When considering the development of global marketing strategies, the question of how to consolidate the preparation of financial reports have turned out to be one of the most crucial problems. In an attempt to make the process of reporting easier and to create global standards, the International Financial Reporting Standards (IFRS) were developed. IFRS was meant to become a successful alternative to the Generally Accepted Accounting Principles (GAAP), and it was believed that it would simplify financial reporting by setting common requirements for all organizations. However, along with the apparent advantages suggested by this system, some drawbacks undermine the success of IFRS. This paper explores the benefits and limitations of IFRS. It argues that despite the disadvantages, IFRS has a strong potential to revolutionize the financial reporting system and create a solid base for a standardized approach to reporting.
History and Goals of IFRS
The IFRS was introduced by the IFRS Foundation and the International Accounting Standards Board (IASB) with the intent to establish an exclusive set of high-quality, comprehensible, legal, and globally acknowledged standards of financial reporting grounded on explicitly coherent principles (Chaudhry et al. 2015). Prior to introducing IFRS, developed nations used to have unique sets of rules for financial reporting. In 2005, a new era in world business conduct began as many countries united their efforts to develop a universal set of financial reporting policies for the global capital market, resulting in IFRS (Chaudhry et al. 2015). 2007 and 2008 were significant years for acceptance of IFRS throughout the world. In 2007, the Securities and Exchange Commission gave up reconciliation with US GAAP demand concerning the reporting manner of foreign private registrants. As a result, those whose reporting was done by IFRS did not have to adjust their shareholders’ equity and net income to the equity of US GAAP (Chaudhry et al. 2015). Thus, the SEC recognized IFRS as a basis for transparent and accurate financial reporting. Such changes led to the request of domestic companies to be allowed to choose their reporting approach (US GAAP or IFRS). By the end of 2008, the SEC initiated the process of acquiescence, starting with large organizations and broadening to include all publicly held ones. However, in 2009, the new SEC chair remarked that it was necessary to slow down the process of moving to IFRS (Chaudhry et al. 2015).
The major funders of IFRS are the US, China, Japan, the European Commission, and international accounting organizations (International GAAP 2016 2016). Funding of IFRS is largely grounded in national funding systems that are contingent on gross domestic product. The most important financial boards and the leaders of G20 have declared their support of IFRS as a high-quality single set of accounting standards (Burton and Jermakowicz 2015). However, it is noted that the process of classifying financial reporting systems, as well as choosing the most suitable one, is not an easy matter (Nobes 2014). IFRS includes several advantages and disadvantages that will be described in the following sections.
Benefits of IFRS
The major asset of IFRS is its potential to provide opportunities for better global comparability. Also, such aspects as transparency, reliability, and understandability of financial reporting and financial statements are considered to be benefits of IFRS (Kılıç et al. 2014). Greater comparability may be achieved through a universally established set of accounting standards as opposed to each county having its peculiar GAAP that is difficult to analyze and compare with others. IFRS allows international companies to evaluate and compare their performance efficiently and meaningfully (International GAAP 2016 2016). Thus, if the financial statements of organizations are composed with the help of IFRS, it is much easier for prospective investors to compare them and evaluate their feasibility. In research focused on analyzing the benefits of mandatory adoption of IFRS, Brochet et al. (2013) mention that such implementation presents market benefits using improved comparability of financial statements. With this enhanced comparability, insiders are less likely to be able to use private information (Brochet et al. 2013). Therefore, mandatory adoption of IFRS not only enhances comparability but also brings about advantages for the capital market by eliminating insiders’ ability to profit from private information.
Understandability and transparency of financial reporting are regarded as significant benefits offered by IFRS. Gassen (2017) analyses the capability of IFRS to provide a better comprehension of financial reporting, and remarks that the impact of IFRS is most vividly observed in private companies’ work where it functions as a prototype for national administrative reforms. About the potential advantages of IFRS for the global economy, Gassen (2017) notes that they are apt to fluctuate across jurisdictions; thus, he suggests that the most developed economies prefer a regulatory regime that allows them to find a balance between costs and benefits.
The ability of IFRS to increase market liquidity is considered to be another of its assets. However, research by Christensen et al. (2013) indicates that such an increase is not noted in all countries. In particular, scholars have remarked that the liquidity effects of IFRS are most vividly noted in five countries in the European Union that jointly implemented crucial adjustments in reporting enforcement (Christensen et al. 2013). Therefore, while the increase in market liquidity is regarded as an advantage of IFRS, it is not possible to say that this benefit is equally experienced by all of the countries that have adopted the system. Still, market liquidity, along with the cost of capital, is regarded as a benefit presented by the IFRS process of disclosure and reporting (Leuz and Wysocki 2016). Based on the market, liquidity effect is the idea that information irregularities between investors introduce adverse choice into share markets (Leuz and Wysocki 2016). Those investors who are uninformed or insufficiently informed are concerned about doing business with the ones who have better access to data. Therefore, IFRS helps to build trusting relationships between the organizations.
One more aspect provided by IFRS that is considered advantageous is the increased quality of reported earnings (Ismail et al. 2013). It has been noted that diverse accounting standards are connected with varying degrees of earnings quality. Research indicates that it is possible to attain higher earnings quality through implementing more precise and severe accounting standards as well as restricting the number of accounting alternatives and setting more distinct rules (Ismail et al. 2013). Therefore, to achieve the benefits of increased quality of reported earnings, it is necessary to make sure that there is a limited number of accounting choices and that the rules are clear. This, in addition to the previously mentioned benefits of IFRS, serves as a basis for understanding the potential advantages for the organizations that choose to adopt this system. However, it would be wrong to say that IFRS is an entirely positive approach to regulating business affairs. The next section will discuss the disadvantages of IFRS.
Drawbacks of IFRS
The two main problems associated with IFRS implementation are a lack of training and additional financial expenditures (Kılıç et al. 2014). Both of these issues may be serious limitations for some companies that wish to transfer to IFRS. The key critical argument against the adoption of IFRS is that the standards were developed by IASB without taking into consideration the specifics of economic development and cultural difference between countries (Kılıç et al. 2014). Researchers note that arranging a universal standard of accounting is not sufficient to maintain comparability between various countries’ financial statements due to factors concerning the motivations of countries, organizations, and preparers (Kılıç et al. 2014).
Another drawback of IFRS is that IASB’s expertise in the sphere of accounting may not be enough to establish a simple standard for non-listed systems since the majority of its members are proficient in the financial reporting of large listed organizations but not small ones (Kılıç et al. 2014). Such an imbalance may lead to an incorrect understanding of the standards and therefore result in companies’ failure in the global market. The problem of dissimilarity between companies’ approach to the implementation of IFRS is also discussed in the study by Tuzarová and Mejzlík (2018). Scholars remark that it is much easier for large organizations than small ones to adopt IFRS. According to Tuzarová and Mejzlík (2018), the larger a company is, the more comprehensively it can involve the premises of IFRS in its financial activities.
Another disadvantage of IFRS is that currently, there are no sufficient measures in existence that would help companies to easily transfer from GAAP to IFRS (Abdallah 2016). In particular, it is noted that multinational companies must review their pricing systems before integrating IFRS since the comparability of their financial statement data is crucial to attaining a reliable investigation, which is helpful when companies work on their global strategic goals (Abdallah 2016). Tuzarová and Mejzlík (2018) also emphasize the absence of clear directions as to how an agreement between national accounting standards and IFRS should be achieved. There is currently no formal starting point for establishing the tax base. Thus, it is crucial to develop an exhaustive set of instructions and directions that will cover all elements of setting up a common tax base to guarantee their consistent utilization in all countries (Tuzarová and Mejzlík 2018).
Nobes (2013) points out another drawback of IFRS implementation. According to the researcher, issues such as language, enforcement, and policy options hurt organizations’ financial achievements in the conditions of IFRS (Nobes 2013). It is noted that the problems with adopting IFRS are frequently caused by the loss of meaning in the process of translating financial documents (Nobes 2013). Also, insufficient monitoring is a serious obstacle in the process of adjustment to IFRS (Nobes 2013). Therefore, according to scholars, prior to speaking about the global adoption of IFRS, it is crucial to come up with ways of minimizing the negative outcomes of the drawbacks of this system.
Consequences of IFRS on Financial Reporting Quality
Along with outlining the benefits and limitations of IFRS, scholars have investigated the outcomes of IFRS on the quality of financial reporting. Ahmed et al. (2013) mention that the impact of IFRS adoption on reporting quality is contingent on whether IFRS has a higher or lower quality in comparison with the domestic GAAP (Ahmed et al. 2013). A standard of higher quality eliminates managerial responsibility for financial decisions. Thus, when IFRS is of better quality than domestic GAAP, they are capable of improving financial reporting quality (Ahmed et al. 2013). On the other hand, the quality of accounting falls if IFRS is less successful than domestic GAAP. Christensen et al. (2015) also remarked that while it is a generally accepted idea that the implementation of IFRS has a positive impact on financial reporting quality, such features as the size of a company or what connections it has can change the consequences of IFRS adoption significantly.
The analysis of IFRS suggested in the paper provides insight into the advantages and disadvantages of implementing a standardized system of financial reporting to the global market. Upon investigation, the argument included in the thesis statement was proved. The major limitations of IFRS are the need for additional training, costs, and language issues. The advantages, which outnumber the limitations, are concerned with the possibility of reaching greater comparability, transparency, and understandability of financial reporting. Additionally, IFRS help to increase market liquidity and provide a higher quality of reported earnings. Therefore, it is possible to say that despite some disadvantages, IFRS has a strong potential to improve the financial reporting system.
Abdallah, W. M. (2016), The conversion from US-GAAP to IFRS and transfer pricing: irreconcilable differences. Journal of Accounting and Management 6(1), 71-84.
Ahmed, A. S. et al. (2013), Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research 30(4), 1344-1372.
Brochet et al. (2013), Mandatory IFRS adoption and financial statement comparability. Contemporary Accounting Research 30(4), 1373-1400.
Burton, F. G. and Jermakowicz, E. K. (2015), International financial reporting standards: a framework-based perspective, New York: Routledge.
Chaudhry, A. et al. (eds.) (2015) Wiley 2015 interpretation and application of international financial reporting standards, Hoboken: John Wiley & Sons.
Christensen et al. (2013), Mandatory IFRS reporting and changes in enforcement. Journal of Accounting and Economics 56(2-3), 147-177.
Christensen et al. (2015), Incentives or standards: what determines accounting quality changes around IFRS adoption? European Accounting Review 24(1), 31-61.
Gassen, J. (2017), The effect of IFRS for SMEs on the financial reporting environment of private firms: an exploratory interview study. Accounting and Business Research 47(5), 540-563.
International GAAP 2016 (2016) Chichester: John Wiley & Sons.
Ismail, W. A. W. et al. (2013), Earnings quality and the adoption of IFRS‐based accounting standards. Asian Review of Accounting 21(1), 53-73.
Kılıç, M. et al. (2014), Preparedness for and perception of IFRS for SMEs: evidence from Turkey. Accounting and Management Information Systems 13(3), 492-519.
Leuz, C. and Wysocki, P. (2016), The economics of disclosure and financial reporting regulation: evidence and suggestions for future research. Journal of Accounting Research 54(2), 525-622.
Nobes, C. (2013), The continued survival of international difference under IFRS. Accounting and Business Research 43(2), 83-111.
Nobes, C. (2014), International classification of financial reporting, 3rd Edition, New York: Routledge.
Tuzarová, S. and Mejzlík, L. (2018), ‘The IFRS assessment by publicly traded companies’, in D Procházka (ed.), The impact of globalization on international finance and accounting: 18th annual conference on finance and accounting (ACFA), Prague: Springer, pp. 341-356.