The Arguments for Harmonising International Accounting Standards

Understanding harmonization and its need in the context of international accounting standards

In its simplest meanings, harmonization in the context of international accounting is a process that aims at reducing differences among the financial reporting processes around the world, intending to achieve comparability (between reported financial information by organizations in various global jurisdictions) as well as aiding with a better understanding of the financial information for making better informed economic decisions.

With the progressive globalization of the world economies during the past few decades, businesses increasingly compete and complement at a global level. The drive for seeking business as well as capital in the global markets has become an important part of growth strategies for a large number of commercial entities around the world. The successful implementation of such strategies heavily depends upon certain attributes of the global financial infrastructure including the possibility and the ease of cross-border transactions and the free flow of international capital. It is estimated that out of all financial transactions that occur in modern times, more than a third occur across borders, and that number is expected to grow.

In a hypothetical environment, where various countries and jurisdictions require a diverse and possibly divergent set of accounting standards, transparency as well as (ease of) understandability of the financial information will arguably suffer. Potential cross-border activities will likely be complicated and the need for lengthy reconciliations and/or audits to achieve understandability, comparability, and reliability will add to the cost and complexity, as well as to the risk for those making economic decisions based on the available financial information.

It is in this background, that the need for greater harmonization of global accounting standards was felt many decades ago and since then global efforts to achieve that objective have taken many forms. The most notable such effort is the development of the International Accounting Standards (IFRS) since the inception of the IASB at the turn of the millennium (2000).

As we now turn our attention to the identification and critical review of the arguments for harmonizing international accounting standards, we will focus primarily on the facts around the emergence and adoption (or lack of it) of IFRS, since it represents the major tool for achieving the desired harmonization. Its success and/or failure to achieve the desired/claimed objectives could be used as a very representative set of benchmarks for critically reviewing the desirability of global accounting standards harmonization.

The claimed advantages of harmonization

As per the description given on IFRS Foundation’s website (The IFRS Foundation. 2021. Ifrs.org. [Online]. [7 March 2021]. Available from: https://www.ifrs.org/ ), ‘the IFRS Foundation is a not-for-profit, public interest organization established to?develop a single set of high-quality, understandable, enforceable and globally accepted accounting standards (IFRS Standards) and to promote and facilitate the adoption of the standards. The organization was founded under the auspices of global securities regulators with the aim of contributing to the development of global financial markets and cross-border economic activity.’

To identify the intended benefits of harmonizing the global accounting standards, perhaps it makes sense to take a look at the mission statement of IFRS Foundation as given on its registered website (The IFRS Foundation. 2021. Ifrs.org. [Online]. [7 March 2021]. Available from: https://www.ifrs.org/ ).

‘Our mission is to develop IFRS Standards that bring transparency, accountability and efficiency to financial markets around the world. Our work serves the public interest by fostering trust, growth, and long-term financial stability in the global economy.

• IFRS Standards bring transparency by enhancing the international comparability and quality of financial information, enabling investors and other market participants to make informed economic decisions.
• IFRS Standards strengthen accountability by reducing the information gap between the providers of capital and the people to whom they have entrusted their money. Our Standards provide the information needed to hold management to account. As a source of globally comparable information, IFRS Standards are also of vital importance to regulators around the world.
• IFRS Standards contribute to economic efficiency by helping investors to identify opportunities and risks across the world, thus improving capital allocation. The use of a single, trusted accounting language lowers the cost of capital and reduces international reporting costs for businesses.

IFRS Standards are currently required in more than 140 jurisdictions and permitted in many more.’

Further, as per the IFRS Foundation, ‘High-quality financial information is the lifeblood of capital markets. Accounting standards are a set of principles companies follow when they prepare and publish their financial statements, providing a standardized way of describing the company’s financial performance. Publicly accountable companies (those listed on public stock exchanges) and financial institutions are legally required to publish their financial reports in accordance with agreed accounting standards.’ (The IFRS Foundation. 2021. Ifrs.org. [Online]. [7 March 2021]. Available from: https://www.ifrs.org/ ).

An analysis therefore of the claims made by the IFRS Foundation shows that there are essentially three fundamental quality attributes which adoption of IFRS (and hence the broader drive for global harmonization of accounting standards) promises to deliver:

1. Increased Transparency. This is likely to accrue as more and more businesses around the world follow a common set of detailed rules as well as principles for measurement, treatment, and presentation of financial transactions and results. It is believed that such practice is likely to increase the international comparability (and hence increased transparency) of financial information, resulting in the ease of making informed economic decisions by global investors and other market participants.
2. Increased Accountability. In the context of cross-border transactions and multinational organizations, a uniform (harmonized) set of high-quality accounting standards could likely aid with increasing management accountability and could be of immense value to regulators around the world.?
3. Increased Economic Efficiency. ?By eliminating or reducing the need for dual reporting systems or lengthy and complicated reconciliations, a harmonized set of high-quality accounting standards will inevitably reduce the cost both in terms of accounting and auditing. Coupled with this, the increased understandability and comparability of financial information is likely to assist with higher cross-border investment activity at (comparatively) lower levels of perceived risks. The combined effect of all such factors is likely to have a positive impact on global economic efficiency.

It must also be mentioned that one of the primary drivers for the emergence of the need for harmonization in the accounting standards has been the increasing activity in cross-border security markets. In the search for new avenues of raising capital, companies increasingly resort to listing on cross-border security exchanges. As a result, the International Organization of Securities Commissions has been instrumental in several ways in assisting the development of IFRS. The objective off-course is to increase the global capital market's efficiency by improving the ease of making informed decisions by global investors.

Academic research aimed at verifying (or refuting) these claims has been ongoing for almost as long as the drive for harmonization itself. Though certain studies also conclude otherwise (owing primarily to various challenges related to the fundamental differences in national cultures, tax, and political structures, etc.) the results broadly support perhaps in an overwhelming way that the jurisdictions that have either adopted IFRS or have brought their national accounting standards very close to the IFRS, have witnessed some degree of enhancement in the efficiencies of their capital markets. Also, the improvements are far better in jurisdictions with stable and strong legal systems.

Perhaps the most forceful argument in the favor of the desirability of harmonization could be built around the fact that despite many setbacks and challenges, nearly 140 countries/jurisdictions today have either adopted or permitted the use of IFRS for their domestically listed companies. Though partly this could be attributed to factors other than the desire for achieving enhancement in the financial reporting quality and the resulting ancillary benefits.

The United States of America presents another picture where the goal of harmonization (US GAAP and IFRS) could not be achieved even after near two decades of periodic (and somewhat constant) efforts. The reasons for this merit another detailed discussion which is beyond the scope of this essay. However, it must be mentioned that the SEC (securities and exchange commission), as well as the US accounting standards-setting body FASB, have not stated explicitly that they do not intend to achieve harmonization with IFRS. In fact, it is the other way round. The SEC, however, does now allow foreign companies with US listing to report their financial statements in accordance with the IFRS only i.e., there is an option not to reconcile their financial statements with the US GAAP. This alone has addressed one of the major issues which were faced by the global businesses who wished to list on US securities markets and has resulted in a significant increase in the foreign companies listed in the US.

The IFRS Foundation has also been successful in seeking corporation & backing (through various forms of corporation agreements) by the following organizations:

• Basel Committee on Banking Supervision.
• The World Bank.
• European Securities and Markets Authority.
• International Organization of Securities Commissions.
• International Actuarial Association.
• International Federation of Accountants.
• International Integrated Reporting Council.
• International Forum of Accounting Standard Setters.
• International Valuation Standards Council.

As per a statement on the IFRS Foundation website, (The IFRS Foundation. 2021. Ifrs.org. [Online]. [7 March 2021]. Available from: https://www.ifrs.org/ ), ‘in addition, both the Financial Stability Board and the International Organization of Securities Commissions (IOSCO) recommend jurisdictional use of IFRS Standards as part of their compendiums of recommended international standards to protect investors and reduce systemic risk.’ The G20 meetings (on more than one occasion) have also supported the idea of harmonization of accounting standards.

The above-mentioned facts add immense weight to the assertion that the need for harmonization of accounting standards (in one way or another) is indeed being backed by a majority of the countries around the world.

The Claimed Disadvantages of Harmonization

Though the benefits of harmonization can be demonstrated empirically and the circumstantial evidence is abundant, there nonetheless are costs attached with the realization of those benefits. It is sometimes claimed that when jurisdictions adopt compliance with a harmonized set of accounting standards (such as IFRS), the benefits do not accrue evenly for all businesses whilst the cost of implementation/adoption (learning curves, conversion of systems, capacity building, etc.) is likely to be borne by a wider number of businesses (which can see or realize no clear benefits).

Since national accounting standards evolve in a particular context of the relevant economic, political & social structures, taxation needs, perceived levels of corruption, etc. an adoption of a harmonized set of international accounting standards such as IFRS could possibly have adverse effects on accountability, transparency & efficiency in the national context and the local regulator could find its ability to effectively regulate rather diminished.

The control mechanisms which evolved over the years in the national context could weaken and as a result, the competitive environment and a state of the level playing field in an economy will likely suffer.?

In this context, perhaps one has to weigh the benefits and the real cost for achieving the supposed international comparability of financial information by the adoption of a harmonized set of international accounting standards.

Conclusion

Whilst some of the arguments against the desirability of international harmonization of accounting standards sound compelling at first, nearly all of those arguments rather reflect the challenges for the development of a set of harmonized accounting standards that are more in line with the needs of a wide range of stakeholders.

Globally interlinked economies are now a reality and the success of modern businesses as well as national economies to a great degree depend on their ability to attract cross-border sources of capital and investments. Without a threshold level of comparability in the readily available financial information of global businesses, efficient capital markets simply cannot function.

This comparability which is achieved through enhanced transparency and a qualitative better understanding of the financial information and the underlying economic measurement units/tools undoubtedly aids a better understanding of systematic and unsystematic risks and better-informed economic decisions by global investors. As a result, the cost of capital is likely to reduce, which in itself could become an engine of global economic growth as the harmonization of international financial reporting standards progresses.

The efficiency of the global capital markets, as well as the individual businesses, has a much better chance of becoming better in an environment where financial information makes more sense and is better and readily understandable by the analysts around the world without having to make lengthy adjustments. Such financial information has much better predictive value and as a result, brings more certainty to the performance and value forecasts available for investors to base their decisions.

It can be concluded therefore that the merits of the desirability of achieving international harmonization in the accounting standards far outweigh any perceived demerits. The challenges related to the development of standards that better reflect the global economy's needs as well as the challenges related to finding consensus and implementation will nonetheless remain for the foreseeable future. i.e., the real challenge perhaps is not to decide whether we should have international harmonization of accounting standards or not. Rather the real challenge is the eventual development of a set of standards on which we can have a global consensus and which better reflects the global needs.