Advantages and disadvantages of international accounting standards: All you need to know
What are international accounting standards? IFRS: Advantages of international accounting standards IFRS: Disadvantages of international accounting standards IFRS vs GAAP Key takeaway
Are you asking for the advantages and disadvantages of international accounting standards?
Although the global standardization of accounting standards has many advantages for international trade, it also has some disadvantages, especially for countries that have well-established GAAPs.
In this article, you will discover what international accounting standards are, its advantages and disadvantages, the differences between IFRS vs GAAP.
Let’s get right into it!
What are international accounting standards?
The IFRS standards (or international financial reporting standards) were put in place in 2005. They thus replaced the IAS standards (international accounting standards), which have existed since 1973. These accounting standards were prepared by the international accounting standards office. In both cases, these standards aim to establish a harmonized accounting statement model, in order to promote international trade.
International Financial Reporting Standards (IFRS) is an accounting policy for the preparation of the financial reports. IFRS accounting standards lay down principles rather than rules, which leaves companies room for maneuver in their financial statement.
These principles are as follows:
- the balance sheet approach (priority of the balance sheet over the income statement),
- the primacy of substance over form,
- the regulation of neutrality,
- the priority given to the investor's vision,
- the important place given to interpretation,
- the precautionary form.
IFRS: Advantages of international accounting standards
The transition to IFRS standards has many advantages.
A globally harmonized system
The purpose of standardization is to establish common rules with the dual aim of standardization and rationalizing the presentation of accounting information likely to meet the presumed needs of multiple users. It thus contributes to the harmonization and improvement of accounting practices and also promotes spatiotemporal comparisons in terms of financial information. The benefits also include lower transaction costs and improved international investment. These IFRS will help investors make informed financial decisions and make forecasts of future business performance.
As a result of this added value, the majority of stock exchanges (such as London, Frankfurt, Zurich, Hong Kong, Amsterdam, and Rome) have accepted the preparation of financial statements of foreign listed businesses under IFRS.
Easy comparison of company ratings
Because they are using the global accounting standard, it is easier to compare the economic results of two companies by verifying their financial statement, although they come from different countries. For example, if you compare a US company that used US GAAP and a Chinese company that uses Chinese accounting regulations, the result can not be impartial because it is not based on the same code.
With the international accounting standard, every company in the world would be required to evaluate their income and accounting results in the same way.
Prudent management, with safer and less volatile long-term investments
Some businesses have updated more or less legal practices changes of accounting texts. These cases highlighted the need to review the accounts. Indeed, a system of regulations was previously applicable to accounting and the disadvantage of a rule is to authorize what it does not prohibit.
Currently, a standards reference system is applicable. The standards, therefore, make it possible to provide a common reference system in order to interpret and compare financial information on a common basis. A common language has therefore been created and is understood by the various partners. Standards have been put in place to define an asset, an amortization.
On the other hand, standardization makes it possible to define common and imperative concepts and directives such as the principle of prudence, the rule of independence of exercises.
Greater transparency of information and better communication
The publication of accounting standards responds to a need for cross-sectoral harmonization and contributes to providing greater transparency in financial communication.
Its mission is to regulate financial communication but also to increase transparency and comparability of information intended for investors, firms, financial markets, and supervisory authorities.
International accounting standards have to meet three main values:
- Completeness: The financial statements must transcribe the activity of the company and promote the disappearance of off-balance-sheet information.
- Comparability: Financial statements are standardized and identical to all companies.
- Neutrality: The standards must not leave any leeway to companies in managing the accounts.
IFRS: Disadvantages of international accounting standards
Disadvantages of IFRS include a lack of detail, significant adoption costs, and the perception that IFRS is a less stringent standard than what is already in place in some countries.
Lack of detail
Investors, regulators, employees, and the general public rely on the financial reporting system which requires companies to disclose details of their financial condition annually. This information should be presented in a consistent manner to allow reviewers to compare it to industry standards. To ensure standardization of financial reporting, the accounting industry in each country adopts GAAP which determines the appropriate way for accountants to present financial information on behalf of businesses.
IFRS is less detailed than GAAP. In an effort to achieve global standards that are acceptable to all, the IASB has had to give up a level of detail that national standards currently enjoy due to the process of developing these standards over time. In addition, GAAP is considered the gold standard for financial reporting. In the United States and countries such as Canada, there is little incentive to adopt what some consider a lower standard for the sake of overall consistency.
Significant adoption costs
Other significant disadvantages of IFRS relate to implementation costs. The accountancy profession in each country adopting the new standards would have to bear the costs of re-education and training. Businesses should also invest time and resources in the rehabilitation process. Another problem is the cost for businesses that operate only at the national level. The transition to IFRS for these businesses far outweighs the benefits.
Capital markets and the standards are not the same in different countries
One of the disadvantages of adopting a single standard is that capital markets are not the same in different countries. Businesses in a country may depend primarily on bank financing to raise capital; their financial statements may want to emphasize prudence and a strong balance sheet, as banks only want repayment with interest; they do not speculate.
In other countries, the main source of capital is the sale of shares. A company in such a country may want to maximize its financial profitability relative to its balance sheet.
IFRS vs GAAP
To help you understand the differences between IFRS and GAAP, here is the comparison table based on some criteria.
|Format||No need of special format of the income statement is necessary.||Use a one-step or multi-step format.|
|Recognition criteria||All financial transactions related to the provision of services, sales of goods, construction contracts, and the use of the entity's assets by others (royalties, interest, etc.) are covered by two accounting standards.||Income recognition guidelines focus on (a) recognition of realizable or earned profit and (b) recognition of earned benefit. Under the recognition criteria, no financial income will be recognized until the exchange transaction has occurred.|
|VSOE||There is no notion of fair value VSOE within the meaning of IFRS, which makes it increasingly necessary to comply with the separation criteria according to IFRS.||There are very specialized guidelines for accounting for software benefit, and one aspect of it is the requirement to demonstrate the fair value of VSOEs so that the different pieces of software can be separated for accounting purposes.|
|Building financial contract||The percentage of completion method is usually preferred to build financial contracts.||The zero-profit method is used to build financial contracts.|
Although international accounting standards (IFRS) contain lots of advantages, it exists also disadvantages that can be challenges for businesses. Despite certain criticisms, this major IFRS standards project will make it possible to codify and harmonize financial statements on a global scale. The road is still long and strewn with pitfalls before arriving at a totally effective system, but the will of the States for more prudence and transparency is very strong.