Nadezhda Stepanova
Need for IFRS Enforcement
Setting universal financial reporting standards is not an easy task. The International Accounting Standards Committee (IASC) has gained an overall recognition as an efficient accounting standard setter since its formation in 1973. The IASC used to focus on setting IFRS. Now it is facing a new issue, i.e. finding the way of enforcing and achieving compliance with these standards.
The benefits of these Standards are obvious. IFRS-based financial statements will enable investors and creditors to assess the ability of enterprises to generate earnings and repay debts. The compliance with the Standards makes sure that the financial statements of different enterprises are comparable irrespective of their location and industry as well as the financial statements of an enterprise are comparable through time. No doubt, the preparation of such financial statements requires professional expertise, the use of judgments driven by the supply and demand in a market economy as well as estimates of projected values. In addition to a significant amount of measurement and presentation requirements, the Standards set extensive disclosure requirements for each line item and key operating factors to be reflected in the notes to the financial statements.
The enterprise’s management responsible for the preparation of financial statements should bear in mind that under IAS 1, Presentation of Financial Statements, financial statements cannot be described as being in compliance with IFRS if there is a departure from at least one IFRS and even if these departures are disclosed in the notes. This provision was included in the revised IAS 1 so that a departure from IFRS might occur only in extremely rare circumstances: «An enterprise whose financial statements comply with IAS should disclose that fact. Financial Statements should not be described as complying with IAS 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».
While the proper legal framework has been developed successfully, proper implementation of the Standards is still required. A comprehensive infrastructure must be in place in order for IFRS to be used, interpreted, and enforced consistently throughout the world. The IASC has been improving and interpreting the Standards on an on-going basis. The IASB as a restructured standard setter has seven members who are responsible for liaison with national accounting regulators in order to harmonize national standards and IFRS. This will enable a larger number of companies to state their compliance with IFRS and national standards. Currently, differences between IFRS and national standards make this impossible.
Auditing firms play a key role in this process. The International Federation of Accountants (IFAC) has stated that auditors are asserting that financial statements comply with International Accounting Standards (IAS) when the accounting policies and notes indicate otherwise.
Research on IFRS compliance
The Association of Chartered Certified Accountants (ACCA) published a research report by Sidney J. Gray and Donna L. Street, Observance of International Accounting Standards: Factors Explaining Non-compliance (ACCA, 2001). The objective of this research was to examine the financial statements and footnotes of a worldwide sample of companies referring to the use of IFRS to explore the extent of non-compliance and to provide information about the factors associated with non-compliance. The research was based on a sample of 279 companies that referred to the use of IFRS in their annual reports.
The research was based on financial statements for 1998 that were prepared prior to the enactment of the above amendments to IAS 1, Presentation of Financial Statements. If the amendments were in force at the time when financial statements were prepared, enterprises in most cases could not have referred to their compliance with IFRS because they did not disclose all relevant information and applied IFRS non-compliant accounting policies.
The major findings reveal troubling levels of non-compliance with IFRS. Companies applied only certain requirements of IFRS without disclosing reasons for departures. Key factors associated with levels of compliance included:
- listing status,
- being audited, and
- country of domicile.
The level of compliance with IFRS disclosure requirements varies by type of IFRS as shown in Table 1, ranging from 55% to 81% with an overall compliance level of 72%. On the other hand, compliance levels are higher for IFRS measurement and presentation standards, as shown in Table 2, ranging from 72% to 94% with an overall compliance level of 86%.
With regard to factors associated with compliance with key IFRS disclosure requirements, it was found that compliance tends to be significantly greater for multinational companies; enterprises that are in the transportation, communications and electronics industry; and that are audited. Compliance tends to be high for companies that are domiciled in China or Switzerland. On the other hand, significantly lower levels of compliance are found for companies domiciled in France, Germany, or other western European countries.
As regards compliance with key IFRS measurement and presentation standards, compliance tends to be higher for companies that are audited and that are domiciled in China. At the same time, compliance tends to be more problematic for companies domiciled in France or Africa.
Companies based in Switzerland and China have been successful, possibly because of the need to overcome national barriers to IFRS compliance and be viewed as acceptable to the international investment community.
Thus, key motivations for complying with IFRS are clearly linked to being listed outside the home region (e.g. in the USA). Being audited is also an important factor promoting compliance though full compliance with IFRS does not apply in all cases.
Research Findings Solutions
These findings highlight the importance of ongoing efforts by the IASB and International Federation of Accountants. Although the IASC has worked diligently to develop a set of high quality accounting standards, this research reveals continued problems associated with non-compliance. Hence, the focus of attention is switching from accounting standard setting to enforcement. 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.»
As was mentioned above, the IFRS compliance of audited financial statements tends to be higher though there were instances where large firms have signed off despite non-compliance with IFRS disclosure, measurement and presentation standards. Audit firms should maintain the quality of their services and confirm IFRS compliance only if statements comply with each and every IFRS.
In regard to enforcement of IFRS, the first step is for audit firms to enforce the recently revised IAS 1, Presentation of Financial Statements, and refuse to sign any audit opinion referring to IFRS unless the statements comply with each and every IFRS.
In the view of observers, «this will enable a much quicker jump to proper disclosures than all meetings of committees in the world». While the new international framework has been developed successfully, implementation will likely be slow, painful, and costly. Significant efforts are required to overcome cultural and other barriers and achieve global acceptance and enforcement of IFRS and International Standards on Auditing in more than 180 countries.
The cooperation of accounting standard-setters, accountants and auditors will assist in the preparation of fully compliant financial statements.
Nadezhda Stepanova is senior auditor, UNICON/MS Consulting Group. She can be contacted by telephone (095) 319 6636.