Question:
Do the current accounting standards live up to their objectives? Critically discuss.
This report covers the most crucial aspect of the introduction of the current accounting standard i.e. whether the same has been able to deliver what it promised. The main purpose of implementing such a detailed accounting standard theory was simply to give a more comprehendible overview to the end users and the investors. Also the financial crisis that took in the year 2008 , the effects of which are still being felt by the economies world wide has led to the introduction of a more stringent accounting standard. Some of the important standards that have undergone a change are standards on leases, consolidation of financial statements and accounting for financial instruments. The new accounting standard although has delivered what it supposed to yet there are some complexities attached to it which needs to be addresses. The most important is adequate training to the people, cost factors and the implementation in a more phased manner. The report below clearly describes the various objectives that some of the important standards have been able to meet and some glitches attached to it though not to influential so as to defeat the entire objective of the said standards.
The current accounting standards which is recognized and followed worldwide is the International Financial Reporting System IFRS. This standard enables comparison of the business activities across the globe via a common global financial language which puts all entities with similar business lines on the same platform. The main objective for the introduction of the same was especially for the listed entities so that there reporting of the financials is easily comparable across all the jurisdictions of the various countries. The said reporting language was introduced and made mandatory for the larger entities because they had dealings across the globe. It was first introduced in the European Union but the concept of harmonization which the standards offered soon forced the other countries also to adopt the same. The current accounting standards thus enable easy comparison and better dependability on the financial statements published by the various entities for the end users. However even though the current accounting standards have been able to live up to the objectives yet there are some hurdles and blockages which still need to be taken care of (Galuszka, 2008).
Some of the standards spelt out in the current accounting standards live up to the objectives but not fully. It has some glitches which should be addressed to on time before the same fails. Lease accounting has always been the most debatable one of all. The current accounting standard IFRS 16 on lease accounting replaces IAS 17. IFRS 16 is an improved version of the lease accounting that is adopted. The said standards is mandatorily to be applied from the year 2019, however if companies decide to apply the same before that then they are to compulsorily also apply IFRS 15 i.e. revenue from contracts with customers also. The lease accounting has undergone substantial changes such as it has spelt out directions regarding reporting the leases in the balance sheet and the measurement criteria for leases. The main objective for the introduction of this accounting standard was to ensure that the users of the financial statements are not mislead anymore. An estimation of US$1.25 trillion of off balance sheet leases was made by the SEC in the year 2005 which raised concerns regarding transparency about lease transactions within the entities (Deloitte, 2016).
Therefore a revolutionary change was introduced in the accounting for leases which ensured that the assets and the liabilities arising from the leases should be recognized clearly in the balance sheet irrespective of the type of lease transaction. The unavailability of the information about the lease transact-tions in the balance sheets of the companies befitted the concept of true and fair view as it was difficult for the users and the investors to compare two companies one who purchase assets based on borrowed funds and the other who acquire assets on lease but do not make any adjustments in the balance sheet (Ifrs.org, 2016). Thus the objective of the said standard was to get operating lease and finance lease on an equal platform. As per the said standard a leased asset is capitalized by taking out the NPV of the lease payments to be made in future. The NPV is shown as a leased asset or made a part of the property plant and equipment category in the balance sheet. Further the lease payments that is to be made is shown as a financial liability of the concern. This will have a material effect on the leverage ratios of the companies who are mainly using leased assets. However there has been one exception to this standard. The short term leases and the leases which are of a lower value are exempted from this standard. This is due to the insignificant impact that the same would have on the users decision making tools. Thus companies who are basically working upon the model of off balance sheet funding will be effected the most (Ey.com, 2016).
The main objective of the implementation of the said standard is to help the decision makers to take a more informed decision. The cost of borrowing or the liability of the concern will not change, it is the transparency which will have a positive impact on the decisions. The most sought after benefit for the entities is that the said standard will not deter the companies from leasing assets. The main reason for the introduction of the current accounting standards is that the accounting statements represent a true and fair view for the users and the investors. The application of this standard enables to provide a clearer picture about the various assets and the liabilities that the company owns and owes and also the leverage ratios and the data regards the capital employed are more transparent (Kpmg.com, 2016).
The IFRS 16 thus has been able to live up to its objectives quite well addressing the most important concept of transparency however the shareholders and the investors are to be made to understood the benefits. Initial implementation costs are high as it needs proper training to the accounting staff, implementation of a new system, understanding the tax implications and preparing two types of statements initially so as to make the readers understand the changes and react in a positive manner.
Another very important accounting standard that is to be read with that of lease accounting is IFRS 15 ,revenue from contracts with customers. As stated above the application of the said standard becomes a mandate with immediate effect with leases are accounted for as per the IFRS 16 before 2019. Revenue recognition is one of the most significant requirements of any entity as this information will help the users to analyse the performance of the company and how much revenue is being generated from the assets deployed (Ifrs.org, 2014,). Limitation in the guidance spelt out with regards the recognition of the revenue made the introduction of the said standard. The said standard promises to deliver a better comparable data of the revenues generated by the entities from its customers. It also reduces the applicability of the various directives in addressing revenue recognition issues on a case to case basis and also improves the disclosure patterns thus providing information that is more useful and relevant. The said standard pronounces the fact that revenue should be recognized once the transfer of the goods and services has taken place to the requisite customer. The timing for the recognition was very unclear in the previous spelt out standards which has become clear in the current accounting standard (Pwc.com, 2014). Also one of the most significant issue that the standard addresses is that of accounting for variable consideration. It immediately estimates the value by expected to be received and then the same is made a part of the transaction’s price. The significance of the financing components in case of existence of a gap between the payment and the delivery of the good by the company mainly in case of contracting arrangements is accounted for in IFRS 15. Lastly the disclosure requirements are also very transparent in this standard. The revenue of the company can easily be correlated with the financial position stated as the standard requires disclosure of both qualitative as well as quantitative data (www2.deloitte.com, 2015).
Thus IFRS 15 has very nicely been able to phase out the various kinds of contracts and how the revenue for the same should be recognized. Also the disclosure requirements are varied enough to help the investors understand the revenue in contract to the isolation that was prevalent in the earlier standards for revenue recognition (iasplus.com, 2016).
The next accounting standard that would help to analyse the fact as to how much has the current accounting standard helped to live up to the objectives is accounting standard on financial instrument i.e. IFRS 09. The entities implementing the said standard have made it very clear that implementation of the said standard fully in a strategic manner will take a ot of time as its application will impact the data, system and the various key performance indicators of the company. The banking sector is the one which will suffer a hit as the said standard is completely different with the one that used to exist, IAS 39 and the said standard is basically applicable in this sector mainly. Although the fact that all companies across the globe will have an impact with this standard cannot be ignored as well (ey.com, 2015).
Appropriate classification and measurement of financial instruments is the crux of any financial instrument and to ensure that the same is done in an apt way, the said standard was introduced. The measurement criteria is different as per the said IFRS. The financial instruments are either measured at amortization cost or fair value method via the profit and loss account or the comprehensive income account. The said standard also removed the cap with regards the cost exemption for the unlisted equity and the related derivatives where the fair value could not be determined accurately. Thus now the same is adequately measured and recognized at fair value (Vials 2012). The said standard provides transparency to such a level that it also measures the credit risk involved with various financial instruments and whether the same will lead to any default since recognition of the same in the financials of a company. If so the same is required to be disclosed adequately for the investors to get an overview of the various investments made by the company and how much sound are they. Financial Instruments are wary towards periodical impairments. The said standard enables to provide a wider scope of application of the same. The old model of expected losses in case of impairment is applied by this standard too however the difference in the model used for calculation for the amortised cost assets and the assets available for sale category (Tcs.com, 2014).
IFRS 9 does not make the application of hedge fund accounting mandatory. However the standard clearly states that hedge accounting enables the entities to show the activities that it is undertaking so as to mitigate the various risks involved with respect to certain financial instruments. It correlates the gain or losses incurred due to hedging with regards the risk exposures that they are exposed to due to hedging (Silvia 2014). Thus this provides a very clear picture to the investors about the risk taking appetite of the entity. Finally what is important is the extent of disclosure requirements that a standard offers. From a layman’s perspective the disclosures play a very vital role. The new accounting standard introduces various more areas of disclosures such as impairments, hedging and a more adequate and clearer classification and measurement methodology within the acceptable norms (Casplus.com, 2016). It ensures to portray a more realistic view of the financial instruments that the organization has invested into. How the various instruments are effecting the cash flows of an entity is what ultimately all the users look at. The investors are concerned about the soundness of the investment and this can be understood only via detailed disclosure requirements. However IFRS 9 is the most complex of all yet the objectives that it defines to meet is broad enough for meeting the expectations of the users of the financial statements. Though it requires adequate cost for implementation yet the benefit derived over shadows the cost involved drastically (Deloitte, 2014).
Another very important current accounting standard which is a good example to determine whether the current accounting standard live up to its objective is IFRS 10 and IFRS 12, Consolidated financial statements and Disclosure of interest in other entities respectively. The first one lays downs the various principles to be followed for the preparation and the presentation of consolidated financial statements while the latter spells out the various details to be disclosed by the reporting entity regarding its interest in the subsidiary, associate, joint ventures and other unconsolidated structured entities. IFRS 10 provides consistency in application of the consolidation procedure which is very important for comparing similar entities. While the other standard provides a more deep detailing of the controlling interest of the reporting entity. This was demanded by the users basically to enable them to be able to take a more informed decision before inve-sting. The importance of this standard got recognition more after the world economic crisis in the year 2008 (Ifrs.org, 2011).
IFRS 10 talks about control in any manner and provides a single accounting solution for all. The most important objective that these two standards serve is disclosure requirements. Clarity is attained with regards the disclosure of consolidated as well as consolidated entities. The most significant concept about IFRS 10 is that it does not introduce any new method of consolidation, instead improvises on the existing one only by adding some more guiding principles. Such as the financial reporting standard has a section defining the guidelines about the potential voting rights of an entity over companies that they control. It states that if the controlling interest is substantive enough to affect the entities financial statements then the potential voting rights hold importance. It has a wider outlook in analysing the controlling interest of an entity over the other entity (Higgins 2016).
The main purpose that this standard serves is proper consolidation rather than the extent of consolidation. Another very important part that this standard clarifies is the meaning of control and what type of control calls for a consolidation. It is very similar to IAS 27 with only one difference that is of adopting a single method of consolidation. The consolidation standard addresses some issues clearly such as consolidation guidance in case there is a chance of control without having majority voting rights. This is a development to the previous accounting standard which was unclear with regards this situation. Further assessing of control with regards relation with various agents was also a matter of concern and vague in nature. The said confusion was curtained off by IFRS 10 which states clear guidance with regards the agent and principle relation and the situations which would help to determine the same.
These two accounting standards have enabled and lived up to the objectives that it supposes to deliver. Although nothing comes without cost but the benefit of detailed and deep rooted disclosures, a proper assessment of controlling rights and interests and various transitional provisions is way above all. The confidence that the investors derive from such a clarity is beyond doubt. The disclosure requirements that IFRS 12 demands is more informed and organized. It detailing is such that valuations and equity analysis is easily comprehendible (Spector 2011). All the users are not well conversant as to how to interpret a financial statement but if the same is prepared with regards set principles and guidelines then the same can be of use to any investor. It is seen a general practice that the reporting entities involvement in other entities is not disclosed if the same is not a part of the consolidated structured entity. This is what the said standard clarifies that if there is a financial implication and interest then disclosure is a must (Briginshaw 2008).
Further would like to highlight on the fact that the adoption of the current accounting standard has enabled to meet the expectations of the investors and the end users. It not only is beneficial for the outsiders but also for the various organizations, It helps in inculcating discipline amongst the entities also. The current accounting standards main purpose was to clarify the hiccups which the preparers as well the users had with regards presentation of information in a more informed manner. The global financial crisis 2008 was an eye opener for all. The inaccurate and incomplete disclosures and accounting by the entities led to uninformed investments, thus leading towards losses and increasing mis trust. It also affects the economical conditions world wide. The new standards are complex in nature but not all. Some enable more clarity such as IFRS 16 on leases which eradicates the entire concept of off balance sheet funding and does not classify leases into operating and finance anymore. Though this has a negative effect on the entities but the users are benefited as now they do not have to re-consider these off balance sheet terms while taking investment decisions. The next was standard regarding revenue recognition which is of utmost importance. The standard clarifies the timing of recognition of the revenue which is the most crucial part while preparing the financials of an entity. This has a major implication over the profit and loss of the organization and its profitability ratios as well. Lastly the standard regards consolidation and disclosure is equally important. This standard enables better consistency and uniformity which was missing in the previous standards (Tokar 2015).
Conclusion
Thus it can be said that although he applicability of the said standards is limited to entities with a larger net worth and capital and those who are listed in the stock exchanges yet these are the ones which actually have a significant impact on the various economies. The cost involved is high but the same is not as much as the benefit that it provides. The application though requires education and training and better clarity but the same can be achieved through phased out implementation of it. The objective of providing a clearer and a more discrete picture of the financial position of the organizations is well met via the implementation of the current accounting standards though with some glitches which are too small to effect the advantages it offers.
References:
Deloitte, 2016, IASB Issues IFRS 16- Leases,
Ey.com, 2016, Leases- A summary of IFRS 16 and its effects, viewed on 22 June 2016,
Kpmg.com, 2016, IFRS 16 Leases – A more transparent balance sheet,
Ifrs.org, 2014, IFRS 15 Revenue from Contracts with Customers, viewed on 22 June 2016,
iasplus.com, 2016, IFRS 15- Revenue from Contracts with Customers, viewed on 22 June 2016,
Vials, A., 2012, The future of IFRS financial instruments accounting, IFRS Newsletter Financial Instruments,
Casplus.com, 2016, IFRS in focus , IFRS 9: Financial Instruments – high level summary, viewed on 22 June 2016,
Ifrs.org, 2011, IFRS 10: Consolidated Financial Statements and IFRS 12 Disclosure of Interest in Other Entities, viewed on 22 June 2016,
Higgins, K., 2016, A practical guide to implementing IFRS 10 Consolidated Financial Statements , viewed on 22 June 2016
Galuszka, P., 2008, Pros and Cons of IFRS, viewed on 22 June 2016,
Pwc.com, 2014, Revenue from contracts with customers, viewed on 22 June 2016.
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