International Financial Reporting Standards (IFRS) are emerging as the primary accounting language of the world. At least 100 countries have already adopted IFRS and 30 others have declared their intention to adopt or converge with IFRS over the next two-three years.
Here’s how it all started.
The history of International Accounting Standards (IAS, or international GAAP, or generally accepted accounting principles) goes back to 1967, when a study group was established comprising key accounting bodies from the UK, the US and Canada. This study group went on to become the International Accounting Standards Committee (IASC), which was instrumental in rolling out IAS. IASC resulted from an agreement between the accountancy bodies of 10 countries: the US, Canada, Mexico, the UK, Ireland, France, Germany, the Netherlands, Japan and Australia. As its membership grew, IASC also developed close interaction with global economic bodies such as the Organisation for Economic Co-operation and Development, the World Bank, the United Nations, the Asian Development Bank and the International Organization of Securities Commissions (Iosco).
IASC had its first formal meeting with the Securities and Exchange Commission (SEC) in 1984, and started its comparability project with US GAAP in 1987. As businesses became transnational, companies and investors started realizing the importance of having one set of global accounting standards. In 1996, the US Congress acknowledged the need for a high-quality comprehensive international accounting standard. By 1998, more than 100 countries had become IASC members, and some European countries passed laws permitting large companies to use IAS for domestic reporting and filing purposes. A year later, Iosco supported the use of IASC standards by multinational firms for cross-border offerings and listings. In 2001, the European Commission (EC) legislated use of IAS for all listed companies from 2005, and set the ball rolling for IAS.
In 2001, IASC was rechristened the International Accounting Standards Board (IASB), with Sir David Tweedie as chairman. IASB and the Financial Accounting Standards Board (FASB), the principal US body for setting accounting standards, concluded the Norwalk Agreement in 2002 which laid down a framework for bridging the gap between IAS and US GAAP. The first IFRS was published in June 2003, titled “IFRS 1—First-time Adoption of International Financial Reporting Standards”.
The epicentre for world economic growth was then moving elsewhere from the US—particularly West Asia, Latin America, Africa, India and China. Many of these countries at some point in history were under European colonial rule and influence. The local GAAP in these countries were and are mirror images of various European acceptable principles such as UK GAAP, French GAAP or German GAAP. For example, in India, the accounting standards and Companies Act were largely modelled on the UK lines. In fact, some Indian standards are almost replicas of the UK IAS standards.
For a long time, multiple versions of GAAP existed in Europe as its countries were divided. It took some time for Europe to get its act together. This was followed by the unification of European economies (EU) and emergence of the euro as an alternative currency to the US dollar. Over the next five-six years, the euro and IFRS became synonymous with the EU. With IFRS gaining prominence in European markets, it became relatively easier for most countries across Latin America, Africa and Asia to tag along. It was relatively easier and a next logical step for these emerging economies to embrace IFRS rather than US GAAP.
Events in the US also did not help US GAAP. The dot-com bust and rigorous Sarbanes-Oxley compliances made the US markets vulnerable and shook investor confidence worldwide. Being a new initiative, IFRS was more contemporary and able to adequately reflect the changing needs of business and investors. Also, being principle-based, it offered a more comprehensive solution vis-a-vis US GAAP, which is largely rule-based, too voluminous and cumbersome.
By 2006, more than 100 foreign private issuers had registered with SEC. The American Institute of Certified Public Accountants and SEC could see that, with strong global support for IFRS, it would be difficult for the US to remain isolated. In November 2007, SEC allowed foreign private issuers listed in the US to file IFRS financial statements without any reconciliation with US GAAP. It took its most significant step on 27 August when it proposed a road map for IFRS adoption in the US. Although it delays adoption for a majority of the companies until 2014, it also permits large US firms (some 100 of them meeting specified criteria) to file IFRS financial statements with SEC for the years ending on or after 15 December 2009. With this, IFRS may have conquered the last stumbling block in its journey towards being a truly global standard.
What enabled IFRS to come into existence was the long-felt need for unification of business systems and financial reporting platforms, greater comparability of financial results and free movement of financial and human capital. Investors, stakeholders and corporate managements were tiring of multiple GAAP reporting and reconciliations. IFRS has proved to be the right catalyst for driving change towards this global convergence of accounting GAAP.
India will move to IFRS starting 2011. Navin Agrawal is a director with Ernst and Young India Pvt. Ltd. This is the first of a series that will analyse the impact of IFRS on industries and regulatory issues pertaining to its convergence with Indian GAAP. Respond to this column at email@example.com