The International Accounting Standard Board (IASB) is a liberated, privately funded accounting standard setter based in London, England. The IASB was founded on April 1, 2001 as the successor to the International Accounting Standards Committee (IASC). It is responsible for developing a single set of high quality, understandable, enforceable and globally accepted financial reporting standards, so called as International Financial Reporting Standards (IFRS) -the new name for International Accounting Standards (IAS) issued after 2001. Furthermore, it encourages the application of these standards.
The IASB structured by IFRS Foundation is an independent organization which having two main bodies, the Trustees and the IASB, as well as IFRS Advisory Council and the IFRS Interpretations Committee (formerly the IFRIC). The IASC Foundation Trustees appoint the IASB members to exercise oversight, review effectiveness, and raise the funds needed, but the IASB has responsibility for setting IFRSs.
On the other hand, since 1973, the Financial Accounting Standard Board (FASB) which is a self-governing, not-for-profit organization has been designated to develop generally accepted accounting principles (GAAP) within the United States in the public interests. Those standards are officially recognized as authoritative by the Securities and Exchange Commission (SEC) (Financial Reporting Release No. 1, Section 101, and reaffirmed in its April 2003 Policy Statement) and the American Institute of Certified Public Accountants (Rule 203, Rules of Professional Conduct, as amended May 1973 and May 1979). They are important because decisions on allocating scarce resources rely heavily on credible, concise and understandable information.
In the fourth quarter of 2002, "The Norwalk Agreement", a Memorandum of Understanding signed between the FASB and IASB was a significant step towards the US formalizing its commitment to the convergence of US GAAP and IFRS. Both the FASB and IASB pledged to use their best efforts to make their existing financial reporting standards fully compatible as soon as is practicable and to coordinate their future work programs to ensure that once achieved, compatibility is maintained.
The FASB and IASB then added to their agendas in October 2004 a joint project to develop an improved, common conceptual framework that builds on their existing frameworks. It provides a sound foundation for developing future accounting standards. In the meeting, a staff from CFA Institute namely Rebecca McEnally, has proposed a project on revenue recognition and the Boards' project is to reduce differences between their income tax accounting standards. The project focuses on the changes in the environment since the original frameworks were issued, as well as omissions in the original frameworks, in order to efficiently and effectively improve and complete the existing frameworks (FASB Chairman Robert Herz and IASB Chairman David Tweedie, 2004).
In 2010, they have begun the mutual project. The Boards are conducting this joint project in eight phases. Each of the first seven phases will involve planning, research, initial Board deliberations, public comments, and re-deliberations on major aspects of the Boards' frameworks. The eighth phase will be used to address any remaining issues. For each phase, the Boards plan to issue documents that will seek comments from the public on the Boards' tentative decisions. The Boards will consider these comments and re-deliberate their tentative decisions. To some extent, they have also keen in seeking comments on several phases simultaneously (Liz Gagnon, FASB Assistant Project Manager and Allison McManus, IASB Technical Manager).
Secondly, it gives priority to addressing and deliberating those issues within each phase that are likely to yield benefits to the Boards in the short term. In other words, that is the cross-cutting issues that affect a number of their projects for new or revised standards. As a result, work on several phases of the project will be conducted concurrently and the Boards expect to benefit from work being conducted on other projects.
In addition, the Boards will initially consider concepts applicable to private sector business entities, and then jointly consider the applicability of those concepts to private sector not-for-profit organizations. Representatives of public sector standard-setting Boards are monitoring the project and, in some cases, considering the potential consequences of private sector deliberations for public sector entities.
Needs of International Conceptual Framework
First of all, it is important to note that a conceptual framework is basically a foundation. In this case, that foundation serves as a guide to standard setters as they establish the principles and concepts that underpin financial accounting and reporting standards. However, it is not an accounting standard and, thus, it cannot override the requirement of IFRSs.
One of the issues the FASB currently faces is that the existing conceptual framework has not been updated in a number of years. So, while it remains a valuable tool, there are certain areas that have become out-of-date, given the complex and shifting nature of financial reporting. Therefore, it is so important to develop an updated framework that will serve as a better, more effective guide in developing improved and simplified standards for constituents. Similar issues and situation faced by IASB on their framework.
As a result, as IASB and FASB move toward international convergence, it makes sense for them to work together to develop a common framework that provides greater consistency in global standard setting and guides the Boards to similar conclusions that result in converged standards that produce more useful financial reports (G. Michael Crooch, FASB Board Collaborator, August 2006).
It plays an important role as it assists the IASB in the development of new and existing standards. Since it has been standardized, the preparers are easier to apply IFRSs more effectively if they understand the concepts. Such framework creates harmonization by ensuring the consistency of treatment of items in the preparation of financial statements and to reduce the number of alternative treatments permitted by IFRSs. By doing this, it can also help external users like investors easier to evaluate and interpret the performance of entities and make comparisons among companies based on their financial statements.
In recent accounting environment, there are two main types of accounting systems:
(A) Rules-based System (US)
(B) Principles-based System (UK)
(A) Rules-based Financial Reporting System
US GAAP refers to a list of detailed rules that must be followed by preparers when preparing financial statements under Rules-based System. In other words, rules-based system is commonly used in US. Most of the accountants favor the prospect of using rules-based standards, because in the absence of rules they could be brought to court if their judgments of the financial statements were incorrect. When there are strict rules that need to be followed, the possibility of lawsuits is diminished (Investopedia, 2009).
Advantages
Easier to audit for compliance purposes, and may produce more consistent and comparable financial reports across entities.
Having a set of rules can increase accuracy and reduce the uncertainty that can cause aggressive reporting decisions by management.
Disadvantages
The lack of flexibility in terms of the changing conditions and new products requires almost continual maintenance at times.
Entities may search for loopholes that meet the literal wording of the standard but violate the intent of the standard.
The complexity of rules, however, can cause unnecessary complexity in the preparation of financial statements.
(B) Principles-based Financial Reporting System
Today, IFRS is an example of principles-based system which normally used in UK. Work is underway around the world to shift toward a single set of high quality standards through the global adoption of IFRS. As IFRS is adopted in more nations, regulators, preparers, auditors and investors will face the challenge of working together with the IASB to make sure that IFRS is principles-based. There are some keys of elements of a high quality principles-based accounting standard:
Faithful presentation of economic reality
Responsive to users' needs for clarity and transparency
Consistency with a clear Conceptual Framework
Based on an appropriately-defined scope that addresses a broad area of accounting
Written in clear, concise and plain language
Allows for the use of reasonable judgment
Advantages
Require less maintenance due to the flexibility with regard to new and changing products and environments.
Broad principles avoid the risks associated with precise requirements that allow contracts to be written specifically to manipulate their intent. A 1981 study sponsored by FASB found evidence that managers purposefully try to structure leases as operating leases to avoid incurring additional liabilities. Providing broad guidelines may improve the representational faithfulness of financial statements.
Allow accountants to apply professional judgment in assessing the substance of a transaction which substantially different from the underlying "box-ticking" approach common in rules-based accounting standards. FASB Chairman Robert Herz said that "I believe the professionalism of financial statements would be enhanced if accountants are required to utilize their judgment instead of relying on detailed rules."
Result in simpler standards. Herz has claimed that a principles-based system would lead to standards that would be less than 12 pages long, instead of over 100 pages (Business Week online, 2002). Principles would be easier to comprehend and apply to a broad range of transactions.
Transparency. Harvey Pitt, former SEC chairman, explained this as follows: "Because standards are developed based on rules ... they are insufficiently flexible to accommodate future developments in the marketplace. This has resulted in accounting for unanticipated transactions that is less transparent."
Provide accounting statements that more accurately reflect a company's actual performance.
Disadvantages
More subjective and difficult to audit relative to compliance, and concern over consistent and reliable interpretations across entities.
To the extent that they rely on individual judgment to interpret and implement the standards, there is a danger that they can be used to manipulate financial results.
Enron Case (US)
Enron Corporation was an American energy company set in the Enron Complex in Downtown Houston, Texas. It was practicing based on rules-based accounting. In year 2001, it was revealed that the reported financial condition was sustained substantially by creatively planned accounting fraud, has then known as the "Enron scandal". Enron has since become a popular symbol of willful corporate fraud and corruption. What actually went wrong? Well, the claims reconciliation process, the allowable claims against the company are expected to be approximately $63 billion, and the cash and equity assets available for ultimate distribution are expected to be around $12 billion (Enron's acting CEO and chief restructuring officer).
Enron collapsed mainly due to the sophisticated accounting techniques posted venture capital cash as profit. Besides, Enron had created offshore entities, units which used for planning and avoidance of taxes, raising the profitability of its business. It, however, created a dangerous spiral in which each quarter. Corporate officers would have to perform more and more contorted financial deception to create the illusion of billions in profits while the company was actually losing money.
Despite of the disability to repay the debts, Enron even tried to maintain a good impression to public by pushing up the share price in the stock market, at which point the executives began to work on insider information and trade millions of dollars worth of Enron stock. In addition, failure in raising investment against its own assets and stock for employees and shareholders had also hit the corporation down.
The scandal eventually brought into questions the accounting practices and activities of many corporations throughout the United States and was a factor in the creation of the Sarbanes-Oxley Act of 2002. The scandal affected the wider business world.
Perwaja Steel Case (Malaysia)
Perwaja Terengganu Sdn Bhd is a Malaysia government-owned steel manufacturer. In February 2004, it faced liquidity problem and was insolvent. Its losses and debts had a total of RM10 billion (National Audit Department). It was unable to pay some of its creditors and was seeking a grace period on payment of interest and principal on some of its borrowings. It encountered a serious financial crisis which may require a further injection of large sums of public funds by the government.
Perwaja's alleged management irregularities:
Payment of US$27.1 million to a mysterious company in Hong Kong.
Misused of US$196 million loan.
Purchase of parts not used by the company and of questionable quality.
Contract to pay a local company almost RM200, 000 a month for gardening, cleaning and vehicle maintenance.
Awarding construction contracts worth RM529 million to Man Shoon Group of companies, controlled by a long time associate of Eric Chia without asking for competitive bids or referring the deals to Perwaja's tender committee.
Contract to pay Tomen, a Japanese firm, commission at the rate of US$3 per metric ton of ore purchased when the typical commission internationally was about US$0.75 per ton.
Engaging a Singaporean commodity trading firm to market Perwaja's direct-reduced products at a shipment price of US$112 per ton at a time when the quoted market price was US$150 per ton.
Eric Chia, the former head of state firm Perwaja Steel, was accused of approving fraudulent payments to a fictitious company. Prosecutors claimed that he had overseen the transfer of 76.4m ringgits ($22m) in funds to a bogus company in 1994 but Mr Chia denied all wrongdoing. The court held that the prosecution had failed to prove its case.
Conclusion
Between the rules-based and principles-based modules, the latter seems to be more practical and preferred by the global community, given its universal appeal based on ethics, sound judgment, transparency, credibility and even downright common sense factors. Moreover, in the globalised business arena, this system would be easier to adopt, comprehend and acceptable as against rigid rules that may be interpreted differently from one country to another.
Well, in my point of view, I would rely neither principles-based system nor rules-based system. Since they do have the pros and cons, it is important for the preparers to decide in which circumstances or extents, should the system to be practiced. It is very subjective for interpretations as a result rules will only be as good as those who use them wisely.
