International Financial Reporting Standards (IFRS) are a globally acceptable system of fiscal analysis whose primary objective is to harmonize economic reporting. The International Accounting Standards Board (IASB) recognizes IFRS as an efficient means of providing a common approach to analyzing business affairs (De George, Li & Shivakumar 2016). Increased foreign investment and trade require investors and multinationals to come up with a single system of analyzing their financial performance.
De George, Li, and Shivakumar (2016) maintain that IFRS is gradually replacing the various accounting standards that are used in different countries. It enables accountants to compile books of accounting that are consistent, understandable, and comparable. Some critics of IFRS argue that this system of financial reporting has not fulfilled its intended purposes. They allege that many accountants continue to use the International Accounting Standards (IAS), which were instituted by the International Accounting Standards Committee (IASC), thereby hindering the harmonization of financial reporting (De George, Li & Shivakumar 2016).
IFRS faces great opposition in the United States with most accountants opting to use General Acceptable Accounting Principles (GAAP). The G20 countries understand the significance of using common standards of financial reporting and are calling on the United States to embrace IFRS. There are numerous benefits and risks associated with using a single system of financial reporting globally. This paper will discuss the merits and demerits of adopting IFRS. It will also touch on the impacts of IFRS on the quality of financial reporting.
Advantages of IFRS
The use of multiple accounting standards prevents investors from making informed decisions on the most profitable market to target. Wieczynska (2016) alleges that the adoption of IFRS and the application of consistent accounting principles will enable investors to identify the best markets internationally, thus being able to diversify their investments. Currently, the accounting standards used in the United States and other parts of the world differ significantly. These principles use different variables to analyze the financial status of businesses and nations. Hence, at times, investors encounter challenges in determining where to spend their money.
The application of numerous accounting standards has had a toll order on inexperienced investors. Wieczynska (2016) argues that some financial consultants take advantage of neophyte investors and dupe them to invest in companies that do not earn them significant returns. IFRS uses accounting principles that are easy to understand. Accordingly, it is easy for prospective investors to assess the financial position of the companies that they wish to venture into without the help of professionals.
Many scholars agree that there is a need for companies across the globe to use financial reporting standards that are comparable and understandable. The use of a common reporting system reduces information asymmetry and boosts capital flow between nations (Cascino & Gassen 2015). On the other hand, some financial experts dispute that it would be difficult to adopt common standards of financial reporting because of variations in market characteristics and business environment across nations. They fail to acknowledge that it would be hard for companies and states to benefit from global capital without harmonizing their accounting standards.
The use of common accounting standards builds confidence between investees and financiers. International investors believe in the financial report of a company, therefore not hesitating to fund it. Mostly, international and local investors seek the opinion of financial analysts before venturing into any business. Cascino and Gassen (2015) posit that the analysts ought to have experience in the interpretation and projection of the economic performance of businesses to enable shareholders to make sound investment decisions. IFRS provides truthful information to financial experts, hence enabling them to predict the future performance of the business.
Multinational corporations require comparing the financial performance of their subsidiaries operating in various countries. The use of multiple accounting standards prevents companies from determining which economic region is good for investment. The application of manifold reporting criteria contributes to financial misunderstandings, which are costly to investors. As Yurt and Ergun (2015) state, the adoption of IFRS will help multinationals to use the same variables to evaluate the viability of various economic blocks.
Yurt and Ergun (2015, p. 13) assert that this will “increase transparency, as a consequence allowing easy cross-border investment with higher liquidity and low cost of capital”. It is imperative to note that IFRS is premised on principle-based and not legal-based philosophy. Therefore, its accounting standards make sure that a financial statement reflects a precise, pertinent, and true picture of the business. Using common accounting standards will prevent the possibility of companies manipulating their financial records to mislead potential investors.
Moreover, it will be easy for individuals to invest in foreign countries because they will not have challenges in monitoring their investments. The use of many accounting standards results in companies taking a lot of time to prepare financial statements. The adoption of IFRS will assist in reducing the time taken to compile financial reports, therefore saving companies enormous capital.
Realizing when business is operating at a loss is significant to existing and potential investors. Yurt and Ergun (2015) contend that IFRS enables companies to determine if they are incurring losses, therefore prompting the management to take the necessary actions. Loss recognition and enhanced transparency are some of the features that make IFRS a superior financial reporting system. Yousefinejad et al. (2018) say that these qualities are essential for corporate governance. The transparency that IFRS guarantees requires companies to acknowledge when they are doing badly. Consequently, this system of financial reporting is helpful to financiers because it safeguards their interests.
Disadvantages of IFRS
One of the disadvantages of IFRS adoption is that it is costly in terms of implementation. Sharma, Joshi, and Kansal (2017) maintain that multinational corporations require altering their internal systems to ensure that they correspond to the new reporting principles. Moreover, accountants from countries that do not use IFRS have limited or no experience in this system (Sharma, Joshi & Kansal 2017). Adopting this reporting method would lead to companies incurring costs attributed to training.
Some businesses would have to hire additional accountants, adding to their operations costs. Sharma, Joshi, and Kansal (2017) say that accepting IFRS would be costly to small enterprises, which cannot afford to hire accountants. Such companies would require seeking the assistance of financial consultants every time they want to gauge their economic viability.
Competition is healthy, especially in the accounting sector. The global adoption of IFRS would render redundant other accounting standards. Tsunogaya, Hellmann, and Scagnelli (2015) assert that allowing accounting principles like GAAP to work alongside IFRS would create healthy competition, thus avoiding manipulation of statements. One of the major disadvantages of adopting IFRS is that it would create room for information doctoring.
As aforementioned, IFRS is founded on principle-based standards, so it is intrinsically flexible. This flexibility would create a significant opportunity for companies to manage their revenues, thus affecting the quality of accounting. IFRS is not legal-based, thus it can be exploited by unscrupulous business operators. Dishonest companies might take advantage of the global adoption of IFRS principles to alter their financial statements to lure unknowing investors.
Individuals who support the global adoption of IFRS cite comparability as one of the benefits of taking this action. However, they fail to acknowledge that it is hard to achieve comparability, especially when operating in a global setting. The nature of IFRS is a major hindrance to this system being accepted globally. Tsunogaya, Hellmann, and Scagnelli (2015) contend that this method of financial reporting demands prudence and is less detailed compared to GAAP.
Tsunogaya, Hellmann, and Scagnelli (2015, p. 5) allege, “IFRS has wider rules and lacks specific guidance on how to apply it, therefore creating room for diverse interpretations”. IFRS allows accountants to use value judgment in the preparation and interpretation of financial statements. Companies may bribe these financial consultants to influence their assessment, hence frustrating the realization of the global system of financial reporting.
The international adoption of IFRS would involve translation of these accounting standards into numerous languages as not all countries are conversant with English. Yousefinejad et al. (2018) utter that translating IFRS into multiple languages would distort the meaning of some principles, leading to misinterpretation. The primary objective of adopting IFRS is to harmonize the preparation and interpretation of financial statements.
Nevertheless, this goal may not be realized due to language barriers. Yousefinejad et al. (2018) argue that IFRS is not yet globally accepted and this poses a challenge to its adoption. Countries such as the United States continue to use GAAP standards. The lack of acceptance of IFRS internationally creates significant challenges for multinational companies that have subsidiaries in the United States. These corporations are forced to prepare their financial statements using two sets of standards.
Impacts of IFRS on Quality of Financial Reporting
The effects of the adoption of IFRS on the quality of financial reporting differ across nations due to variations in accounting background and legal frameworks. The impacts of IFRS in the United States may vary from those in other nations because of disparities in institutional features. Masoud and Ntim (2017) argue that the adoption of IFRS equips analysts with a broad comprehension of financial information, thereby minimizing earnings projection mistakes and dispersion.
As Masoud and Ntim (2017) state, IFRS requires economic analysts to gather comprehensive data about a company before compiling its financial statement. This system of pecuniary reporting ensures that analysts prepare an inclusive and accurate report.
Global implementation of IFRS would have both positive and negative impacts on the quality of financial reporting. A study by Nijam and Jahfer (2016) found that the use of IFRS impacts the quality of disclosure. Nijam and Jahfer (2016, p. 99) concluded, “IFRS imposes relatively more disclosure requirements in the course of improving financial reporting quality and addressing information asymmetry”.
Many scholars have evaluated the relevance of these requirements and realized that they help to improve the quality of disclosure. A study of Australian, Swiss, and German companies that have adopted IFRS affirms that this system of financial reporting boosts disclosure quality (Nijam & Jahfer 2016). It is worth noting that IFRS emphasizes transparency in accounting operations. Moreover, it curtails managerial discretion, thus guaranteeing that companies do not conceal information that might taint their financial statements.
One of how IFRS impacts the quality of financial reporting involves how it treats intangibles. Duarte, Saur-Amaral, and Azevedo (2015) argue that leaders of badly performing companies use “ingenious” reporting techniques to conceal their poor financial status from investors. IFRS ensures that such managers do not take advantage of the privileges provided for by accounting standards such as GAAP to lie to shareholders.
Duarte, Saur-Amaral, and Azevedo (2015) insist that IFRS limits the number and types of intangibles that a company can capitalize on. Moreover, this accounting system regulates the value assigned to intangibles. IFRS improves the quality of financial reporting by minimizing the possibility of managers using discretionary powers found in other accounting principles to manipulate statements. This financial reporting approach makes it hard for leaders to overstate revenues and assets.
The adoption of common accounting standards would help companies and investors to compare financial performances of various economic blocks, thus being able to make sound investment decisions. The implementation of IFRS would ensure that both international and local shareholders, analysts, and policymakers have accurate information about the economic position of companies to project their real values and future performance.
Despite the benefits associated with IFRS, this system of financial reporting is costly to implement, especially for small companies because they require hiring experienced accountants for training their workers. The adoption of IFRS would eliminate competition between various accounting standards, consequently creating room for businesses to alter their statements to conceal losses. The global acceptance of IFRS would boost the quality of financial reporting because this system emphasizes absolute disclosure. It would be difficult for managers to use their discretion to exaggerate assets or revenues.
Cascino, S & Gassen, J 2015, ‘What drives the comparability effect of mandatory IFRS adoption?’, Review of Accounting Studies, vol. 20, no. 1, pp. 242-282.
De George, ET, Li, X & Shivakumar, L 2016, ‘A review of the IFRS adoption literature’, Review of Accounting Studies, vol. 21, no. 3, pp. 898-1004.
Duarte, AMP, Saur-Amaral, I & Azevedo, GMC 2015, ‘IFRS adoption and accounting quality: a review’, Journal of Business & Economic Policy, vol. 2, no. 2, pp. 104-123.
Masoud, N & Ntim, CG 2017, ‘The effects of mandatory IFRS adoption in financial analysts’ forecast: evidence from Jordan’, Cogent Business & Management, vol. 4, no. 1, pp. 1-18.
Nijam, HM & Jahfer, A 2016, ‘IFRS adoption and financial reporting quality: a review of evidence in different jurisdictions’, International Letters of Social and Humanistic Sciences, vol. 69, no. 1, pp. 93-106.
Sharma, S, Joshi, M & Kansal, M 2017, ‘IFRS adoption challenges in developing economies: an Indian perspective’, Managerial Auditing Journal, vol. 32, no. 4, pp. 406-426.
Tsunogaya, N, Hellmann, A & Scagnelli, SD 2015, ‘Adoption of IFRS in Japan: challenges and consequences’, Pacific Accounting Review, vol. 27, no. 1, pp. 3-27.
Wieczynska, M 2016, ‘The “big” consequences of IFRS: how and when does the adoption of IFRS benefit global accounting firms?’, The Accounting Review, vol. 91, no. 4, pp. 1257-1283.
Yousefinejad, M, Ahmad, A, Salleh, FMD, Rahim, AR & Azam, HMD 2018, ‘The mediating effect of information asymmetry on IFRS and foreign direct investment’, International Journal of Economics and Management, vol. 12, no. 2, pp. 641-656.
Yurt, C & Ergun, U 2015, ‘The IFRS adoption and accounting quality: a comprehensive trend analysis’, International Journal of Academic Research in Economics and Management Sciences, vol. 4, no. 2, pp. 11-19.