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Arguments for and against IFRS: Advantages and Disadvantages

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zeba afaque

on 5 May 2014

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Transcript of Arguments for and against IFRS: Advantages and Disadvantages

IFRS Adoption
Major differences between
In the past decade, IFRS went from being little used to what is now the world’s dominant set of accounting standards.
IFRS are widely regarded to be more principles-based than US GAAP.

How widespread is the adoption IFRS
around the world?
Arguments for and against IFRS:
Advantages and Disadvantages of IFRS

What is IFRS?
Presented by:
Zeba Afaque

What is IFRS?
International Financial Reporting Standards (IFRS) is a set of accounting standards developed by an independent, not-for-profit organization called the International Accounting Standards Board (IASB).

IFRS is sometimes confused with International Accounting Standards (IAS), which are older standards that IFRS has now replaced.

The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements.

IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting.

IFRS has a different probability threshold and measurement objective for contingencies.
Research and Development costs are expensed in US GAAP. In IFRS, Research costs are expensed and Development costs are capitalized.
IFRS relies more on fair values, has less specific requirements for revenue recognition, can accelerate the recognition of stock options expenses, may classify certain financial instruments as debt instead of equity, and may include more related entities in the consolidated financial statements.
In an overall sense, IFRS and US GAAP are far more similar than they are different. The influence of US GAAP and US practices on IFRS is substantial.
Overall, there are more advantages to IFRS than there are disadvantages.

The world's economies are becoming more integrated and having one accounting system will make life a little less complicated for both the companies and the investors.

As multinational businesses continue to grow and expand, a thorough knowledge of IFRS is now essential for internationally active, growing businesses.

There seems to be worldwide consensus surrounding the need for one global set of high-quality accounting standards and that IFRS is currently best positioned to fulfill that need.

The End
Study on Fraud
Rules-based systems encourage creativity (and not the good kind) in financial reporting. They allow some to stretch the limits of what is permissible under the law, even though it may not be ethically or morally acceptable.
A principles-based system requires companies to report and auditors to audit the substance or business purpose of transactions.

A rules-based system allows managers to ignore the substance and, instead ask, “Where in the rules does it say I can’t do this?”

Studies point out that the rules-based US accounting standards have been blamed for allowing and even encouraging opportunistic managers to structure transactions to produce misleading financial statements.

According to a study conducted during the five-year period 2001 to 2005, accounting scandals at 38 companies became public knowledge under the US rules-based GAAP system as compared to only 12 companies under the more principles-based IFRS system.
This is because tighter standards can lead to more transaction structuring or real earnings management. According to a study, under certain conditions, real earnings management increases as standards become tighter or more rules based this is because auditors are less likely to challenge structured transactions when accounting standards
are more precise.
Another reason that converting to IFRS is advantageous is that comparing financial statements will be easier for companies, investors and the public.

In today's global economy the consistency of one reporting standard will make it more efficient for investors to research and compare financial statements globally and more effectively.

This will result in an increase of capital flow and international investments, which will further reduce interest rates and lead to economic growth.

For example, the chairman of the Malaysian Accounting Standards Board has a positive outlook on the benefits of comparability. He said that the use of IFRS compliant financial reporting standards has enabled Malaysian companies to be recognized by international investors as being transparent and comparable and has lead to more investment in their economy.

A study conducted in 2008 investigated the effects of mandatory IFRS adoption on market liquidity, cost of capital, and equity valuations in 26 countries.

They find that market liquidity increases after IFRS adoption. They also find weak evidence of a decrease in firms’ cost of capital and an increase in equity valuations.

Another study found that the adoption of IFRS in the EU reduced the cost of equity capital. The study documented that the cost of equity capital decreased by 47 basis points as a result of applying IFRS.

Furthermore, a number of empirical studies examine whether the quality of financial reporting improves subsequent to IFRS adoption.

Using an international sample from 21 countries, a study found that firms voluntarily adopting IFRS generally experience less earnings management, more timely loss recognition, and greater value-relevance than do matched sample firms applying local GAAP.

Another strand of research examines a broader range of economic consequences of IFRS adoption.

Evidence indicates that IFRS adoption leads to higher market liquidity, more investment flows through foreign mutual funds, more favorable terms in private debt contracting, greater analyst coverage, and lower stock return synchronicity.

Opponents of IFRS consider the argument “greater comparability will be reached by switching to IFRS” as flawed.

They argue that even if IFRS was implemented, there would still be differences in financial reporting, and financial statements would not be “identical” because of the differences in national laws, economic conditions, and objectives.

Furthermore, environmental factors such as culture, language, and legal system affect how IFRS is applied.

The differing backgrounds of people in numerous countries applying IFRS means that interpretative differences will arise because of different historical practices.

It is argued that if some countries interpret IFRS differently than other countries, then how would that lead to comparability between financial statements between those countries?

Thus, properly evaluating investment opportunities in any country requires that the investor understand the culture of that country.
In addition to these added costs, it has been found that the audit fees of public accounting firms increase after the transition to IFRS. This occurred in New Zealand, which experienced significant increases in terms of audit fees in the year prior to IFRS adoption, the year of adoption, and in subsequent years.

Although the initial cost of converting to IFRS is large, however, in the long run it will benefit the company by creating more opportunities and making it more cost effective.

The most noteworthy disadvantage of IFRS is the cost of application by companies. This comprises of changing the internal systems to make it compatible with the new reporting standards, training costs and etc.

Also, it will take a substantial amount of time to convert to IFRS completely, depending on the size of the company.

Conversion experiences in Europe, as well as Asia and Australia, show that conversion projects often take more time and resources than originally planned.

However to minimize costs, it is important that companies engage in early preparation for the change in standards. This will help companies control costs as well as understand and manage the challenging scope of implementation.

Beginning in 2005, virtually all publicly-held companies listed on exchanges in the European Union were required to use IFRS.

Australia, New Zealand, Hong Kong, Singapore, and the Philippines have adopted IFRS, as have many countries bordering on the European Union.
Most countries, including China, Japan, India, Russia, Brazil, and Colombia are moving towards IFRS.

Many small or developing countries have turned to IFRS as their national GAAP.
A Dutch insurance company curbed costs during its IFRS conversion by adding to the IFRS conversion team a few members who were familiar with the business of IFRS.
Both studies find that improvements due to the adoption of IFRS are more pronounced in countries with strong legal enforcement and where firms have incentives to be transparent than in countries with weak legal enforcement.
There is a growing stream of research that empirically investigates the effects of IFRS adoption around the world.
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