Research Paper on "Creating a Universal Standard for Accounting and Finance"

Research Paper 25 pages (7907 words) Sources: 25

[EXCERPT] . . . .

This is creating contention about how it is valued in the future by taking a here and now approach. Under IFRS standards, they feel that this is not reflecting the nature of the way firms operate. In many situations, they will claim the increase or write off without looking at issues such as: the current state of the economy, the effects of revenues and other intangible factors which can impact these forces. This is different from IFRS that is looking at an asset's net worth in the future using unrealized events. (Bellandi 2012)

According to a study conducted by Van der Meulen (2007), there are challenges in encouraging firms to switch to GAAP standards when they do not see the larger benefits. In this case, she examined different German-based organizations that are embracing either one. The results indicate that many will choose GAAP. In this study they explore attribute differences between U.S. GAAP and IFRS earnings. They test two market-based earnings attributes, i.e., value relevance and timeliness, as well as two accounting-based earnings attributes predictability and accrual quality. These attributes are tested for German New Market firms as they are allowed to choose between IFRS and U.S. GAAP for financial reporting purposes. Overall, they find that U.S. GAAP and IFRS only differ with regard to predictive ability. The fact that U.S. GAAP accounting information outperforms IFRS also holds after controlling for differences in firm characteristics, such as size, leverage and the audit firm. However, their results to suggest that these differences are not fully valued by investors, as we do not observe significant and consistent differences for the value-relevance attribute. (Van der Meulen 2007) This is illustrating how there are not big difference between them. However, the challenge is encouraging other firms to see the benefits of IFRS standards and to be motivated to embrace them.

The types of businesses that are affected are large multinational entities with various operations in different parts of the world. This is problematic, for these firms as they have to change how they are reporting and releasing financial information to investors' regulators. Some of most notable include: airlines, technology companies, manufacturers, oil / gas producers, service organizations, financial institutions and transportation organizations.

A good example of this can be seen with a study that was conducted by Bao (2012). In this case, he is studying the effect of the differences related to reporting inventory, property plant and equipment, intangible assets, and development costs between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) companies. Both univariate tests (t-tests) and multivariate tests (ANOVA, probit and logit analyses) are used to compare the ratios between IFRS and U.S. GAAP companies. The results consistently show that IFRS-country firms have a significantly higher current ratio, a significantly lower asset turnover ratio, and a significantly lower debt-to-asset ratio. (Bao 2010) These insights are showing how the differences in reporting standards will have a dramatic impact on the way various ratios are calculated. The result is that these shifts will have a dramatic impact on the balance sheet of the firm and the value of various assets (i.e. their common stock and bonds).

Henry (2009) determined that these shifts will have an effect depending upon the industry and business model of the firm. He evaluated the extent to which the FASB and IASB convergence projects and the EU-wide adoption of IFRS have impacted the differences between firms' financial results under U.S. GAAP and IFRS. Using 2004 to 2006 reconciliation disclosures of 75 EU cross-listed firms, he found that the average gap between U.S. GAAP and IFRS income and between U.S. GAAP and IFRS shareholders' equity declined from 2004 to 2006, consistent with convergence, though the net income gap remains significant. Although both pensions and goodwill are included in the convergence projects, these adjustments appear to be the dominant reconciliation items. Across the EU, net income and shareholders' equity reconciliation amounts differ significantly by industry and by legal origin of the firm's home country, raising questions about the homogeneity of IFRS as implemented. Furthermore, most firms report IFRS net income (shareholders' equity) higher (lower) than U.S. GAAP net income (shareholders' equity), with the result that 28% of the sample firms' 2006 ROE under IFRS is more than 5 percentage points higher than under U.S. GAAP, whereas fewer than 10% of the sample report ROE more than 5 percentage points lower. Finally, shareholders' equity reconciliations and income reconciliations appear value-relevant, although results are somewhat sensitive to model specification. Overall, their findings indicate that significant numerical differences still exist between results under IFRS and U.S. GAAP, despite convergence. In light of the SEC's elimination of the requirement for reconciliations between the two sets of standards and the potential adoption of provisions allowing U.S. firms to choose between the standards, investors and other financial statement users should be aware of the significant numerical differences. (Henry 2009)

These insights are showing that certain firms will benefit from integration. While at the same time, there is a negative impact on those who are taking a domestic vs. international focus. This is underscoring how the differences in reporting and standards will have an impact on which preferences are utilized by actuaries.

As far as accounting practices are concerned, convergence will change how firms are reporting information. This occurs through focusing on the future value of certain assets and understanding the worth of different kinds of inventory / assets. These variables will have an impact on the firm's ability to report financial information to various stakeholders. A few of the most notable areas that are affected include: intangible assets, the way write offs are reported and how inventory is valued / the kinds of procedures which are utilized. This will change the focus of actuaries in understanding the impacts of these transformations and analyzing the financial position of the organization. When this happens, there will be a transformation in the way managers are reporting financial information to regulators and investors. (Shamrock, 2012)

Another area is in the way the inventory is reported. Utilizing GAAP, this is occurring through using a first in first out or last in first out basis to estimate these costs. This is designed to improve a firm's ability to control these costs and determine how much they are worth. While IFRS provisions, do not allow this inventory approach. (Shamrock, 2012)

These methods will be impacted by any kind of convergence through changing how different items are reported. This will transform the way the information on the balance sheet and income statement is listed. It is based upon how assets are valued and the assumptions taken. In the future, this will require a shift in the procedures which are utilized by firms. (Shamrock, 2012)

The biggest obstacle for convergence is some firms are used to their current practices and are reluctant to switch to another form. This is because it will cost them millions of dollars and they will have to update their previous financial information over the last several years to reflect them. At the same time, there is the possibility that executives will not understand what is happening inside the organization. This increases the chances of under or over reporting their earnings to investors. When this happens, it means that the price of the stock could see increased amounts of volatility. (Larson, 2004) (Bellandi, 2012)

Moreover, various countries have different tax systems in place which are not aligned with other accounting methods. The integration to a new standard, will make it more costly for them to take write offs and report the total amounts of revenues which are generated. These variables require firms to spend more money and it increases the chances of them having to pay more in taxes. This will have an impact on a firm's earnings per share and the total returns they are delivering over the long-term. (Larson, 2004) (Bellandi, 2012)

The differences between the standards are showing the benefits and drawbacks of each one. These distinctions are important, in illustrating the possible challenges with convergence and why it has taken so long to achieve these larger objectives. While at the same time, it is illustrating how taking a one size fits all approach is ineffective in encouraging larger shifts. This is because each business and its industry are different. The result is that many firms need to have greater amounts of flexibility in reaching the goals. This is creating controversy with various researchers having contrasting ideas and theories in achieving these larger benchmarks.

Addressing the Disparities between IFRS and GAAP

One of the biggest challenges with addressing any kind of differences between the two standards is the kinds of approaches that must be utilized. This is troubling, as there are conflicting views surrounding the best avenues for achieving these larger objectives. In many cases, firms are forced to comply with IFRS guidelines. This is because there are over 100 countries around the globe which mandate all publically traded entities following… READ MORE

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