related documents
RR74 - Observance of International Accounting Standards - Factors explaining non-compliance
ACCA Research Report No. 74
The objective of this research was to examine the financial statements and footnotes of a worldwide sample of companies referring to the use of International Accounting Standards (IAS), to explore further the extent of noncompliance, and most importantly to provide information about the factors associated with noncompliance. A fuller understanding of the factors driving noncompliance should assist the International Accounting Standards Board (IASB), International Federation of Accountants (IFAC) and other interested parties such as the International Forum on Accountancy Development (IFAD), in addressing this crucial problem. To facilitate the worldwide acceptance of IAS, auditors and regulators must address enforcement issues.
The major findings of this research are that there is a significant extent of noncompliance with IAS and that key factors associated with levels of compliance include listing status, being audited by a Big 5+2 firm, the manner of reference to IAS, and country of domicile.
More specifically, with regard to compliance with IAS disclosure requirements, compliance tends to be greater for companies with a non-regional listing; that are in the transportation, communications and electronics industries; that refer exclusively to the use of IAS; that are audited by a Big 5+2 firm; and that are domiciled in China or Switzerland. On the other hand, compliance tends to be more problematic for companies domiciled in some Western European countries, notably France and Germany.
As regards compliance with IAS measurement and presentation standards, compliance tends to be higher for companies that make exclusive reference to the use of IAS, are audited by a Big 5+2 firm, and that are domiciled in China. At the same time, compliance tends to be lower for companies domiciled in France or Africa.
Motivations for complying with IAS are clearly linked to being listed outside the home region (e.g. in the USA). Being audited by a Big 5+2 firm is also an important factor promoting compliance, though this does not apply in all cases. National barriers to IAS compliance are also evident especially in a number of European countries, notably France and Germany. Interestingly, there are higher levels of compliance for companies based in Switzerland and China, possibly because of the need to do more to overcome perceptions relating to their traditional national accounting models and to be viewed as acceptable to the international investment community.
These findings highlight the importance of ongoing efforts by several organisations – including the International Accounting Standards Committee (now Board), IFAC and IFAD – to raise the standard of accounting and audit practices worldwide. While the IASC/IASB has worked diligently to develop a set of high quality accounting standards, the World Bank and others have criticised the audit profession for not enforcing appropriate application of IAS. The IASC (1999) has stated:
'identifying and dealing with departures by preparers from International Accounting Standards… is primarily a matter for auditors, professional accountancy bodies, IFAC, national enforcement agencies and supranational bodies such as IOSCO and the Basel Committee. IASC does not have the resources or the legal authority to do this effectively.'
Organisations including IFAC and IFAD are currently working with the IASC/IASB to address the enforcement of IAS.
IASC efforts
Regarding the manner in which companies refer to IAS, IAS 1 Presentation of Financial Statements was revised during 1997 (effective for accounting periods beginning on or after 1 July 1998). One of the main aims of the revision was to ensure that departures from IAS requirements are restricted to extremely rare cases. Paragraphs 11 and 12 of IAS 1R state:
'an enterprise whose financial statements comply with International Accounting Standards should disclose that fact. Financial statements should not be described as complying with International Accounting Standards unless they comply with all the requirements of each applicable Standard and each applicable Interpretation of the Standing Interpretations Committee. Inappropriate accounting treatments are not rectified either by disclosure of the accounting policies used or by notes or explanatory material.'
As the current research focused primarily on 1998 year end accounts, IAS 1R was not mandatory. Hence, future research is needed to explore the impact of IAS 1R on compliance. Specifically, a comprehensive review of 1999/2000 accounts is needed to determine the extent to which companies ceased referring to IAS when notable exceptions are evident. For example, our sample included several companies that claim that the financial statements are in compliance with both domestic GAAP and IAS, claim that the financial statements are in accordance with IAS with exceptions, or claim that the financial statements are prepared according to national GAAP and that they also comply with IAS in all material aspects or are consistent with IAS. Our research suggests that IAS 1R should result in some of these companies dropping any form of reference to IAS, as a review of their 1998 accounts reveals the omission of relevant disclosures and the application of measurement practices that are not permitted by IAS. Alternatively, a more positive scenario may emerge whereby the level of compliance with IAS by some of these companies may improve dramatically. Such references to IAS have given rise to unjustified criticism of IAS in the accounting literature and by accounting regulators. In these instances, the issue is not the quality of IAS but the lack of enforcement.
The recent restructuring of the IASC should also assist in addressing the noncompliance problems identified by the current research. The new IASB Board includes seven members who will also serve as liaisons with national accounting standard setting boards. The intention is that these liaisons will work to harmonise their national standards with IAS, thereby making it possible for more companies to state accurately that their financial statements are in compliance with both IAS and national GAAP. Currently, differences between national GAAP and IAS often make this impossible.
Regulatory efforts
Regulatory bodies may also assist in improving compliance with IAS. For example, the US SEC has noted some situations where a foreign registrant's footnotes assert that financial statements comply in all material respects with IAS or are consistent with IAS, yet the company has applied only certain IAS or omitted information without explaining the reasons for exclusion. The SEC has stated that it will challenge such assertions and where they cannot be sustained will require either changes to the financial statements to conform with IAS or the removal of the assertion of compliance with IAS. Similar actions by other regulatory bodies and stock exchanges would be greatly welcomed by the IASB.
In February 2001, the European Commission formally presented a proposal for a Regulation requiring listed companies to prepare consolidated financial statements based on IAS no later than 2005. The Commission's proposal is a priority measure under the Financial Services Action Plan endorsed by the Lisbon European Action Plan. Support for the Commission's proposal is growing. A recent survey of 700 listed companies reveals that 79 per cent of the Chief Financial Officers support the European Commission's proposal.
In line with the requirements of the Regulation, an accounting technical committee has been set up as a private-sector initiative entitled the 'European Financial Reporting Advisory Group.' The EFRAG will represent users, preparers, the accounting profession and national standard setters, and will provide technical expertise concerning the use of IAS within the European legal environment. It will participate in the international accounting standard setting process and organise the coordination within the EU of views concerning IAS. As the current research revealed that noncompliance with IAS was particularly problematic in France, Germany and some other Western European countries, this EU initiative will probably have a very significant impact on the enforcement of IAS and thereby raise the level of compliance across the EU.
Restructuring of IFAC and the formation of IFAD
Other efforts to address compliance problems facing the IASC/IASB include the formation of the IFAD and the restructuring of IFAC. IFAD was established following the Asian financial crisis in response to a call in 1997 from James Wolfensohn, president of the World Bank. Wolfensohn criticised the accounting profession for not doing enough to enhance the accounting capacity and capabilities in developing and emerging nations. Then IFAC President Frank Harding held discussions with the then Vice President of the World Bank, Jules Muis, regarding joint efforts in this area. IFAD, representing an alliance of accountancy groups and firms across the world, is intended to be a platform via which regulators, international financial institutions, investors and representatives of the accountancy and auditing profession acting together to promote high quality financial reporting can reduce the risk of economic downturns such as the Asian financial crisis.
Currently, IFAD is undertaking country-by-country reviews of accounting standards, ethics and disciplinary procedures, corporate governance, banking and company law. IFAD plans to benchmark information collected through these individual country reviews against international standards and will finance consultants to visit countries to help fill the gaps wherever these may be identified.
The significant nature of differences between the GAAP of 53 countries and IASC GAAP is detailed in IFAD's publication, GAAP 2000. IFAD is firmly committed to encouraging convergance of national accounting standards with IAS. Successful implementation of IFAD's vision would go far in addressing a key problem revealed by the current research. Specifically, several sample companies argued that their financial statements were in compliance with national GAAP, and additionally argued that they complied with IAS in all material aspects; however, the research indicated that compliance was problematic for this group. Raising national standards to satisfy the IAS benchmark would greatly minimise such misinterpretations.
At the May 2000 conference of IFAC, World Bank advisor Ira Millstein criticised the accountancy profession, particularly, the Big 5, for failing to offer consistent standards of audit that meet the needs of investors worldwide. Millstein argued:
'You are not doing everything you can do to provide consistent, cohesive information. Accounting and auditing are the lynchpin to improve capital flows. If you provide wrong information, you can misguide capital flows. If you lead, others will follow.'
He urged the large firms to establish 'voluntary minimum guidelines and a comfort zone' below which they would never venture. In response, Harding, then President of IFAC, noted this was the reason IFAD was established. The current research suggests that IFAD has a long road ahead of it. While the findings of this research indicate compliance was greater for companies audited by the Big 5+2 firms, numerous examples were identified where an international firm signed its brand name to financial statements that clearly did not comply with all IAS disclosures and measurement and presentation practices.
In May 2000, IFAC agreed to a restructuring plan. As part of the restructuring, IFAC and the large international accounting firms have undertaken a major new initiative designed to raise standards of financial reporting and auditing globally in an effort to protect the interests of cross-border investors and promote international flows of capital. A key component of this effort is the establishment of a new IFAC-sponsored Forum of Firms (FoF) that will work closely with IFAC in developing and encouraging implementation of international accounting and auditing standards. Plans also provide for the independent oversight of IFAC's public interest activities.
Participation in the new IFAC Forum of Firms is open to any firm with offices in more than one jurisdiction or that has, or intends to have, transnational clients and is willing to comply with rigorous quality obligations. These would include:
• having policies and practices in compliance with ISAs and the IFAC Code of Ethics
• maintaining appropriate internal control procedures including intra-firm practice review
• agreeing to implement training on international accounting and auditing standards including the IFAC Code of Ethics
• agreeing to subject assurance work to periodic external quality assurance
and
• agreeing to support the development of the professional bodies and implementation of international standards of accounting and auditing in developing countries.
Perhaps the most important of these obligations is the agreement to subject all of a firm's offices in all jurisdictions to independent quality assurance reviews. While the international firms have undergone peer review on a national basis in countries such as the USA and Canada, this will represent the first effort to implement global peer review and look at each of the large firms as one entity throughout the world. Membership in the Forum is conditional on compliance with these reviews. The Forum of Firms will work alongside IFAD to improve the quality of global accounting and auditing. Additionally, an independent Public Oversight Board will ensure the activities of IFAC and its FoF are in the public interest.
Implications of the research
The incorporation of IAS in EU legislation will be highly significant as this research has indicated that compliance was particularly problematic for companies domiciled in France, Germany and some other Western European countries. Yet the key to global acceptance and enforcement of IAS lies with successful implementation of IFAD's goals and IFAC's new initiatives. Inter alia, IFAD must promote accounting education, addressing IAS’s, ISA’s and IFAC’s Code of Ethics, on a global basis. At the same time, members of IFAC's FoF need to adhere to their May 2000 agreement and take a solid stand by insisting on comparable implementation of accounting and auditing standards on a global basis. In regard to the enforcement of IAS’s, the first step is to enforce IAS 1R and refuse to sign any audit opinion referring to IAS unless the statements comply with each and every IAS. The next step is to promote IAS and ISA as benchmarks. In an ideal world, firms would not append their names to audit reports unless the measurement and presentation practices and disclosures adhere fully to the international benchmarks. The national standard can no longer suffice. One commentator has argued that 'this would begin a push toward appropriate disclosure faster than all the committee meetings in the world'. Additionally, the IFAC Monitoring Committee must exercise close oversight over member institutes and be willing to challenge, or even expel, those that do not promote international standards of accounting and auditing as the benchmark within their jurisdictions.
While the new international framework has been developed successfully, implementation is likely to be slow, painful and costly. As noted by IFAD, 'financial accountability and reporting laws must transcend cultural beliefs and practices and must specifically address the issues of corruption, fraud, and misrepresentation'. Only time will tell if the efforts of IFAD and IFAC can overcome cultural and other barriers and achieve global acceptance and enforcement of IAS and ISA in over 180 countries around the world. In the meantime, IFAC's transnational FoF must take the lead by upgrading quality standards to a consistent worldwide level. These firms should fulfill their commitment to improve training in international standards and ensure compliance with IAS and ISA as well as IFAC's Code of Ethics throughout their global networks.
The research results reported here confirm earlier reports of significant noncompliance. As noted above, this work needs now to be replicated on financial statements prepared on the basis of the new IAS 1R and in the context of the new global regulatory mechanism.
Street and Gray, 2001
Executive summary
The objective of this research was to examine the financial statements and footnotes of a worldwide sample of companies referring to the use of International Accounting Standards (IAS), to explore further the extent of noncompliance, and most importantly to provide information about the factors associated with noncompliance. A fuller understanding of the factors driving noncompliance should assist the International Accounting Standards Board (IASB), International Federation of Accountants (IFAC) and other interested parties such as the International Forum on Accountancy Development (IFAD), in addressing this crucial problem. To facilitate the worldwide acceptance of IAS, auditors and regulators must address enforcement issues.
The major findings of this research are that there is a significant extent of noncompliance with IAS and that key factors associated with levels of compliance include listing status, being audited by a Big 5+2 firm, the manner of reference to IAS, and country of domicile.
More specifically, with regard to compliance with IAS disclosure requirements, compliance tends to be greater for companies with a non-regional listing; that are in the transportation, communications and electronics industries; that refer exclusively to the use of IAS; that are audited by a Big 5+2 firm; and that are domiciled in China or Switzerland. On the other hand, compliance tends to be more problematic for companies domiciled in some Western European countries, notably France and Germany.
As regards compliance with IAS measurement and presentation standards, compliance tends to be higher for companies that make exclusive reference to the use of IAS, are audited by a Big 5+2 firm, and that are domiciled in China. At the same time, compliance tends to be lower for companies domiciled in France or Africa.
Motivations for complying with IAS are clearly linked to being listed outside the home region (e.g. in the USA). Being audited by a Big 5+2 firm is also an important factor promoting compliance, though this does not apply in all cases. National barriers to IAS compliance are also evident especially in a number of European countries, notably France and Germany. Interestingly, there are higher levels of compliance for companies based in Switzerland and China, possibly because of the need to do more to overcome perceptions relating to their traditional national accounting models and to be viewed as acceptable to the international investment community.
These findings highlight the importance of ongoing efforts by several organisations – including the International Accounting Standards Committee (now Board), IFAC and IFAD – to raise the standard of accounting and audit practices worldwide. While the IASC/IASB has worked diligently to develop a set of high quality accounting standards, the World Bank and others have criticised the audit profession for not enforcing appropriate application of IAS. The IASC (1999) has stated:
'identifying and dealing with departures by preparers from International Accounting Standards… is primarily a matter for auditors, professional accountancy bodies, IFAC, national enforcement agencies and supranational bodies such as IOSCO and the Basel Committee. IASC does not have the resources or the legal authority to do this effectively.'
Organisations including IFAC and IFAD are currently working with the IASC/IASB to address the enforcement of IAS.
IASC efforts
Regarding the manner in which companies refer to IAS, IAS 1 Presentation of Financial Statements was revised during 1997 (effective for accounting periods beginning on or after 1 July 1998). One of the main aims of the revision was to ensure that departures from IAS requirements are restricted to extremely rare cases. Paragraphs 11 and 12 of IAS 1R state:
'an enterprise whose financial statements comply with International Accounting Standards should disclose that fact. Financial statements should not be described as complying with International Accounting Standards unless they comply with all the requirements of each applicable Standard and each applicable Interpretation of the Standing Interpretations Committee. Inappropriate accounting treatments are not rectified either by disclosure of the accounting policies used or by notes or explanatory material.'
As the current research focused primarily on 1998 year end accounts, IAS 1R was not mandatory. Hence, future research is needed to explore the impact of IAS 1R on compliance. Specifically, a comprehensive review of 1999/2000 accounts is needed to determine the extent to which companies ceased referring to IAS when notable exceptions are evident. For example, our sample included several companies that claim that the financial statements are in compliance with both domestic GAAP and IAS, claim that the financial statements are in accordance with IAS with exceptions, or claim that the financial statements are prepared according to national GAAP and that they also comply with IAS in all material aspects or are consistent with IAS. Our research suggests that IAS 1R should result in some of these companies dropping any form of reference to IAS, as a review of their 1998 accounts reveals the omission of relevant disclosures and the application of measurement practices that are not permitted by IAS. Alternatively, a more positive scenario may emerge whereby the level of compliance with IAS by some of these companies may improve dramatically. Such references to IAS have given rise to unjustified criticism of IAS in the accounting literature and by accounting regulators. In these instances, the issue is not the quality of IAS but the lack of enforcement.
The recent restructuring of the IASC should also assist in addressing the noncompliance problems identified by the current research. The new IASB Board includes seven members who will also serve as liaisons with national accounting standard setting boards. The intention is that these liaisons will work to harmonise their national standards with IAS, thereby making it possible for more companies to state accurately that their financial statements are in compliance with both IAS and national GAAP. Currently, differences between national GAAP and IAS often make this impossible.
Regulatory efforts
Regulatory bodies may also assist in improving compliance with IAS. For example, the US SEC has noted some situations where a foreign registrant's footnotes assert that financial statements comply in all material respects with IAS or are consistent with IAS, yet the company has applied only certain IAS or omitted information without explaining the reasons for exclusion. The SEC has stated that it will challenge such assertions and where they cannot be sustained will require either changes to the financial statements to conform with IAS or the removal of the assertion of compliance with IAS. Similar actions by other regulatory bodies and stock exchanges would be greatly welcomed by the IASB.
In February 2001, the European Commission formally presented a proposal for a Regulation requiring listed companies to prepare consolidated financial statements based on IAS no later than 2005. The Commission's proposal is a priority measure under the Financial Services Action Plan endorsed by the Lisbon European Action Plan. Support for the Commission's proposal is growing. A recent survey of 700 listed companies reveals that 79 per cent of the Chief Financial Officers support the European Commission's proposal.
In line with the requirements of the Regulation, an accounting technical committee has been set up as a private-sector initiative entitled the 'European Financial Reporting Advisory Group.' The EFRAG will represent users, preparers, the accounting profession and national standard setters, and will provide technical expertise concerning the use of IAS within the European legal environment. It will participate in the international accounting standard setting process and organise the coordination within the EU of views concerning IAS. As the current research revealed that noncompliance with IAS was particularly problematic in France, Germany and some other Western European countries, this EU initiative will probably have a very significant impact on the enforcement of IAS and thereby raise the level of compliance across the EU.
Restructuring of IFAC and the formation of IFAD
Other efforts to address compliance problems facing the IASC/IASB include the formation of the IFAD and the restructuring of IFAC. IFAD was established following the Asian financial crisis in response to a call in 1997 from James Wolfensohn, president of the World Bank. Wolfensohn criticised the accounting profession for not doing enough to enhance the accounting capacity and capabilities in developing and emerging nations. Then IFAC President Frank Harding held discussions with the then Vice President of the World Bank, Jules Muis, regarding joint efforts in this area. IFAD, representing an alliance of accountancy groups and firms across the world, is intended to be a platform via which regulators, international financial institutions, investors and representatives of the accountancy and auditing profession acting together to promote high quality financial reporting can reduce the risk of economic downturns such as the Asian financial crisis.
Currently, IFAD is undertaking country-by-country reviews of accounting standards, ethics and disciplinary procedures, corporate governance, banking and company law. IFAD plans to benchmark information collected through these individual country reviews against international standards and will finance consultants to visit countries to help fill the gaps wherever these may be identified.
The significant nature of differences between the GAAP of 53 countries and IASC GAAP is detailed in IFAD's publication, GAAP 2000. IFAD is firmly committed to encouraging convergance of national accounting standards with IAS. Successful implementation of IFAD's vision would go far in addressing a key problem revealed by the current research. Specifically, several sample companies argued that their financial statements were in compliance with national GAAP, and additionally argued that they complied with IAS in all material aspects; however, the research indicated that compliance was problematic for this group. Raising national standards to satisfy the IAS benchmark would greatly minimise such misinterpretations.
At the May 2000 conference of IFAC, World Bank advisor Ira Millstein criticised the accountancy profession, particularly, the Big 5, for failing to offer consistent standards of audit that meet the needs of investors worldwide. Millstein argued:
'You are not doing everything you can do to provide consistent, cohesive information. Accounting and auditing are the lynchpin to improve capital flows. If you provide wrong information, you can misguide capital flows. If you lead, others will follow.'
He urged the large firms to establish 'voluntary minimum guidelines and a comfort zone' below which they would never venture. In response, Harding, then President of IFAC, noted this was the reason IFAD was established. The current research suggests that IFAD has a long road ahead of it. While the findings of this research indicate compliance was greater for companies audited by the Big 5+2 firms, numerous examples were identified where an international firm signed its brand name to financial statements that clearly did not comply with all IAS disclosures and measurement and presentation practices.
In May 2000, IFAC agreed to a restructuring plan. As part of the restructuring, IFAC and the large international accounting firms have undertaken a major new initiative designed to raise standards of financial reporting and auditing globally in an effort to protect the interests of cross-border investors and promote international flows of capital. A key component of this effort is the establishment of a new IFAC-sponsored Forum of Firms (FoF) that will work closely with IFAC in developing and encouraging implementation of international accounting and auditing standards. Plans also provide for the independent oversight of IFAC's public interest activities.
Participation in the new IFAC Forum of Firms is open to any firm with offices in more than one jurisdiction or that has, or intends to have, transnational clients and is willing to comply with rigorous quality obligations. These would include:
• having policies and practices in compliance with ISAs and the IFAC Code of Ethics
• maintaining appropriate internal control procedures including intra-firm practice review
• agreeing to implement training on international accounting and auditing standards including the IFAC Code of Ethics
• agreeing to subject assurance work to periodic external quality assurance
and
• agreeing to support the development of the professional bodies and implementation of international standards of accounting and auditing in developing countries.
Perhaps the most important of these obligations is the agreement to subject all of a firm's offices in all jurisdictions to independent quality assurance reviews. While the international firms have undergone peer review on a national basis in countries such as the USA and Canada, this will represent the first effort to implement global peer review and look at each of the large firms as one entity throughout the world. Membership in the Forum is conditional on compliance with these reviews. The Forum of Firms will work alongside IFAD to improve the quality of global accounting and auditing. Additionally, an independent Public Oversight Board will ensure the activities of IFAC and its FoF are in the public interest.
Implications of the research
The incorporation of IAS in EU legislation will be highly significant as this research has indicated that compliance was particularly problematic for companies domiciled in France, Germany and some other Western European countries. Yet the key to global acceptance and enforcement of IAS lies with successful implementation of IFAD's goals and IFAC's new initiatives. Inter alia, IFAD must promote accounting education, addressing IAS’s, ISA’s and IFAC’s Code of Ethics, on a global basis. At the same time, members of IFAC's FoF need to adhere to their May 2000 agreement and take a solid stand by insisting on comparable implementation of accounting and auditing standards on a global basis. In regard to the enforcement of IAS’s, the first step is to enforce IAS 1R and refuse to sign any audit opinion referring to IAS unless the statements comply with each and every IAS. The next step is to promote IAS and ISA as benchmarks. In an ideal world, firms would not append their names to audit reports unless the measurement and presentation practices and disclosures adhere fully to the international benchmarks. The national standard can no longer suffice. One commentator has argued that 'this would begin a push toward appropriate disclosure faster than all the committee meetings in the world'. Additionally, the IFAC Monitoring Committee must exercise close oversight over member institutes and be willing to challenge, or even expel, those that do not promote international standards of accounting and auditing as the benchmark within their jurisdictions.
While the new international framework has been developed successfully, implementation is likely to be slow, painful and costly. As noted by IFAD, 'financial accountability and reporting laws must transcend cultural beliefs and practices and must specifically address the issues of corruption, fraud, and misrepresentation'. Only time will tell if the efforts of IFAD and IFAC can overcome cultural and other barriers and achieve global acceptance and enforcement of IAS and ISA in over 180 countries around the world. In the meantime, IFAC's transnational FoF must take the lead by upgrading quality standards to a consistent worldwide level. These firms should fulfill their commitment to improve training in international standards and ensure compliance with IAS and ISA as well as IFAC's Code of Ethics throughout their global networks.
The research results reported here confirm earlier reports of significant noncompliance. As noted above, this work needs now to be replicated on financial statements prepared on the basis of the new IAS 1R and in the context of the new global regulatory mechanism.