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Harmonization and Convergence of International Accounting Standards

Accounting refers to the systematic process that entails identification, recording, classification, measuring, summarizing, interpreting, verification and communication of financial and accounting records. The concept of international accounting therefore denotes the deliberate process of converging and harmonizing international accounting standards in order to create uniformity in recording and interpretation of accounting records. According to Hail, Leuz and Wysocki (2009) international accounting refers to the process of documenting international transactions while at the same time, making comparisons of accounting principles across different countries. International accounting is also involved in the harmonization of different accounting standards with the aim of creating a uniform accounting standards that will be applicable in all countries across the globe. Barth (2008) define harmonization as the deliberate process of breaching differences in the use and subsequent application of accounting principles in different countries. The idea of harmonization was however replaced by convergence which denotes the process of developing a unified set of quality accounting standards that govern interaction between nations and capital markets. This essay therefore presents critical arguments on harmonization and convergence of international accounting standards.

Waehrisch (2011) notes that differences in international accounting practices have hindered accountants from applying uniform accounting standards and principles.  As a result, different countries tend to produce financial statements that are dissimilar. These differences emerge from differences in the way assets and inventories are valued across different accounting standards. These differences could also impact on the determination of income, disclosure practices, asset management, and depreciation methods among other factors related to finance and accounting. Apparently, these differences often lead to problems since various countries across the globe participate in international trade which makes it harder for accountants to realize a uniform accounting figure. Accounting reports generated using different accounting standards are often incomparable. An understanding of the mismatch problem has led to widespread concerns over the need for harmonization and convergence of financial reporting across the world. Wu and Zhang (2009) argue that harmonization and convergence might not promise different results. In fact, he states the cultural, legal and historical differences between nations makes it mandatory for countries to have different approaches to accounting standards and principles.

Currently, there are two major accounting standards across the world. Generally Acceptable Accounting Principles (GAAP) used by the US and other countries while the European Union together with 100 other countries applies International Financial Reporting Standards (IFRSs) (Hail, Leuz & Wysocki 2009). Since 2002, there have been frantic efforts coordinated by the International Accounting Standards Board (IASB) aimed at harmonizing and converging accounting standards. According to the journal article “Global Accounting Convergence and the Potential Adoption of IFRS by the U.S”, by Hail, Leuz and Wysocki (2010), it is made categorical that the world needs a standard and harmonized accounting systems because of the following reasons. First, convergence and harmonization will lead to an improvement in disclosure and reporting quality. Hail, Leuz and Wysocki (2010) note that corporate reporting carries economic consequences for firms and at times, it is impossible to enumerate accounting errors. Creating a unified accounting system will therefore help prevent liquidity problems. This argument is supported by the thinking that asymmetry in sharing information might influence investors in security markets. Thus, asymmetry in market information will reduce the willingness for investors to trade and sell their shares. By creating harmonized accounting standards, such asymmetries will be reduced and this will promote disclosure and reporting quality leading to increased trading activities in the security markets.

Secondly, harmonization and convergence results into the creation of comparable reporting practices. Leuz, Nanda and Wysocki (2013) observes that uniformity in the reporting of accounting standards will improve the dimension of accounts reporting thus promoting comparability. The ability for firms to generate similar and uniform financial statements increases comparability which lowers the cost of capital. This is because investors can easily compare the progress of their firms. Comparability will enable investors to make decisions on which firms are profitable and which ones are risky or less risky. Likewise, such comparisons will facilitate cross-border trade and investments which leads to market integration. Foreign investments have been associated with the improvement of liquidity which enlarges investor bases. This improves risk sharing and thus lowering cost of capital. Leuz (2003) adds that convergence could result into cost-benefits associated with trade off. The ability for accounting standards to enhance comparability choices and reporting quality means that firms will reduce on direct and indirect disclosure costs such as certification, as well as dissemination and preparation of accounting reports.

Based on these arguments, Hail, Leuz and Wysocki (2010) observe that it is not optimal to advocate for convergence of accounting reporting regimes. He argues that accounting diversity is motivated by legal and historical factors which are specific to countries. The current divergent accounting regime has therefore been applauded for promoting convenience in reporting of accounting records and reports. It acknowledges that countries have different accounting ethics, standards, and cultures, believes, economies, and political systems. These preconceived notions impact on the willingness to adopt harmonization and convergence. Secondly, arguments against convergence indicate that it will be cumbersome and time consuming to convince these countries into adopting new accounting standards which they are not familiar with (Leuz & Verrecchia 2000). The initial transition from previous accounting standards to the new accounting standards regime implies that firms might be at risk of losing out on record mismatch. Such an event will completely affect normal business operations across the globe since it will trigger a lack of consumer confidence in the security markets.

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