International Accounting Standards

As countries developed different cultures, languages, and social and economic traditions, they developed different accounting practices as well. In an increasingly globalized world, however, these differences are not optimal for the smooth functioning of international business.

The purpose of accounting is to communicate the organization’s financial position to company managers, investors, banks, and the government. Accounting standards A system of rules and principles that prescribe the format and content of financial statements. provide a system of rules and principles that prescribe the format and content of financial statements. Through this consistent reporting, a firm’s managers and investors can assess the financial health of the firm. Accounting standards cover topics such as how to account for inventories, depreciation, research and development costs, income taxes, investments, intangible assets, and employee benefits. Investors and banks use these financial statements to determine whether to invest in or loan capital to the firm, while governments use the statements to ensure that the companies are paying their fair share of taxes.

The Emergence of New International Accounting Standards

The International Accounting Standards Board (IASB) is the major entity proposing international standards of accounting. Originally formed in 1973 as the International Accounting Standards Committee (IASC) and renamed the International Accounting Standards Board in 2001, the IASB is an independent agency that develops accounting standards known as international financial reporting standards (IFRS)Standards that are developed by the International Accounting Standards Board (IASB) for reporting company financial results and that are followed by over one hundred nations throughout the world..

The IASB is composed of fifteen representatives from professional accounting firms from many countries. These board members formulate the international reporting standards. For a standard to be approved, 75 percent of the board members must agree. Often, getting agreement is difficult given the social, economic, legal, and cultural differences among countries. As a result, most IASB statements provide two acceptable alternatives. Two alternatives aren’t as solid or straightforward as one, but it’s better than having a dozen different options.

Adherence to the IASB’s standards is voluntary, but many countries have mandated use of IFRS. For example, all companies listed on EU stock exchanges are required to use IFRS. The same is true for all companies listed on South Africa’s Johannesburg Stock Exchange and Turkey’s Istanbul Stock Exchange. In all, over one hundred nations have adopted or permitted companies to use the IASB’s standards to report their financial results.

The United States doesn’t mandate using the IFRS. Instead, the United States has the Financial Accounting Standards Board (FASB), which issues standards known as generally accepted accounting principles (GAAP)Standards that are developed by the US Financial Accounting Standards Board (FASB) for reporting company financial results and that all US companies or companies operating in the US must follow.. The US currently mandates following GAAP. However, the FASB and IASB are working on harmonizing the accounting standards; many IASB standards are similar to FASB ones. The United States is moving toward adopting the IFRS but hasn’t committed to a specific time frame.

The primary reason for adopting one standard internationally is that if different accounting standards are used, it’s difficult for investors or lenders to compare the financial health of two companies. In addition, if a single international standard is used, multinational firms won’t have to prepare different reports for the different countries in which they operate.

Accounting standards can be complex; and this makes modification of standards difficult. In addition, differing practices among various nations add to the complications of a unified accounting format. For example, in the United States and Great Britain, individual investors provide a substantial source of capital to companies, so accounting rules are designed to help individual investors. In contrast, the tradition in Switzerland, Germany, and Japan is for companies to rely more on banks for funding. Companies in these countries have a tighter relationship with banks. This means that less information is disclosed to the public. It also results in accounting rules that value assets conservatively to protect a bank’s investment. In other countries, the government steps in to make loans or invest in companies whose activities are in the “national interest.”

Finally, accounting rules in China follow neither IFRS nor GAAP, which makes it hard for investors to gauge the true value of a company. To address this issue, some large Chinese companies report results in both Chinese accounting standards and the IASB’s standards. The two accounting standards can show quite different results for the same company, which is why convergence proponents advocate using one global accounting standard.