB website, it has been found that both of them have not reached on the same conclusion that helps in adoption of IFRS by the FASB. It can be proved with very important example. It has been claimed by FASB and IASB that they aims to provide the high quality standards but there has been major difference in the definition of elements of financial statements. There are certain areas where IASB has accepted that they fail to provide judgment or guidelines for specific transaction or disclosure but same has been properly handled by the US GAAP.

PoliticalFactors

The political factor can also be regarded as the major reason for influencing the adoption of IFRS into the US. US are reluctant to adopt the IFRS for the sake of protecting the interests of domestic investors. The adoption of IFRS could promote the uniformity in the financial reporting process and thus causing the entry of global investors that could negatively impact the welfare of US domestic investors. Also, complying with US GAAP would protect the interest of the domestic investors by providing them reliable and faithful financial information. As such, they are protected largely from receiving manipulated financial information that could cause them to take inaccurate economic decisions (Wolk, Dodd &Rozicky, 2012).

Benefits perceived by the nation (United States) after the successful adoption of IFRS as their local standards

The list of benefits that United States will achieve after the successful adoption of IFRS as their local GAAP as under:

The increase in comparability: The companies that uses similar accounting standard as their basis of preparation can have greater comparability as compared to companies that applies different basis of preparation of financial statements. The comparability is required where companies are from different countries. The purpose to have greater comparability between companies belonging to different countries is to help the investors to compare the two or more companies that are from different countries. For example, investors can easily evaluate the performance of companies in Australia and India as both the countries applies IFRS but it is not possible to compare the performance of companies in United States and Australia as they both use different accounting standards (Nobes& Parker, 2012).

Increase of flexibility in accounting standards: When the accounting standards are based on principles instead of rules it will helps to produce the global set of accounting standards that has a goal to arrive at a reasonable valuation to accomplish the various tasks. This allows the companies to adopt IFRS as their main standards which produces financial statements that is easy to read and understand.It can be better understood through an example. The financial report that uses US GAAP will require special accounting knowledge to understand the accounting methods applied by the company and results performance as it is very difficult to read and understand rule based standards (Nobes& Parker, 2012). In case of IFRS, the accounting standards are based on principles and it can be easily understood through use conceptual framework. Conceptual framework is used by IASB as the base to draft the accounting standards (IFRS).

Explanation of the ‘free-market’ arguments in support of reducing or eliminating accounting regulations

The free-market approach in context of accounting regulations and practices is based on the idea that the disclosure of accounting information is regulated by the law of supply and demand and therefore has regarded the presence of accounting rules and policies to be unnecessary. This approach as regarded the disclosure of accounting information to be a natural exchange process as its demand is caused by the users and supply comes from different companies to meet this demand by developing and presentation of financial statements. As such, it can be stated that necessary and relevant information is presented by the business companies as per the basic law of supply and demand that promotes rational dissemination of information. The users that are the stakeholders of an entity cause the need for publishing useful accounting information for facilitating their decision-making process. The suppliers, that are, the business managers are motivated to provide required accounting information for maintaining continuous flow of resources from the investors (Sorrentino, 2011).

The approach of free-market that promotes elimination of internationalization of accounting standards can be adequately explained by agency theory. The theory has stated that business managers, are the agents, who holds the responsibility of maximizing the welfare of the businessowners, that are, the principal. This causes the need for business managers to take actionssuch as disclosure of accounting information for attracting funds from the investors in order to achieve the objectives of enhancing the value for shareholders. In addition to this, the theory has also stated that motivation to voluntary disclose the accounting information by the business managers emerges from reducing the monitoring costs. The monitoring costs can be stated as the cost incurred by the shareholders for assessing the behavior of managers for ensuring that their goals are aligned with each other. The monitoring costs can result in decreasing the compensation of managers that they are likely to receive for delivering increased results for the shareholders. As such, business managers tend to disclose the financial information by developing the financial reports for reducing the monitoring costs and ensuring their personal welfare (Bahnson, Paul & Paul, 2008).

The business entities always face fierce competition to acquire the limited economic resources from its stakeholders. As such, the business managers always place increasing importance for seeking attention from all its stakeholders such as customers, investors, government and others. This is required for receiving their continuous support from all the stakeholders and ensuring the sustainable growth of an entity. The business managers as such always tend to disclose the financial information to the stakeholders for promoting transparency and accountability within their business operations. This helps them to reduce the information asymmetry and seeking attention from all its stakeholders. As per the free-market approach it can be ensured that market mechanism regulates the amountof information that should be provided by a business entity. The business managers tend to develop an optimal arrangement between the owners and themselves for developing and publishing the financial reports. Therefore, the process of developing global accounting standards or accounting legislations does not hold any significance in enriching the quality of financial information disclosed by the business entities (Deegan, 2014).

Cnswer 4: ounter arguments developed in support of accounting regulation as per ‘Pro-Regulation’ Approach

On the other hand, the approach of ‘pro-regulation’ has stated the presence of accounting regulations o be highly important for reducing the inconsistencies present within the market. The free-market approach has emphasized that efficient allocation of resources is itself regulated by the forces of demand and supply. However, it may lead to causing the issue of information asymmetry that is non-equal distribution of information among all the stakeholders. This is because accounting experts can easily interpret the information disclosed by an entity. However, the general users who lack accounting knowledge may often find it difficult to comprehend the financial information that can be presented in a complex manner by an entity. The adoption of an internationally recognized accounting framework would help in reducing the complexity in the financial reports by increasing the understandability of the financial information among all the general users. Thus, it can be stated that equal distribution of financial information among all the stakeholders of an entity is possible with the development and implementation of standardized accounting policies (Sorrentino, 2011).

As per the agency theory, which has stated that business managers and owners who hold a relation of principal-agent, the owners tend to reduce the agency costs by developing mutual goals that is acceptable by both of them. For example, linking of compensation of managers with the firm performance directs them to adopt the use of practices for maximizing the financial performance. However, in the absence of accounting regulations, the business managers may only disclose the information that is good and may hide the materialistic information that can have a negative impact on its goodwill in the investors mind. This can negatively impact the interest of the shareholders in the long-term by leading to failure of a corporation and negatively impact its brand image among the eyes of its investors (Deegan, 2014).

The absence of accounting regulations as per the ‘pro-regulation’ approach can result in causing failure of market. This is because the business managers tend to adopt the use of monopolistic methods for developing the financial reports and this could negatively impact the accounting data disclosed to the end-users. The dissemination of accounting information can be incomplete by a business entity in the absence of accounting rules and regulations. The introduction of regulation system is essential for preventing the users from competing with one another and leading to cause the development of an effective market. It has been argued by the supporters of accounting regulation that free-market approach is largely ineffective in achieving the social goals of a company that is disseminating equal amount of accounting information. This approach can also be supported by the views and opinions of public interest theory. The development of financial statements as per the standard accounting policies would help in reducing the inconstancies’ present within the market in the case of free-market approach. The inconsistencies present in the market as per the free-market approach can negatively impact the public interest. Thus, the presence of accounting regulation is necessary to protect the public interests and maximize their welfare to large extent as possible (Baker, 2005).

Conclusion

It can be stated from the overall discussion held in the report that adoption of IFRS into the US GAAP has both potential benefits and costs. SEC is emphasizing on implementing IFRS into the US business entities for achieving the FASB objective of developing globally recognized accounting standards. At present, the costs are outweighing the benefits and this is restricting the SEC to fully integrate with the IFRS standards. The report has also discussed the free-market and pro-regulation approach that exist in the context of the issue of standardization of accounting policies. The free-market approach has stated the elimination of accounting policies standardization on the basis of law of supply and demand. However, pro-regulation approach has advocated it on the basis of reducing the chances of market failure and ensuring rational dissemination of financial information to the end-users.

References

Bahnson, Paul, R. & Paul B.W. (2008). The Spirit of Accounting: What Good are Principles without Principles? Accounting Today 22, pp.16-17.

Baker, C. R. (2005). What is the meaning of ‘the public interest’ examining the ideology of the American accounting profession.Accounting, Auditing and Accountability Journal 18, pp. 690-703.

Bayerlein, L., &Farooque, O. (2012). Influence of a mandatory IFRS adoption on accounting practice: Evidence from Australia, Hong Kong and the United Kingdom. Asian Review of Accounting 20(2), pp.93?118.

Deegan, C. (2014). Financial Accounting Theory.McGraw-Hill Education Australia.

Hail, L., Leuz, C., &Wysocki, P. (2010). Global Accounting Convergence and the Potential adoption of IFRS by the United States: An Analysis of Economic and Policy Factors. Accounting Horizons, 24(3), 355-394.

KPMG. (2015). Defining issues. Retrieved 7 October, 2018, from https://home.kpmg.com/cn/en/home/insights/2016/01/defining-issues.html

Nobes, C. & Parker R. (2012).Comparative International Accounting. Pearson Education Limited.

Sorrentino, M. (2011). The “Production” of Accounting Information between Regulatory and Free Market Approach: An (Eternally) Open Issue. Journal of Modern Accounting and Auditing, January 11 (1), pp.1-9.

Wolk, H. I., Dodd, J. L., &Rozicky, J. J. (2012).Accounting theory: Conceptual issues in a political and economic environment.Sage Publications.