Chapter 2

International Harmonization of Financial Reporting

Learning Objectives
1. Explain the meaning of harmonization.
2. Identify the arguments for and against international harmonization of
accounting standards.
3. Discuss major harmonization efforts.
4.Explain the principles-based approach used by the International
Accounting Standards Board (IASB)
What is harmonization?
Harmonization -- the process of increasing the level of agreement in
accounting standards and practices between countries.
Harmonization is not the same as standardization
whereas standardization implies the elimination of alternatives in
accounting for economic transaction and other events , Harmonization
refers to reduction of alternatives while retaining a high degree of
flexibility in accounting practices, so harmonization allows different
countries to have different standards as long as the standards do not
conflict.
The two levels of Harmonization
Harmonization in accounting standards, which is increased
agreement in accounting rules.
Harmonization in practice, which is increased agreement in actual
accounting practices.
Harmonization in standards may or may not result in
harmonization in practice.
Arguments for and against Harmonization
Arguments for Harmonization :Proponents of accounting harmonization argue that : Harmonization expedite the integration of global capital
markets and make easier the cross-listing of securities because
of the comparability of Financial statements.
Harmonization facilitate international mergers and acquisitions.
Harmonization reduce investor uncertainty and the cost of
capital.
Harmonization reduce financial reporting costs.

 Harmonization allow for easy adoption of high-quality

standards by developing countries.
Arguments for Harmonization :Proponents of accounting harmonization argue that its not
necessary to force all companies world wide to follow comment set
of standards.
Significant differences in standards currently exist .
The political cost of eliminating differences.
Overcoming Nationalism and traditions.
Perhaps it will not provide significant benefits.
Will cause Standards Overload for some firms.
Diverse standards for diverse places is acceptable.
Harmonization Efforts
Organizations involved
Association of South East Asian Nations (ASEAN).
United Nations (UN) / European Union (EU).
International Organization of Securities Commissions (IOSCO).
International Federation of Accountants (IFAC).
IASB and FASB.
International Organization of Securities Commissions (IOSCO).
See web site http://www.iosco.org
Established in 1974, International Organization of Securities
Commissions IOSCO today IOSCO is the leading organization for
securities regulators around the world , with about 135 ordinary,
associate, and affiliate members from about 100 countries , and aims
among other things to :
Achieve improved market regulation internationally.
Facilitate cross-border listings.
Advocates for the development and adoption of a single-set of high
quality accounting standards.
International Federation of Accountants (IFAC).
See web site http://ifac.org
Formed in 1977, International Federation of Accountants (IFAC) aims
to develop international standards of auditing, ethics, education, and
training , In pursuing these goals IFAC has contributed to the
harmonization process in many ways as :
Began International Forum on Accountancy Development (IFAD)
to enhance the accounting profession in emerging countries. That

was in response to criticism from the world bank after the Asian
financial crises that the accounting profession was not doing
enough to enhance the accounting capacity capabilities in emerging
countries .
Started the Forum of Firms to raise global standards of accounting
and auditing (Details at www.ifad.org).

EU European Union :
See web site http://europa.eu/index_en.htm
The European Union EU was the EU was established by the Treaty of
Maastricht on November 1993 upon the foundations of the preexisting European Economic Community, founded in March 1957
with the signing of the Treaty of Rome by sex European nations
(Belgium, France, Germany, Italy, Luxemburg, and the Netherlands),
and now EU Comprising 27 member states .
The European Union EU Has worked to harmonize accounting
standards within the EU, primarily by way of two directives, EU
directives possess the force of law .
Fourth Directive 1978
a set of comprehensive accounting rules covering the content of
annual financial statements, their methods of presentation and
measurement and disclosure. The Fourth Directive built on the
principle of a true and fair view.
Seventh Directive 1983
requires consolidated financial statements for company groups of
a certain size.
International Accounting Standard Board (IASB)
International Accounting Standard Board was created in 2001 to
replace the predecessor, the IASC (International Accounting
Standards Committee).
IASC was established in 1973 by an agreement of the leading
accounting profession bodies in 10 countries (the United States of
America, Australia, Canada, France, Germany, Japan, Mexico,
Netherlands, United Kingdom and Ireland ).
The IASC harmonization effort from 1973 to 2001 evolved in
several phases, the initial phase was the issuance of 26 IASs, the

approach was lowest-common-denominator, so many of these

standards allowed multiple options.
IASB works toward harmonization of international accounting
standards.
The mission of IASB is to develop, in the public interest, a single
set of high quality, understandable and international financial
reporting standards (IFRSs) for general purpose financial
statements.
International Accounting Standard Board Comprised of 14
members (12 full, 2 part-time).
7 members of 12 full time must have a formal liaison responsibility
with a national board.
Standard development process is open and Standards are
principles-based.
Since establishment of IASB, focus is on global standard-setting
rather than harmonization per se.

IASB Major Initiatives

Comparability Project
Begun in 1989, which can be described as the second phase of the
IASCs effort (The third phase was the Framework for the
Preparation and Presentation of Financial Statements).
The comparability of financial statement Project aims at eliminate
most of choices of accounting treatment currently primeted under
IASs.
Comprehensive review of existing IAS , and as areult many of
IASs were revised In order to increase rigor of IAS.
IOSCO Agreement
The final Phase IASC work to harmonization .
Begun in 1993 and ended with the creation of IASB in 2001
The main activity during this period was establishment of a core set
of 30 accounting standards could be endorsed by IOSCO for crosslisting .
Standards agreed upon by IOSCO and IASC.
IASB Revised Structure
The restructured IASB is overseen by the IASC Foundation
which also oversees:
The International Financial Reporting Interpretations
Committee (IFRIC).
The Standards Advisory Council (SAC).

 Also, IFRSs are subject to due process and the IASC

Foundation now periodically reviews its constitution.

IASB Perspective
IASB attempts to follow a Principles-Based approach to standard
setting.
As such accounting standards are grounded in the IASB
Framework.
A Principles-Based approach
Represents a contrast to a Rules-Based Approach.
Attempts to limit additional accounting guidance (e.g., FASB
EITFs, FASB Interpretations).
Is designed to encourage professional judgment and discourage
over-reliance on detailed rules.
IASB Framework and IFRSs
IASB Framework (more details required in single file about
Framework).
The most important phase of harmonization activity is releasing
Framework for the Preparation and Presentation of Financial
Statements.
The objective and underlying assumptions of financial statements.
Qualitative characteristics of information.
Definition, recognition, and measurement of elements in financial
statements.
Concepts of capital maintenance.
Possesses objective and underlying assumptions of financial
statements.
Primary objective is to provide information useful to decision
making.
Underlying assumptions include accrual-basis and going concern.
Qualitative characteristics of information
Understandability should be understandable to people with
reasonable financial knowledge.
Comparability allows for meaningful comparisons to financial
statements of previous periods and other companies.

 Relevance useful for making predictions and confirming existing

expectations.
Reliability free from bias (neutral) and represents that which it
claims to represent (representational faithfulness).

Definition assets, liabilities, and other financial statement

elements are defined.

Recognition guidelines as to when to recognize revenues and

expenses.

Measurement various bases are allowed, historical cost, current

cost, realizable value, and present value.

Financial capital maintenance

One approach to income measurement.

Net income represents the increase in net financial assets,

excluding owner transactions.

The approach in U.S. GAAP.

Physical capital maintenance

Another approach to income measurement.
Net income represents increase in physical productive capacity.
Excluding owner transactions.
Requires current costs for measurement of certain physical assets.

Presentation of Financial Statements (IAS 1)

This standard provides guidance in the following areas

Purpose of financial statements to provide decision-useful

information.

Components of financial statements balance sheet, statements of

income, cash flows, changes in equity, and notes to the financial
statements.

Fair presentation the overriding principle of financial statement

presentation.

Accounting policies

Should be consistent with all IASB standards.

When specific guidance is lacking, use standards on similar issues,

and definitions of the financial statement elements.

Basic principles and assumptions

Reiteration of underlying assumptions.

Accrual basis/going concern/comparability.

Structure and Content of Financial Statements

Provides information on presentation format:

Current/noncurrent.

Items to be included on face of financial statements.

Content of notes.
First Time Adoptions of IFRSs (IFRS 1)
Provides guidance for first time adoption.
Much used in 2005, particularly in EU.
Requires compliance with all effective IFRSs.
Allows exemptions when costs deemed to outweigh benefits.

Use of IFRSs
Evidence of support for IFRSs

Adoption by the EU public companies in the EU were required to

begin using IFRSs in 2005.

IOSCO has endorsed IFRSs for cross-listings.

Many developing nations have adopted IFRSs.

Some countries disallow IFRSs for domestic firms but allow

foreign companies to use them.

U.S. is a major exception, does not allow use of IFRSs.

IASB/FASB Convergence
The Norwalk Agreement
Reached in 2002 Between the IASB and FASB.
Is a promise of cooperation in standard-setting between the
International Accounting Standards Board (IASB) and the Financial
Accounting Standards Board (FASB).
IASB and FASB pledged to use there best effort to
1. make there existing financial reporting standards fully compatible
as soon as practicable .
2. to coordinate there work program to ensure that once achieved
compatibility is maintained
The Agreement Represents a significant step To work toward
accounting standards convergence to achieve international
harmonization..
IASB/FASB Convergence

1.
2.
3.
4.
5.
6.

The key initiatives in the Norwalk Agreement was 6 projects

Joint projects boards will work together to address some issues
(e.g., revenue recognition).
Short-term convergence the tow board agreed to undertake Shortterm project to remove differences between IFRSs and U.S. GAAP for
issues where convergence is deemed most likely.
IASB liaison IASB member in residence at FASB.
Monitoring IASB projects FASB monitors IASB projects of most
interest.
Convergence research project identification of all major differences
between IFRSs and U.S. GAAP.
Convergence potential FASB assesses agenda items for possible
cooperation with IASB.