Pouilly Kimberly

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During the past year there has been much discussion regarding accounting practices and methods. Prior to his retirement Securities Exchange Commission Chairman Christopher Cox was actively pursuing “an international language of disclosure and transparency”. Since his retirement, Mary Schapiro, Cox’s successor, has questioned the urgency of such a proposal. Addressing the necessity for uniform accounting, in addition to the potential benefits and concerns is the purpose for this paper.

Global Economy:
In order to stimulate the economy and provide jobs for the American public the President adopted the Recovery Act. Construction projects funded through this Recovery Act are required to ‘Buy American’. If an American manufactured product is unavailable, then, products may be obtained from NAFTA – North American Free Trade Agreement Countries. In searching for screen door hardware it was apparent that very few products are actually, manufactured, assembled, and distributed within the United States of America.

America has become a Global Economy. The American-made screen door has parts manufactured from more than three different countries in at least two hemispheres.

This globalization of the economy has created the need for one accounting language. Currently, the language of choice is IFRS – International Financial Reporting Standards. The International Accounting Standards Board, created in 2001, was asked to create a set of standards for the emerging markets of the newly established European Union. There are currently more than 113 countries requiring or permitting the use of IFRS.

Why Not GAAP?
GAAP is the acronym used for the Generally Accepted Accounting Principles. It is the system currently used in the United States. It is an evolution of rules, begun in 1934, that address current situations in industry, economy and the financial markets. This rules-based approach has been thoroughly tested in the courts, however, it is lacking in clarity. Many of the necessary exceptions to these rules have created ambiguity instead of clarity.

The International Financial Reporting Standards are principle based. Because there are few rules, more disclosures are needed to explain the financial statements. This information outside the financial statements clarifies the reported information to potential investors. It also creates the transparency needed to see through the financial statements to the actual position of the reporting entity.

The Benefits of a Global Accounting Language
The benefits of a global accounting language far outweigh the costs associated with changing methods and standards of accounting. These benefits include cost and time savings in preparing only one set of financial records for an entire multinational company. Uniform standards are seen as beneficial to the development of international relationships. Having one set of financial standards reduces accounting risk, decreasing investment costs.

Now, many publicly traded international companies based in the United States are required to prepare and maintain multiple sets of accounting records. One set is USGAAP to meet the requirement of the SEC for being publicly traded on the NYSE. Other sets are maintained to meet the requirements of the accounting boards of the other countries in which they do business. For example, McDonalds Corp. conducts business throughout the world. Until recently, their corporation prepared different methods of accounting records for the United States, Canada, Europe, Japan, and Australia. Two sets of accounting records are all McDonald’s needs in 2011. This is a tremendous savings in human resources and costs to the corporation.

Facilitating international business through uniform standards is equated to the ease of travel created when having only one language or currency. Each of the players is aware of the value of an item and can express that value in similar terms.

Barry Jay Epstein, PhD, CPA, outlines the economic effects of the United States adoption of IFRS in his article by the same name. In the article he states, ”having uniform, high-quality standards has been extolled as fostering international business relationships, with the goal being the facilitation of cross-border capital flows and lowering the cost of capital” He further states that lower costs of capital are a result of the elimination of accounting risk. Accounting risk is the risk of not understanding the applied principles of the entity reporting. It is also the risk that the entity is not applying its principles in a consistent manner.

Financial Markets: is IFRS good or bad?
As stated previously, having one set of accounting standards creates liquidity in the marketplace. As investors become more confident in the information reported by an entity, the securities of that entity become more desirable, creating a larger liquid market for their securities. In addition, costs have been reduced through risk removal. The risks of inaccurate reporting and misinterpretation of unfamiliar statements are some of the risks removed.

There is some concern regarding the effects of the accounting changes to inventory, and the tax liabilities created. LIFO, last-in-first-out, method of costing inventory is not allowed in IFRS. Many larger corporations use this method as a tax savings device. The Internal Revenue Service only allows the LIFO costing method for taxes when it is used for financial reporting. (This is so the entity does not use LIFO to report a loss on taxes and FIFO – first-in-first-out to report a profit in financial reports.

This change in accounting creates a large tax liability. Caterpillar Tractor Company is reported to have a LIFO reserve of $2 billion. United Technologies estimates its first year tax liability under IFRS to be approximately $4 billion. Due to other tax considerations these liabilities cause, which are beyond the scope of this paper, accommodations will need to be made by the IRS.

Concerns Specific to Financial Risk Management Divisions
One of the major differences between the US GAAP standards and the IFRS method is the number or amount of disclosures required for financial reporting. One of the areas affected by this difference is the Financial Risk Management Division. Under IFRS 7 Disclosure Requirements, each investment instrument must be classified by the amount of risk taken, how that risk is to be managed. In addition, hedging instruments must also be quantitatively and qualitatively described based on the risk being hedged and the financial instruments designated as hedging instruments. Gains and losses on hedges must also be listed separately.

How to Prepare
Start planning now for what some call the “inevitable move to IFRS” Begin evaluating current positions and investments within the risk management portfolio. Clean it. Any investments not conducive to disclosure, offset.

The cost of converting to IFRS is predicted at .05% of revenue to 1% of revenue. Rebalance the portfolio to protect and to enhance current cash positions.

Educate the entire risk management team on the language of IFRS. As of Dec 2007, many international companies listed on US Stock Exchanges are no longer required to prepare reconciliations of their financial statements to GAAP. For these companies, the last reconciliations filed with the SEC were in 2006. IFRS is the only meaningful data present for these companies. Education is an absolute necessity to making sound financial decisions.

Historically, accounting standards have changed in conjunction with the economy, the financial markets, and technology. IFRS is the next change. Over time, this change should prove beneficial to the financial risk management industry.


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