CHAPTER 3

INTERNATIONAL HARMONIZATION OF FINANCIAL

REPORTING
Chapter Outline
I.

Accounting harmonization is a process that reduces alternatives while retaining a high

degree of flexibility in accounting practices.
A. Harmonization is different from standardization (or uniformity) which implies the
elimination of alternatives in accounting practices.
B. The objective of accounting harmonization is to have comparable financial statements
from companies in different countries.
C. Harmonization of regulations (de jure harmonization) does not necessarily produce
harmonization of practices (de facto Harmonization).

II.

There are many arguments for international harmonization of accounting standards. The
arguments include that it would:
A. Make financial statements of companies in different countries, comparable hence
make it easier for investors to evaluate foreign firms.
B. Simplify for MNCs the evaluation of possible foreign takeover targets.
C. Reduce the financial reporting costs for foreign listed companies.
D. Make it easier for companies to access foreign capital markets.
E. Make it easier for MNCs and international accounting firms to transfer accounting
personnel to other countries.
F. Raise the quality level of accounting practices internationally.

III.

There are many arguments against international harmonization of accounting standards.

A. Considering the differences among countries in terms of socio-politico-economic
systems, it would be almost impossible to arrive at a set of accounting standards
that
would satisfy all of the parties involved.
B. Nationalism. International standards would be perceived as a set of standards
developed to suit the requirements of other countries, and hence would not be
received favorably.
C. The need for harmonization is not universally accepted.
D. It is unnecessary to force all companies worldwide to follow a common set of rules.
Todays global capital market has evolved without harmonized accounting
standards.
E. It would lead to a situation of standards overload.
IV.

IASB has the primary responsibility for international harmonization/convergence of

accounting standards.
A. IASB was formed in 2001 to replace its predecessor IASC, with the objective of
developing a set of high quality accounting standards to be used through out the
world.
B. The work of the IASB is funded and monitored by the IASC Foundation.
C. IASB follows a due process procedure and adopt a principles-based approach in
developing international standards.
D. In addition to the IASB itself, the other main components of the international standardsetting include the IASC Foundation and its Trustees, the IFRIC and the SAC.
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E. The IFRSs also include IASs and Interpretation of international standards.

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F. As of May 2005, 41 IASs and 6 IFRSs have been issued.

G. IASB uses a conceptual framework as the basis for developing international financial
reporting standards.
H. IASB has issued a set of guidelines for first time adopters (IFRS 1).
V.

There are a number of ways in which a country might adopt IFRSs.

A. Replace national GAAP with IFRSs.
B. Require parent companies to use IFRSs in preparing consolidated financial
statements.
C. Require stock exchange listed companies to use IFRSs in preparing consolidated
financial statements.
D. Require foreign companies listed on Domestic stock exchange(s) to use IFRSs.
E. Require domestic companies listing on foreign stock exchanges to use IFRSs.

VI.

There are some concerns about adopting IFRSs.

A. They are too complicated for some companies.
B. Using them as the basis for taxation could be a problem.
C. Some IFRSs, for example, those related to financial instruments and fair value
accounting, are controversial.
D. Guidance for first-time adopters is inadequate.
E. In countries which do not have well-developed capital markets, and where the users
are satisfied with the local standards, the adoption of IFRSs would be of little benefit.
F. There could be language translation issues.

VII. Despite the difficulties, there seems to be a world-wide trend towards convergence of
IFRSs.
A. Support for the IASB structure and its highest common denominator approach.
B. The Norwalk agreement.
C. The IASBs initiatives to facilitate and enhance its role as a global standard-setter, for
example, the issue of guidelines for first-time adopters, holding public round table
forums, and direct liaison with some national standard setters.

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Answers to Questions
1. Harmonization refers to a process of reducing unnecessary differences in accounting across
countries, while retaining a degree of flexibility. Harmonization allows different countries to
have different standards as long as the standards do not conflict.
Standardization, on the other hand, implies a complete elimination of alternatives with all
countries following the same standards.
2. Multinational corporations can benefit from harmonization in the following ways:
Reduce the cost of preparing worldwide consolidated financial statements.
Make it easier to transfer accounting staff from one country to another.
Make it easier to analyze the financial statements of potential foreign acquisition
companies.
Make it easier to benchmark against foreign competitors.
3. The EU Directives were not completely effective in generating comparability across EU
member nations because the Directives:
a. allowed countries to choose among available options in many areas and
b. did not cover many accounting issues, such as leases and translation of foreign currency
financial statements.
4. The three phases in the life of the IASC were:
a. 1973-1988 lowest common denominator approach to standard setting
b. 1988-1993 reduction of existing options in IASs through the Comparability of Financial
Statements Project
c. 1993-2001 development of core set of standards under the IOSCO Agreement
5. IOSCOs endorsement of IASs legitimized the IASCs claim as the international accounting
standard setter. This also helped in addressing, at least partly, the problem of IASCs lack of
enforcement power.
6. Twelve of 14 members of the IASB are full-time. They are required to sever all ties to former
employers to establish their independence. The most important criterion for selection of
IASB members is technical competence. These aspects of the Boards structure confirm the
IASBs commitment to develop the highest quality standards possible. In addition, the IASB
follows an open process in which constituents are able to provide input and feedback on
IASB projects and proposed standards. The geographical representation is achieved
through the method of appointing the IASC Foundation Trustees.
7. A principles-based approach to accounting standard setting refers to the development of
standards that provide the basic guidelines for accounting in a particular area without getting
bogged down in detailed rules. The IASB uses a principles-based approach in developing
IFRSs. Traditionally, the U.K. and the member countries of the British Commonwealth have
adopted this approach.
8. IFRSs appear to cover most of the major accounting issues. With the issuance of IFRS 2,
Share-based Payments, IFRSs even provide guidance with respect to the accounting for
stock options. Other than banks and financial institutions (IAS 30), IFRSs do not provide
rules for specific industries. On the other hand, IAS 41, Agriculture, provides guidelines for
a particular sector of the economy for which rules are lacking in many countries.
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9. The IASB has adopted a principles-based approach to develop a set of accounting standards
that constitute the highest common denominator of financial reporting. This approach is in
sharp contrast to the approach adopted by the IASC in its early years. Also, unlike the IASC,
the IASB is now formally linked to national standard setters. Seven of the 14 Board
members have a direct liaison relationship with influential national standard setters and the
IASB has entered into a formal agreement to converge its standards with those of the U.S.
FASB. The major change is in the emphasis of the role of the IASB, from harmonization to
global standard setting.
10. The different ways in which IFRSs might be used within a country include:
Required of all companies domiciled within the country.
Required of parent companies in preparing consolidated financial statements; national
GAAP used in parent company-only financial statements.
Required of all companies (both domestic and foreign) publicly traded within the country;
non-listed companies use national GAAP.
Required of foreign companies that are publicly traded within the country. Domestic
companies use national GAAP.
Required of domestic companies with foreign operations and/or foreign stock exchange
listings. Domestic companies without a foreign presence use national GAAP.
Instead of requiring the use of IFRSs in each example above, a country could allow the
use of IFRSs in lieu of domestic GAAP in each situation.
11. There are several factors that might inhibit worldwide comparability of financial statements
even if IFRSs are required in every country. First, even though the Comparability Project of
the 1990s reduced the number of alternative methods allowed, several IFRSs continue to
allow companies to choose between a benchmark and an allowed alternative treatment. If
the benchmark is adopted by one company and the allowed alternative by another company,
strict comparability will not exist. (It should be noted that this is also true within a country if
domestic GAAP allows choice among alternatives, for example, in depreciation and
inventory valuation methods.) Second, even if the same treatments are selected, crossnational comparability could be harmed if accountants apply the principles-based IFRSs
differently. Differences in cultural values across countries could cause accountants to have
biases, for example, with respect to conservatism that could influence their judgment in
applying IFRSs.
12. IAS 1 indicates that, if existing IFRSs do not provide guidance in a specific area,
management should refer to the definitions, and recognition and measurement criteria for
assets, liabilities, income and expenses set out in the Framework.
13. The overriding principle in IAS 1 is fair presentation.
14. A firm should claim to prepare financial statements in accordance with IFRSs only if it
complies with all requirements of each Standard and each applicable Interpretation.
15. Publicly traded U.S. domestic companies must use U.S. GAAP in preparing financial
statements. Foreign companies registered with the SEC may use IFRSs in preparing
financial statements filed with the SEC. However, IFRS net income and IFRS stockholders
equity must be reconciled to a U.S. GAAP basis.

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The most likely use of IFRSs in the U.S. in the future is to allow foreign companies to file
IFRS-based financial statements with the SEC without providing a reconciliation to U.S.
GAAP. Conceivably, IFRSs could replace U.S. GAAP as the accounting standards required
to be used by publicly traded domestic companies as well. However, as the IASB and FASB
work toward convergence of their respective standards and the differences disappear,
adoption of IFRSs by U.S. regulators becomes less likely.

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Solutions to Exercises and Problems

1. A major concern particularly in continental Europe is that the IASB is attempting to impose a
certain style of accounting on every country. The reason for this concern is the fact that
IFRSs are based on Anglo-Saxon accounting principles, which are not the basis of
accounting systems in most continental European countries. There is also a concern that the
IASB standard setting process is dominated by representatives from Anglo-Saxon countries.
Recognizing these and other similar concerns, the IASC Foundation Constitution Committee
is currently undertaking a review of its constitution, and has identified as one of the key
areas for consideration the appropriateness of the IASBs existing formal liaison
relationships. The Committee recognizes that the IASB should liaise with a broad range of
national standard-setters, beyond the ones currently recognized in the Constitution. In
addition, the IASB has attempted to make the standard setting process more transparent, by
holding public meetings to discuss accounting issues, and increasing the opportunities for
interested parties to contribute to the standard setting process.
2. a. The ultimate objective of adopting IFRSs is to ensure that financial statements
prepared by firms in different countries are comparable.
b. There are several issues that might hamper the EU from achieving the objective of
financial statement comparability through the use of IFRSs:
The preparers of financial statements need to interpret and understand the
requirements included in financial reporting standards in a consistent manner.
Language will be a major issue in this regard. The IFRSs are written in English
and need to be translated into different languages. It is possible that the
meanings of some of the terms used may be lost in translation, because of the
absence of any equivalent terms in a particular language. This would be an
impediment to achieving comparable financial statements.
The decision to adopt IFRSs in EU member countries involves a change in
accounting values (especially conservatism and secrecy) in most EU countries.
The main focus of accounting in these countries has been either taxation or
providing information to government, whereas IFRSs are aimed at providing
information for the efficient working of the capital market. Eight of the ten
countries which gained membership of EU in May 2004 were former Soviet
Union countries. Changing the accounting culture in these countries in particular
will be a major challenge facing the EU.
In addition, there is lack of a tradition in exercising professional judgment in
financial reporting in many EU countries. Using professional judgment within the
principles-based system of IFRSs to comply with IAS 1s overriding principle of
fair presentation might be something that EU accountants will need to learn
how to do over time.
Another major challenge is the absence of an adequate accounting
infrastructure, particularly in most of the new member countries. Successful
adoption of IFRSs requires, among other things, a well-developed accounting
profession, a business sector that supports IFRSs, and an effective enforcement
mechanism. The EU will have challenges in all these areas given the
backgrounds of its member countries.

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3. Some of the key points to include in your report include:

Make sure that IFRSs have been translated into the local language without losing the
spirit of the financial reporting requirements.
Develop an educational and training program to educate accountants about IFRSs.
Propose reorientation of the system of professional accounting education focusing
on market based economic imperatives.
Emphasize the need for an effective enforcement mechanism with appropriate
disciplinary procedures to deal with non-compliance.
Propose setting up a web page for the accounting oversight body to respond to ongoing issues.
Introduce measures such as seminars to convince the business community of the
benefits of adopting IFRSs.
Ensure that the accounting oversight body remains independent from outside
interference.
Request adequate funding to allow the oversight body to discharge its
responsibilities effectively.
4. Examples of countries that might have their own, different reasons for not
permitting the
use of IFRSs include the United States, Mexico, and Japan. The
reasons
can
be
summarized as follows:
United States: U.S. GAAP is considered to be better-suited (superior) for the U.S.
capital market environment than IFRSs. Permission for U.S. companies to use
IFRSs would amount to lowering the quality of the standards.
Mexico: Mexicos business activities are strongly influenced by U.S. investments
through NAFTA. For Mexican companies, it is more important to follow
U.S.GAAP than IFRSs in accessing the U.S. capital market.
Japan: Traditionally Japanese financial reporting is based on tax rules, and the
main source of finance for business is bank credit. Cross-ownership is also
common among Japanese companies. The equity capital market has not been a
major influence in developing financial reporting standards in Japan.
5. The purpose of this exercise is to encourage students to use the Internet to search for
relevant information about the various initiatives taken by the IASB from time to time. The
information required for this exercise is directly available from the IASB website.
6. The purpose of this exercise is to encourage students to find the necessary information
independently. They can select their own country or another country of their choice. In
answering this question, students will become familiar with how a particular professional
accounting body responds to the global trend toward convergence in financial reporting
standards.

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7. There are several reasons why Anglo-Saxon accounting might be of interest to Chinese
accounting regulators. First, China has expressed a commitment to adopt
IFRSs. To be
successful in adopting IFRSs, a clear understanding of Anglo-Saxon accounting
necessary, as IFRSs are based on Anglo-Saxon accounting. Second, Anglo-Saxon
accounting has been evolved over a long period of time in a particular
socio-economic
and political environment, focused on capitalism, whereas in China, the focus has been on
communism. Adopting capitalist measures in a communist environment is a major challenge
for the Chinese regulators. Translating some of the fundamental concepts of Anglo-Saxon
accounting, such as true and fair view, into Chinese language would be another challenge.
Further, the main purpose of Anglo-Saxon accounting is to facilitate efficient working of the
capital market, which is self-regulated.
8. Honda Company raises a large proportion of its funding from overseas markets, particularly
from the United States. The Companys shares are listed on the New York Stock Exchange.
As a condition of listing, it has to submit a set of annual financial statements based on US
GAAP. As the U.S. financial reporting standards are generally considered to be of high
quality, financial statements prepared by using them are also accepted in other overseas
stock exchanges. If Honda Company used IFRSs in preparing its consolidated financial
statements then it would have to submit a separate reconciliation to the U.S. SEC. So, the
companys desire to access the U.S. market easily could be the possible reason for
preparing its consolidated statements in conformity with U.S.GAAP.
9. The purpose of this exercise is to provide the students with an opportunity to learn how
different pieces of information can be extracted from different sources and used to address a
given problem concerning international harmonization of accounting standards. For this
exercise, it is necessary to log on to the NYSE website at www.nyse.com, and find out the
country origins of foreign companies listed on the exchange.
10. The ultimate objective of the efforts at setting global standards for accounting and financial
reporting is to make corporate financial reports comparable, regardless of their geographical
origin. However, setting global standards alone is not sufficient to achieve this objective.
Some commentators argued that the rules-based approach to setting accounting standards
was responsible for the accounting scandals in the U.S. However, the Parmalat scandal in
Italy showed that this was not necessarily correct, and that scandals can happen anywhere,
because the reasons are much more complicated than just the nature of the accounting
standards used. The lesson referred to in the Financial Times statement is that effective
enforcement is equally important as the type of regulation or accounting standard used, and
that enforcement effectiveness is influenced by such factors as the availability of adequate
resources for the enforcement agencies, and their level of independence from political
interference.
11. The purpose of this exercise is to encourage students to look beyond the text book to
search for the relevant material. The chapter provides the structure for this exercise. What is
required is to expand on the material that is already in the textbook.

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12. In accordance with IFRS 1, First Time Adoption of IFRSs, the following are steps that must
be taken by the fixed assets accounting department manager in preparing IFRS-based
financial statements.
i.
Identify the IFRSs effective as of December 31, 2007 that are relevant in
accounting for fixed assets.
ii.
Determine the amounts related to fixed assets that will appear on the
January 1, 2006 IFRS opening balance sheet based on IFRSs in effect
at December 31, 2007.
iii.
Preparation of the IFRS opening balance sheet will require:
Determining whether any costs previously expensed under previous
GAAP should have been capitalized as a fixed asset under IFRSs
and, conversely, whether any costs capitalized as a fixed asset
under previous GAAP should have been expensed under IFRSs. If
so, make necessary adjustments.
Determine whether any assets classified as a fixed asset under
previous GAAP would not be under IFRSs, and vice versa. If so,
make necessary adjustments.

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CASE 1: Jardine Matheson Group

As required by IAS 1, Jardine presents a consolidated income statement (profit and loss
account), balance sheet, cash flow statement, and statement of changes in equity in its annual
report.
Presentation of Profit and Loss Account
Jardine uses the function of expenses format in its income statement as allowed by IAS 1.
The company does present the minimum items required as shown in the illustrative IFRS
income statement in Exhibit 3.
Presentation of Balance Sheet
Jardine does classify assets and liabilities as current and non-current as required by IAS 1. The
format used by Jardine is considerably different from the illustrative IFRS balance sheet in
Exhibit 4, but the minimum items required by IAS 1 are presented, with the possible exception
that Jardine does not separate retained earnings from other reserves, but instead combines
these in the line item revenue and other reserves. There are considerable terminology
differences such as:
IAS 1
Property, plant and equipment
Inventories
Cash and cash equivalents
Trade and other payables
Retained earnings

Jardine
Tangible assets
Stocks and work in progress
Bank balance and other liquid funds
Creditors and accruals
Revenue and other reserves

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CASE 2: Comments on the IASBs ED 4 Disposal of Non-Current Assets and

Presentation of Discontinued Operations
a. Comment letters are available on IASB website.
b. Issues raised by authors of comment letters:
BP
ED 4 is an attempt to converge with SFAS 144. However, there are two differences in the
standards that could lead to a lack of comparability.
1. Whereas SFAS 144 uses the term probable in the context of the criteria for classification
of a non-current asset as held for sale, ED 4 uses the phrase highly probable, which
establishes a higher threshold. Fewer items will be classified as held for sale under ED 4
than under SFAS 144, negatively impacting comparability.
2. A second concern is that the definition of component differs between ED 4 and SFAS
144.
Bundesverband deutscher Banken
1. Providing a list of criteria for determining whether an asset should be classified as held
for sale is at odds with the IASBs principles-based approach to standard setting.
2. Disclosing details on estimated selling price before sale negotiations have been
concluded is competitively sensitive.
3. Argue that within one year be replaced by in the near future in the context of
determining whether an asset should be classified as held for sale.
Both authors comment on specific wording used in the ED. BdB also raises the more
general concern that ED4 is at odds with a principles-based approach to standard setting.
c. The implication of BPs comments is that, even if ED4 and SFAS 144 are very similar,
comparable results might not be obtained because of some very specific differences in
wording and definition between the two standards. The greater implication is that
convergence might not lead to 100% comparability.
d. BdB expresses a concern with ED4 providing more detailed guidance that would be
expected of a principles-based standard. This occurs because of the desire to converge
ED4 with SFAS 144, which provides a considerable amount of detailed guidance. If the
IASB/FASB convergence process becomes too much of a one-way street, i.e., IASB moving
in the direction of FASB, then other countries might begin to question the legitimacy of the
IASB as the global standard setter.

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CASE 3: The European Perspective on International Accounting Standards

Key concerns related to the work of the IASB raised in these three articles include:
1.

Convergence of IAS with U.S. GAAP: U.S. GAAP is viewed as too complex, too
prescriptive; convergence with U.S. GAAP has caused IFRSs to become longer,
more rules-based, and requiring less judgment. IAS 32 and IAS 39 on financial
instruments are examples of issues where IFRSs converging with U.S. GAAP is
problematic.

2.

Mandatory expensing of stock options (proposed in ED2) is seen as problematic.

3.

IASB is unwilling to move away from theoretical concepts to accept solutions that
are based upon solid, practical experience.

4.

Standard setting procedures should become more open and thorough allowing
all parties concerned to fully participate in the process at all stages.

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