Module: 4
Financial Standards and Codes: Report of Advisory Group on International Accounting and Auditing

International Accounting Standards (ISAC) and US GAAP

International Accounting Standards Committee (IASC)

The IASC was formed in 1973 through an agreement made by professional accountancy bodies from various countries. Since 1983, IASC's members have included all the professional accountancy bodies that are members of the International Federation of Accountants (IFAC). Many other organizations are now involved in the work of IASC and many countries that are not members of IASC make use of International Accounting Standards. Prior to its reconstitution, as explained later, Institute of Chartered Accountants of India had a nominee on the Board of IASC and it has committed to harmonise Indian Accounting Standards with International Accounting Standards.

The objectives of IASC as stated in its constitution are: -

• to formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance;

• to work generally for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements.

It has been decided in 1999 to have a new structure for the functioning of IASC. Under the new structure, the IASC has been reorganized as a separate foundation governed by Trustees. The trustees are 19 individuals of diverse geographic and functional backgrounds. The Trustees appoint the members of the Board, SIC (Standards Interpretation Committee) and Standards Advisory Council.

The new Board will have fourteen members (12 full time members and 2 part time members). The foremost qualification of Board membership will be technical expertise and the Trustees will exercise their best judgement to ensure that the Board is not dominated by any particular constituency or regional interest. At least 5 Board members will have a background as practicing auditors, at least 3 will have a background in the preparation of financial statements, at least 3 will have a background as users of financial statements and at least one will have an academic background. It is expected that the proposed structure will come into effect shortly.

In some cases, where International Accounting Standards permit more than one accounting treatment for similar transactions and events, one treatment is designated as the "benchmark treatment" and the other as the "allowed alternative treatment". Such identification of "benchmark treatment" out of two alternatives in various standards was carried out under "Comparability and Improvement" Project carried out during 1987 to 1993 under which 10 core standards were reviewed and revised.

The International Organization of Securities Commission (IOSCO) is looking to IASC to provide mutually acceptable International Accounting Standards for use in multinational securities offerings and other international offerings. Already many stock exchanges require or allow foreign issuers to present financial statements in accordance with International Accounting Standards. As a result, a growing number of companies disclose the fact that their financial statements conform to International Accounting Standards.

In 1995, IASC agreed with IOSCO to develop a set of "Core Standards" as identified in a list developed by IOSCO in 1993. It was agreed that if the completed Core Standards satisfy IOSCO, it would consider endorsing International Accounting Standards for cross-border capital raising and listing purposes in all global markets. By 1999, IASC completed work on the major projects in the work plan agreed with IOSCO. In October 1998, a declaration by the finance ministers and central bank governors of the G7 countries called on IOSCO "to carry out a timely review" of the core standards.

First, IASC's standards were endorsed by the Board Committee and then, subsequently, by the International Organization of Securities Commission (IOSCO) in June 2000. This endorsement is a recommendation to all IOSCO members to permit incoming multinational issuers to use IASC standards to prepare their financial statements for cross border offerings and listings.

The IOSCO endorsement allows the individual regulators to require certain supplementary treatments, namely reconciliation of certain items, certain additional disclosure and specified choice between alternatives in IASC's standards. IOSCO's endorsement is considered as a landmark for improved global financial reporting.

After the significant announcement of IOSCO's endorsement of International Accounting Standards, the second was the European Commission's decision to require listed companies throughout the European Union to use IAS from 2005. The benefit of this decision is both European and International. Second, Fourth and Seventh Directives notwithstanding, the European accounting standards remain highly fragmented. The decision of the European Commission provides critical support to the process of bringing European capital markets together, for which comparable and reliable financial data is the lifeblood.

US GAAP have evolved from experience, reason, custom, usage and to a significant extent, practical necessity. US GAAP are contained in a variety of pronouncements which carry different levels of authority.

The principal sources are:

• Pronouncements issued by the board of the Financial Accounting Standards Board (FASB). These include Standards, Interpretations and Concept Statements. Also, the staff of the FASB publishes Technical Bulletins and Implementation Guides (Questions and Answers). In addition, the FASB publishes the consensus views of its Emerging Issues Task Force (EITF).

• Pronouncements of the American Institute of Certified Public Accountants (AICPA). These include Accounting Principles Board (APB), Opinions and Accounting Research Bulletins (ARB) issued by the Committee on Accounting Procedures; and

• Pronouncements of the Securities and Exchange Commission (SEC) which issues regulations and pronouncements which govern entities which issue securities to the public and which are listed on stock exchanges. These include: Regulation S-X (for financial statement requirements); Regulation S-K (for non-financial information requirements); Financial Reporting Releases and Accounting and Auditing Enforcement Releases. The staff also issues Staff Accounting Bulletins.

The real battle in the world of accounting is between US GAAP and International Accounting Standards. Many big companies would like to tap US financial markets or benchmark their financials statements with US GAAP. However, one essential factor that goes against US GAAP is that they are the standards of one particular country, and have been developed to meet the needs of the business and investor communities of that country. The US standard setters have no mandate to broaden their consideration to the international scene.

The International Accounting Standards provide a solution to the above problem faced by US GAAP. International Accounting Standards are formulated after participation of and interaction with the international community. The recent endorsements of International Accounting Standards by IOSCO and the European Commission have given IAS the vital credibility that they needed. Even SEC in USA has invited comment letters on its Concept Release on International Accounting Standards and proposals to recognize financial statements in accordance with IAS subject to certain supplementary treatments like reconciliation of certain items and certain additional disclosures etc.

The International Accounting Standards (IAS) serve as a benchmark for comparison with the Indian accounting standards (AS) from the angle of statutory recognition.

It may be stated that by nature the Accounting Standards can be broadly classified into two types, viz., those where the focus is on the accounting treatment/measurement, and those which require more disclosures as additional useful and relevant information in relation to the working of the entities.

The major differences between AS and IAS in respect of accounting treatment or disclosure prescribed are discussed in Annexure III. A few are highlighted below.

Indian practice often differs from that required by IAS because of the absence of specific rules in the following areas:

• parent enterprises are not required to issue consolidated financial statements (IAS 27.7)

• accounting for associates and joint ventures (IAS 28 and IAS 31)

• impairment of assets (IAS 36)

• the capitalization of leases (IAS 17.12)

• discounting of provisions (IAS 37.45)

• the methods to be used when accounting for employee benefit obligations (IAS 19.64/78/83)

• accounting for deferred tax (IAS 12).

There are no specific rules requiring disclosures of:

• a statement of changes in equity (IAS 1.7)

• the fair values of financial assets and liabilities, except for quoted investments (IAS 32.77)

• discontinuing operations (IAS 35)

There are inconsistencies between Indian and IAS rules that are likely to lead to differences for many enterprises in certain areas. Under Indian rules:

• the classification of business combinations as acquisitions or uniting of interest is not based on the ability to identify an acquirer (IAS 22.8)

• exchange differences arising on foreign currency liabilities related to the purchase of fixed assets are used to adjust the fixed assets rather than being taken to income (IAS 21.15)

• certain research costs can be capitalized (IAS 38.42)

• certain expenditures on intangible items that are not assets can be capitalized (IAS 38.56)

• revaluations of assets do not need to be kept up-to-date (IAS 16.29)

• operating lease payments are generally recognized on the basis of legal arrangements rather than straight-line, and there are no specific requirements on the treatment of lease incentives (IAS 17.25, SIC 15)

• the completed contract method may be used to recognize revenues on construction contracts (IAS 11.12)

• provisions can be created when there is no obligation (IAS 37.14)

• proposed dividends are accrued (IAS 10.11)

• an issuer's financial instruments are generally accounted for on the basis of their legal form, and compound instruments are not split into liability and equity components (IAS 31.18/23)

• the calculation of earnings per share may use a variety of bases (IAS 33.10/11/20)

The US GAAP standards often serve as the yardstick for the Indian accounting standards from the point of view of practical perception of the investor. For many major global business enterprises the accounting standards that they are most familiar with, other than their own domestic standards, are those of the USA. This is because many such enterprises have sought to have their capital listed on the stock exchanges of the USA. The USA has over the past many years also been the world's major capital supplier and a company in any part of the world which becomes large has an eye to tap the capital market in USA. Many companies have, therefore, voluntarily, started reformatting their financial statements in accordance with US GAAP and publishing such reformatted accounts as additional information. Some of these companies have plans to get their capital listed on stock exchanges in USA now or in future. Even those companies which do not have such plans in contemplation feel it advisable to present their financial affairs to the shareholders and public compared against the benchmark of US GAAP.