One of accounting’s leading lights, Professor Ray Ball, revisits the question: have IFRS delivered on their promise as a global financial reporting framework?
It has been more than a decade since the International Financial Reporting Standards (IFRS) were adopted by many countries around the world for financial reporting purposes.
Put simply, the IFRS attempted to create a common global language for business affairs, and to make company accounts readable and comparable no matter where companies were.
The decision to make this significant change was driven in large part by the perceived need for a single global reporting language to serve the needs of increasingly globalised capital markets. IFRS-based financials were considered critical to attracting and securing foreign investment.
In other words, the standards in the IFRS were a mechanism to facilitate the flow of equity and debt capital both within and across global economies.
IFRS adoption was not just supposed to make transactions more efficient. It was also assumed that the new standards would bring benefits such as increased transparency, greater comparability and lower cost of capital.
Have the IFRS delivered on their promise? It is still too early to tell, according to distinguished accounting academic and global accounting hall-of-fame inductee Professor Ray Ball FCPA, from the University of Chicago’s Booth School of Business.
No verdict yet
When the IFRS was first established, Ball was cautious about the standards, arguing in a famous 2006 paper that the differences between nations’ peoples and cultures, their companies and laws, would mean that accounting standards would need to differ too.
In his April 2016 paper, IFRS – Ten Years Later, Professor Ball revisits the issue. His latest verdict: it’s still hard to tell whether international standards are doing much good.
“After a decade of hindsight,” he writes, “IFRS adoption is an innovation of historical proportions whose worldwide effects remain somewhat uncertain.”
The global spread of IFRS has been significant. According to the International Accounting Standards Board (IASB), the organisation responsible for the development of IFRS, at last count 119 jurisdictions “require IFRS for all or most domestic publicly accountable entities”.
One of the concerns at the outset was that IFRS adoption would not be uniform. Professor Ball points out that this has not transpired to a significant degree; instead, formal adoption has been remarkably uniform.
However, uniform implementation of IFRS remains a concern. For many of the claimed benefits of IFRS adoption to be realised, consistent implementation would have to occur, but just as Ball suggested in 2006, largely local economic and political forces have given rise to differences in IFRS implementation.
The problem with principles
IFRS has been developed as a principles-based framework of financial reporting, requiring a considerable degree of estimation and judgement.
The principles-based approach provides greater discretion in accounting policy choice, Ball notes in his 2016 paper, while the estimation of future outcomes could give rise to differences depending on the variables and techniques used.
Professional judgement plays a significant part in many short-term estimates, including deferred revenues, bad debt provisions, and income tax and inventory valuations. Equally, professional judgement is required for long-term estimates such as asset impairments, retirement benefit costs and liabilities, and deferred tax.
Discretion in accounting policy choice and the role of estimation can both result in differences in reported numbers that undermine comparability.
Fair value accounting is another dominant feature of IFRS that can be subjective. Establishing reliable fair value measures can be challenging in some emerging economies where the necessary information may not be readily available.
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The right regulatory environment?
The regulatory environment of a jurisdiction can also have an impact on the implementation of IFRS, according to Ball.
Many countries that have adopted IFRS may not have the infrastructure necessary to enforce the actual implementation, and in some cases the local economic and political factors may act as a deterrent to enforcing implementation.
For example, substandard application of IFRS may arise in a jurisdiction with less developed regulatory oversight of financial reporting.
In a 2001 paper, Ball highlighted some of the interlocking infrastructures needed for an efficient public financial reporting system:
- a well-trained and competent audit profession
- separation between the systems of public financial reporting and corporate taxation
- structures of corporate ownership and governance that foster a genuine demand for reliable public information
- a system for setting and maintaining high quality independent accounting standards
- an independent legal system for detecting and penalising fraud, manipulation and failure to comply with accounting and other disclosures
Ball’s paper highlights a distinction between the information usefulness of IFRS-based financial reports and their value relevance for debt contracting.
He observes that the considerable use of fair value measures and the associated subjectivity in estimating fair values undermines the usefulness of IFRS-based financial reports for borrowing purposes, in particular when calculating accounting-based debt covenants.
Let down by implementation
The inconsistent implementation across jurisdictions that have already adopted IFRS is undermining the primary goals of IFRS, according to Ball.
There is also the fact that some of the world’s major economies – including the US, China, India and Japan – have not adopted IFRS. Although China, India and Japan have committed to a move towards IFRS in the future, US commitment to IFRS adoption remains elusive.
Evidence from other independent research initiatives supports some of Ball’s assertions around the implementation of IFRS. A translation-related issue has been identified in a recent research report published by the Australian Accounting Standards Board.
The key findings indicate that there are differences in the interpretation by accounting professionals of the terms of likelihood (terms such as “probable”, “possible” and “virtually certain”) between Korean and English IFRS versions.
Another issue highlighted is the marked increase in non-accounting based covenants in the years since IFRS adoption. Notably, independent research funded by CPA Australia has identified an increase in the use of non-GAAP (generally accepted accounting principles) measures since the introduction of IFRS-based financial reporting in New Zealand.
While we continue to gather evidence in determining the worldwide effects of IFRS, a bigger question remains to be answered: whether periodic financial reporting, under IFRS or another framework, effectively serves user needs.
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