ACCOUNTING: CONVERGENCE
Convergence
Accounting standards Convergence is creating one collection of accounting standards to be applied globally (Ashley B. Harper, 2012). The idea of accounting standards
convergence arose in the 1950s following the World War II economic integration and the rise of capital flows across borders. The first convergence efforts focused on
harmonization—reduction differences between accounting principles in capital markets globally. The concept of harmonization was replaced with convergence to create
international accounting standards to be used in all key capital markets. IASB and FASB have been collaborating since 2002 to converge and improve the IFRS and
accepted accounting principles (GAAP) in the U.S (Lam, 2015).
The fact that the global convergence process of the accounting standards has mainly involved the IFRS and not the US GAAP has been greatly debated. Due to the U.S.
control of the financial markets in the 1990s, many assumed that accounting should converge to the US standards. Two key phenomena worked to reduce the probability of
international accounting converging around US GAAP (1) EU’s resolve to embrace IFRS (2) WorldCom and Enron scandals.
Convergence of accounting standards has many benefits that can lower the transaction costs of financial reports preparation because they would comply with just one
standard. Also, the following are the additional benefits of convergence. There are general externalities that arise due to the widespread use of common standards.
Further, there is improved comparability in the various entities of financial statements. Network externalities arise due to the situation where every individual
benefit from the use of a single set of standards due to the high number of people using it too (Philip Schellekens, 2007). The advantages arise because the users of
accounting standards would not have to waste time, resources and efforts in learning and applying the various accounting standards in their organization. Another key
benefit of accounting standards convergence is comparability of the entities in financial statements (Ashley B. Harper, 2012). Consequently, convergence would assist
managers and investors when making decisions in capital markets. The above is critical because financial statement are not just a source of information about the
company but also serves as a reference point when comparing them with other businesses.
The disadvantages of accounting convergence also exist. It is argued that convergence would create both one-off transitional costs and ongoing costs for maintaining a
body for standard setting for the accounting principles. For example, there would be cost associated with the negotiations among the local and IFRS boards (Lam, 2015).
Further, there would be direct compliance costs that would arise from the accounting standards convergence. Further, convergence would deny the financial statements
users the power to choose to use the accounting standards that best fits the nature and environment of their business. Also, convergence would eliminate the dual
monopoly and replace it with the single monopoly that would bring with it the numerous inefficiencies that lead to reduced flexibility and lack of innovation in the
standards created (Ashley B. Harper, 2012). Finally, it is argued that the produced standards would be based on political compromise rather than searching for the
optimal accounting outcome.
Adoption of IFRS in Europe
The realization that many big European firms were generating capital in the U.S. and the European Union securities exchanges allowed companies to apply the US GAAP
created panic. It was feared the market-based standardization could eventually lead to the adoption of the American accounting standards as the common standards
globally. The IASB’s standards emerged as the most sensible choice for Europe, both politically and economically (Guggiola, 2010). The UE leaders aimed to influence
international accounting convergence to make the IFRS become the commonly-applicable rules and principles globally, which would make them more competitive compared to
the U.S. By declaring the IFRS as their official accounting standards, European Union offered a clear substitute to the GAAP for investors.
The act of adopting the IFRS for the EU was a critical shift the international accounting standards convergence. However, the Enron and MCI WorldCom scandals added
such an adoption which undermined the investors’ trust in the dominance of the GAAP compared to other standards in other parts of the world.
A key difference between the EU-IFRS and GAAP was that IFRS is founded on shared principles, but GAAP is founded on precise rules. Since it was evident that the US
rules can be followed religiously but fail to be respected, the principles-based approach became more attractive that the rules-based approach for the investors (Lam,
2015). Despite that they are less precise, the standards founded on principles are considered to render it difficult for the accountants to utilize gaps that could
exist in standard’s wording (Ashley B. Harper, 2012). By using the standards in accordance with the principles, the accountants are forced to trail the rules spirit.
Therefore, because the IFRS is founded on principles and not detailed rules has made it gain increased legitimacy worldwide.
The 2002 Sarbanes-Oxley Act of that emerged following the WorldCom Enron and Enron scandals acknowledged the legitimacy of the IFRS standards. Consequently, the Act
enjoined the SEC and FASB to examine international activities when setting standards in the US (Guggiola, 2010). Acknowledging the international move for IFRS and the
stresses of the Act, the FASB and SEC resolved to give the IFRS more significance. After an assembly in 2002 by IASB and FASB, a joint agreement was created to allow
the bodies to synchronise their work programs with the goal of eliminating the differences between their standards (Philip Schellekens, 2007). Also, the EU hoped that
after convergence was achieved, SEC could eliminate the requirement that foreign firms should resolve their financial statements with GAAP.
The adopting of international accounting standards has many benefits. A client should be able to expand the operations to the international vendors, lenders, and
customers of its environment even though they operate in the central United States. The capital markets are worldwide, and the financial information is given using
international accounting standards, and this helps in decision making. The financial statement prepared by the client should be based on international accounting
standards for better understanding for the vendors. In most counties adoption of IFRS is coupled with a great paradigm shift. The use of a number of rule allows the
incorporation of set of principles with the goal of offering critical information that may be sued in making financial decisions. Further, IFRS adoption is linked with
heightened accounting system complexity which demand a greater sense of commitment and assessment for the managers at different levels. However, it is anticipated that
the benefits arising from IFRS adoption would have more benefits than the costs linked with the paradigm shift. Another argument of the IFRS is that its adoption
allows better acquisition of reliable informing due the use of measurement and recognition criteria which reality shows the economic reality of firms. Consequently,
the adoption of IFRS in EU has delivered numerous benefits for the clients, forms and the economy. Considering the above information convergence directed towards IFRS
would be favourable for the world financial system in their reporting goals.
IFRS1
The IFRS1 is a finance reporting started given by the IASB, and it outlines the requirements needed for preparing and presenting financial statements and reports for
organizations that are first time adopters of IFRS, which serves to ensure that such documents contain high-quality information. The standard was recommended by the
European Commission to be used by EU members (Guggiola, 2010). The goal of IFRS 1 is to guarantee that the organizations’ first financial statements following the IFRS
adoptions would be comparable and transparent; offer a “suitable starting point” in the IFRS accounting and have more benefits than costs (Ashley B. Harper, 2012).
The IFRS1 was met with major controversy despite being a key milestone towards financial reporting convergence. IFRS 15 revenues from customer’s contracts were aimed
to fill the gap among IFRS and GAAP (Lam, 2015). The central principle of IFRS 15 is the recognition of revenue to show the handover of pledged offerings to clients in
a value that exposes the consideration (payment) that the entity anticipates to be entitled to their offerings.
IFRS 15 revenues from customer’s contracts, when a customer has the choice of buying warranty disjointedly, it is considered a distinct service due to the to the
entity pledges to offer the service in addition to a product that possesses the functionality outlined in the contract. Therefore, the entity will account for pledged
warranty like a performance obligation and apportion a part of the performance obligation price.
Under IAS 18 when the procedure funds a financing transaction, consideration of fair value is resolved through discounting of future receipts through imputed interest
rate (Philip Schellekens, 2007). Such a rate is determined by the prevalent rate of a comparable device of issuer having a comparable credit rating or through an
interest rate which discounts instruments’ nominal sum to prevailing cash sales prices.
The experts claim that the firms to be most affected by the IFRS 15 include the real estate, software development, and telecom industries. Further, individuals working
in industries that have bundled contracts of “product + service” will also be affected. Such include the telecommunications and software development where clients pay
prepayment plans with a handset (Ashley B. Harper, 2012). Consequently, the IFRS 15 requires that transaction price is allotted to performance obligations (individual)
for the contract and be identified once the obligations are fulfilled or delivered. Therefore, the telecom should give portion of prepayment plan revenue with the free
handset to the scale of the handset.
In the IAS 18, revenue is described as the economic benefits gross inflow from ordinary operating activities (Philip Schellekens, 2007). This implies that when an
operator offers the handset for free through a prepayment plan, then revenue for the handset will be considered as 0.
Example
Reddy signs a 24-month telecom agreement with XYZ, a mobile operator. The conditions of the plan as outlined below:
monthly fixed fee for Reddy is a monthly fixed fee of $100
Reddy got the free handset at the start of the scheme.
XYZ sells a similar handset at $300 and similar monthly prepayment plans minus a handset for $80 per month.
Under IAS 18
The IAS 18 rules state that XYZ must apply the recognition principles to the distinctly identifiable elements of the single deal. Therefore, the handset plus monthly
plan must be identified separately. The assumption is that there would be no revenue from the handset since XYZ gave it for free (Guggiola, 2010). The cost of the
handset reflects on the profit or loss; XYZ treats it as the cost of acquiring a new client. Monthly plan revenue is established monthly. Hence, journal entry will be
to cash and credit revenues or credit receivables with $100.
Under IFRS 15, XYZ must identify the first contract, which is the 24-moth plan with Reddy. Further, XYZ would acknowledge the performance obligations for the parties
in the contract.
Deliver the handset.
Deliver network services for the 24-month plan period.
Transaction price would be $2400 (24 months * $100 per month). Next, would be to allocate the transaction price of $2400 to the individual performance obligations for
contact founded on the distinct selling prices. Further, XYZ must identify revenue when it fulfils its performance obligation in the contract.
Conclusion
Therefore, the largest impact of the IFRS 15 is that companies would be reporting their profits in different ways, and there would be a change of the profit reporting
patterns. With IFRS 15, the company’s reported profits would be the equivalent in total, however they have a different pattern over time.
Ashley B. Harper, L. L., 2012. The Convergence Of Multinational Standards And Practices In International Financial Reporting. s.l.:s.n.
Christopher S. Armstrong, M. E. B., 2008. Market Reaction to the Adoption of IFRS in Europe.
Ebimobowei, A., 2012. Convergence of Accounting Standards: The Continuing Debate.
Guggiola, G., 2010. IFRS Adoption In The E.U., Accounting Harmonization And Markets Efficiency: A Review.
Indapurkar, D. K., n.d. Convergence with IFRS: Hopes and Challenges. [Online]
Available at: http://www.indianmba.com/Faculty_Column/FC1083/fc1083.html
Lam, H., 2015. Why does the U.S. Continue to Use GAAP and Will it Ever Converge to IFRS?.
Lavi, M. R., 2016. The Impact of IFRS on Industry. s.l.:s.n.
LLP, E. &. Y., 2015. International GAAP 2015: Generally Accepted Accounting Principles under International Financial Reporting Standards. s.l.:s.n.
Ltd, P. I., 2015. Wiley IFRS 2015: Interpretation and Application of International Financial Reporting Standards. s.l.:s.n.
Philip Schellekens, R. B., 2007. Finance and Convergence: What’s Ahead for Emerging Europe?. s.l.:s.n.
