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Rules vs. Principles

Rules-based or principle-based? That’s the million-dollar accounting question of the decade. Via principle-based standards, interpretations, and frameworks for creating financial statements, International Financial Reporting Standards (IFRS) provides guidance on income, financial position, and cash flow report preparation and offers a flexible alternative to more rigid rules-based standards.

The new standards, built on key components of the widely recognized International Accounting Standards (IAS), issued between 1973 and 2001, are endorsed by the International Accounting Standards Board (IASB). Rather than using a traditional rules-based approach, IFRS uses a principles-based philosophy. Under this structure, the goal of each standard is to arrive at a reasonable valuation, while acknowledging the existence of multiple paths to that goal – giving each company the freedom to adapt IFRS to its particular situation.

A financial statement should reflect a true and fair view of the business affairs of an organization. A wide range of stakeholders – from investors to regulators – use financial statements to assess the financial position of a business. IFRS, through its added flexibility,  helps create easier-to-understand and more consistently comparable financial statements for diverse stakeholders.

For example, with IFRS, a business can present its financial statements on the same basis as do its foreign competitors, allowing direct comparison. Companies with subsidiaries in countries that require or permit IFRS may be able to use one accounting approach throughout the organization.

 

Enhanced Comparability

Within the organization, the flexibility of IFRS makes it easier to standardize across markets and geographies and compare results from multiple countries. A company may choose IFRS, for example, if it is a subsidiary of a foreign company using IFRS, has a foreign investor that uses IFRS, or wishes to raise capital abroad – all scenarios in which a business could benefit from more easily understandable and comparable financial statements.

Additionally, IFRS is accepted as a financial reporting framework for companies seeking admission to almost all the world’s stock exchanges. By making financial statements more transparent, it reduces barriers to cross-border securities trading. IFRS financial statements are universally understood and comparable – qualities that can improve or initiate relationships with customers and suppliers across national borders.

This enhanced comparability of companies’ financial information, combined with improved stockholder communication, reduces investor uncertainty, lowers risk, increases market efficiency – and eventually minimizes the cost of capital.

 

Three Approaches to IFRS Adoption

There are three approaches to IFRS, dictated primarily by the local accounting standards governing body.

Adoption. This approach directly adopts IFRS standards as the accounting norm for preparing financial statements. India, for example, plans to take this approach.

Convergence. This approach adapts local accounting standards so they align with IFRS. Local standards remain the preferred reporting accounting norm, though they might be updated to reflect IFRS. Australia is taking this approach.

Endorsement. This approach allows local governing bodies to incorporate individual IFRS standards into local accounting or GAAP standards. A country using this approach endorses the use of applicable IFRS standards, but keeps local standards as the norm, without necessarily updating them. This is the approach of the United States.

 

Group-Level Consolidation in an IFRS Environment

Group consolidations take on new meaning in an IFRS environment, where guidance is provided for preparation of group-level financial statements in accordance with IFRS standards. This approach requires eliminating intercompany and cross-ownership activities, even if all underlying information is not IFRS compliant.

An EPM solution from SAP can help companies consolidate for IFRS at the group level, and produce IFRS-compliant reporting, even when local levels use other standards. In other words, the solution helps you combine multiple GLs based on local GAAP requirements, while still producing IFRS-complaint group-level financial statements. Take, for example, an EU company in which the majority of subsidiaries run IFRS, but a few subsidiaries in Asia still run local GAAP. The company can use a SAP EPM solution to create consolidated IFRS reports, without requiring the Asian subsidiaries to convert their GLs to IFRS.

 

Learn More

Business analytics services from SAP can help with IFRS-compliant consolidation at the group level, increasing the accuracy and effectiveness of your company’s financial reporting. To find out more, please visit us online.

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1 Comment

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  1. Gregory Misiorek
    Hi Peter,

    i think condorsement and incorporation (not to be confused with a way of forming a business in the US) are part of the latest vocab from SEC/FASB on IFRS in the US.

    it’s easy to lose track of the wording changes and i can only imagine how hard it must be to translate it from English into any other language.

    in any event, enjoy the soc media space.

    thx,

    greg

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