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By Anne J. Rich, CMA

Reprinted with permission of the Institute of Management Accountants, from Management Accounting, April 1995; permission conveyed through Copyright Clearance Center, Inc.

In the past, U.S. businesses did not have to pay attention to International Accounting Standards (IAS). But as the business world shrinks and the number of international transactions grows, most U.S. businesses recognize they must adapt to a global environment. Within this context, understanding the increasingly rigorous IAS is becoming a necessary skill for management accountants.

Support for Using IAS

Why should American accountants begin to change their perception about International Accounting Standards?
  • Many countries already use IAS, and management accountants should be aware of their impact on U.S. standards.
  • International transactions are increasing at an amazing rate, and U.S. companies will have to evaluate foreign companies in order to extend credit and vice versa.
  • With the growth of American subsidiaries abroad, companies are required to report in the subsidiary’s host country as well as consolidating using U.S. generally accepted accounting principles (GAAP). Preparing financial statements using two or more accounting standards is very costly—using the International Accounting Standards would lower this cost. (For a look at some of the differences between U.S. accounting standards and IAS, see sidebar on p. and Table 1.)
  • Finally, the number of joint ventures with foreign corporations has increased. As U.S. companies and foreign companies become partners, the exchange of information would be facilitated by a common format. China, for example, uses the IAS for the regulation of its joint ventures.

Here are some additional reasons for supporting the International Accounting Standards.

Capital markets. Ignoring the International Accounting Standards could place U.S. companies at a competitive disadvantage. Many international corporations are looking to U.S. capital markets for financing. European companies have indicated that all they need is U.S. acceptance of the International Accounting Standards Committee (IASC) principles and they will be eager to list on the New York Stock Exchange (NYSE)—as they do on the London and Hong Kong stock exchanges. Daimler Benz recently listed on the NYSE, but it is the only German company to do so. American investors do not have easy access to investing in foreign companies. We can expect in the near future that many U.S. corporations will seek financing from international capital markets.

IOSCO. One of the more significant drivers of international standards for accounting is the International Organization of Securities Commissions (IOSCO). This organization has been working with the IASC to reach agreement on mutually acceptable international standards of accounting and disclosure for international securities offerings and other foreign lists. For example, several IOSCO members require foreign issuers to present financial statements in conformity with IAS. If IASC is able to meet all of IOSCO’s requirements, IOSCO will accept international standards for accounting in cross-border public offerings.

The World Bank. Another supporter of IAS is the World Bank. It prefers, to the extent possible, that project accounts be maintained in accordance with generally accepted international standards. Many developing countries use the Standards.

Multinational companies. International Accounting Standards are receiving increased recognition from multinational companies. This situation exists particularly in countries where the Standards are accepted as either the preferred accounting principle or as allowed alternatives. For example, Ciba-Geigy Limited Group, Switzerland, changed its accounting system on January 1, 1993, in order to comply with the IAS and with the European Community’s directives. Shanghai Petrochemical in the People’s Republic of China uses IAS as its principal accounting policies. The 1994 Annual Report for Anglo American Corporation, South Africa, states the accounting policies substantially comply with the International Accounting Standards.

SEC. The Securities & Exchange Commission (SEC) is working with IOSCO and the IASC. The SEC now will accept cash flow statements from foreign issuers that conform with IAS 7. The SEC also has accepted as equivalent information value to GAAP the international standard for amortization of goodwill, the distinction between acquisition (purchase) and unitings of interests (poolings) in business combinations, and foreign subsidiaries operating in the currency of a highly inflationary economy.

FASB. The Financial Accounting Standards Board (FASB) is watching the International Accounting Standards carefully. A major project of the FASB is consolidations—the United States is out of step with the IASC on that issue. In 1993, the FASB stated that its project on earnings per share (EPS) had two objectives: to simplify procedures for the computation of EPS by U.S. companies and to make U.S. standards on EPS compatible with international standards. The FASB is coordinating its project with the IASC’s work on EPS. In September 1994, the FASB and the IASC Steering Committee met to discuss a number of issues for which the two organizations have reached different conclusions.

International Accounting Standards Committee

The organization that has had the most significant impact on developing international standards for accounting is the International Accounting Standards Committee. The IASC was formed in 1973 in order to improve and harmonize financial reporting and focuses primarily on developing and publishing International Accounting Standards. The Committee is located in London, England, and includes more than 100 organizations representing more than 80 member countries.
The objectives of the IASC are:
  • To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance;
  • To work generally for the improvement and harmoni[z]ation of regulations, accounting standards and procedures relating to the presentation of financial statements. 1

The IASC Board comprises representatives of accounting organizations from 13 countries and representatives from a maximum of four organizations other than accounting but with an interest in financial reporting. The Board includes representatives from Australia, Canada, France, Germany, India, Italy, Japan, Jordan, the Netherlands, the Nordic Federation of Public Accountants, South Africa, United Kingdom, and the United States. In addition, there are representatives of the International Coordinating Committee of Financial Analysts’ Associations. The U.S. representative is the AICPA.

The Board also meets with the IASC Consultative Group, an international group that comprises representatives of users and preparers of financial statements and standards-setting bodies, as well as observers from intergovernmental organizations. The FASB, for example, is a member of the Group. The IACS is funded by professional accountancy bodies and other organizations on its Board, the International Federation of Accountants (IFAC), and by contributions from multinational companies, financial institutions, accounting firms, and other organizations.

Similar to the FASB, the IASC adds topics to its work program, sets up steering committees to develop Statements of Principles, prepares Exposure Drafts, and, ultimately, presents International Accounting Standards.

To date, the IASC has issued 31 International Accounting Standards and two major Exposure Drafts: financial instruments and income taxes. The Board also has issued a guideline titled "Framework for the Preparation and Presentation of Financial Statements."

In 1987, the IASC decided there were too many acceptable alternative accounting treatments in its Standards and began a project to look into this matter. In January 1989, E32, "Comparability of Financial Statements," was published, which represented the culmination of the first stage of the project. It dealt with 29 issues concerning existing Standards that allowed too many choices of accounting treatments. A second document, "Statement of Intent on the Comparability of Financial Statements," was issued in June 1990 as a result of feedback to the Board.

The "Statement of Intent" identified three issues—research and development, inventories, and capitalization of borrowing costs—on which the Board decided to make substantive changes. The IASC also identified 21 issues it considered noncontroversial and on which Standards would be published without any changes from the E32 proposals.

The IASC has identified a broader base of users of financial statements than the FASB. The IASC includes as users: present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies, and the public. Financial statements must provide information about the financial position, performance, and changes in financial position that is useful to a wide range of users in making economic decisions.

International Accounting Standards recognize accrual accounting and the going-concern concept. Many of the qualitative characteristics found in the FASB’s Conceptual Framework also are found in the International Accounting Standards Committee’s Framework. The definitions of assets, liabilities, and equity also are very similar. Finally, the recognition principle is similar to that used in the United States.

Recently, the IASC decided to reduce the number of accounting alternatives and began its Comparability Project. As a result, in 1993, many alternative treatments were eliminated with the issuance of 10 revised International Accounting Standards. Some issues were resolved by identifying a benchmark treatment—the preferred method—and an allowed alternative.

The most controversial problem the IASC settled is the treatment of inventories. In earlier drafts, LIFO accounting for inventories was to be eliminated. Effective January 1,1995, however FIFO is the benchmark treatment, and LIFO is the allowed alternative treatment. If LIFO is selected, then the company must provide disclosures that reconcile differences between income using LIFO and income following the benchmark treatment, FIFO.

Reconciliation is achieved by disclosing the difference between the amount of the inventories as shown in the balance sheet and either (a) the lower of the amount arrived at in accordance with the historic cost using FIFO or the weighted average cost and the net realizable value or (b) the lower of current cost at the balance sheet date and the net realizable value.

IASC Projects

What are the current and future projects of the IASC? The outstanding issues in "Statement of Intent on Comparability of Financial Statements" relate to IAS 25, "Accounting for Investments." The IASC will consider this Statement as part of its larger project on financial instruments. It has taken a lead role in the development of accounting standards related to this subject. Now IASC is reviewing IAS 17, "Accounting for Leases." Here the issue is recognition of finance income on a finance lease.

In 1988, the IASC began its review of IAS 12, "Accounting for Taxes on Income." In 1989, it published E33. As a result of strong negative comments, it has just issued another Exposure Draft before approving a revised Standard along with a Background Issues document. The document indicates there are two approaches to the liability method: the balance sheet liability method and the income statement liability method. Previously, the IASC recommended the income statement method. The new Standard, E49, adopts the balance sheet liability method that was developed by the FASB. While the international standard now has the same theoretical approach to accounting for income taxes as GAAP, there still is one area of difference. The IASC decided that it would not permit the recognition of the deferred tax liability in certain cases where the consideration paid for an asset implicitly takes into account its nondeductibility for tax purposes. Long-term assets with a tax base less than cost and nondeductible goodwill amortization are exceptions to deferred tax liabilities. Negative goodwill and government grants are exceptions to deferred tax assets.

In September 1994, IASC published a draft Statement of Principles titled "Reporting Financial Information by Segment." In this document, the IASC recognized there are two popular approaches to defining segments, namely, the business segment approach and the management approach. The former is proposed by the IASC’s Steering Committee, while the latter is the approach being developed jointly by the FASB and the Canadian Institute of Chartered Accountants. The IASC has requested input from accountants before it issues a final report.

The IASC also is developing Standards on intangible assets, earnings per share, agriculture and presentation of financial statements, and postretirement benefits.

The FASB and the IASC: Working Together

Until recently, the AICPA played a more formal role than the FASB with the IASC. In an effort to communicate more effectively, the FASB formed an informal "working group." Beginning in 1991, the working group conducted meetings to enhance communication among standards-setting bodies and to explore conceptual and technical issues about which they have common concerns. They initially focused on one problem that confronts standards setters worldwide—the role of future events for recognition and measurement.

In August 1994, the FASB published a special report, "Future Events: A Conceptual Study of Their Significance for Recognition and Measurement." The principal author is L. Todd Johnson of the FASB. The study represents the combined thoughts of the Australian Accounting Standards Board, the Canadian Accounting Standards Board, the IASC, the United Kingdom Accounting Standards Board, and the FASB. This project also was published by the IASC.

When the FASB proposes changes to GAAP, U.S. accounting professionals respond passionately. It is time for a broader perspective. Management accountants should monitor and participate in the global standards-setting process to ensure their voice is heard.
Discussion Questions
  1. What factors have contributed to the growing support for International Accounting Standards (IAS)?
  2. What has been the role of regulators (IOSCO and SEC) and U.S. standards setters (FASB and AICPA) in international standard setting?

Differences Between IAS and GAAP

Are there any major differences between U.S. accounting standards and the IAS? See Table 1 for a quick overview. Here are some more in-depth differences:
  • Disclosure of Accounting Policies (IAS1). IAS allows more than one method.
  • Inventories (IAS2). This Standard values inventories at lower of historical cost or net realizable value. Net realizable value has a more specific meaning than the GAAP definition of market value. As mentioned earlier, LIFO inventories are reconciled to FIFO, which is a requirement similar to that of the SEC. Most large companies, therefore, will have no difficulty meeting the IAS requirement.
  • Depreciation (IAS4). This Standard requires depreciable assets to be disclosed according to a major class grouping, such as property, plant, and equipment. The rates used to compute the depreciation also are disclosed.
  • Cash Flow (IAS7). The revised Standard, effective January 1, 1995, complies with U.S. GAAP except for certain exemptions for some organizations, the treatment of bank overdrafts, the treatment for operating cash flows associated with the purchase and sale of dealing or trading securities and loans, the cash flows associated with extraordinary items, and the detailed disclosure by major category of other assets and liabilities acquired or disposed of in subsidiaries. There could be controversial differences for some industries.
  • Research and Development (IAS9). This Standard is less stringent than GAAP after the Statement of Financial Accounting Standards (SFAS) 2. IAS9 allows development expense to be deferred if it meets certain criteria.
  • Retirement Benefit Costs (IAS19). The Standard does not address the additional minimum liability.
  • Business Combination (IAS22). The IAS is a departure from GAAP in that it requires the amortization period for expensing goodwill to not exceed five years unless there is justification for a longer period—not to exceed 20 years. Also, where the aggregate fair value of net identifiable acquired assets exceeds the cost of acquisition, the excess (negative goodwill) should be treated as deferred income and recognized as income on a systematic basis or allocated over individual depreciable nonmonetary assets acquired in proportion to their fair values. It is a significant area of contention. Additionally, pooling may be applied to a broader group of transactions, and the IASC’s concept of control is different from GAAP.
  • Related Party Disclosures (IAS24). The Standard requires additional disclosures than required under GAAP. GAAP does not require disclosure of items in the ordinary course of business, such as compensation.
  • Accounting for Investments in Associates (IAS28). The differences occur when using financial statements with a different reporting date.
  • Financial Reporting of Interests in Joint Ventures (IAS31). While the proportionate consolidation method is the benchmark treatment for reporting interest in joint ventures, the equity method is an allowed alternative.

Table 1 Status of International Accounting Standards (IAS) as of November 1994
IAS No Title Effective January 1 Conforms to U.S. GAAP?
1*Disclosure of Accounting Policies1975Yes
2*Inventories1995Yes, additional disclosures required if company uses LIFO
4*Depreciation Accounting1977Yes
5 Information to be Disclosed in Financial Statements1977Yes
7*Cash Flows Statement1994Yes, minor differences
8Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies1995yes
9*Research and Development Costs1995Some differences
10Contingencies and Events Occurring After the Balance Sheet Date1980Yes
11Construction Contracts1995Yes
12Accounting for Taxes on Income1981(under revision)
13Presentation of Current Assets and Current Liabilities1981Yes
14Reporting Financial Information by Segment1983(under revision)
15Information Reflecting the Effects of Changing Prices1983Yes
16Property, Plant and Equipment1995Yes
17Accounting for Leases1984Yes
19*Retirement Benefit Costs1995Some differences
20Accounting for Government Grants and Disclosure of Government Assistance1984Yes
21The Effects of Changes in Foreign Exchange Rates1995Yes
22*Business Combinations 1995Yes, except for goodwill treatment
23Borrowing Costs1995Yes
24*Related Party Disclosure1986Yes, minor differences
25Accounting for Investments1987Yes
26Accounting and Reporting by Retirement Benefit Plans1988Yes
27Consolidated Financial Statements and Accounting for Investments in Subsidiaries1990Yes
28*Accounting for Investments in Associates1990Some differences
29Financial Reporting in Hyperinflationary Economies1990Yes
30Disclosure in the Financial Statements of Banks and Similar Financial Institutions1991Yes, minor differences
31*Financial Reporting of Interests in Joint Ventures1992Yes, minor differences

*For more detail, see sidebar, "Differences Between IAS and GAAP."

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