Assess whether assigning blame to US standards as a cause of corporate failure is fair. Consider whether an exclusive rules-based or principles-based accounting framework is appropriate for modern financial reporting purposes or whether the current international convergence programme might provide a more appropriate model.
“Recent [corporate] accounting scandals [such as Enron and WorldCom]…have led to a concern within the financial/investing community that U.S GAAP has become too rules-based” (Agoglia, et al. 2011: p.747).
Due to the detailed guidance and use of bright-lines tests, corporate executives feel that they invite opportunistic interpretations resulting in less informative and misleading financial statements (Bentson, et al. 2006).
Kershaw (2005) states, that rules-based standard have become useless and dysfunctional as managers tend to use creative accounting techniques when the economic environment changes. This had led the FASB to shift towards a more principles-based regime which will result in more economically meaningful reporting for modern financial reporting purposes (Agoglia, et al.2011).
Although, principle-based standards provide too much flexibility resulting in a lack of comparability between financial statements, it has its advantages which are later discussed in this essay (Agoglia, et al. 2011).
An alternative view is the current international convergence programme which brings together elements of both U.S. GAAP and IFRS (Bader, 2009).
The Term Paper on International Financial Reporting Standards 2
International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the ...
This essay will assess the key features and causes of the failure of Enron and it will consider the argument in favour of and against the application of principles-based and rules-based set of reporting standards. In addition, this essay will assess the argument for and against the development of a single set of International Financial Reporting Standards around the world and the current international convergence programme – the obstacles that face harmonization of international accounting standards and the opportunities it will create for global capital markets in the modern financial reporting environment.
“Enron filed for Chapter 11 bankruptcy on December 2, 2001” (Dossani & Jo. 2010: p.14).
Enron’s fall has been widely seen through the evidence of weaknesses in its corporate governance structure and fraudulent activity (Li. 2010).The board’s inability to effectively monitor the activity of its senior managers raised concerns on the presence of conflicts of interest as being the root cause of this corporate failure (Deakin & Konzelmann. 2003).
The board members of Enron had financial ties with management which reduced their independence significantly as they no longer had the ability to question the practices of the management (Li. 2010).
Moreover, the audit committee failed to ensure the independence of Arthur Andersen despite their awareness on the potential conflict of interest that was present (they received significant consulting fees in addition to their regular audit fee).
As a result, “they did not question the reporting of Arthur Andersen, thereby allowing [management with the help from Arthur Andersen] to inflate Enron’s earning” (Dossani & Jo, 2010: p.20).
In addition Enron manipulated the accounting numbers by inflating its earnings per share figure (EPS) thereby, maximizing the compensation for managers which indicated that the corporate culture of the managers was flawed (Petrick &Scherer. 2003).
Furthermore, Enron took advantage of US accounting rules by removing substantial amounts of debt from its accounts by setting up a number of off-balance-sheet entities. These special purpose entities (SPE’s) were used to hide its losses from bad investments (Dossani & Jo. 2010).
The Essay on Management Accounting and Financial Accounting
The differences between management accounting and financial accounting include:[1] 1. Management accounting provides information to people within an organization while financial accounting is mainly for those outside it, such as shareholders 2. Financial accounting is required by law while management accounting is not. Specific standards and formats may be required for statutory accounts such as ...
Therefore, significant liabilities were not disclosed on Enron’s financial statements which made them look better than they really were (Petrick &Scherer. 2003).
Recent accounting scandals such as Enron and Worldcom have raised much debate on whether principle based accounting or rules based accounting framework is appropriate for modern financial reporting purposes (Kershaw. 2005).
Rules based accounting such as the Generally Accepted Accounting Principle (GAAP) used in the U.S. provides preparers with detailed guidance with bright-line tests hence better clarification and precise answers to questions (Bentson, et al. 2006).
Bright-line tests are quantitative threshold that direct how specific a scenario should be reported in the financial statements (Duchac. 2004).
This potentially increases the consistency of financial statements providing greater comparability (Duchac. 2004).
Adhering to rules therefore increases verifiability for auditors and regulators and as a result, it protects preparers from criticism and lawsuits (Bentson, et al. 2006).
However, the major drawbacks of these standards are that bright-line tests do not allow the exercise of professional judgment which leads to the de-skilling of the profession. In addition, preparers are likely to adhere to the legal minimum and find loopholes within the standards to commit fraudulent activities. “It has been suggested that rules-based standards lead to a “show me where it says I can’t” attitude, which, in turn, can lead to dysfunctional financial reporting behaviour” (Agoglia, et al. 2011: p.749).
Moreover, the burden of compliance is not appropriate for all companies and the complexity of the rules are not flexible to keep up with the changing economic environment (Bentson, et al. 2006).
As the costs outweigh their benefits, U.S. policymakers continue to contemplate a shift towards more principle-based accounting standards (Agoglia, et al. 2011).
In light of recent corporate scandals, the FASB is considering a shift towards more principle-based accounting standards to inhibit aggressive financial reporting (Agoglia, et al. 2011).
The Essay on Financial Accounting Standards Board 4
The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) are two of the most important bodies of the Accounting/Finance field today. Though both boards work together to develop and enforce financial reporting standards for publicly held organizations, the FASB concentrates on the accounting standards in the United States while the IASB sets its focus ...
The more principle- based, International Financial Reporting Standards (IFRS), set out broad guidelines that can be applied to numerous accounting situations. This can potentially improve the representational faithfulness of financial statements (Shortridge &Myring. 2004).
In addition, this approach allows accountants to exercise professional judgement in assessing the substance of the transaction, which can, as a result, enhance the professionalism of the financial statements (Bentson, et al. 2006).
Another reason to why principle-based standards should be applied is that they are relatively simple which makes it easier to understand and apply, to numerous transactions. Moreover, these set of standards provide better financial statements that reflect the true performance of the company (Shortridge &Myring. 2004).
Conversely, the lack of precise guidelines and absence of bright line standards creates inconsistencies on the application of standards across many organisations and reduces the comparability of financial statements which is a significant disadvantage for investors and companies as they cannot make inter-firm comparisons (Agoglia, et al. 2011).
In addition, the lack of specificity in accounting standards would result in an increase in manipulation of financial results (Agoglia, et al. 2011).
The International Accounting Standards Board (IASB) is a private standard-setting body of the IFRS Foundation. It aims to develop in the public’s interest a single set of high quality and understandable standards that can be accepted worldwide (Fulbier et al.. 2009).
Gornik-Tomaszewski & Showerman (2010) states that more than twelve thousand public companies, over a hundred different countries have adopted the IFRS. The development of these single set of international financial reporting standards have become of growing importance as many investors in this ever increasingly integrated world capital market are demanding comparability and transparency of financial reporting worldwide (Gornik-Tomaszewski & Showerman. 2010).
In addition, users and prepares of financial statements are asking for more standardised and widely-accepted financial reporting “in order to reduce diversity and harmonize accounting standards and practices internationally (Bader. 2009: p.99).
The Essay on IFRS and GAAP Accounting Principles
... be used for preparation of financial statements for the public companies. IASB is independent body which sets accounting standards which is based in London ... 2005. Before mandatory introduction for all companies to use IFRS, all countries in European Community regulated separately their standards of reporting (McLaughlin, 2009). The ...
As “we are rapidly heading towards a world where there are two main financial reporting systems – US GAAP…and IFRS…” (Aitken-Davies &Martin. 2006. P.1), the financial accounting Standards Board (FASB) in the US is committed to converge its standards with those of the IASB (James, 2011).
As a result, the IASB and FASB have been systemically working together to remove the substantial difference between U.S. GAAP and IFRS since the establishment of the Norwalk Agreement in 2002 (Bunting & Frank. 2008).
They are committed to develop a set of high quality and compatible accounting standards that are suitable for domestic and cross-border financial reporting (Sweetman. 2009).
Convergence of these standards would therefore bring together elements of both US GAAP and IFRS (Bader. 2009).
However, due to the significant improvements needed on the two sets of standards, the IASB and FASB has decided to stop expending some of its resources on trying to eliminate their differences – instead it aims to develop new common standards that can seek convergence by replacing weaker standards with stronger ones to meet the needs of investors. (Gornik-Tomaszewski & Showerman 2010).
“Efforts to globalize financial accounting standards have accelerated not only globally, but also in the US” (James. 2011: p.127).
Steckel (2004) states that, as cross-border investments and capital flows are on the rise, in the US, it is essential to have a common accounting language As a result, global accounting standard setters must work together to achieve better financial reporting that meets the needs of its investors. The traditional approach of GAAP is being questioned, as many companies outside the US are reporting under IFRS, the companies in the US are put under substantial pressure to adopt the IFRS if they are to remain competitive in the global marketplace (Kranacher. 2008).
This would therefore, require the US to abandon its traditional GAAP standards and fully espouse IFRS (Bader. 2009).
The Essay on Accounting Standards International Ifrs Financial
To help you imagine what your company's accounts might look like under International Financial Reporting Standards, we have published fictitious financial statements for various types of entities to illustrate the disclosure and presentation requirements. In May 2002 the International Accounting Standards Board (IASB) published a revised Preface to International Financial Reporting Standards which ...
The US Securities and Exchange Commission (SEC) will soon require companies in the US to switch from GAAP to IFRS (James. 2011).
The significant argument in favour of the development and adoption of IFRS is that all the member nations of the European Economic Area have fully switched to IFRS. As a result, the increased use of IFRS by companies based in countries around the world is evidence of this phenomenon (Bader. 2009).
In addition, IFRS benefits developed and developing countries alike. The benefits of a single set of IFRS for developing nations are, companies can achieve greater mobility of capital at a lower cost as it allows them to be more efficient in allocating its resources. In addition, the quality of financial statements in improved which reduces earnings management and it avoids the necessity of having to develop their own standards. “These are all compelling incentives for the adoption of IFRS by countries wishing to participate in global capital markets” (Irvine & Lucas. 2006: p.6).
Furthermore, IFRS benefits developed countries as multinational companies are able to save the expense of preparing more than one set of accounts for different national jurisdictions (Bader. 2009).
Harmonisation of financial reporting around the world leads to higher investor confidence. This is because the information they use to base their decisions and do risk assessment on is more reliable and less risky (Aitken-Davies &Martin. 2006).
In addition, a common standard improves the comparability of financial statements worldwide (Bader, 2009).
Adequate level of guidance decreases the complexity of standards which reduces the risk of misunderstanding the information (Barth. 2006).
This therefore, provides investors in the capital markets with better quality information on which to base their investment and credit decision on (Diaconu & Coman. 2006).
Furthermore, Individual companies benefit from lower costs of capital as there is greater confidence in reliable and transparent information i.e. decrease in interest costs and increase in share price. Convergence as a result, improves the credibility of financial information as the quality of accounting practices is improved internationally (Bader, 2009).
The Term Paper on International Financial Reporting Standards
1. Introduction: With the announced adoption of International Financial Reporting Standards (IFRS) for publicly accountable starting 2011 by the Canadian’s Accounting Standards Board (AcSB), issues about the effect on the usefulness of financial statement need serious attention starting on knowing the similarities and differences between Canadian GAAP and IFRS. Some critics have argued that IFRS ...
Moreover, the main factor that motivates convergence is that the SEC has removed the requirement of non-US companies registered in the US to reconcile their reports with GAAP if their accounts initially comply with IFRS (Kranacher. 2008).
Therefore, companies that have joint listings on the stock exchange i.e. in the US and another country will save substantial time and preparation costs as they will no longer have to reconcile their accounts with different national laws and practice (Diaconu & Coman. 2006).
Conversely, the main argument against the development of a single set of IFRS is that countries are experiencing significant difficulties in handing over power to an international body. This is particularly the case for countries that follow the global GAAP as the difference in measurement and terminology between the two standards is significant (Irvine & Lucas. 2006).
In addition, there is the challenge of translating the standards into clear and concise reporting model that can be understood in different languages and contexts. This is particularly a problem when translating into a different language that has no exact or equivalent terminology of regulatory infrastructure (Bader. 2009).
In addition, the lack of skilled personnel means staff must be trained. However, this is a time consuming process therefore a personnel with relevant experience in the application of these standards is needed to ensure a satisfactory transition (James. 2011).
Moreover, the complete overhaul of these standards is very costly as amendment with IFRS to suit each country’s own specific culture and infrastructure is required (Irvine & Lucas. 2006).
In addition, the potential difficulties in achieving international convergence is the sheer cost of conversion faced by companies in the current economic climate and the difficulties in the changes in standards, following convergence, will inevitably create (Aitkin Davies & Martin. 2006).
The cost of eliminating the vast difference in accounting standard between countries is enormous. As a result overcoming the differences is difficult and burdensome (Bader, 2009).
Therefore, to fully implement the changes in standards, sufficient planning of resource needs and allocation will be vital to keep costs under control (Gornik-Tomaszewski & Showerman. 2010).
Another challenge of pursuing convergence is the global dilemma. Many countries exhibit substantial economic and cultural differences (Diaconu &Coman. 2006).
Therefore differences in accounting standards across countries may in fact be appropriate or even necessary. Such differences may “result from countries being at different stages of economic development or countries relying on different sources for financing. “ (Bader. 2009: p.105).
Therefore, maintaining some differences between reporting standards means that the idea of combining all accounting standards into one global set is not widely accepted by all countries (Bader. 2009).
This therefore, raises the point that straightforward translation would be insufficient to enable reports to be universally understood and interpreted (Diaconu & Coman. 2006).
Additionally, many people are not convinced by the need for a single set of international accounting standards. Some have argued that full harmonisation of these standards is neither practical nor truly valuable as it is not clear whether significant benefits will be derived. Convergence will not be achieved without strong enforcement. The international environment with capital markets being at different stages of development and maturity increases the challenge of enforcing these standards. (Bader. 2009).
To conclude, the collapse of Enron was caused by a variety of factors relating to weaknesses in its corporate governance structure and fraudulent activity caused by the manipulation of its rules-based accounting standards. Therefore in my personal view, I believe that assigning blame to US standards as cause of corporate failure is in fact fair. The development of principle-based set of IFRS creates benefits for both developing and developed nations as it improves access to capital, and saves multi-national corporations the expense of reporting under more than one set of standards. However, one set of global accounting standards may not be practical due to inconsistencies between IFRS and each country’s local law. In addition, although, convergence has its advantages of improved comparability of financial statements, increased reliability, reduced investor risk, lower costs of capital and decreased complexity of standards making them easier to understand, it has its drawbacks. The high cost of convergence, the concept of the global dilemma illustrated above and the need for strong competent enforcement leads me to believe that convergence may not be the best alternative to pursue. The decision as to which course of action to take is a difficult one as it has been the topic of much controversy in the accounting industry. As IFRS is widely accepted among many countries, I believe it seems reasonable to conclude that convergence of IFRS and US GAAP is an appropriate model for the modern financial reporting environment.
References
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