CHAPTER 1

Financial Reporting and Accounting Standards

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

1 Describe the global financial markets and their relation to financial reporting.
2 Explain the objective of financial reporting.
3 Identify the major policy-setting bodies and their role in the standard-setting
process.
4 Discuss the challenges facing financial reporting.

PREVIEW OF CHAPTER 1

As the following opening story indicates, countries are moving quickly to adopt
International Financial Reporting Standards (IFRS). It is estimated that over 300
of the 500 largest global companies are using IFRS. However, the accounting
profession faces many challenges in establishing these standards, such as
developing a sound conceptual framework, use of fair value measurements,
proper consolidation of financial results, off-balance-sheet financing, and proper
accounting for leases and pensions. This chapter discusses the international
financial reporting environment and the many factors affecting it, as follows.
This chapter also includes numerous conceptual discussions that are
integral to the topics presented here.

Revolution in International Financial Reporting

The age of free trade and the interdependence of national economies is now with us.
Many of the largest companies in the world often do more of their business in foreign
lands than in their home country. Companies now access not only their home capital
markets for financing but others as well. As this globalization takes place, companies
are recognizing the need to have one set of financial reporting standards. For
globalization to be efficient, what is reported for a transaction in Beijing should be
reported the same way in Paris, New York, or London.
A revolution is therefore occurring in financial reporting. In the past, many countries
used their own set of standards or followed standards set by larger countries, such as
those in Europe or in the United States. However, that situation is changing rapidly. A
single set of rules, called International Financial Reporting Standards (IFRS), is now
being used by over 149 jurisdictions (similar to countries). Here is what some are
saying about IFRS.
• “The global financial crisis that began in 2007 and continues today provides a very
clear illustration of the globally connected nature of financial markets and the
pressing need for a single set of high quality global accounting standards. That is
why the G20 … has supported the work of the IASB and called for a rapid move
towards global accounting.” [Michael Prada, chairman of the IFRS Foundation.]
• “Large multi-national companies stand to realize great benefits from a move to a
single set of standards. Companies will have more streamlined IT, easier training,
and there will be better communication with outside parties. In fact, the move to
IFRS is not so much about the accounting but about the economics of a shrinking
world.” [Sir David Tweedie, former chairman of the IASB.]
• “The added costs from having to use this complex hodgepodge (different country
reporting standards) of financial information can run in the tens of millions of
dollars annually. In the international arena, they can act as a barrier to forming and
allocating capital efficiently. Thus, there are growing demands for the development
of a single set of high quality international accounting standards.” [Robert Herz,
former chairman of the FASB.]
• “The current and growing breadth of IFRS adoption across the world suggests that
IFRS has become the most practical approach to achieving the objective of having
a single set of high-quality, generally accepted standards for financial reporting.
Those who share this belief are influenced by the fact that the IASB's structure and
due-process procedures are open, accessible, responsive, and marked by
extensive consultation.” [KPMG Defining Issues.]
• “Developments such as the shocks of the Asian financial crisis, the Enron and
WorldCom scandals, and Europe's creation of a unified financial market helped
build consensus for global accounting standards. Every relevant international
organization has expressed its support for our work to develop a global language
for financial reporting.” [Hans Hoogervorst, chairman of the IASB, June 2013.]
What these statements suggest is that the international standard-setting process is
rapidly changing. And with these changes, it is hoped that a more effective system of
reporting will develop, which will benefit all.
 Review and Practice

Go to the REVIEW AND PRACTICE section at the end of the chapter for a
targeted summary review and practice problem with solution. Multiple-choice
questions with annotated solutions as well as additional exercises and practice
problem with solutions are also available online.

Global Markets

LEARNING OBJECTIVE 1

Describe the global financial markets and their relation to financial reporting.

World markets are becoming increasingly intertwined. International consumers drive

Japanese cars, wear Italian shoes and Scottish woolens, drink Brazilian coffee and
Indian tea, eat Swiss chocolate bars, sit on Danish furniture, watch U.S. movies, and
use Arabian oil. The tremendous variety and volume of both exported and imported
goods indicates the extensive involvement in international trade—for many
companies, the world is their market.
To provide some indication of the extent of globalization of economic activity,
Illustration 1.1 provides a listing of the top 20 global companies in terms of sales.
ILLUSTRATION 1.1 Top 20 Global Companies in Terms of Sales
Rank Company Country Revenues ($
millions)
1 Walmart U.S. 482,130
2 State Grid China 329,601
3 China National Petroleum China 299,271
4 Sinopec Group China 294,344
5 Royal Dutch Shell Netherlands 272,156
6 ExxonMobil U.S. 246,204
7 Volkswagen Germany 236,600
8 Toyota Motor Japan 236,592
9 Apple U.S. 233,715
10 BP Britain 225,982
11 Berkshire Hathaway U.S. 210,821
12 McKesson U.S. 192,487
13 Samsung Electronics South 177,440
Korea
14 Glencore Switzerland 170,497
15 Industrial & Commercial Bank of China 167,227
China
16 Daimler Germany 165,800
17 United Health Group U.S. 157,107
18 CVS Health U.S. 153,290
19 EXOR Group Italy 152,591
20 General Motors U.S. 152,356
Source: Source: http://beta.fortune.com/global500..
In addition, due to technological advances and less onerous regulatory requirements,
investors are able to engage in financial transactions across national borders and to
make investment, capital allocation, and financing decisions involving many foreign
companies. Also, many investors, in attempts to diversify their portfolio risk, have
invested more heavily in international markets. As a result, an increasing number of
investors are holding securities of foreign companies. For example, over a recent
seven-year period, estimated investments in foreign equity securities by U.S. investors
increased over 20-fold, from $200 billion to $4,200 billion.
An indication of the significance of these international investment opportunities can be
found when examining the number of foreign registrations on various securities
exchanges. As shown in Illustration 1.2, a significant number of foreign companies are
found on national exchanges.
ILLUSTRATION 1.2 International Exchange Statistics
Exchange Market Total Domestic Foreign Foreign
(Location) Capitalization ($ Listings Listings Listings %
millions)
NYSE (U.S.) 19,009,042 2,322 1,834 488 21.0
Nasdaq (U.S.) 7,549,892 2,871 2,489 382 13.3
Japan Exchange 4,967,989 3,525 3,517 8 0.2
Group
London Stock 3,612,520 2,622 2,131 491 18.7
Exchange Group
Euronext 3,425,104 1,057 938 119 11.3
Deutsche Börse 1,682,370 599 538 61 10.2
(Germany)
SIX Swiss 1,458,721 266 230 36 13.5
Exchange
Korea Exchange 1,344,266 2,008 1,992 16 0.8
Nasdaq Nordic 1,282,556 848 813 35 4.1
Exchanges
Australian 1,276,494 2,068 1,947 121 5.9
Securities
Exchange
Johannesburg 1,036,306 377 306 71 18.8
Stock Exchange
Taiwan Stock 843,133 901 826 75 8.3
Exchange Corp.
BM&F Bovespa 752,694 352 341 11 3.1
(Brazil)
BME Spanish 701,756 3,553 3,526 27 0.8
Exchanges
Singapore 668,022 767 484 283 36.9
Exchange
Source: Focus: The Monthly Newsletter of Regulated Exchanges (September 2016).
As indicated, capital markets are increasingly integrated and companies have greater
flexibility in deciding where to raise capital. In the absence of market integration, there
can be company-specific factors that make it cheaper to raise capital and list/trade
securities in one location versus another. With the integration of capital markets, the
automatic linkage between the location of the company and location of the capital
market is loosening. As a result, companies have expanded choices of where to raise
capital, either equity or debt. The move toward adoption of global accounting
standards has and will continue to facilitate this trend.
Financial Statements and Financial Reporting

Accounting is the universal language of business. One noted economist and politician
indicated that the single-most important innovation shaping capital markets was the
development of sound accounting principles. The essential characteristics of
accounting are (1) the identification, measurement, and communication of financial
information about (2) economic entities to (3) interested parties. Financial
accounting is the process that culminates in the preparation of financial reports on
the enterprise for use by both internal and external parties. Users of these financial
reports include investors, creditors, managers, unions, and government agencies. In
contrast, managerial accounting is the process of identifying, measuring, analyzing,
and communicating financial information needed by management to plan, control, and
evaluate a company's operations.
Financial statements are the principal means through which a company communicates
its financial information to those outside it. These statements provide a company's
history quantified in money terms. The financial statements most frequently provided
are (1) the statement of financial position, (2) the income statement (or statement of
comprehensive income), (3) the statement of cash flows, and (4) the statement of
changes in equity. Note disclosures are an integral part of each financial statement.
Some financial information is better provided, or can be provided only, by means of
financial reporting other than formal financial statements. Examples include the
president's letter or supplementary schedules in the company annual report,
prospectuses, reports filed with government agencies, news releases, management's
forecasts, and social or environmental impact statements. Companies may need to
provide such information because of authoritative pronouncements, regulatory rule, or
custom. Or, they may supply it because management wishes to disclose it voluntarily.
In this textbook, we focus on the development of two types of financial information: (1)
the basic financial statements and (2) related disclosures.

Accounting and Capital Allocation

Resources are limited. As a result, people try to conserve them and ensure that they
are used effectively. Efficient use of resources often determines whether a business
thrives. This fact places a substantial burden on the accounting profession.
Accountants must measure performance accurately and fairly on a timely basis, so
that the right managers and companies are able to attract investment capital. For
example, relevant financial information that faithfully represents financial results allows
investors and creditors to compare the income and assets employed by such
companies as Nokia (FIN), McDonald's (USA), Air China Ltd. (CHN), and Toyota
Motor (JPN). Because these users can assess the relative return and risks associated
with investment opportunities, they channel resources more effectively. Illustration 1.3
shows how this process of capital allocation works.
ILLUSTRATION 1.3 Capital Allocation Process

An effective process of capital allocation is critical to a healthy economy. It promotes

productivity, encourages innovation, and provides an efficient and liquid market for
buying and selling securities and obtaining and granting credit. Unreliable and
irrelevant information leads to poor capital allocation, which adversely affects the
securities markets.

High-Quality Standards

To facilitate efficient capital allocation, investors need relevant information and a

faithful representation of that information to enable them to make comparisons across
borders. For example, assume that you were interested in investing in the
telecommunications industry. Four of the largest telecommunications companies in the
world are Nippon Telegraph and Telephone (JPN), Deutsche Telekom (DEU),
Telefonica (ESP and PRT), and AT&T (USA). How do you decide which, if any, of
these telecommunications companies you should invest in? How do you compare, for
example, a Japanese company like Nippon Telegraph and Telephone with a German
company like Deutsche Telekom?
A single, widely accepted set of high-quality accounting standards is a necessity to
ensure adequate comparability. Investors are able to make better investment
decisions if they receive financial information from Nippon Telegraph and Telephone
that is comparable with Deutsche Telekom. Globalization demands a single set of
high-quality international accounting standards. But how is this to be achieved? Here
are some elements:
1. Single set of high-quality accounting standards established by a single standard-
setting body.
2. Consistency in application and interpretation.
3. Common disclosures.
4. Common high-quality auditing standards and practices.
5. Common approach to regulatory review and enforcement.
6. Education and training of market participants.
7. Common delivery systems (e.g., eXtensible Business Reporting Language—XBRL).
8. Common approach to company governance and legal frameworks around the
world.1
Fortunately, as indicated in the opening story, significant changes in the financial
reporting environment are taking place, which hopefully will lead to a single, widely
accepted set of high-quality accounting standards. The major standard-setters of the
world, coupled with regulatory authorities, now recognize that capital formation and
investor understanding are enhanced if a single set of high-quality accounting
standards is developed.

Objective of Financial Reporting

LEARNING OBJECTIVE 2

Explain the objective of financial reporting.

What is the objective (or purpose) of financial reporting? The objective of general-
purpose financial reporting is to provide financial information about the reporting
entity that is useful to present and potential equity investors, lenders, and other
creditors in making decisions about providing resources to the entity. Those
decisions involve buying, selling, or holding equity and debt instruments, and providing
or settling loans and other forms of credit. [1] (See the Authoritative Literature
References section near the end of the chapter.) Information that is decision-useful to
capital providers (investors) may also be useful to other users of financial reporting
who are not investors. Let's examine each of the elements of this objective.

General-Purpose Financial Statements

General-purpose financial statements provide financial reporting information to a

wide variety of users. For example, when Nestlé (CHE) issues its financial
statements, these statements help shareholders, creditors, suppliers, employees, and
regulators to better understand its financial position and related performance. Nestlé's
users need this type of information to make effective decisions. To be cost-effective in
providing this information, general-purpose financial statements are most appropriate.
In other words, general-purpose financial statements provide at the least cost the
most useful information possible.

Equity Investors and Creditors

The objective of financial reporting identifies investors and creditors as the primary
user group for general-purpose financial statements. Identifying investors and
creditors as the primary user group provides an important focus of general-purpose
financial reporting. For example, when Nestlé issues its financial statements, its
primary focus is on investors and creditors because they have the most critical and
immediate need for information in financial reports. Investors and creditors need this
financial information to assess Nestlé's ability to generate net cash inflows and to
understand management's ability to protect and enhance the assets of the company,
which will be used to generate future net cash inflows. As a result, the primary user
groups are not management, regulators, or some other non-investor group.
 What Do the Numbers Mean?

Don't Forget Stewardship

In addition to providing decision-useful information about future cash flows,

management also is accountable to investors for the custody and safekeeping of
the company's economic resources and for their efficient and profitable use. For
example, the management of Nestlé has the responsibility of protecting its
economic resources from unfavorable effects of economic factors, such as price
changes, and technological and social changes. Because Nestlé's performance in
discharging its responsibilities (referred to as its stewardship responsibilities)
usually affects its ability to generate net cash inflows, financial reporting may also
provide decision-useful information to assess management performance in this
role. [2]

Entity Perspective

As part of the objective of general-purpose financial reporting, an entity perspective

is adopted. Companies are viewed as separate and distinct from their owners (present
shareholders) using this perspective. The assets of Nestlé are viewed as assets of the
company and not of a specific creditor or shareholder. Rather, these investors have
claims on Nestlé's assets in the form of liability or equity claims. The entity perspective
is consistent with the present business environment where most companies engaged
in financial reporting have substance distinct from their investors (both shareholders
and creditors). Thus, a perspective that financial reporting should be focused only on
the needs of shareholders—often referred to as the proprietary perspective—is not
considered appropriate.

Decision-Usefulness

Investors are interested in financial reporting because it provides information that is

useful for making decisions (referred to as the decision-usefulness approach). As
indicated earlier, when making these decisions, investors are interested in assessing
(1) the company's ability to generate net cash inflows and (2) management's ability to
protect and enhance the capital providers' investments. Financial reporting should
therefore help investors assess the amounts, timing, and uncertainty of prospective
cash inflows from dividends or interest, and the proceeds from the sale, redemption,
or maturity of securities or loans. In order for investors to make these assessments,
the economic resources of an enterprise, the claims to those resources, and the
changes in them must be understood. Financial statements and related explanations
should be a primary source for determining this information.
The emphasis on “assessing cash flow prospects” does not mean that the cash basis
is preferred over the accrual basis of accounting. Information based on accrual
accounting generally better indicates a company's present and continuing ability to
generate favorable cash flows than does information limited to the financial effects of
cash receipts and payments.
Recall from your first accounting course the objective of accrual-basis accounting: It
ensures that a company records events that change its financial statements in the
periods in which the events occur, rather than only in the periods in which it receives
or pays cash. Using the accrual basis to determine net income means that a company
recognizes revenues when it provides the goods or performs the services (that is,
satisfies its performance obligation) rather than when it receives cash. Similarly, it
recognizes expenses when it incurs them rather than when it pays them. Under
accrual accounting, a company generally recognizes revenues when it makes sales.
The company can then relate the revenues to the economic environment of the period
in which they occurred. Over the long run, trends in revenues and expenses are
generally more meaningful than trends in cash receipts and disbursements.2

Standard-Setting Organizations

LEARNING OBJECTIVE 3

Identify the major policy-setting bodies and their role in the standard-setting
process.

For many years, many nations have relied on their own standard-setting
organizations. For example, Canada has the Accounting Standards Board, Japan has
the Accounting Standards Board of Japan, Germany has the German Accounting
Standards Committee, and the United States has the Financial Accounting Standards
Board (FASB). The standards issued by these organizations are sometimes
principles-based, rules-based, tax-oriented, or business-based. In other words, they
often differ in concept and objective.
The main international standard-setting organization is based in London, United
Kingdom, and is called the International Accounting Standards Board (IASB). The
IASB issues International Financial Reporting Standards (IFRS), which are used
on most foreign exchanges. As indicated earlier, IFRS is presently used or permitted
in over 149 jurisdictions (similar to countries) and is rapidly gaining acceptance in
other countries as well.
IFRS has the best potential to provide a common platform on which companies can
report and investors can compare financial information. As a result, our discussion
focuses on IFRS and the organization involved in developing these standards—the
International Accounting Standards Board (IASB). The two organizations that have a
role in international standard-setting are the International Organization of Securities
Commissions (IOSCO) and the IASB.

International Organization of Securities Commissions (IOSCO)

The International Organization of Securities Commissions (IOSCO) is an

association of organizations that regulate the world's securities and futures markets.
Members are generally the main financial regulator for a given country. IOSCO does
not set accounting standards. Instead, this organization is dedicated to ensuring that
the global markets can operate in an efficient and effective basis. The member
agencies (such as from France, Germany, New Zealand, and the United States) have
resolved to:
• Cooperate together to promote high standards of regulation in order to maintain
just, efficient, and sound markets.
• Exchange information on their respective experiences in order to promote the
development of domestic markets.
• Unite their efforts to establish standards and an effective surveillance of
international securities transactions.
• Provide mutual assistance to promote the integrity of the markets by a rigorous
application of the standards and by effective enforcement against offenses.
IOSCO supports the development and use of IFRS as the single set of high-quality
international standards in cross-border offerings and listings. It recommends that its
members allow multinational issuers to use IFRS in cross-border offerings and listings,
as supplemented by reconciliation, disclosure, and interpretation where necessary to
address outstanding substantive issues at a national or regional level. (For more
information, go to http://www.iosco.org/.)
 What Do the Numbers Mean?

How Is It Going?

How much progress has been made toward the goal of one single set of global
accounting standards? Recent surveys indicate that there is almost universal
support (94 percent) for IFRS as the single set of global accounting standards.
This includes those jurisdictions that have yet to make a decision on adopting
IFRS, such as the United States.
More than 83 percent of the jurisdictions report IFRS adoption for all (or in five
cases, almost all) public companies. Most of the remaining eight non-adopters
have made significant progress toward IFRS adoption. In addition, those
jurisdictions that have adopted IFRS have made very few modifications to the
standards. More than 40 percent of the IFRS adopters do so automatically,
without an endorsement process. Moreover, where modifications have occurred,
they are regarded as temporary arrangements to assist in the migration from
national accounting standards to IFRS. It is expected that most of these
transitional adjustments will ultimately disappear.
Admittedly, a few large and important economies have not yet (fully) adopted
IFRS. But even in such countries, more progress is being made than many people
are aware of. Japan already permits the use of full IFRS and has recently
widened the scope of companies that are allowed to adopt it. In the United States,
non-U.S. companies are allowed to use IFRS for listings on their exchanges.
Today, nearly 500 foreign private issuers are reporting using IFRS in U.S.
regulatory filings, which represents trillions of dollars in market capitalization. In
short, much progress has been made by countries in using IFRS.

Source: Adapted from Hans Hoogervorst, “Breaking the Boilerplate,” IFRS Foundation
Conference (June 13, 2013); and P. Pacter, “Pocket Guide to IFRS Standards: The
Global Financial Reporting Language,” http://www.ifrs.org/Use-around-the-
world/Documents/2016-pocketguide.pdf.

International Accounting Standards Board (IASB)

The standard-setting structure internationally is composed of the following four

organizations:
1. The IFRS Foundation provides oversight to the IASB, IFRS Advisory Council, and
IFRS Interpretations Committee. In this role, it appoints members, reviews
effectiveness, and helps in the fundraising efforts for these organizations.
2. The International Accounting Standards Board (IASB) develops, in the public
interest, a single set of high-quality, enforceable, and global international financial
reporting standards for general-purpose financial statements.3
3. The IFRS Advisory Council (the Advisory Council) provides advice and counsel
to the IASB on major policies and technical issues.
4. The IFRS Interpretations Committee assists the IASB through the timely
identification, discussion, and resolution of financial reporting issues within the
framework of IFRS.
In addition, as part of the governance structure, a Monitoring Board was created.
The purpose of this board is to establish a link between accounting standard-setters
and those public authorities (e.g., IOSCO) that generally oversee them. The
Monitoring Board also provides political legitimacy to the overall organization.
Illustration 1.4 shows the organizational structure for the setting of international
accounting standards.
ILLUSTRATION 1.4 International Standard-Setting Structure

Due Process

In establishing financial accounting standards, the IASB has a thorough, open, and
transparent due process. The IASB due process has the following elements: (1) an
independent standard-setting board overseen by a geographically and professionally
diverse body of trustees; (2) a thorough and systematic process for developing
standards; (3) engagement with investors, regulators, business leaders, and the global
accountancy profession at every stage of the process; and (4) collaborative efforts
with the worldwide standard-setting community.
To implement its due process, the IASB follows specific steps to develop a typical
IFRS, as Illustration 1.5 shows.
ILLUSTRATION 1.5 IASB Due Process

Furthermore, the characteristics of the IASB, as shown below, reinforce the

importance of an open, transparent, and independent due process.
• Membership. The Board consists of 13 full-time members. Members are well-paid,
appointed for five-year renewable terms, and come from different countries.4
• Autonomy. The IASB is not part of any other professional organization. It is
appointed by and answerable only to the IFRS Foundation.
• Independence. Full-time IASB members must sever all ties from their past
employer. The members are selected for their expertise in standard-setting rather
than to represent a given country.
• Voting. Seven of 13 votes are needed to issue a new IFRS.
With these characteristics, the IASB and its members will be insulated as much as
possible from the political process, favored industries, and national or cultural bias.

Types of Pronouncements

The IASB issues three major types of pronouncements:

1. International Financial Reporting Standards.
2. Conceptual Framework for Financial Reporting.
3. International Financial Reporting Standards Interpretations.

International Financial Reporting Standards.

Financial accounting standards issued by the IASB are referred to as International

Financial Reporting Standards (IFRS). The IASB has issued 17 of these standards to
date, covering such subjects as business combinations, share-based payments, and
leases.

Prior to the IASB (formed in 2001), standard-setting on the international level was
done by the International Accounting Standards Committee, which issued International
Accounting Standards (IAS). The committee issued 41 IASs, many of which have
been amended or superseded by the IASB. Those still remaining are considered
under the umbrella of IFRS.

Conceptual Framework for Financial Reporting.

As part of a long-range effort to move away from the problem-by-problem approach,

the IASB uses an IFRS conceptual framework. This Conceptual Framework for
Financial Reporting sets forth the fundamental objective and concepts that the Board
uses in developing future standards of financial reporting. The intent of the document
is to form a cohesive set of interrelated concepts—a conceptual framework—that will
serve as tools for solving existing and emerging problems in a consistent manner. For
example, the objective of general-purpose financial reporting discussed earlier is part
of this Conceptual Framework. The Conceptual Framework and any changes to it
pass through the same due process (preliminary views, public hearing, exposure draft,
etc.) as an IFRS. However, this Conceptual Framework is not an IFRS and hence
does not define standards for any particular measurement or disclosure issue. Nothing
in this Conceptual Framework overrides any specific international accounting
standard. The Conceptual Framework is discussed more fully in Chapter 2.

International Financial Reporting Standards Interpretations.

Interpretations issued by the IFRS Interpretations Committee are also considered

authoritative and must be followed. These interpretations cover (1) newly identified
financial reporting issues not specifically dealt with in IFRS and (2) issues where
unsatisfactory or conflicting interpretations have developed, or seem likely to develop,
in the absence of authoritative guidance. The IFRS Interpretations Committee has
issued over 20 of these interpretations to date.

In keeping with the IASB's own approach to setting standards, the IFRS
Interpretations Committee applies a principles-based approach in providing
interpretative guidance. To this end, the IFRS Interpretations Committee looks first to
the Conceptual Framework as the foundation for formulating a consensus. It then
looks to the principles articulated in the applicable standard, if any, to develop its
interpretative guidance and to determine that the proposed guidance does not conflict
with provisions in IFRS.
The IFRS Interpretations Committee helps the IASB in many ways. For example,
emerging issues often attract public attention. If not resolved quickly, these issues can
lead to financial crises and scandal. They can also undercut public confidence in
current reporting practices. The next step, possible governmental intervention, would
threaten the continuance of standard-setting in the private sector. The IFRS
Interpretations Committee can address controversial accounting problems as they
arise. It determines whether it can resolve them or whether to involve the IASB in
solving them. In essence, it becomes a “problem filter” for the IASB. Thus, the IASB
will hopefully work on more pervasive long-term problems, while the IFRS
Interpretations Committee deals with short-term emerging issues.

Hierarchy of IFRS

Because it is a private organization, the IASB has no regulatory mandate and

therefore no enforcement mechanism. As a result, the Board relies on other regulators
to enforce the use of its standards. For example, the European Union requires publicly
traded member country companies to use IFRS.
Any company indicating that it is preparing its financial statements in conformity with
IFRS must use all of the standards and interpretations. The following hierarchy is
used to determine what recognition, valuation, and disclosure requirements should be
used. Companies first look to:
1. International Financial Reporting Standards, International Accounting Standards
(issued by the predecessor to the IASB), and IFRS interpretations originated by the
IFRS Interpretations Committee (and its predecessor, the IAS Interpretations
Committee);
2. The Conceptual Framework for Financial Reporting; and
3. Pronouncements of other standard-setting bodies that use a similar conceptual
framework (e.g., U.S. GAAP).
In the absence of a standard or an interpretation in item 1 above, companies look to
the Conceptual Framework for Financial Reporting and then to most recent
pronouncements of other standard-setting bodies that use a similar conceptual
framework to develop accounting standards (or other accounting literature and
accepted industry practices to the extent they do not conflict with the above). The
overriding requirement of IFRS is that the financial statements provide a fair
presentation (often referred to as a “true and fair view”). Fair representation is
assumed to occur if a company follows the guidelines established in IFRS.5 [3]

Financial Reporting Challenges

LEARNING OBJECTIVE 4

Discuss the challenges facing financial reporting.

Much is right about international financial reporting. One reason for this success is that
financial statements and related disclosures capture and organize financial information
in a useful and reliable fashion. However, much still needs to be done. Here are some
of the major challenges.

IFRS in a Political Environment

User groups are possibly the most powerful force influencing the development of
IFRS. User groups consist of those most interested in or affected by accounting rules.
Various participants in the financial reporting environment may want particular
economic events accounted for or reported in a particular way, and they fight hard to
get what they want. They know that the most effective way to influence IFRS is to
participate in the formulation of these rules or to try to influence or persuade the
formulators of them.6
These user groups often target the IASB, to pressure it to change the existing rules
and develop new ones. In fact, these pressures have been multiplying. Some
influential groups demand that the accounting profession act more quickly and
decisively to solve its problems. Other groups resist such action, preferring to
implement change more slowly, if at all. Illustration 1.6 shows the various user groups
that apply pressure.
ILLUSTRATION 1.6 User Groups that Influence the Formulation of Accounting Standards

Should there be politics in establishing IFRS for financial accounting and reporting?
Why not? We have politics at home, school, the office, church, temple, and mosque.
Politics is everywhere. IFRS is part of the real world, and it cannot escape politics and
political pressures.
That is not to say that politics in establishing IFRS is a negative force. Considering the
economic consequences of many accounting rules, special interest groups are
expected to vocalize their reactions to proposed rules.7 What the Board should not do
is issue standards that are primarily politically motivated. While paying attention to its
constituencies, the Board should base IFRS on sound research and a conceptual
framework that has its foundation in economic reality.
 What Do the Numbers Mean?

Fair Consequences?

No recent accounting issue better illustrates the economic consequences of

accounting than the current debate over the use of fair value accounting for
financial assets. The IASB has had long-standing standards requiring the use of
fair value accounting for financial assets, such as investments and other financial
instruments. Fair value provides the most relevant and reliable information for
investors about these assets and liabilities. However, in the wake of the credit
crisis of 2008, some countries, their central banks, and bank regulators wanted to
suspend fair value accounting based on concerns that use of fair value
accounting, which calls for recording significant losses on poorly performing loans
and investments, would scare investors and depositors and lead to a “run on the
bank.”
Most notable was the lobbying of then French President Nicolas Sarkozy in urging
his European Union counterparts to back changes to accounting rules and give
banks and insurers some breathing space amid the market turmoil. Mr. Sarkozy
sought agreement to new regulations, including changes to the mark-to-market
accounting rules that have been blamed for aggravating the crisis. International
regulators also have conducted studies of fair value accounting and its role in the
credit crisis. It is clear that political pressure affected the final standard on
financial instruments. The new standard (issued in 2016) permits companies to
use amortized cost instead of fair value for held-for-collection financial assets. The
amortized cost approach was favored by financial institutions with substantial
portfolios of held-for-collection financial assets. These financial institutions applied
much pressure on regulators, noting the dire economic consequences that might
follow if they had to use fair value in reporting on these financial assets. In short,
numbers have consequences.

Source: Adapted from Ben Hall and Nikki Tait, “Sarkozy Seeks EU Accounting
Change,” The Financial Times Limited (September 30, 2008).

The Expectations Gap

Accounting scandals at companies like Parmalat (ITA) and Siemens (DEU) have
attracted the attention of regulators, investors, and the general public. Due to the size
and the number of fraudulent reporting cases, some question whether the accounting
profession is doing enough. The expectations gap—what the public thinks
accountants should do and what accountants think they can do—is difficult to close.
Although the profession can argue rightfully that accounting cannot be responsible for
every financial catastrophe, it must continue to strive to meet the needs of society.
However, efforts to meet these needs will become more costly to society. The
development of highly transparent, clear, and reliable systems to meet public
expectations requires considerable resources.
Significant Financial Reporting Issues

While our reporting model has worked well in capturing and organizing financial
information in a useful and reliable fashion, much still needs to be done. For example,
if we would move ahead to the year 2025 and look back at financial reporting today,
we might read the following.
• Non-financial measurements. Financial reports failed to provide some key
performance measures widely used by management, such as customer
satisfaction indexes, backlog information, and reject rates on goods purchased.
• Forward-looking information. Financial reports failed to provide forward-looking
information needed by present and potential investors and creditors. One individual
noted that financial statements in 2018 should have started with the phrase, “Once
upon a time,” to signify their use of historical cost and accumulation of past events.
• Soft assets. Financial reports focused on hard assets (inventory, plant assets) but
failed to provide much information about a company's soft assets (intangibles). The
most valuable assets are often intangible. Consider Sony's (JPN) expertise in
electronics and Ikea's (NLD) brand image.
• Timeliness. Companies only prepared financial statements quarterly and provided
audited financials annually. Little to no real-time financial statement information
was available.
We believe each of these challenges must be met for the accounting profession to
provide the type of information needed for an efficient capital allocation process. We
are confident that changes will occur, based on these positive signs:
• Already, some companies voluntarily disclose information deemed relevant to
investors. Often such information is non-financial. For example, banking
companies now disclose data on loan growth, credit quality, fee income, operating
efficiency, capital management, and management strategy.
• Initially, companies used the Internet to provide limited financial data. Now, most
companies publish their annual reports in several formats on the Web. The most
innovative companies offer sections of their annual reports in a format that the user
can readily manipulate, such as in an electronic spreadsheet format. Companies
also format their financial reports using eXtensible Business Reporting Language
(XBRL), which permits quicker and lower-cost access to companies' financial
information.
• More accounting standards now require the recording or disclosing of fair value
information. For example, companies either record investments in shares and
bonds, debt obligations, and derivatives at fair value, or companies show
information related to fair values in the notes to the financial statements.
Changes in these directions will enhance the relevance of financial reporting and
provide useful information to financial statement readers.

Ethics in the Environment of Financial Accounting

A noted commentator on the subject of accounting ethics observed, “Based on my

experience, new graduates tend to be idealistic … thank goodness for that! Still it is
very dangerous to think that your armor is all in place and say to yourself, ‘I would
have never given in to that.’ The pressures don't explode on us; they build, and we
often don't recognize them until they have us.” These observations are particularly
appropriate for anyone entering the business world.
In accounting, as in other areas of business, we frequently encounter ethical
dilemmas. Some of these dilemmas are simple and easy to resolve. However, many
are not, requiring difficult choices among allowable alternatives. Companies that
concentrate on “maximizing the bottom line,” “facing the challenges of competition,”
and “stressing short-term results” place accountants in an environment of conflict and
pressure. Basic questions such as, “Is this way of communicating financial information
good or bad?” “Is it right or wrong?” and “What should I do in the circumstance?”
cannot always be answered by simply adhering to IFRS or following the rules of the
profession. Technical competence is not enough when encountering ethical decisions.
Doing the right thing is not always easy or obvious. The pressures “to bend the rules,”
“to play the game,” or “to just ignore it” can be considerable. For example, “Will my
decision affect my job performance negatively?” “Will my superiors be upset?” or “Will
my colleagues be unhappy with me?” are often questions businesspeople face in
making a tough ethical decision. The decision is more difficult because there is no
comprehensive ethical system to provide guidelines. Time, job, client, personal, and
peer pressures can complicate the process of ethical sensitivity and selection among
alternatives. Throughout this textbook, we present ethical considerations to help
sensitize you to the type of situations you may encounter in the performance of your
professional responsibility.

International Convergence

As discussed in the opening story, convergence to a single set of high-quality financial

reporting standards is desirable. Here are some examples of how convergence is
occurring:
1. China is reforming its financial reporting system through an approach called a
continuous convergence process. The goal is to eliminate differences between its
standards and IFRS.
2. Japan now permits the use of IFRS for domestic companies. The number of
companies electing to use IFRS is expected to increase substantially in the near
future.
3. The IASB and the FASB (of the United States) have spent the last 16 years working
to converge their standards. The two Boards just issued new standards on revenue
recognition, financial instruments, and lease accounting. Although the IASB and
FASB standards in these three areas are similar, there are significant differences
as well.8
4. Recently, Malaysia was instrumental in helping to amend the accounting for
agricultural assets.
5. Italy's standard-setting group has provided advice and counsel on the accounting
for business combinations under common control.
In addition, U.S. and European regulators have agreed to recognize each other's
standards for listing on the various world securities exchanges. As a result, costly
reconciliation requirements have been eliminated and hopefully will lead to greater
comparability and transparency. Because international accounting issues are so
important, we provide in each chapter of this textbook Global Accounting Insights,
which highlight non-IFRS standards, mostly those from the United States. This feature
will help you to understand the changes that are taking place in the financial reporting
area as we move toward converged global accounting standards.

What Do the Numbers Mean?

Can You Do That?

One of the more difficult issues related to convergence and international

accounting standards is that countries have diff erent cultures and customs. For
example, the former chair of the IASB explained it this way regarding Europe:
“In the U.K. everything is permitted unless it is prohibited. In Germany, it is the
other way around; everything is prohibited unless it is permitted. In the
Netherlands, everything is prohibited even if it is permitted. And in France,
everything is permitted even if it is prohibited. Add in countries like Japan, the
United States, and China, it becomes very difficult to meet the needs of each of
these countries.”
With this diversity of thinking around the world, it understandable why accounting
convergence has been so elusive.

Source: Sir D. Tweedie, “Remarks at the Robert P. Maxon Lectureship,” George

Washington University (April 7, 2010).

Conclusion

International convergence is underway. Many projects already are completed and

differences eliminated. Others are on the drawing board. However, as one
international regulator indicates, “the ultimate question remains whether IFRS will in
fact function as the single set of high-quality, global accounting standards that the
world has been seeking for so long. At least, when it comes to satisfying investors'
concerns, there is no question of the attractiveness of the promise of a truly global
accounting standard. The only real question is not whether this is good for investors,
but how quickly both the accounting standards and the process by which they are
established and developed can be globally recognized as world-class.”

Review and Practice

Key Terms Review

accrual-basis accounting
 Conceptual Framework for Financial Reporting
decision-usefulness
due process
economic consequences
entity perspective
expectations gap
financial accounting
financial reporting
financial statements
general-purpose financial statements
hierarchy (of IFRS)
IFRS Advisory Council
IFRS Foundation
IFRS Interpretations Committee
International Accounting Standards Board (IASB)
International Financial Reporting Standards (IFRS)
International Organization of Securities Commissions (IOSCO)
interpretations
managerial accounting
Monitoring Board
objective of financial reporting

Learning Objectives Review

1 Describe the global financial markets and their relation to financial reporting.
World markets are becoming increasingly intertwined. With the integration of
capital markets, the automatic linkage between the location of the company and
the location of the capital market is loosening. As a result, companies have
expanded choices of where to raise capital, either equity or debt. The move toward
adoption of global accounting standards has and will continue to facilitate this
trend.
Financial statements and other means of financial reporting. Companies most
frequently provide (1) the statement of financial position, (2) the income statement
or statement of comprehensive income, (3) the statement of cash flows, and (4)
the statement of changes in equity. Financial reporting other than financial
statements may take various forms. Examples include the president's letter and
supplementary schedules in the company annual report, prospectuses, reports
filed with government agencies, news releases, management's forecasts, and
descriptions of a company's social or environmental impact.
Efficient use of scarce resources. Accounting provides reliable, relevant, and
timely information to managers, investors, and creditors to allow resource
allocation to the most efficient enterprises. Accounting also provides
measurements of efficiency (profitability) and financial soundness.
High-quality standards. A single, widely accepted set of high-quality accounting
standards is a necessity to ensure adequate comparability. Investors are
increasingly making investing decisions across international jurisdictions. As a
result, investors need financial information that is comparable across national
boundaries. But what are high-quality accounting standards, how should they be
developed, and how should they be enforced is still a much debated issue.
2 Explain the objective of financial reporting.
The objective of general-purpose financial reporting is to provide financial
information about the reporting entity that is useful to present and potential equity
investors, lenders, and other creditors in making decisions about providing
resources to the entity. Information that is decision-useful to investors may also be
useful to other users of financial reporting who are not investors.
3 Identify the major policy-setting bodies and their role in the standard-setting
process.
The International Organization of Securities Commissions (IOSCO) does not set
accounting standards but is dedicated to ensuring that the global markets can
operate in an efficient and effective manner. The International Accounting
Standards Board (IASB) is the leading international accounting standard-setting
organization. Its mission is to develop, in the public interest, a single set of high-
quality and understandable International Financial Reporting Standards (IFRS) for
general-purpose financial statements. Standards issued by the IASB have been
adopted by over 149 jurisdictions (similar to countries) worldwide, and all publicly
traded European companies must use IFRS.
IFRS is comprised of (a) International Financial Reporting Standards, (b)
International Accounting Standards, and (c) interpretations issued by the IFRS
Interpretations Committee or the former Standing Interpretations Committee (SIC).
In the absence of a standard or an interpretation, other accounting literature,
including that contained in the Conceptual Framework for Financial Reporting and
recent pronouncements of other standard-setting bodies that use a similar
conceptual framework, can be applied.
4 Discuss the challenges facing financial reporting.
Challenges include (1) IFRS in a political environment; (2) the expectations gap;
(3) financial reporting issues related to key performance measures widely used by
management, forward-looking information needed by investors and creditors,
sufficient information on a company's soft assets (intangibles), and real-time
financial information, including fair values; (4) ethics in accounting; and (5)
international convergence.
 Enhanced Review and Practice

Go online for multiple-choice questions with solutions, review exercises with

solutions, and a full glossary of all key terms.

Practice Problem
At the completion of Bloom NV's audit, the president, Judy Bloom, asks about the
meaning of the phrase “in conformity with IFRS” that appears in your audit report on
the management's financial statements. Judy observes that the meaning of the phrase
must include something more and different than what she thinks of as “standards.”
Judy is curious about the pronouncements that are encompassed in IFRS and
wonders, if there are different types of pronouncements, which are more authoritative
than others?

Instructions

a. Describe the pronouncements that comprise IFRS.

b. Explain to Judy how a company determines which type of pronouncement takes
precedence when deciding the recognition, valuation, and disclosure related to a
particular transaction.
 Solution

a. The IASB issues three major types of pronouncements:

1. International Financial Reporting Standards.
2. Conceptual Framework for Financial Reporting.
3. International Financial Reporting Standards Interpretations.
IASB standards are financial accounting standards issued by the IASB and
are referred to as International Financial Reporting Standards (IFRS). The
Conceptual Framework for Financial Reporting sets forth the fundamental
objective and concepts that the Board uses in developing accounting
standards that will serve as tools for solving existing and emerging problems
in a consistent manner.
b. The hierarchy of IFRS to determine what recognition, valuation, and disclosure
requirements should be used is:
1. International Financial Reporting Standards.
2. International Accounting Standards.
3. Interpretations from the International Financial Reporting Standards
Interpretations Committee.
Any company indicating that it is preparing its financial statements in
conformity with IFRS must comply with all these standards and
interpretations.

WileyPLUS

Many more assessment tools and resources are available for practice in
WileyPLUS.

Questions

1. What is happening to world markets, and what are the implications for financial
reporting?
2. Differentiate broadly between financial accounting and managerial accounting.
3. What are the major financial statements, and what is the difference between
financial statements and financial reporting?
4. How does accounting help in the capital allocation process?
5. What is the benefit of a single set of high-quality accounting standards?
6. What is the objective of financial reporting?
7. What is meant by general-purpose financial statements?
8. Who is the primary user group for general-purpose financial statements?
9. Comment on the following statement: A perspective that financial reporting should
be focused only on the needs of the shareholders—often referred to as the
proprietary perspective—is considered appropriate.
10. Comment on the following statement: The objective of financial reporting is
primarily to provide decision-useful information for assessing the performance of
management.
11. What are the two key organizations in the development of international accounting
standards? Explain their role.
12. What is IOSCO?
13. What is the mission of the IASB?
14. What is the purpose of the Monitoring Board?
15. How are IASB preliminary views and IASB exposure drafts related to IASB
standards?
16. Distinguish between IASB standards and the Conceptual Framework for Financial
Reporting.
17. Rank from most authoritative to least authoritative the following three items:
Conceptual Framework for Financial Reporting, International Financial Reporting
Standards, and International Financial Reporting Standards Interpretations.
18. Explain the role of the IFRS Interpretations Committee.
19. What are some of the major challenges facing the accounting profession?
20. What are the sources of pressure that change and influence the development of
IFRS?
21. Some individuals have indicated that the IASB must be cognizant of the economic
consequences of its pronouncements. What is meant by “economic
consequences”? What dangers exist if politics play too much of a role in the
development of IFRS?
22. If you were given complete authority in the matter, how would you propose that
IFRS should be developed and enforced?
23. One writer recently noted that a high percentage of all companies prepare
statements that are in accordance with IFRS. Why then is there such concern about
fraudulent financial reporting?
24. What is the “expectations gap”? What is the profession doing to try to close this
gap?
25. How are financial accountants challenged in their work to make ethical decisions?
Is technical mastery of IFRS not sufficient to the practice of financial accounting?

Concepts for Analysis

CA1.1 (LO3) (IFRS and Standard-Setting) Presented below are five statements that
you are to identify as true or false. If false, explain why the statement is incorrect.
1. IFRS is the term used to indicate the whole body of IASB authoritative literature.
2. Any company claiming compliance with IFRS must follow most standards and
interpretations but not the disclosure requirements.
3. The primary governmental body that has influence over the IASB is the IFRS
Advisory Council.
4. The overriding requirement of IFRS is for the financial statements to give a fair
presentation (or true and fair view).
5. The IASB has a government mandate and therefore does not have to follow due
process in issuing an IFRS.
CA1.2 (LO2,3) (IFRS and Standard-Setting) Presented below are four statements
that you are to identify as true or false. If false, explain why the statement is incorrect.
1. The objective of financial statements emphasizes a stewardship approach for
reporting financial information.
2. The objective of financial reporting is to prepare a statement of financial position, a
statement of comprehensive income, a statement of cash flows, and a statement of
changes in equity.
3. The difference between International Accounting Standards and IFRS is that
International Accounting Standards are more authoritative.
4. The objective of financial reporting uses an entity rather than a proprietary approach
in determining what information to report.
CA1.3 (LO2,3,4) (Financial Reporting and Accounting Standards) Answer the
following multiple-choice questions.
1. IFRS stands for:
a. International Federation of Reporting Services.
b. Independent Financial Reporting Standards.
c. International Financial Reporting Standards.
d. Integrated Financial Reporting Services.
2. The major key organizations on the international side are the:
a. IASB and IFRS Advisory Council.
b. IOSCO and the U.S. SEC.
c. London Stock Exchange and International Securities Exchange.
d. IASB and IOSCO.
3. Which governmental body is most influential in enforcing IFRS?
a. Monitoring Board.
b. IFRS Advisory Council.
c. IOSCO.
d. IFRS Foundation.
4. Accounting standard-setters use the following process in establishing international
standards:
 a. Research, exposure draft, discussion paper, standard.
b. Discussion paper, research, exposure draft, standard.
c. Research, preliminary views, discussion paper, standard.
d. Research, preliminary views, exposure draft, standard.
5. IFRS is comprised of:
a. International Financial Reporting Standards and FASB financial reporting
standards.
b. International Financial Reporting Standards, International Accounting
Standards, and International Accounting Standards Interpretations.
c. International Accounting Standards and International Accounting Standards
Interpretations.
d. FASB financial reporting standards and International Accounting Standards.
6. The authoritative status of the Conceptual Framework for Financial Reporting is as
follows:
a. It is used when there is no standard or interpretation related to the reporting
issues under consideration.
b. It is not as authoritative as a standard but takes precedence over any
interpretation related to the reporting issue.
c. It takes precedence over all other authoritative literature.
d. It has no authoritative status.
7. The objective of financial reporting places most emphasis on:
a. reporting to capital providers.
b. reporting on stewardship.
c. providing specific guidance related to specific needs.
d. providing information to individuals who are experts in the field.
8. General-purpose financial statements are prepared primarily for:
a. internal users.
b. external users.
c. auditors.
d. government regulators.
9. Economic consequences of accounting standard-setting means:
 a. standard-setters must give first priority to ensuring that companies do not suffer
any adverse effect as a result of a new standard.
b. standard-setters must ensure that no new costs are incurred when a new
standard is issued.
c. the objective of financial reporting should be politically motivated to ensure
acceptance by the general public.
d. accounting standards can have detrimental impacts on the wealth levels of the
providers of financial information.
10. The expectations gap is the difference between:
a. what financial information management provides and what users want.
b. what the public thinks accountants should do and what accountants think they
can do.
c. what the governmental agencies want from standard-setting and what the
standard-setters provide.
d. what the users of financial statements want from the government and what is
provided.
CA1.4 (LO1) (Financial Accounting) Omar Morena has recently completed his first
year of studying accounting. His instructor for next semester has indicated that the
primary focus will be the area of financial accounting.
Instructions

a. Differentiate between financial accounting and managerial accounting.

b. One part of financial accounting involves the preparation of financial
statements. What are the financial statements most frequently provided?
c. What is the difference between financial statements and financial reporting?
CA1.5 (LO3) (Need for IASB) Some argue that having various organizations
establish accounting principles is wasteful and inefficient. Rather than mandating
accounting rules, each company could voluntarily disclose the type of information it
considered important. In addition, if an investor wants additional information, the
investor could contact the company and pay to receive the additional information
desired.
Instructions

Comment on the appropriateness of this viewpoint.

CA1.6 (LO3) (IASB Role in Standard-Setting) A press release announcing the
appointment of the trustees of the new IFRS Foundation stated that the International
Accounting Standards Board (to be appointed by the trustees) “… will become the
established authority for setting accounting Standards.”
Instructions

a. Identify the sponsoring organization of the IASB and the process by which the
IASB arrives at a decision and issues an accounting standard.
b. Indicate the major types of pronouncements issued by the IASB and the
purposes of each of these pronouncements.
CA1.7 (LO4) (Accounting Numbers and the Environment) Hardly a day goes by
without an article appearing on the crises affecting many of our financial institutions. It
is estimated that the financial crisis of 2008, for example, caused a deep recession.
Some argue that if financial institutions had been required to report their investments
at fair value instead of cost, large losses would have been reported earlier, which
would have signaled regulators to close these financial institutions and, therefore,
minimize the losses to many investors.
Instructions

Explain how reported accounting numbers might affect an individual's perceptions and
actions. Cite two examples.
CA1.8 (LO3,4) (Politicization of IFRS) Some accountants have said that
politicization in the development and acceptance of International Financial Reporting
Standards (IFRS) is taking place. Some use the term “politicization” in a narrow sense
to mean the influence by governmental agencies, such as the European Union and
the U.S. Securities and Exchange Commission, on the development of IFRS. Others
use it more broadly to mean the compromise that results when the bodies responsible
for developing IFRS are pressured by interest groups, businesses through their
various organizations, financial analysts, bankers, lawyers, academics, auditors, and
so on.
Instructions

a. What arguments can be raised to support the “politicization” of accounting rule-

making?
b. What arguments can be raised against the “politicization” of accounting rule-
making?
CA1.9 (LO3) (Models for Setting IFRS) Presented below are three models for setting
IFRS.
1. The purely political approach, where national legislative action decrees IFRS.
2. The private, professional approach, where IFRS is set and enforced by private
professional actions only.
3. The public/private mixed approach, where IFRS is basically set by private-
sector bodies that behave as though they were public agencies and whose
standards to a great extent are enforced through governmental agencies.
Instructions

a. Which of these three models best describes international standard-setting?

Comment on your answer.
b. Why do companies, financial analysts, labor unions, industry trade
associations, and others take such an active interest in standard-setting?
CA1.10 (LO4) (Economic Consequences) Several years ago, then French President
Nicolas Sarkozy urged his European Union counterparts to put pressure on the IASB
to change accounting rules to give banks and insurers some relief from fair value
accounting rules amid market turmoil. Mr. Sarkozy sought changes to the mark-to-
market accounting rules that have been blamed for aggravating the crisis.
Instructions

Explain how government intervention could possibly affect capital markets adversely.
CA1.11 (LO3,4) (Rule-Making Issues) When the IASB issues new
pronouncements, the implementation date is usually delayed for several months from
date of issuance, with early implementation encouraged. Karen Weller, controller,
discusses with her financial vice president the need for early implementation of a rule
that would result in a fairer presentation of the company's financial condition and
earnings. When the financial vice president determines that early implementation of
the rule will adversely affect the reported net income for the year, he discourages
Weller from implementing the rule until it is required.
Instructions

Answer the following questions.

a. What, if any, is the ethical issue involved in this case?
b. Is the financial vice president acting improperly or immorally?
c. What does Weller have to gain by advocacy of early implementation?
d. Which stakeholders might be affected by the early implementation decision?
CA1.12 (LO4) (Financial Reporting Pressures) The following is abbreviated
testimony from Troy Normand in the WorldCom (USA) case. He was a manager in
the company reporting department and was one of five individuals who pleaded guilty.
He testified to avoid prison time.
Q. Mr. Normand, if you could just describe for the jury how the meeting started and
what was said during the meeting?
A. I can't recall exactly who initiated the discussion, but right away Scott Sullivan
acknowledged that he was aware we had problems with the entries, David Myers had
informed him, and we were considering resigning.
He said that he respected our concerns but that we weren't being asked to do
anything that he believed was wrong. He mentioned that he acknowledged that the
company had lost focus quite a bit due to the preparations for the Sprint merger, and
that he was putting plans in place and projects in place to try to determine where the
problems were, why the costs were so high.
He did say he believed that the initial statements that we produced, that the line costs
in those statements could not have been as high as they were, that he believes
something was wrong and there was no way that the costs were that high.
I informed him that I didn't believe the entry we were being asked to do was right, that
I was scared, and I didn't want to put myself in a position of going to jail for him or the
company. He responded that he didn't believe anything was wrong, nobody was going
to be going to jail, but that if it later was found to be wrong, that he would be the
person going to jail, not me.
He asked that I stay, don't jump off the plane, let him land it softly, that's basically how
he put it. And he mentioned that he had a discussion with Bernie Ebbers asking
Bernie to reduce projections going forward and that Bernie had refused.
Q. Mr. Normand, you said that Mr. Sullivan said something about don't jump out of the
plane. What did you understand him to mean when he said that?
A. Not to quit.
Q. During this meeting, did Mr. Sullivan say anything about whether you would be
asked to make entries like this in the future?
A. Yes, he made a comment that from that point going forward we wouldn't be asked
to record any entries, high-level late adjustments, that the numbers would be the
numbers.
Q. What did you understand that to be mean, the numbers would be the numbers?
A. That after the preliminary statements were issued, with the exception of any normal
transaction, valid transaction, we wouldn't be asked to be recording any more late
entries.
Q. I believe you testified that Mr. Sullivan said something about the line cost numbers
not being accurate. Did he ask you to conduct any analysis to determine whether the
line cost numbers were accurate?
A. No, he did not.
Q. Did anyone ever ask you to do that?
A. No.
Q. Did you ever conduct any such analysis?
A. No, I didn't.
Q. During this meeting, did Mr. Sullivan ever provide any accounting justification for
the entry you were asked to make?
A. No, he did not.
Q. Did anything else happen during the meeting?
A. I don't recall anything else.
Q. How did you feel after this meeting?
A. Not much better actually. I left his office not convinced in any way that what we
were asked to do was right. However, I did question myself to some degree after
talking with him wondering whether I was making something more out of what was
really there.
Instructions

Answer the following questions.

a. What appears to be the ethical issue involved in this case?
b. Is Troy Normand acting improperly or immorally?
c. What would you do if you were Troy Normand?
d. Who are the major stakeholders in this case?

Using Your Judgment

Financial Reporting Problem

Lola Otero, a new staff accountant, is confused because of the complexities involving
accounting standard-setting. Specifically, she is confused by the number of bodies
issuing financial reporting standards of one kind or another and the level of
authoritative support that can be attached to these reporting standards. Lola decides
that she must review the environment in which accounting standards are set, if she is
to increase her understanding of the accounting profession.
Lola recalls that during her accounting education there was a chapter or two regarding
the environment of financial accounting and the development of IFRS. However, she
remembers that her instructor placed little emphasis on these chapters.
Instructions

a. Help Lola by identifying key organizations involved in accounting rule-making at

the international level.
b. Lola asks for guidance regarding authoritative support. Please assist her by
explaining what is meant by authoritative support.

Financial Reporting Case

The following comments were made at an Annual Conference of the Financial

Executives Institute (FEI).
There is an irreversible movement toward a single set of rules for financial reporting
throughout the world. The international capital markets require an end to:
 1. The confusion caused by international companies announcing different results
depending on the set of accounting standards applied.
2. Companies in some countries obtaining unfair commercial advantages from the
use of particular national accounting standards.
3. The complications in negotiating commercial arrangements for international
joint ventures caused by different accounting requirements.
4. The inefficiency of international companies having to understand and use a
myriad of different accounting standards depending on the countries in which
they operate and the countries in which they raise capital and debt. Executive
talent is wasted on keeping up to date with numerous sets of accounting
standards and the never-ending changes to them.
5. The inefficiency of investment managers, bankers, and financial analysts as
they seek to compare financial reporting drawn up in accordance with different
sets of accounting standards.
Instructions

a. What is the International Accounting Standards Board?

b. What stakeholders might benefit from the use of international accounting
standards?
c. What do you believe are some of the major obstacles to convergence?

Accounting, Analysis, and Principles

The founders of Oslo Group, Finn Elo and Venden Hakala, are about to realize their
dream of taking their company public. They are trying to better understand the various
legal and accounting issues they will face as a public company.
Accounting

a. What are some of the reporting requirements that their company will have to
comply with when they offer securities to investors and creditors?
b. Identify the two entities that are primarily responsible for establishing IFRS,
which will be applied when preparing their financial statements. Explain the
relationship of these two organizations to one another.
Analysis

a. What is decision-usefulness?
b. Briefly describe how the financial statements that Oslo prepares for its
investors and creditors will contribute to decision-usefulness.
Principles

Oslo will prepare its statements in conformity with IFRS. Finn and Venden have heard
about an IFRS hierarchy. Briefly explain this hierarchy and advise them on how the
hierarchy affects the application of IFRS.
Bridge to the Profession

Authoritative Literature References

[1] The Conceptual Framework for Financial Reporting, “Chapter 1, The Objective of
General Purpose Financial Reporting” (London, U.K.: IASB, September 2010), par.
OB2.
[2] The Conceptual Framework for Financial Reporting, “Chapter 1, The Objective of
General Purpose Financial Reporting” (London, U.K.: IASB, September 2010), par.
OB4.
[3] International Accounting Standard 8, Accounting Policies, Changes in Accounting
Estimates and Errors (London, U.K.: IASB, 1993), par. 12.

Research Case

As a newly enrolled accounting major, you are anxious to better understand

accounting institutions and sources of accounting literature. As a first step, you decide
to explore the IASB's Conceptual Framework for Financial Reporting.
Instructions

Access the Conceptual Framework at the IASB website (http://eifrs.iasb.org/) (you

may register for free eIFRS access at this site). When you have accessed the
document, you can use the search tool in your Internet browser to respond to the
following items. (Provide paragraph citations.)
a. What is the objective of financial reporting?
b. What other means are there of communicating information, besides financial
statements?
c. Indicate some of the users and the information they are most directly
concerned with in economic decision-making.

Global Accounting Insights

LEARNING OBJECTIVE 5

Compare IFRS and U.S. GAAP and their standard-setting processes.

Most agree that there is a need for one set of international accounting standards. Here
is why:
• Multinational companies. Today's companies view the entire world as their
market. For example, many companies find their largest market is not in their home
country.
 • Mergers and acquisitions. The mergers that led to international giants
Kraft/Cadbury (USA and GBR) and Vodafone/Mannesmann (GBR and DEU)
suggest that we will see even more such mergers in the future.
• A single set of high-quality accounting standards ensures adequate
comparability. Investors are able to make better investment decisions if they
receive financial information from a U.S. company that is comparable to an
international competitor.
• Information technology. As communication barriers continue to topple through
advances in technology, companies and individuals in diff erent countries and
markets are becoming comfortable buying and selling goods and services from
one another.
• Financial markets. Financial markets are some of the most significant
international markets today. Whether it is currency, equity securities (shares),
bonds, or derivatives, there are active markets throughout the world trading these
types of instruments.

Relevant Facts

Following are the key similarities and diff erences between U.S. GAAP (the standards
issued by the Financial Accounting Standards Board) and IFRS related to the financial
reporting environment.

Similarities

• Generally accepted accounting principles (GAAP) for U.S. companies are

developed by the Financial Accounting Standards Board (FASB). The FASB is a
private organization. The U.S. Securities and Exchange Commission (SEC)
exercises oversight over the actions of the FASB. The IASB is also a private
organization. Oversight over the actions of the IASB is regulated by IOSCO.
• Both the IASB and the FASB have essentially the same governance structure, that
is, a Foundation that provides oversight, a Board, an Advisory Council, and an
Interpretations Committee. In addition, a general body that involves the public
interest is part of the governance structure.
• The FASB relies on the U.S. SEC for regulation and enforcement of its standards.
The IASB relies primarily on IOSCO for regulation and enforcement of its
standards.
• Both the IASB and the FASB are working together to find common ground
wherever possible.

Differences

• U.S. GAAP is more detailed or rules-based. IFRS tends to simpler and more
flexible in the accounting and disclosure requirements. The diff erence in approach
has resulted in a debate about the merits of principles-based versus rules-based
standards.
• Differences between U.S. GAAP and IFRS should not be surprising because
standard-setters have developed standards in response to different user needs. In
 some countries, the primary users of financial statements are private investors. In
others, the primary users are tax authorities or central government planners. In the
United States, investors and creditors have driven accounting-standard
formulation.

About the Numbers

The FASB and its predecessor organizations have been developing standards for
nearly 80 years. The IASB is a relatively new organization (formed in 2001). As a
result, it has looked to the United States to determine the structure it should follow in
establishing IFRS. Thus, the international standard-setting structure (presented in
Illustration 1.4) is very similar to the U.S. standard-setting structure. Presented below
is a chart of the FASB's standard-setting structure.

On the Horizon

Both the IASB and the FASB are hard at work developing standards that will lead to
the elimination of major diff erences in the way certain transactions are accounted for
and reported. In fact, beginning in 2010, the IASB (and the FASB on its joint projects
with the IASB) started its policy of phasing in adoption of new major standards over
several years. The major reason for this policy is to provide companies time to
translate and implement international standards into practice.

GAAP Self-Test Questions

1. GAAP (for U.S. companies) stands for:

a. Government accepted accounting practices.
b. Generally accepted auditing policies.
c. Generally accepted accounting principles.
d. Gevernment approved accounting principles.
2. Oversight of accounting standard-setting is as follows:
 a. IASB oversees FASB.
b. IOSCO oversees both the IASB and FASB.
c. SEC oversees both the IASB and FASB.
d. SEC oversees FASB, IOSCO oversees IASB.
3. Governance of the FASB involves:
a. FASB, FAF, FASAC, and IOSCO.
b. FASB, FAF, FASAC, and staff and task forces.
c. FASB, FAF, IASB, and task forces.
d. FASB, FAF, IASB, and the SEC.
4. Which of the following statements is false?
a. FASB is a government office within the SEC.
b. The FASB and IASB have similar governance structures.
c. U.S. GAAP is generally viewed as more detailed or rules-based, IFRS is
viewed as more principles-based.
d. The SEC oversees FASB standards-setting.
5. Which of the following statements is true?
a. The IASB does not include the public interest in its governance.
b. The IASB structure has both advisory and interpretation functions, but no
Foundation.
c. The IASB has been in existence longer than the FASB.
d. The IASB structure is quite similar to the FASB's, with a Foundation, Board,
Advisory Council, and Interpretations committee.

GAAP Concepts and Application

GAAP1.1 What organizations are the two key players in the development of U.S.
GAAP? Explain their role.
GAAP1.2 What might explain the fact that different accounting standard-setters have
developed accounting standards that are sometimes quite different in nature?
Answers to GAAP Self-Test Questions

1. c 2. d 3. b 4. a 5. d

Notes
1
Robert H. Herz, “Towards a Global Reporting System: Where Are We and Where
Are We Going?” AICPA National Conference on SEC and PCAOB Reporting
Developments (December 10, 2007).
2
As used here, cash flow means “cash generated and used in operations.” The term
cash flows also frequently means cash obtained by borrowing and used to repay
borrowing, cash used for investments in resources and obtained from the disposal
of investments, and cash contributed by or distributed to owners.
3
The IASB was preceded by the International Accounting Standards Committee
(IASC), which came into existence on June 29, 1973, as a result of an agreement
by professional accountancy bodies in Australia, Canada, France, Germany,
Japan, Mexico, the Netherlands, the United Kingdom and Ireland, and the United
States. A revised agreement and constitution was signed in November 1982 and
has been updated most recently in 2009. The constitution mandates that all
standards and interpretations issued under previous constitutions continue to be
applicable unless and until they are amended or withdrawn. When the term IFRS is
used in this textbook, it includes standards and interpretations approved by the
IASB, and International Accounting Standards (IAS) and SIC interpretations issued
under previous constitutions.
4
IASB membership reflects geographical representation, generally with members
from Europe, the Americas, Asia—Oceania, and Africa.
5
However, as IASB chairman Hans Hoogervorst noted, “It is not always obvious what
is lobbying by vested interests and what is public interest feedback whose purpose
is to help us deliver a high quality standard. More often than not the vested interest
is packaged in public interest arguments. Sometimes even users do not want
change. Analysts are so much in love with their own models that they do not want
our standards to shed light on complex issues.” See “Strengthening Institutional
Relationships,” www.IASB.org (September 23, 2013).
6
In rare cases, compliance with a standard or interpretation is judged to be misleading
when it conflicts with the objective of financial reporting. In this case, it is possible
to have what is referred to as a “true and fair override.” If this occurs, extensive
disclosure is required to explain the rationale for this unusual exception.
7
Economic consequences means the impact of accounting reports on the wealth
positions of issuers and users of financial information and the decision-making
behavior resulting from that impact. The resulting behavior of these individuals and
groups could have detrimental financial effects on the providers of the financial
information. See Stephen A. Zeff, “The Rise of ‘Economic Consequences’,” Journal
of Accountancy (December 1978), pp. 56–63.
8
The chairman of the IASB recently noted that the notion of the United States
embracing IFRS is politically dead. The IASB is now taking the position that it will
attempt both to avoid divergence and favor convergence between IFRS and U.S.
GAAP wherever possible.