Globalization has closely linked different markets. With the rise in globalization and market integration, there is a quest to establish a set of global accounting standards. Though progress has been made in establishing a common set of accounting standards, the process still faces challenges that have made it impossible to establish common accounting standards. This paper addresses there benefits of having converging the accounting standards and goes ahead to look at the challenges that make it difficult to converge the accounting standards.
The rise in globalization has led to the quest to achieve common international accounting standards. Financial users around the world are working towards establishing a common set of worldwide accounting standards though it is yet to be accomplished. This is unfortunate given the many benefits of adopting common accounting standards all over the world. Establishing the same accounting standards would mean that each organization prepares financial statement using the same rules.
This would make it easier for users of financial statements to compare the financial position of different companies. The use of a similar set of global standards would improve the quality of financial reporting. Companies around the world would follow the same high-quality standards and they would have to adhere to these rules hence the quality of financial reporting would improve around the globe. Using a similar set of global standards would enhance efficiency and reduce the cost of capital.
The allocation of funds of companies around the globe would reduce the cost of and enhance efficiency. However, even in light of these benefits of having global accounting standards, the world is yet to achieve common accounting rule. For the last two decades, financial experts have been working towards achieving similar accounting standards without success. Progress has been made but there are still notable differences in financial reporting between countries. Part of the reason the common global accounting standards have not been achieved is due to sovereignty of nations.
Countries feel that having one set of accounting standards would undermine the sovereignty of a nation. This termed as westernization by various nations who feel that the western countries have a tendency to impose rules on other countries. The second challenge is lack international regulatory body that would be used to implement the international accounting standards. Despite the challenges, the world needs to look for a workable solution and converge the accounting standards to enjoy the benefits of a common set of global accounting standards.
Reason the world Need International Accounting Standards
Financial reporting standards around the globe are different, and this creates inconsistency in financial reporting. Today, the world economy has become integrated. Globalization is on the rise, and every market is connected to the other market. Globalization closely links markets together, and effects felt in one market are felt in other markets in different countries (Albrecht, Stice, Stice, & Swain, 2014).
Furthermore, countries are coming together to create economic blocs as each country is realizing the need to integrate and form a single market without barriers. As the world is converging and becoming one market each day, financial expert are also looking for a way to remove the inconsistency in financial reporting. The inconsistencies are a major setback to the users of financial reports. Investors rely on financial statements to make investments decisions. Globalization has encouraged investors to invest in global companies.
However, inconsistency in financial reporting makes it difficult to get the right information. A company located in different countries follows different accounting standards to prepare its financial reports hence it becomes difficult to make sense out of different financial reports provided. There is a need to achieve consistency and ensure that investors are provided with the right information when making decisions around the globe.
International convergence is a concept that was established in the 1950s after the Post World War. It was round this time that countries started creating strong economic blocs that eliminated tariffs and reduced the requirements to move across nations. The integration and diversity of the world increased the cross-border capital flows increasing the need to converge the accounting standards.
Previously, the world had been working towards harmonization of accounting standards but with the integration, it was clear that convergence was appoint of urgency (Horton, Serafeim, & Serafeim, 2013). Different countries sought to come up with the same reliable accounting standards that would be used to represent information of organizations operating in major capital markets.
This led to the formation of the International Accounting Standards Committee which is the modern day International Accounting Standards Board. IASB has made progress in the quest for a unified global accounting standard. This board came up with international financial reporting standards (IFRS). The IFRS is used in more than 100 countries most of them are European Union member states.
Benefits of Having Common Accounting Standards
Comparability is one of the greatest advantages of using financial statements. Financial statements are used to indicate the performance of an organization. A person wishing to evaluate the performance of an organization should critically look at the financial records. Financial statements provide a summary of financial position making it possible for investors to understand the position of a company.
However, when companies use different accounting standards, it becomes difficult to understand the financial reports (Atrill & McLaney, 2012). A company in China and a company in the United States will use different accounting standards making it difficult for financial reports users to compare the performance of companies. Using global accounting standards would make comparability a reality.
Items located in financial reports would be similar, and an individual comparing the performance of different companies would compare the essential parts of the reports (Christensen, Lee, Walker, & Zeng, 2015). Users of financial reports can be able to compare important aspects of a business such as liquidity, credit worthiness, profitability, and solvency.
Comparability is not limited to different companies. There are companies operating in different countries. For instance, General Motors, and Mac Donald are operating in different parts of the world. The multinationals have many subsidiaries around the world that use different accounting standards. The companies must adhere to the local accounting standards of each country that they operate in (Drury, 2013).
This makes it difficult for organizations to compare the financial reports of same organization but located in different countries. With international accounting standards, the organizations can be able to measure the performance of each entity regardless of its geographical location. Additionally, the companies would be able to consolidate the financial reports easily and understand how each of entity contributed to the overall performance of the organization.
Improve Quality of Financial Reports
At the top of agenda of the ISAB is to improve the quality of financial standards. The IFRS was established to enhance the quality of financial reports across the world. A global set of accounting standards would be high quality standards (Crosson & Needles, 2013). As much as countries are willing to converge to same accounting standards, they are not willing to compromise the quality of financial reports.
Quality financial reports would provide the user of financial reports with the right information. Investors can make the right investment decision when provided with the right information. If companies across the world would follow high-quality accounting standards, then the financial information provided would be clear, useful and relevant to the users of financial reports.
The cases of the financial crisis of 2008 make it critical to have reliable and quality accounting standards. The financial crisis which affected the world’s strongest economies was caused by lack of adequate regulation where companies provided misleading financial information. A single set of global standards would improve the quality of accounting standards. Companies would not find a loophole to mislead users of financial reports since the global standards are clear and target to ensure that financial report represent the true position of a company.
Companies that have embraced the IFRS have improved the quality of financial reporting. A report released by the IASB indicated that the IFRS has improved the quality of financial reports (Crosson & Needles, 2013). The report further indicated that capital market participants and investors who use information prepared using the IFRS standards get the right information and can be able to evaluate the financial position of different companies use the international standards.
Implementing unified financial reporting standards would not only enhance comparability, but it would simplify financial reporting. This is especially true for organizations that have subsidiaries around the world. The companies prepare different financial reports that adhere to local standards but at the end of the day the organizations have to consolidate the financial reports (Becker, Schäffer, & Thaten, 2015). It is difficult to consolidate financial reports prepared using different rules. This is because the items are not represented and accounted for the same way.
The items represent in one financial report in one country may differ from the items of another country making it difficult for multinationals to consolidate the financial reports. Additionally, without converged financial accounting standards, the countries are forced to prepare financial reports using different currencies such as yens, pounds, and dollars depending on the locality they operate (Brochet, Jagolinzer, & Riedl, 2013). It becomes difficult to consolidate the financial reports because they have to consider the foreign exchange rates.
Financial reports simplify the process of mergers and acquisition. Companies are looking to make strategic mergers and acquisition to increase their market share. Mergers and acquisition are becoming prevalent today as companies globalize (Bradshaw, 2010). Companies are establishing mergers to launch products successfully in new markets. Using global accounting standards would enable companies to make the right mergers and acquisition. The companies can be able to look at financial reports comprehensively and compare the results with ease enabling them to make sound decisions.
Reduction in Cost of Capital
Shifting from locally accepted principles to international reporting standards will reduce the cost of capital. Research conducted on the EU nations showed that using a the same accounting standards has boosted the net income by 25%. Companies recorded a rise in earnings before taxes and depreciation. A second study that focused on 30 European organizations showed that the application of the same accounting standards increased profits by $30 billion (Albu & Alexander, 2014).
Implementing similar accounting standards across the world indicates that companies allocate capital more efficiently, and the markets would be more efficient. International accounting standards would also converge the regulation of financial reports hence companies would strive to be efficient. To be ahead of competitors and to attract investors companies would enhance efficiency hence global market would be more efficient.
Differences in Accounting Practices in Different Countries
Publicly held countries use the generally accepted accounting principles. Different countries have accepted various accounting principles which are recognized by the different nationals. Research indicates that over 132 countries have so far embraced the IFRS, but there is still a difficult in implementation (Wang, 2014). Countries are not implementing the IFRS standards in the same manner because they have national accounting standards. For instance, the U.S. has U.S. Generally Accepted Accounting Principles (GAAP) and the U.K. use the U.K. GAAP.
Since 2005 Japan started converting to the IFRS from the Japanese Generally Accepted Accounting Principles. However, there are still notable differences between the ways countries treat financial reports. For instance, the United States and United Kingdom accounting standards are stock market oriented because the foreign companies based in these countries rely on the stock exchange as a source of finance.
On the other hand, the accounting standards of Japan are bank oriented because companies rely on bank loans and not willing to participate in stock markets. Japan and the U.K. are guided by different accounting laws. For instance, the United Kingdom is guided by the common legal system while Japan is guided by the code and civil legal system. The differences in accounting practices make it difficult to find one single accounting standards. Countries are not willing to abandon their way of doing things to adopt a new single set of accounting.
For instance, the United States was hard hit by the financial crisis. The country established the Sarbanes Oxley law which increase regulation and specifically focuses on financial reporting. This means that companies in the United States must follow the U.S. GAAP and meet the legal requirements in financial reporting as stipulated by various laws concerning financial reporting (Arnold, 2013). It is difficult for companies to adopt a common set of accounting standards because there are local accounting standards that are unique to each country and laws that must be met.
The generally accepted accounting standards and the International accounting standards treat items of financial reports differently. For instance, there is a distinction in the way the U.K GAAP and IFRS treat leases. The IFRS requires a company to capitalize leases as long as the lease term is major part of the assets economic life. Conversely, the U.K. GAAP requires a company to capitalize a lease as long as the term of the lease is equivalent to 75% of the asset’s economic life (Horton, Serafeim, & Serafeim, 2013).
Converging the different accounting practices of different countries is a big challenge. Countries already have their accounting principles and the way they treat different items such as the lease in the example above is different. It is a big challenge to harmonize the accounting standards and find a set of standards that will be accepted by different countries (DeMiguel, Nogales, & Uppal, 2014).
The politics of the pride of a nation and sovereignty has worsened the chance of achieving global accounting standards. Establishing a global set of standards would impose accounting standards on countries. The global set of accounting standards has already come under criticism because it undermines the sovereignty of nations. Financial experts in the United States released a report that revealed that a global set of financial standards would impact on the quality of financial report negatively (Weil, Schipper, & Francis, 2013).
The experts argued that global set of accounting standards replaces comparability with quality. The report indicates that the current accounting standards in the United States focus on the quality of financial reports and adopting other standards would undermine the sovereignty of the nation and at the same time lower the quality of financial reports.
The global accounting set of standards has been criticized as western dominance. The Western countries have often been criticized of imposing rules and regulations on countries. The wave of democratization, for instance, has been cited as a move by West to dominate (Arrow & Lind, 2014). When coming up with the global accounting standards, the West is actively involved and poor countries do not get to contribute adequately. When the accounting standards are imposed on other countries, it strips them the ability to establish different accounting standards that are unique to the situation.
Lack of Regulatory Body
Though more than 130 countries have adopted the IFRS, there are notable differences financial reports. This is because there is no regulatory body that ensures that each country strictly follows the accounting standards. There is no international regulatory body that can mandate countries to adhere to accounting process. According to Scott (2012), to achieve consistency in the preparation of financial report, there must be an international regulatory body. The regulatory body should oversee the implementation of converged accounting standards.
Additionally, it would be in-charge of dealing with companies that fail to comply with the accounting standards. The regulatory body should be endowed with the authority to regulate both public and private entities to ensure that financial reports meet the international standards. Without the regulatory body, it is impossible to achieve consistency and ensure that all companies are using the same set of global standards.
The Costs of having Global Set of Standards
Having a worldwide accepted accounting standards would increase the cost of accounting in various companies. First, establishing a global set of standards would require that accountants worldwide are retrained. The accountants must be trained on how to prepare the financial accountants using the new accounting standards (Brigham & Ehrhardt, 2013).
Companies would have to incur the costs of retraining the accountants in order to adhere to the new set of accounting standards. The second cost is that failure in the accounting system would cause a worldwide failure. Leiwy and Perks (2013) stipulate that a failure in the accounting standards would cause accounting standards at the same time.
Getting a set of global accounting standards has definitely been at the top of agenda of the IASB in the last decade. Amidst the challenges this course changes there are doubts as to whether it is still possible to attain the global accounting standards. The pride of nationalism and politics of sovereignty make it difficult every day to achieve a single set of global accounting standards.
Every country wants to maintain certain aspects of its accounting standards making it difficult to come up with a common set international accounting standard that will be widely accepted. The world lacks an international regulatory body that will be in charge of implementation and ensuring companies comply with the laws. Lastly, the differences in accounting practices across countries make it impossible to establishing similar accounting standards.
However, there are numerous benefits of applying the same accounting standards. They include comparability, enhancing market efficiency, simplification and improving the quality of financial accounts. In light of these benefits, countries should work together to find a solution and establish a common set of international accounting standards.
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