The International Financial Reporting Standards
The International Accounting Standards Board (IASB) has some standards, interpretations, and framework that it has adopted to be applied on a global scale. These standards, interpretations, and frameworks are referred to as the International Financial Reporting Standards (IFRS). The IFRS were formed from the previous standards that were practiced. The International Accounting standards were in use from 1971 until 2001 when the IFRS were proposed. The change arose from the transition of responsibility to set international accounting standards from the International Accounting Standards Committee (IASC) to the IASB. The IASB in its first meeting adopted both the IAS that were existent and the Standing Interpretations Committee Standards (SICs) (Collings, pr. 6). Standards continued to be developed with time by the IASB and these new standards that continue to develop are referred to as the IFRS. Adopting these standards creates various challenges to the accounting service industry. There are also various impacts that arise from adopting the standards. This paper will focus on the challenges to be expected in adoption of the IFRS in the UK and the impacts that adopting the IFRS will have on accounting service industry as well as the small and medium businesses.
Corporate financial reporting has seen a major change in recent times as many listed companies in Europe and other places move to IFRS. The UK is one of the countries aiming to adopt the IFRS. Moving to the IFRS will not be smooth. There will be problems that the UK will have to face as it shifts from the GAAP to the IFRS. The challenges that will arise during implementation of the IFRS are acceptable given the positive impact that the IFRS has on international business. There is increased comparability and the global harmonization of financial reporting.
The proposals to implement IFRS will affect the business industry in the UK except for those that have already adopted the IFRS or those that can adopt the Financial Reporting Standard for Smaller Entities (FRSSE) due to their small size. In the process of implementation, the major challenge will be the fear of change and the costs arising from the shift to IFRS. The nation has to consider which part it will play to ensure the transition process is smooth. One major role that the government of UK will have is creating awareness on the importance of adopting IFRS over GAAP. Not all businesses are in support of the new standards. Once the advantages that can be realized from IFRS are made clear, most business entities that are uncertain whether to embrace the new standards will change their view. There is also the challenge of the extent to which the international standard setters are expected to offer support.
The United Kingdom is most likely going to need little support as it has had time to strategize and mobilize firms to be prepared for the end of GAAP and the consequent introduction of IFRS. The effects of UKs national initiatives to achieve international convergence on the reporting entities of the nation will pose another problem. The United Kingdom will have to think of the actions to address these effects. The education and training of professional accountants will have to be altered in order to keep pace with the fast changing environment in which the IFRS are set. There is also the need to inform the public, analysts, investors, and journalists of the changes that will arise and the consequences of these changes. This will avoid a scenario where these players regard the changes and consequences as a sign of the unsuitability of the IFRS and team up to oppose it. The United Kingdom is a common-law country that has a diverse base on investors, active stock, and debt markets, investor protection mechanisms that are strong and a financial reporting system that is investor oriented. The accounts of firms in the UK will therefore not be affected much by the transition since the business market and environment of United Kingdom use significantly similar approaches (Tendeloo and Vanstraelen, 2005, p.164).
The implementation of the IFRS in the UK would have some impacts on the accounting service industry such as reduced information asymmetry. This would make the communication between managers, lenders, shareholders and other interested parties smoother (Bushman and Smith, 2001: p 256). The result would be lower agency costs. The reduced information asymmetry would also lower the costs of equity and debt financing. On a general scale the impacts of IFRS would have more advantages than limitations. Higher comparability, increased international investment, and lower transaction costs are some of the benefits that will be brought by IFRS in the UK. In addition, investors will be able to make informed financial decisions as well as predictions of concrete future financial performance. These future predictions will improve the quality of accounting and transparency (Tendeloo and Vanstraelen, 2005). There will be no room for manipulation of earnings and the efficiency of the stock market will be enhanced.
Firms will be impacted positively in terms of their stock returns and financial performance measures that are stock related. The stock market liquidity would most probably be reinforced. Reduced cost of capital, reduced transaction costs, increased market value, and positive reputation are sample characteristics of the change firms are likely to undergo after adopting IFRS. Avenues for manipulation of reported earnings and bonuses or misleading of investors would reduce significantly due to the less subjectivity that would arise. Since the UK has strong investor mechanisms, the costs of adoption wouldnt be high as the managers are less likely to influence or tamper with the reported accounting figures due to the lower level of earnings management (Leuz and Verrecchia, 2000, p.111). Liquidity, investment performance, growth, profitability, and leverage are some possible impacts of adoption of IFRS in the UK.
The international financial reporting standards are shareholder-oriented and they encouraging the fair value approach to be used in financial statement presentation. As a result of being fair value oriented, IFRS could bring about volatility in both book earnings and reported earnings in the UK. Greater volatility will arise in income related figures as well as leverage measures (Iatridis, 2008, p.15). The income volatility that would arise from the fair value orientation of IFRS would introduce risk of debt covenant violation for those firms adopting the new standards. Rising financial distress is expected to affect the financial position of firms.
A study on the adoption of IFRS and the financial statement effects in the UK finds that the implementation of IFRS in the United Kingdom is more likely to give a favorable impact on the firms financial measures (Iastridis, 2010 p. 13). Compared to the GAAP regime, the higher values of profit were observed in firms that adopted IFRS. The profitability measures that were used include earnings per share (EPS) and operating profit margin (OPM). A positive coefficient of dividend per share was found in the application of IFRS. This can be attributed to the high profitability that was observed under IFRS since it would enable distribution of higher dividends by the firms to their shareholders. This higher profitability may either be volatile or not.
A higher market to book value ratio was also found under the IFRS in the study. The growth prospects of firms were reinforced when the IFRS were used as a widely accepted financial reporting language. The results for leverage measures were higher in the IFRS firms. This high leverage measures were found from the long-term liabilities to capital employed and the total liabilities to shareholder funds as well as interest cover. The adoption of IFRS proved to improve borrowing terms. Due to the high quality associated with the financial reporting of IFRS, the credibility of financial statements was enhanced and in turn lenders got provided with more certainty and information on the firms ability to meet their financial obligations in a timely manner. This certainty and confidence in transparency therefore improved borrowing terms. Lower liquidity was however found in the IFRS firms possibly due to the higher leverage measures and financial obligations. The negative coefficient cash flow per share was the indicator for the lower liquidity.
The adoption of IFRS and the volatility resulting from it in accounting figures was found to not adversely affect the ability of the firms to pay interest on outstanding balance and to not lead to financial distress. High debt firms were found to display higher interest cover compared to the one in the UK GAAP. This indicates that despite the higher leverage in IFRS, firms ability to fulfill their financial obligations is not mitigated by the volatility brought about by adoption of IFRs. The higher OPM and return on asset displayed by the IFRS regime further supports the theory that volatility does not affect the firms ability to fulfill its financial obligations adequately.
The Accounting Standards board has recently proposed a three tier system. Public accountable entities will continue following the IFRS. Non- publicly accountable entities will apply IFRS for SMEs. Small entities will continue applying the Financial Reporting Standards for Small Entities (FRSE). Small and medium sized businesses will be affected unless they have already adopted IFRS or they are small enough to adopt the Financial Reporting Standards for Small Entities. IFRS for SMEs are international standards that have been in development from 2008 with the aim of providing a set of accounting principles that are simplified, stand alone, and appropriate non-publicly accountable entities that are small. For reasons of consistency the IFRS for SMEs have principles that are based on the full IFRS ones. On a general level, the IFRS for SMEs are considered a good thing for businesses in UK since they simplify the requirements for full IFRS at the same time providing greater convergence as the shift from a GAAP regime to IFRS regime is applied. Although no formal date has been proposed yet for the introduction of the standards, planning ahead for the impact of the changes is recommendable for business leaders in the United Kingdom.
One difference between IFRS for SMEs and UK GAAP that might impact greatly on small and medium sized businesses is the changes in definition of financial instruments. Once these definitions of financial instruments are altered the industry player will have to adjust to the new definitions. Also the techniques for financial measurement might change. There is also the change that goodwill and intangibles will face. There will no longer be amortization of goodwill and presentation of annual impairment reviews will be required. Capitalization of acquired intangible assets will be compulsory and they will have to be assigned a finite useful life. The recognition basis from differences in timing in the GAAP to temporary differences under the new standards will be a change to expect. Preparation of a cash flow statement in all the entities applying for IFRS for SMEs will now be required. The condition for measurement of all fixed assets at a cost with no re-valuing option will be introduced.
The named changes are just the major changes that are expected to arise from the transition to the IFRS for SMEs in the UK. An initial version of the new standards is available though from the IASB website. Approximately 90% of companies within the United Kingdom will be affected by the adoption of the IFRS for SMEs (Roy, pr. 8). There is however, one condition that business entities should realize before taking any major step; once adopting the IFRS, there is no room for switching back to GAAP. This is therefore not a try and error scenario and critical evaluation of the suitability of these new standards to ones entity is important. The FRSSE allows for businesses to refer back to full UK GAAP in preparation of financial statements where guidance cannot be found in the FRSSE on how a specific item should be treated in terms of accounting. This referral is aimed at ensuring that the true and fair treatment is practiced. However this is not the case in IFRS where instead an alternative provision is specifically set to address this. These are some of the differences in the two standards that have to be considered before venturing into the IFRS.
Companies adopting IFRS for the first time might decide to restate the prior years of financial statements. However, application of IFRS is not a change in accounting policy and therefore this move would not be justified. Looking at it more conventionally, applying IFRS for the first time is introduction of a whole new basis of financial reporting (Buzzaccot, pr. 4). As a result financial statements of prior years should be converted to IFRS and not restated as some businesses would set to do.
First time applications would be required to recognize all IFRS Liabilities and assets. Assets and liabilities would also have to be classified by IFRS. Measurement of assets and liabilities would be done in accordance with IFRS. Other requirements that will arise in the first time adoption include disclosure of whether financial statements comply with IFRs. The disclosure of the impact felt on the reporting of financial performance, cash flows, and financial position as a result of adoption of IFRS for the first time is also required by reporting entities. The United Kingdom will have to champion for staff training in organizations on the area of IFRS in order for awareness to be created on the differences between IFRS and the UK GAAP so that clients and other parties are not left out.
The United Kingdom has joined other nations in the adoption of international accounting standards. Introducing the IFRS in the nation is expected to be faced by challenges. However these challenges are acceptable considering the benefits to be realized from these new standards. Before the IFRS starts being viewed as an advantageous shift, there are several impacts that the accounting service industry and small and medium sized businesses will have to overcome first.
Liquidity, investment performance, growth, profitability, and leverage are examples of elements that will be impacted in the accounting service industry. Small and medium sized entities which previously followed the UK GAAP or the FRSSE will have to adjust to the differences between the previous standards and the new standards. The most important thing, though is for awareness to be created on a national scale such that when the day of transition finally comes, all the involved parties will be prepared strategically, psychologically and emotionally.
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Iatridis, G. 2010. IFRS Adoption and Financial Statement Effects: The UK Case. Retrieved December 9, 2011 from: http://www.eurojournals.com/irjfe_38_12.pdf
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