Financial Accounting Goes Global: Challenges for firms in Taiwan
Written By: Joseph Chou
International Financial Reporting Standards (IFRS) are accounting principles established by the International Accounting Standards Board (IASB). The IASB, in turn, was established in 1973, with founding members representing Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the U.K., Ireland and the U.S. Today, all major countries have joined the organization, one of whose founding purposes is to establish a set of globally applicable accounting standards.
After the European Union adopted IFRS in 2005, the number of countries that require or allow financial statements to be compiled using IFRS has grown to over a hundred countries, and it is estimated that 150 countries will have adopted IFRS by 2011. In the U.S., meanwhile, the Securities and Exchange Commission (SEC) announced in November 2007, a full year ahead of the originally announced schedule, that foreign-based companies listed in the U.S. would no longer need to reconcile their IFRS-based financial statements with U.S. accounting standards (i.e., US GAAP) for their annual "20-F" filings to the SEC, beginning with 2007 20-F forms filed in 2008. Judging from this accelerated relaxation of rules, the SEC and accounting professionals in the U.S. have realized that the IFRS wave sweeping the world has become unstoppable.
That is not all: The U.S. Financial Accounting Standards Board (FASB) and the IASB are engaged in intense and close cooperation to revise old standards and jointly issue new ones so that IFRS and US GAAP become ever more consistent. We can anticipate, therefore, that in five to ten years at the latest the age of "global accounting standards" will have arrived. On the strength of this pervasive trend, one can imagine that in a few years IFRS will occupy a decisive position in international capital markets. As a result, IFRS have become a subject that Taiwan's globalizing corporations can ill afford to ignore.
How did adoption of IFRS become such an irresistible trend? The answer lies mainly in the following:
- Internationally, it is believed that financial statements compiled following IFRS are more transparent and credible, and offer investors and banks a higher quality of financial information. By boosting the image of firms that have the capacity to do excellent financial reporting, IFRS have a gradual but positive influence on how effective firms can be at raising funds on international capital markets.
- Corporate financial statements compiled by international competitors based on IFRS possess a higher degree of comparability, so they provide a basis for formulating strategic decisions for international operations.
- Overall, using IFRS promotes the efficiency and fluidity of international capital, thus facilitating a range of endeavors such as obtaining financing in international capital markets and undertaking cross-border M&A.
The necessity of integrating accounting standards
Accounting is the language of business. A corporation's financial condition and operating results need to be reflected in financial statements compiled using accounting standards or financial reporting standards. Accounting serves as a basis for senior management to evaluate operating performance and formulate business strategies. An even more important function in our capitalistic society is providing investors and creditors a key reference for decision-making, and when global investors look for investment targets, they are not constrained by international boundaries. At many highly internationalized European companies, stakes held by foreign shareholders exceed 50%, which is yet more evidence of the borderless nature of money in the global economy.
In today's borderless financial marketplace, if corporate financial information were still compiled according to different accounting standards in each country, so that investors had to go through a conversion process before they could get financial information compiled with accounting standards they are familiar with, then investors in international capital markets would find evaluating investment targets tremendously inconvenient; or else corporations would be weighed down by the daunting task of compiling numerous different sets of financial statements for investors in different countries. In terms of capital market efficiency, this would impose virtually unbearable costs. Over the long term, it would reduce the willingness of enterprises to seek financing from international capital markets. More importantly, it would reduce the efficiency of circulation within the overall international capital market. With so much at stake, there is little doubt over the need to integrate accounting standards.
The first step towards integration is reaching a consensus, so countries must abandon their parochial tendencies, join in promoting this formidable task, and set a timetable for accomplishing it. The IASB has been leading this effort, and the results have been superb, but so far the position of the U.S., with the world's largest capital market, remains unclear. Although it was a founding member of the IASB and has consistently participated in establishing international accounting standards, the U.S. has still not decided whether it will adopt international standards in the future. While the SEC has agreed to accept foreign company financial statements compiled directly using international accounting standards in applications for listings on U.S. capital markets, so that they would no longer need to be converted, it still has not agreed to let domestic companies adopt international standards, and so it remains to be seen whether more complete integration will prove feasible. We can be certain, however, that without U.S. participation and cooperation, the job of accounting standard integration will not be finished.
The second step towards integration is to carefully compare the primary accounting standards currently prevailing to find where they differ, seek compromises that are relatively reasonable and acceptable to all, and then put together a complete set of standards, all the while checking to make sure there are no contradictions among them. After this set of globally consistent accounting standards is ready, the IASB must still go through a public hearing process to give people in member countries time to offer their views, and after their views have been heard it must decide whether changes are called for. Finally, once the new accounting standards are finalized and issued, the world has to adhere to them.
Accounting standards in Taiwan
In their early incarnations, Taiwan's accounting standards followed the US GAAP framework, with many Statements of Financial Accounting Standards (SFAS) conforming closely to their U.S. counterparts, but after Taiwan joined the IASB, international standards became the framework for setting accounting standards, with reference made to US GAAP only if there appear to be shortcomings in the former. This approach puts Taiwan in the mainstream of international accounting practices. However, although Taiwan's accounting standards are named similarly to their international counterparts, adoption of the latter is less than complete, and as a result, financial information compiled using Taiwan's standards is not widely accepted.
After years of hard work, Taiwan's accounting standards have, for the most part, been harmonized with IFRS, and apart for a few exceptions, such as the loan impairment section of IAS 39 not having been incorporated under Taiwan's SFAS 34, there are no major differences between SFAS rules and the various international standards. In practice, however, the many IFRS interpretations and opinions of the IASB are not necessarily adopted in Taiwan because they fall outside the scope of Taiwan's accounting standards. Even if accounting principles and rules are consistent, government regulations may make their application inconsistent with IFRS. A recent example is with employee bonuses, for which the accounting basis in Taiwan is the price at the end of the year, possibly producing large differences in booked values compared with IFRS. Also, unlike IFRS, SFAS 34 uniformly adopts the cost method to recognize equity investments in unlisted companies.
Apart from regulations, application in practice often results in major differences, the most common example being the purchase price allocation (PPA) used for mergers and acquisitions. Internationally, the typical practice is to have an experienced outside expert provide a professional opinion for enterprises to use as the basis for making accounting entries, whereas in Taiwan this is most often an internal decision, yielding results that are usually different from those that would have been obtained using the former method.
The future of US GAAP
The U.S. has always been proud of the thoroughness and strictness of its accounting standards. Before the Enron affair, few doubted that such pride was justified, but after Enron and a string of other fraud cases emerged, many started to question whether the emphasis in US GAAP on detailed rules might give companies even more room for manipulation. As long as transactions were designed to comply with the regulations, they could be carried out accordingly regardless of their substance. Although this view may not be entirely correct, it does reflect reality to some extent, and it is precisely for this reason that the U.S. FASB has started to consider abandoning its particularism and converging towards international standards. If international and U.S. accounting standards were integrated, globally consistent accounting standards would no doubt soon appear, because there are no other accounting standards out there that could resist them. Whatever the IASB and FASB agreed to, countries would be compelled to accept them unless their investors and corporations had no contact with the outside world.
The effect of IFRS on corporations in Taiwan
As Taiwan's corporations continue making strides towards globalizing their operations, more and more of them are seeking financing in international capital markets through overseas listings, or by issuing Euro convertible bonds (ECB), global depository receipts (GDR) or American depository receipts (ADR). Although not all international capital markets require adoption of IFRS, that does not mean they will not do so in the future. Also, even if capital markets do not require it, if other global/international-level corporations or important competitors have adopted IFRS, Taiwanese corporations may have no choice but to go along with adoption of IFRS in order to maintain their competitive edge. As a result, financial accounting personnel in Taiwan have a continuing need to follow developing trends in international accounting principles. They should not stand on the sidelines.
Unlike past accounting standards that emphasized historical cost, IFRS is mainly a set of balance sheet-oriented fair value pricing models in which the measurement of gains and losses is greatly influenced by changes in the fair value of net assets. In addition, the scope of consolidated statements is extended from equity control to substantive control, up to and including special purpose entities with no equity investment. In the past, when Taiwan-based companies have converted using IFRS, the larger differences were in consolidated statements, income recognition, corporate M&A, financial instruments, equity-based compensation and investments in third companies. On disclosures, IFRS also differ from Taiwan's regulations in many areas.
Converting to IFRS requires reexamining the documents and processes of all significant transactions, so it typically requires more time for advance preparation. If a Taiwanese corporation knows that it will have to compile IFRS-compliant financial statements in the future, it must prepare early. In its advance preparation work, it should seek opinions from outside experts: After all, most financial accounting practitioners lack real-world experience in IFRS conversion and are not familiar with IFRS rules. To carry out conversion work and keep on schedule, it can be a great help to have the assistance of a group of experienced experts to review documents and processes, identify differences in accounting principles, gather data needed for conversion, and handle related project management aspects.
Concluding remarks
The impact of IFRS, on multinational corporations' financial statements or on international capital markets, is no less that that of Sarbanes-Oxley in the U.S. However, given the thirst of corporations and investors for globally consistent financial reporting standards, the IFRS tide has become irresistible. For Taiwan's multinational corporations looking to extend their global deployment strategies, preparation must begin without delay to compile financial statements in accordance with IFRS, so that they can demonstrate internationalized financial statement standards, attract favorable attention from international market analysts and investors, and obtain financing in international capital markets.
Joseph Chou is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to Joseph.Chou@tw.pwc.com .
(The article was published in Commercial Times on 14th January, 2008)