Global Accounting Standards: IFRS, GAAP, and Comparability
Legal Systems and Accounting Standards
Code Law vs. Common Law Systems
The two major types of legal systems are code law and common law. Code law countries tend to have an accounting law, which is rather general and does not provide much detail. In common law countries, a non-legislative organization generally develops accounting standards, which tend to provide much more detail than is found in the accounting laws of code law countries.
Challenges of Accounting Diversity for Multinational Corporations
Accounting diversity presents several challenges for multinational corporations:
Consolidated Financial Statements
The preparation of consolidated financial statements on the basis of parent company GAAP is complex. Each foreign subsidiary must either keep two sets of books—one in local GAAP and one in parent company GAAP—or its local GAAP financial statements must be reconciled to parent company GAAP.
Access to Foreign Capital Markets
Accounting diversity also complicates multinational corporations’ access to foreign capital markets, as investors and lenders in foreign countries might require financial statements prepared in local GAAP.
Foreign Acquisition Decisions and Comparability
A third problem for multinational corporations caused by worldwide accounting diversity relates to a lack of comparability of financial statements when making foreign acquisition decisions. The multinational corporation might need financial statements for the potential acquisition target prepared in accordance with a set of accounting standards with which its managers are familiar and that fairly present operating performance and financial position.
Evolution of International Accounting Standards Committee (IASC)
The International Accounting Standards Committee (IASC) evolved through three distinct phases:
1973-1988: Lowest Common Denominator Approach
In its first 15 years, the IASC’s main activity was the issuance of International Accounting Standards (IAS), many of which allowed multiple options to accommodate existing accounting practices in various countries.
1988-1993: Reduction of Options via Comparability Project
This phase focused on the reduction of existing options in IAS through the Comparability of Financial Statements Project.
1993-2001: Core Standards Development under IOSCO
The final phase began with the IOSCO agreement in 1993 and concluded with the creation of the IASB in 2001. The main activity during this period was the development of a “core set” of international standards that could be endorsed by IOSCO for cross-listing purposes.
Barriers to Global Financial Statement Comparability
Even if International Financial Reporting Standards (IFRS) were required in every country, several factors could still inhibit worldwide comparability of financial statements:
Alternative Treatments within IFRS
Even though the Comparability Project of the 1990s reduced the number of alternative methods allowed, several IFRS continue to allow companies to choose between a benchmark and an allowed alternative treatment. Strict comparability will not exist if one company adopts the benchmark and another adopts the allowed alternative.
Subjective Application of Principles-Based IFRS
Even if the same treatments are selected, cross-national comparability could be harmed if accountants apply the principles-based IFRS 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 IFRS.
Key Differences Between IFRS and U.S. GAAP
There are several types of differences between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP):
Definition Differences
Differences in definitions can occur even though concepts are similar, leading to variations in recognition and/or measurements.
Recognition Differences
Variations in recognition criteria and/or guidance related to (a) whether an item is recognized, (b) how it is recognized, and/or (c) when it is recognized (timing differences).
Measurement Differences
Differences in the approach for determining the amount recognized, resulting from either (a) a difference in the method required, or (b) a difference in the detailed guidance for applying a similar method.
Alternatives Allowed
One set of standards allows a choice between two or more alternative methods, while the other set of standards requires one specific method to be used.
Lack of Requirements or Guidance
IFRS may not cover an issue addressed by U.S. GAAP, and vice versa.
Presentation Differences
Differences in the presentation of items within the financial statements.
Disclosure Differences
Variations in information presented in the notes to financial statements related to (a) whether a disclosure is required and/or (b) the manner in which a disclosure is required to be made.
IAS 16: Property, Plant, and Equipment Models
International Accounting Standard (IAS) 16 allows for two models for reporting property, plant, and equipment:
The Cost Model
Under the cost model, property, plant, and equipment is carried at cost less accumulated depreciation and any accumulated impairment losses.
The Revaluation Model
Under the revaluation model, property, plant, and equipment is reported on the balance sheet at a revalued amount, measured as fair value at the date of remeasurement, less accumulated depreciation and any accumulated impairment losses.