Essay: Harmonization And Convergence In International Accounting Standards, Fair Value Measurement Vs Historical Cost, And Phase A Of The Financial Reporting Conceptual Framework.

Distinguish between harmonisation and convergence, providing benefits and limitations of both concepts.
Critically discuss Phase A (objectives and qualitative characteristics) of the conceptual framework for financial reporting 2010. 
Critically discuss the arguments for and against the use of fair values in the preparation and presentation of financial statements. Your discussion must include comparisons to the historical cost convention.

International Accounting Standards

After the World War II, the initial approaches were for bringing harmonization in the accounting principles so that the differences could be reduced all around the world. The concept of convergence arose firstly in the late 1950s. With continuous efforts and from the perception of fulfilling desired objectives, in the 1990s, the convergence concept replaced the harmonization concept (Atkinson, 2012).

The report discusses about harmonization and convergence. In this report we will also discuss about the Phase A of the conceptual framework for financial reporting 2010, the arguments related to fair value measurement in replacement of historical measurement and evaluation of IFRS 15- Revenue from Contracts with Customers in comparison to IAS 18- Revenue.

Harmonization is the process of bringing an uniformity in accounting standards used so as to increase the comparability capability of accounting practices by having a defined set of variations. Basically, harmonization of accounting standards is a process that brings together the international accounting standards into an agreement so as to achieve a common platform where accounting principles used are common  (Berry, 2009).

The two terms called harmonization and convergence are in connection with IFRS and still differ in some way. Convergence is a term used more frequently by the standard setters. As per FASB (2012), the international convergence refers to the objective of adopting a single set of accounting standards which are highly qualitative so as to bring consistency and uniformity all over the world. Where harmonization practice was adopted for reducing variations in accounting practices by setting a boundary defining the tolerable variations, Convergence refers to adoption of measures by countries across the globe to convert from national GAAP to IFRS  (Horngren, 2012). Harmonization was a voluntary attempt by standard setters for removal of obstacles that hinders the integration of the IFRS into the converging country's financial system. Such obstacles arise due to differences in exchange rates, quotations of international markets, holding subsidiary operations where the two companies are located in different countries, etc. It is observed that two terms are used interchangeably (Boyd, 2013).

The two concepts follow the same direction and adoption of convergence is indirectly adopting harmonizing principles. The adoption would deliver a greater comparability as investors needs varies from person to person. A consistency in accounting standards all across the globe would help the investors to compare the financial statements of different companies. However, such adoption is costly and can put a financial burden. Also, being new in nature for the business world, it is obvious to not expect a thorough knowledge of such standards from business enterprises and on the other hand, such businesses can use it to manipulate their profits so as to win the potential investors and public confidence (Ittelson, 2009). 

Approximately, there are 120 nations that has to adopt IFRS for their listed companies. However, 90 countries have successfully adopted IFRS as introduced by International Accounting Standards Board (IASB) and also, include an acknowledgement statement that includes conformity of such principles in audit reports. Currently, countries such as United States, Japan, India, Malaysia, Colombia and Russia have successfully adopted IFRS  (Joubert, 2017).

The conceptual framework (Phase A)

In adoption of a single set of accounting standards, Europe has initiated a global movement since 2000. European Union was of the opinion that a common market for providing financial services was important for EU to exercise a healthy competition against capital markets of US. Thus, for achieving such a common market, a common set of standards were required to be adopted by EU for once and all  (Kusano, 2018). Although EU attempted to harmonize its practices in financial system in the 1970s and 1980s, such efforts were proved ineffective. The various attempts were made by EU and continuous failure made EU believe that the only possible way of achieving its objective couldn't be US GAAP. Therefore, the choices left to EU were either formulating its own European accounting standards or adopting IFRS formulated by IASB. The failures of attempts made by EU clearly proved that formulation of European accounting standards wasn't possible. Thus, left with an only option that fits into the books of EU both politically and economically, EU finally adopted IFRS convergence (Alvarez, 2013) .

The two boards called FASB and IASB signed a memorandum of understanding known as 'Norwalk Agreement' where the board decided to combine their efforts to make their financial statements deliver full compatibility. Their future efforts would involve ensuring compatibility, that is, compliance according to US GAAP will automatically result in compliance with IFRS. In line with this agreement, the boards introduced a number of short term as well as long term convergence projects that targeted to reduce the variations in the two sets of standards. The Norwalk Agreement was updated multiple times. Steps such as G-20 have been adopted defining a path towards a single set of global accounting standards  (Bragg, 2015).

The conceptual framework (Phase A)

The conceptual framework project has been conducted in eight phases where PHASE A deals with the objectives of financial reporting and such qualitative characteristics that make the financial information useful. As on September 28^th 2018, the Phase A of the framework was completed.

The financial reporting forms the basis of Conceptual Framework (Girard, 2014). The ultimate objective of general purpose financial reporting is providing financial information through the best possible preparation and presentation of it that acts useful for potential investors, creditors and other lenders so that necessary decisions can be made such as buying or holding equity instruments, sanctioning of loan, providing resources to the entity and such other decisions (Lerner, 2009).

As we know, different investors have different needs and desires. Thus, financial reporting standards are to be implemented in such a way that it can satisfy all kinds of investor's requirements. Such reporting standard doesn't really define the value of a reporting entity but they tend to provide sufficient information to external users that can be used for estimating the value. In the nutshell, we can say that financial information requires to be understood properly by the management because it is important for it to provide sufficient information that delivers quality like relevance, transparency (McLaney & Adril, 2016). Also, it doesn't mean that all the information is to be provided because at the end, that would be a burden more as well as bulky for investors serving less qualitative reports. Thus, financial reporting standards aim at guiding the management for the best preparation and presentation.

The use of fair value in the preparation and presentation of financial statements

With the term qualitative financial reports, it is important to understand quality in what terms. Few qualitative characteristics of financial reports :

• Fundamentals: This includes relevance and faithful representation. Relevance refers to the reliability of the information provided that they are capable enough to influence the financial user’s decisions. A number of information is based on assumptions, judgments and predictions. Therefore, it is important for the management to use the most relevant techniques and methods that investors can rely upon. An economic phenomenon is represented by the reports both in words and numbers (Noreen, 2015). Not only relevance is important but also a faithfulness is required that whatever it was targeting to represent is represented. For a perfect faithful representation, three characteristics are important called complete, neutral and free from errors. It is obvious that perfection is a rare thing but the targets are to achieve it to the extent possible. Financial information is needed to be both relevant and faithfully represented, that is, neither an unfaithful representation of a relevant data nor a faithful representation of an irrelevant data can help users make potential decisions (Picker, 2016).
• Enhancing: The relevant financial information are enhanced when the information serves characteristics such as comparability, timeliness, understandability and verifiability. The reports are required to be made in such a way that the external users can compare various alternatives in terms of financial information and accordingly, make decisions. Verifiability is important as if defines the match between the expectations and actual presentation, that is the information management wanted to deliver is actually delivered or the information presented verifies with the intentions of the management. Timeliness is important as information if not provided on time can lead to unfavourable decisions. Thus, timeliness influences a user's decisions. A proper classification, characterization and clear presentation of financial information helps in clear understanding by the external users (Ramírez, 2018). The complex information of the entity has to be moulded and presented in such a manner that the users can understand it from the company's perception. It is important for a company that their users understand the information in the way they wanted them to understand.

IFRS 13 states about the fair value measurements where fair value is defined as the price expected to be received or paid when selling an asset or transferring of a liability respectively between the market participants in the form of a transaction at the measurement date. Basically, accounting standards requires a business to record its assets and liabilities at the current price prevailing in the market  (Lyon, 2010). Such fair value estimation delivers more accuracy and relevance. Such measurements consider the internal factors such as manner of use of asset, location of it, depreciation method used, etc and external factors such as market fluctuations, economic and social environment etc. A business value is defined by the value of its assets and liabilities and therefore, for that purpose, it is important that such elements are measured at their fair value so that the external users can accurately estimate the fair value of the business and make important decisions accordingly (Robinson, 2014).

Historical measurement believes in recording of assets and liabilities at their historical value or their original value. This method involves easy calculations and is reliable. It shows the original worth of an asset or a liability. What differentiates both of them is relevance  (Piper, 2015). Since fair value measurement is based on current market conditions, it is more relevant for external users to make decisions. For example, an asset bought today will not have the same worth after twenty years. While historical cost will show it at the original value, it will unnecessarily show high business value which would be considered as vague or would even serve as a way of manipulating the external users. That is why, fair value measurement is preferred over historical measurement  (Simpson, 2012).

IFRS 15 – Revenue from contracts with customers

IFRS 15 involves recognition of revenue of those goods or services which has been promised to be provided and also on the other hand, reflects the consideration amount that the entity expects to receive during exchange of those goods or services. Usually, the following steps defines the model of such a standard.

• Step 1 : Identification of contract with the customer : IFRS 15 involves making of a contract between the buyer and the seller so as to create legal obligations and rights.
• Step 2 : Identification of performance obligations : The contract defines the performance obligations on both the buyer and the seller, that is, a seller is expected to transfer the goods or services on time while a buyer is expected to fulfill its performance by making payment against such receipt.
• Step 3 : Determination of transaction price : The transaction price refers to the amount of consideration that is to determined, agreed between the two parties and stated in the contract.
• Step 4 : Allocation of transaction price to the performance obligations : There should be a clear match between the services or goods provided and the consideration charged against it. Sometimes, such price includes discounts or variable considerations etc.
• Step 5 : Recognition of Revenue : When the performance obligations are fulfilled from both the parties, the entity is required to recognize the revenue in its books.

In contrast to IAS 18, the two standards differ in revenue recognition. IAS 18 recognizes revenue when the risks and rewards are transferred on the sale of goods while IFRS 15 recognizes revenue when the control of such goods is transferred to the customers (Skonieczny, 2012). For IAS 18, there are different criteria of revenue recognition for different activities such as sale of goods, interests, royalties, rendering of services, dividends, etc. Thus, IAS 18 requires a lot of information, making it complicated in nature and also, creating a lot of confusions among the companies. However, IFRS 15 provides a uniform method of revenue recognition, that is, it uses its standardized five step model as stated above. IFRS 15 has been effective from January 2018 and has replaced IAS 18  (Holtzman, 2013).

Conclusion 

IFRS convergence is a complex procedure and demands comprehensive disclosures, yet considering the corporate scandals and the increasing demand for transparency, understandability , fair presentation etc , it is better to prepare financial reports in such a manner. The total convergence has been dreamt for more few years but only time would show the results of global efforts. Adoption of single set of accounting standards across the globe would bring world economic growth and consistency. Thus, the challenges faced and that will be faced might be tough but the results would be worth.

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