After studying this chapter, you should be able to do the following:

1. Describe the conceptual framework for financial reporting.
2. Identify factors that can influence a country’s accounting standards.
3. Identify the role that the IASB intends to play in the establishment of uniform worldwide accounting standards.
4. Identify the direction that the FASB intends to follow for public companies.
5. Describe how accounting standards in Canada are tailored to different types of organizations.
6. Analyze and interpret financial statements to assess the impact of different accounting methods on key financial statement ratios.
7. Identify some of the differences between IFRS and ASPE.

Historically, considerable diversity existed with respect to financial reporting across countries. Differences include the format and presentation of financial statements, the measurement and recognition rules followed in preparing financial statements, disclosures provided in the notes to financial statements, and even in the terminology used to describe items reported on financial statements.

Accounting systems differ across countries partially because of differences in environmental factors such as the type of legal system followed in the country, the importance of equity as a source of financing (private/government funding versus public markets) and the level of development of capital markets, the extent to which accounting statements serve as the basis for taxation, the economic and political ties between countries, and the level of inflation experienced in the country.

The worldwide diversity in accounting practices causes problems that can be quite serious for some parties. Parent companies with foreign subsidiaries must convert from foreign GAAP to parent company GAAP to prepare worldwide consolidated financial statements. To gain access to foreign capital markets, companies often find it necessary to prepare information based on foreign GAAP. This is especially true for foreign companies wishing to gain access to the U.S. capital markets. Accounting diversity makes it difficult for potential investors to compare financial statements between companies from different countries in making international investment decisions.

Harmonization is the process of reducing differences in financial accounting reporting across countries, thereby increasing the comparability and usefulness of financial statements. The ultimate form of harmonization would be the use of similar financial reporting standards by all companies in the world.

There are usually many factors that influence a country’s accounting standards. The following five factors can affect standards: the role of taxation; the level of development of capital markets; differing legal systems (code law versus common law); political and economic ties between countries; and inflation levels.

The International Accounting Standards Committee (IASC) was formed in 1973 to develop international accounting standards (IAS) universally acceptable in all countries. In 2001, the International Accounting Standards Board (IASB) replaced the IASC as the result of a major restructuring, and adopted the IASs developed by its predecessor. Note that standards issued by the original IASC were issued in numerical order with the prefix IAS, while subsequent standards issued by the IASB were also issued numerically with the prefix IFRS (International Financial Reporting Standards). Together, IASs, IFRSs, and Interpretations make up IASB GAAP and are referred to collectively as IFRS.

The IASB does not have the ability to require the use of its standards. However, a relatively large number of countries either require or allow domestic companies to use IFRS. Since 2005, all publicly traded companies in the European Union have been required to use IFRS in preparing their consolidated financial statements. Two other important developments occurred when Australia switched over to IFRSs in 2005, and New Zealand switched in 2007. The standards boards of both Australia and New Zealand issued new domestic standards that were “equivalent to” IFRSs, rather than simply adopting IFRS. Companies in over 100 countries are now using IFRSs.

Accounting principles in the United States are set by FASB, which is a private organization. FASB’s pronouncements are rule based and are far more detailed than those of both the CICA Handbook, Part I (IFRSs) and the CICA Handbook, Part II (ASPE – Accounting Standards for Private Enterprises), which are often described as principle-based standards requiring greater application of professional judgment by the preparers and auditors of financial statements.

In September 2002, the IASB and the FASB signed the Norwalk Agreement, in which they each acknowledged their commitment to the development of high quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting; an important step to converge their financial reporting standards as soon as is practicable. The FASB’s initiatives to further converge include a short-term project to eliminate differences in which convergence is likely to be achievable in the short term by selecting existing standards from either U.S. GAAP or IASB requirements. The FASB and IASB also are jointly working on several projects that deal with broader issues, including a project to create a common conceptual framework.

Given the fact that a global economy will require some sort of harmonized accounting standards if it is to function properly, the Securities and Exchange Commission (SEC) made a monumental decision to change the requirements for foreign registrants. Commencing in November 2007, foreign registrants could use IFRSs in preparing their financial statements without reconciling them to U.S. GAAP. In 2008, the SEC released a roadmap for possible adoption of IFRSs by U.S. public companies by 2014. At one time, Canada intended to harmonize its standards with those of the United States; however, in 2006 the Accounting Standards Board (AcSB) decided to adopt IFRSs for publicly accountable enterprises and in 2009 decided to develop a separate part of the CICA Handbook dedicated solely to private enterprises (Part II, ASPE).

The CICA Handbook is the primary source of GAAP for Canadian companies. To clearly differentiate the different sets of standards, the CICA Handbook was broken down into five parts as follows:

• Part I — the IFRSs that apply to publicly accountable enterprises;
• Part II — the accounting standards that apply to private enterprises (ASPE);
• Part III — the standards for not-for-profit organizations;
• Part IV — the standards that apply to pension plans; and
• Part V — the standards constituting Canadian GAAP before the mandatory effective date for the adoption of Parts I, II, III, or IV.

GAAP for Publicly Accountable Enterprises — In 2006, with the announcement of the adoption of a strategic plan that would see the harmonization of the CICA Handbook with IFRSs for publicly accountable enterprises. Harmonization was chosen instead of the simple adoption of the international standards because security regulations and federal and provincial Companies Acts require financial reporting to be in accordance with Canadian GAAP. Because of this requirement, Part I of the CICA Handbook now contains standards that are the same as IFRSs. Rather than always referring to Part I of the CICA Handbook, we will simply refer to IFRSs. Commencing in 2011, Canadian publicly accountable enterprises had to report under IFRSs. The IFRSs were quite similar to Canadian standards prior to the adoption of the international standards, because they are based on similar conceptual frameworks and reach similar conclusions. However, there were many differences in the detailed requirements.

GAAP for Private Enterprises — After much discussion and input from interested stakeholders, in 2009 the Canadian Accounting Standards Board (AcSB) chose a GAAP approach for private enterprises by developing a separate part of the CICA Handbook dedicated solely to private enterprises (Part II, ASPE). Private enterprises may adopt either ASPE (Part II) or IFRS (Part I). Whichever set of standards is adopted, it must be the whole package. It is not possible to apply certain standards from ASPE and others from IFRSs.

GAAP for Not-for-profit Organizations — In December 2008, the AcSB and the Public Sector Accounting Board (PSAB) jointly issued an Invitation to Comment, Financial Reporting by Not-For-Profit Organizations. In December 2010, the final standards for NFPOs were released. As part of this process, the not-for-profit (NFP) sector was divided into two sectors: the government NFP sector and the non-government NFP sector. The government NFP sector includes NFPOs that are controlled by the government. They have a choice to follow either the 4200 series of the CICA Public Sector Accounting (PSA) Handbook or the PSA Handbook without the 4200 series. The non-government NFP sector includes NFPOs that are not controlled by the government. They have a choice to follow either IFRSs (which do not currently contain any standards specifically tailored for NFPOs) or Part III of the CICA Handbook. A NFPO applying Part III of the Handbook also applies the standards for private enterprises in Part II, to the extent that the Part II standards address topics not addressed in Part III.

GAAP for Government and Other Government Organizations — All levels of government should follow the PSA Handbook. Government business enterprises are expected to follow IFRSs. Other government organizations can either follow IFRSs or the PSA Handbook.

We have seen many examples in this chapter of differences in accounting and reporting practices. U.S. GAAP is different than IFRSs. ASPE is different than IFRSs. The CICA Public Sector Accounting (PSA) Handbook is different than Parts I, II, or III of the CICA Handbook. With all of these differences, is there an opportunity for a company to manipulate its financial statements by choosing policies to produce desirable results? Do financial analysts know that these choices exist in accounting? Do they understand the impact of the different accounting methods on the financial statements? These questions point out the importance of disclosing accounting policies in the notes to the financial statements. This will allow users to determine whether or not the same policies are being used by different entities and whether adjustments must be made to make the statements comparable from one entity to the next.