International Financial Reporting Standards (IFRS) are the common accounting rules which define how a transaction should be reported. It also includes rules about the information to include or disclose on financial statements. It is a unitary set of standards that has helped to solve many problems in the accounting world for organizations, but this system has also been responsible for creating problematic outcomes as well.
There are several countries who have not yet adopted IFRS, including the United States. Because this system does not receive global acceptance, the accounting by foreign-based companies that conduct business in a nation which doesn’t use the International Financial Reporting Standards becomes more of a challenge. These firms must create a statement using one system, and then make another report using the Generally Accepted Accounting Principles that others use.
As with any other method of accounting, there are some specific advantages and disadvantages of adopting IFRS to consider. This system can offer more flexibility, but that benefit can also lead to the manipulation of standards to make an organization seem more financially secure than what it is in reality. That’s why each key point must receive careful review and consideration.
List of the Advantages of Adopting IFRS
1. It would create a single set of accounting standards around the world.
Instead of using multiple accounting standards based on the preference of each country where an organization does business, adopting the International Financial Reporting Standards would enable agencies from different segments of the globe to apply the same standards in every transaction. The advantage to find here is an increase in transparency, which would then allow for more accessible cross-border investments. It would decrease the cost of capital while providing higher liquidity during each transaction.
2. It would reduce the time, effort, and expense of preparing multiple reports.
The presence of International Financial Reporting Standards around the world would allow organizations to cut down on the amount of time they spend on preparing their financial statements. There would be fewer costs associated with this work as well since there would no longer be multiple standards and regulations to follow based on where the company is doing business each year. Some agencies would immediately reduce the number of reports they produce from three to just one each year, saving them more time, labor, and money since there is less work to do.
3. It would not be a costly transition in the United States.
Although one of the disadvantages of adopting IFRS is the one-time cost that would impact the economy, the actual expense of transitioning to this global standard is minimal. The total cost for the entire economy of the United States would be approximately $8 billion, which means the average one-time cost to a multinational company would be $3.25 million. Most agencies would save a lot of money if they adopted International Financial Reporting Standards because it would reduce the amount of work it takes to remove errors, meet multiple regulations, and distribute the information effectively. Over 100 countries so far have either adopted or are in the process of adopting IFRS right now.
4. It would make it easier to monitor and control subsidiaries from foreign countries.
Under the current system in the United States, agencies and their subsidiaries must create parallel reports using GAAP and IFRS, which means there is an increased risk of error and additional auditing requirements necessary to ensure compliance. If the International Financial Reporting Standards were to receive adoption in the U.S., then it would eliminate the potential for misunderstandings. It would help shareholders and firms to simplify their investment decisions.
The U.S. has long been the world leader for taking a strong moral stand on financial ethics, with most nations following the same standard as the United States for generations. Now over half of the world is moving in the direction of IFRS, which means it should be strongly considered for implementation for American firms as well.
5. It would follow the same process that many American agencies already follow.
Another benefit to consider with the adoption of IFRS is the fact that many American-based companies doing business overseas are already preparing reports based on this standard. They are producing a simultaneous GAAP report to satisfy domestic regulations while meeting the international rules. By adopting this practice, the U.S. would help many large businesses to stop their excessive work immediately, allowing them to focus on what they do best. This advantage would allow U.S. businesses to be the driving force in the establishment and adoption of international standards once again.
6. It would offer more flexibility in the accounting practices.
International Financial Reporting Standards use a principles-based system instead of one that is based on a philosophy which follows specific rules. That means the goal of each standard in IFRS is to reach a reasonable valuation, and there can be several ways to reach that outcome. This structure gives an agency the freedom it needs to adapt the global system to fit their specific situations, which eventually leads to the production of useful statements that are much easier to read.
7. It would make it easier for all companies to do business in foreign countries.
The Internet, transportation technologies, and communication tools encourage us to use a system of globalization today more than ever before in human history. Almost any company has the power to expand beyond their country of origin when providing goods and services to their customers. Because small business owners face a high cost of compliance since there are two sets of standards in place today, the added cost of reporting a financial statement using IFRS and GAAP can be cost-prohibitive. That limits the ability of today’s startups to become tomorrow’s international disruptors.
Having a single set of accounting standards for every agency around the world would allow for more expansion opportunities because there would be fewer regulations in the way. You would get to streamline operations internally because you would have the confidence in knowing that every other agency was behaving in the same way.
8. It would help to streamline the system by creating one centralized authoritative body.
If we were to adopt IFRS, then we would be adopting a single set of unified global accounting standards. This advantage would allow for rulemaking and policy authorities to have a vestment in a central authoritative body that could oversee the standards and overall compliance. The current standards and rules for the different accounting systems in use are currently set by the legislative branches in their respective nations. Instead of working with a patchwork set of systems that could require a new report in each country, moving to the International Financial Reporting Standards would create a committee that would be charged with the fair implementation of these rules.
9. It would create a higher return on equity.
More than 70% of the companies examined between 2004-2006 had a higher return on equity under IFRS when compared to the GAAP system used in the United States. Reconcilation amounts always vary by industry and country, but the advantage remains the same. Whether the firms operate inside the U.S. or outside of it, there are better returns to find when using these accounting standards. Although the net income levels for the firms show declines in the differences between the two standards, the overall benefits can better support economic growth thanks to increases in stock value, dividend payments, and a strong regulatory environment.
10. It would improve the rates of foreign direct investment around the world.
The presence of the International Financial Reporting Standards globally would make it easier for companies to invest in one another whenever there is a market opportunity which presents itself. Research in the area of foreign direct investment shows that the presence of multiple standards creates uncertainty in this monetary transfer because of the uncertainty which exists in the differences between the various financial standards. There may also be a lack of familiarity or understanding with the anticipated future cash flows.
When we adopt IFRS, then there will no longer be a home-bias in place for shareholders to prefer domestic firms over international ones. There will be a familiarity and certainty in the financial information that will enhance their decision-making process.
11. It would be helpful to newer investors and smaller investments.
IFRS would help investors who are new to their industry to understand the information in the financial statements because the data would be simpler and of better quality. This advantage would allow anyone to become competitive because there is a greater understanding of what is going on with the financial health of an organization. This structure creates risk reduction benefits during each trade because everyone will be working from the same understanding of each data set instead of the multiple-tier system that we currently use for international companies and small U.S. firms.
List of the Disadvantages of Adopting IFRS
1. It would increase the cost of implementation for small businesses.
Large businesses would absorb the cost of adopting the International Financial Reporting Standards thanks to their need to produce these reports outside of the U.S. already. Only small businesses which provide local goods and services would receive the brunt of this expense since they’d be forced to change as well. Since there are fewer resources available for SMEs, it would take them more time and effort to train their staff in this method. This process means that it would be the sole proprietors, single-person LLCs, and partnerships which would bear the brunt of this accounting change.
The SEC estimates that it would cost 12% of global revenues to implement IFRS standards in the United States, so the $8 billion estimate could be way off. Since the primary benefit with this effort would be to achieve additional comparability, the system may not be worth the expense. Kara Stein, who serves as an SEC member, describes the situation in this way. “I am not convinced of a need to abandon U.S. GAAP in favor of IFRS,” she said. “That is not to say that the GAAP system is perfect. Nor is IFRS perfect… neither may serve investors well in today’s post-financial crisis, technologically disrupted, and data-driven world.
2. It would lead to concerns with standards manipulation.
The flexibility of IFRS can create numerous benefits, but it also creates a disadvantage with this feature. Organizations can choose to use only the methods that they wish to incorporate in their reporting, allowing their financial statements to show the results they desire. This structure makes it easier to incorporate profit or revenue manipulation into the findings, making it easier to hide financial problems that might exist. The International Financial Reporting Standards can even lead to fraudulent activities, like changing the method of inventory valuation to make more income come into the profit and loss statement to make it seem like the company is in a better position than it actually is.
3. It would require global consistency in auditing and enforcement.
The enforcement of the International Financial Reporting Standards can create some disadvantages as well. Although the United States has an effective enforcement policy on its accounting rules, trying to enforce this level of consistency on other member countries can be challenging. The differences in political and economic systems works to reduce the amount of comparability which is available, even if it can improve the efficiency of audits or eliminate information understanding.
4. It would increase the amount of work placed on accountants.
The implementation of a new system of global accounting standards would require a complete revision of the domestic accounting processes and strategies. Although the CFO of each organization would be responsible for this task under most circumstances, the implementation of the new rules would come from the accounting team. These departments are already busy trying to manage the rules and regulations that are in place currently, so they would be asked to continue with their daily work while creating the foundation for this system to receive implementation too.
When you add in the additional training that many accountants would require to stay in compliance with the new rules, determining how continuing education programs would work is an issue that has little clarity at the moment.
5. It would create an adjustment period filled with tumult.
When organizations begin to move from their current accounting standards mandated by the country of origin to the global accounting rules set by the International Financial Reporting Standards, then there is an increased risk of suffering from a costly delay or mistake during the transition period. Since every country maintains their own complex systems of regulations that govern financial reporting without direct involvement with the standards in use, there might still be a requirement to offer multiple reports as well. That means the only difference we see when adopting IFRS globally is a shift in the presentation of what the agencies provide.
6. It would require changes at the educational level as well.
There are numerous business that would feel the financial impacts of adopting IFRS immediately, even though the SEC estimates that about 100 firms are already using this as their primary standard since a majority of their revenue comes from overseas. We must also adjust the curriculum offered at many business schools because the International Financial Reporting Standards are not taught regularly in the United States. Even though it would make cross-border investments much more accessible, it would require a grassroots movement to shift the educational perspective in accounting to achieve many of the benefits listed above.
7. It would not reduce the home-court advantage for the modern firm.
Although there are some shareholders who would be more inclined to support foreign businesses if we adopt IFRS, there is no guarantee that this would happen throughout every demographic. Authors Teri Yohn and Messod Beneish found that there is a home bias effect still in place after adopting the International Financial Reporting Standards internationally. Investors prefer to work with companies that are closer to home, so foreign firms receive fewer direct investments even when the switch to the global system takes place.
8. It would still require global acceptance to be useful.
If the United States decides to adopt IFRS, then there would still be other holdouts around the world that would choose to use their preferred domestic standard. Any companies choosing to do business overseas might need to continue producing 2+ reports when necessary to comply with those standards. Since a majority of the businesses in the U.S. operate locally, the time and expense to implement this system would not make much sense. The greatest brunt of the disadvantages of the International Financial Reporting Standards would always be felt by the country’s smallest companies.
Conclusion of the IFRS Advantages and Disadvantages
Although a number of countries have made the move to adopt IFRS, the United States is not one of them. Mary Jo White, the Chairman of the SEC, recently said that promoting a standard set of global accounting rules should become of the top priorities of her agency. How that would look from an American perspective could be very different than what the rest of the world is already using.
IFRS has been in place since 2006, and it offers an increased comparability across agencies who operate between countries. The reality of this system is that the debate could be in reverse as well. Other countries could evaluate the pros and cons of joining the U.S. GAAP accounting practices instead to make it easier to do business in North America.
The advantages and disadvantages of IFRS work to eliminate the reconciliation of the books that must happen under the current system so that there is a unified picture available before making future decisions. Creditors would no longer face this issue when comparing or evaluating the creditworthiness of agencies operating abroad. We are all seeking ways to reduce barriers to global expansion, which is why switching to these standards is one idea that receives robust consideration.
Natalie Regoli is our editor-in-chief. The goal of ConnectUs is to publish compelling content that addresses some of the biggest issues the world faces. If you would like to reach out to contact Natalie, then go here to send her a message.