Background: Accounting Standards
31. Although general purpose financial reports are intended to provide financial information for external users, the value of such reports can be undermined. At the extreme, information can be disguised so as to obscure the actual position and performance of the entity preparing the report. However, even without persons behaving in a less than forthright manner, the value of general purpose reports can be limited if the external users relying on them cannot readily comprehend the information. In particular, if an entity creates its financial reports using unique accounting practices and methods, the value of information presented is significantly undermined. The financial report could not be properly understood without first understanding that entity's unique accounting practices.
32. Accounting standards therefore provide a general framework to communicate financial information so that the financial performance and position of an entity can be meaningfully assessed. Although accounting standards do not require identical reports from all entities, persons with knowledge of the basic framework and degree of discretion available to a given entity are able to readily discern the information relevant to them. This information enables investors, creditors, analysts, regulatory authorities and the entities themselves to make informed decisions about the allocation of resources.
33. The significantly improved comprehensibility of reports produced in accordance with accounting standards promotes investor confidence and market integrity. Investors, shareholders, regulators and other stakeholders can more accurately assess the position of entities, enhancing the integrity of the market. Where a market is seen to operate with integrity, investor confidence generally improves. Investors can also make investments in individual entities with confidence in that entity. This general and individual confidence leads to a reduction in the cost of capital throughout the economy. Public confidence in the integrity of the financial reporting framework is therefore central to maintaining and expanding a sophisticated domestic capital market.
34. In relation to the not-for-profit sector, accounting standards also enhance accountability, enabling stakeholders to more readily track public monies and ensure they are put to their proper purpose. In the public sector, accounting standards provide a framework for parliamentary scrutiny of the government's management of the Crown's assets and liabilities. For public benefit entities, confidence is analogous to the private market - where the public has confidence that their contributions are being used appropriately, future fundraising activities are more likely to succeed.
35. However, in today's increasing global economy where capital flows across borders, domestic conformity is inadequate. An international investor wishing to invest must, before studying the financial reports of a given entity, understand the reporting framework of the country in which that entity is based. In line with the reasons for imposing domestic conformity, there have therefore been moves to introduce international conformity through the use of identical standards.
36. The concept of an internationally accepted single set of financial reporting standards is not new. Markets have long recognised the need for reliable and transparent accounting and financial reporting to enable decisions by those providing capital. The various stockmarket crashes of the 1980s and the 1998 Asian economic crisis renewed these calls for a commitment to a single set of financial reporting standards, a call that has been reinforced by recent corporate collapses and scandals. Various bodies and individuals have also identified financial reporting as one aspect of corporate performance where there is scope to improve the accountability of participants.
The International Accounting Standards Board
37. The International Accounting Standards Board ("IASB")16 is an independent, privately funded accounting standard setter based in London. The IASB is committed to developing, in the public interest, a single set of high quality, understandable, global accounting standards for profit-seeking corporates that require transparent and comparable information in general purpose financial statements. In addition, the IASB co-operates with national accounting standard setters, including those in New Zealand, to achieve convergence in accounting standards around the world.
38. For those countries that do not currently have high-quality accounting standards, the international standards are perceived as being more rigorous than their present regimes. By making accounting standards more rigorous, financial information is potentially more transparent and reliable to decision-makers such as investors, lenders and other stakeholders. This transparency also deters corporate fraud and other misreporting, and promotes the prospects of legitimate businesses, as prospective investors and lenders are more likely to provide capital at lower premiums for risk where any uncertainties are reduced.
39. Countries that already have rigorous accounting standards are also trending towards adoption to increase the potential for capital raising through improving the comparability (and hence transparency) of financial data across jurisdictions. This cross-border comparability facilitates international investment, enabling entities to access to access global capital at cumulatively lower cost. It should, however, be noted, that some individual entities may experience greater difficulty in capital raising due to weaker balance sheets and greater perceptions of risk following adoption of IFRS and corresponding accounting recalculations.
40. In addition, there are reduced compliance costs for multinational corporations because financial reports filed by subsidiaries for local regulatory purposes are prepared according to the same set of standards as the reports prepared for their parents for consolidation purposes. Finally, accounting skills learned in one jurisdiction may be more readily transferable to other countries.
41. Related to the above points, benefits also flow from being perceived to comply with international norms and standards. A country that is seen to have a rigorous set of internationally compliant financial reporting standards is likely to be a more attractive investment destination.
42. The International Financial Reporting Standards ("IFRS") promulgated by the IASB are likely to become a key measure of the integrity and maturity of a nation's financial reporting regime. These international standards are being, or have been, adopted, by approximately ninety economies, including Hong Kong, Singapore, China, the members of the European Union and Australia. It should, however, be noted that only Australia will have near-universal application of international standards. IFRS will only apply to public issuers in the European Union, and only to companies in Hong Kong and Singapore. Notable countries not adopting IFRS include Canada, Japan and the United States.
The Norwalk Agreement
43. Although the United States will not be adopting IFRS, the IASB and the United States Financial Accounting Standards Board ("FASB")17 have signed a memorandum of understanding ("the Norwalk Agreement") acknowledging the two boards' commitment to developing compatible high-quality accounting standards.
44. This memorandum includes both a short-term project aimed at removing a variety of individual differences between the United States and the international requirements, and the removal of more substantive differences through a longer term co-ordination arrangement.
45. This project is currently underway, the IASB and the FASB having recently released a joint discussion document,18 with more planned. This project is likely to conclude by late 2005.
The International Federation of Accountants - Public Sector Committee
46. Although IFRS are gaining strong support internationally, given the size of the project, many areas are comparatively undeveloped. In particular, IFRS have virtually no application outside of the profit-seeking sphere. As a general point, the quality of reports produced by public sector entities is widely regarded as being inferior to those of the private sector. For example, many governmental agencies internationally still provide their reports on a cash accounting basis. The shortfalls of this approach have recently been highlighted in relation to the United States federal deficit by a number of commentators.19
47. However, this area has been addressed by other organisations. The International Federation of Accountants ("IFAC")20 is a global organisation of the accountancy profession, representing approximately 2.4 million accountants worldwide employed in a variety of disciplines. It performs a variety of important functions, and is committed to ensuring high-quality accounting practices.
48. The IFAC has a number of committees, including the Public Sector Committee ("IFAC-PSC")21 that focuses on the accounting, auditing, and financial reporting needs of national, regional and local governments, and related governmental agencies. As a part of this function, it issues International Public Sector Accounting Standards ("IPSAS"). IPSAS, many of which are based on international accounting standards, are aimed at ensuring governments and government bodies produce financial reports that are of a high standard and useful to those that rely on such reports.
Application in New Zealand
49. In New Zealand, the ASRB announced on 19 December 2002, after consulting with key parties, including Ministers, that it had decided New Zealand entities should be required to adopt international standards for reporting periods commencing 1 January 2007, with the option to adopt for reporting periods commencing 1 January 2005. This early "opt-in" option is primarily to allow dual-listed entities, that will be required to prepare financial statements according to international standards from 2005 due to other countries' requirements, to prepare a single set of reports.
50. Throughout 2003, the ASRB, ICANZ and others have been working to implement the ASRB decision, and entities, particularly large companies and public issuers, have been determining the likely impact on their financial reports, preparing for necessary changes to their accounting systems, and considering the impact on their financing arrangements. However, although there is a reasonable public awareness of IFRS, significant education about the actual impacts of the adoption of IFRS is desirable. This is likely to be particularly relevant for entities outside the category of large companies and public issuers.
51. Although New Zealand already has very rigorous accounting standards that are held in high international regard, New Zealand will still be able to benefit from the adoption of IFRS. Multinational firms in particular will see reduced costs, as there will be no need to reformulate accounts for local requirements.22
52. However, the most significant advantage to New Zealand from adopting IFRS will be international comparability. International investors will be able to readily comprehend New Zealand financial reports without the need to first expend time and effort to understand New Zealand's financial reporting framework. This in turn may lead to more foreign direct investment, a key factor identified in the government's Growth and Innovation Framework.23
53. As for other areas of corporate governance and business regulation, there are also benefits that flow from being perceived to comply with the norms and standards that are internationally accepted. Adopting IFRS will ensure that New Zealand remains at the forefront of accounting practice. Further, New Zealand may be a more attractive investment destination if it can demonstrate its compliance with these internationally accepted norms and standards.
54. The adoption of IFRS is also in accordance with Australia and New Zealand's desire to reduce the obstacles to conducting business on a trans-Tasman basis. Australia will be adopting IFRS from 2005,24 and, even in isolation, New Zealand's adoption will be a valuable contribution towards reducing trans-Tasman business costs, as financial reports will be considerably more comparable. Financial reports produced for New Zealand or Australian domestic requirements should also fulfil the requirements of the other jurisdiction.
55. Any advantages that stem from maintaining unique standards (for example, adaptability for New Zealand conditions), may be off-set by the costs of being different, in particular, potentially being bypassed as an investment destination by those that do not understand the differences. This factor is particularly important for small countries such as New Zealand that place comparatively high importance on international investment, as the costs of being different are likely to be proportionally more significant.
56. While corporate New Zealand predominantly supports the introductions of IFRS in principle,25 and other sectors were supportive of a single set of standards based on IFRS, the consequences of such a change will vary. Some individual entities are likely to experience weaker balance sheets and greater volatility in reporting. This may lead to some dissatisfaction as the detail of the changed requirements becomes more apparent.
57. Overall, the adoption of IFRS will be an important step forward, both in New Zealand's financial reporting landscape and in New Zealand's participation of global projects such as this generally.
58. As a general point, it should be noted that this paper does not, for the most part, concern itself with the substantive content of individual accounting standards. The focus is rather on the legal framework surrounding those standards.
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