In the book The World is Flat: A Brief History of the Twenty-first Century, Thomas L. Friedman analyzes how the world has changed because of the technological advantages that have created a global economy. In this global economy, companies don’t try to operate in small markets as individual silos, instead, companies try to grow out of their small markets and even move to other countries. As mentioned by the IFRS Foundation on their website, “modern economies rely on cross-border transactions and the free flow of international capital” (IFRS, n.d.). The goal of a company is to make as much profit as possible even if they have to move production to different countries. For example, Mercedes-Benz is a German company with a factory in Germany, that still has manufacturing or assembling plants in different parts of the globe (Daimler Global Site, n.d.). The same company might be using different accounting standards depending on the location of the plant. For example, in the United States, the accounting standard implemented is the Generally Accepted Accounting Practice or GAAP while in other countries it is used the International Financial Reporting Standards or IFRS (Weygandt et al, 2015). Thus, a company might have to adopt multiple standards and we will discuss some of the problems caused by not having an international accounting standard.
By having different accounting standards across the world, transparency is affected and it allows companies to inflate or misinterpret numbers. As GAAP is used in the United States while other countries have different standards, it is very difficult to know the status of a company abroad. If the US company tries to acquire a company overseas that has a different set of standards, it would not know the actual financial position of this company. For example, when trying to acquire Daewoo Motor Corp for 6.9 billion dollars, Ford Motor Co. converted the books into the GAAP to see that the company had a bigger debt and commitments than anticipated (Connolly, 2007). Other irregularities found by the conversion included fake profits at a failed Ukrainian plant (Connolly, 2007), and Daewoo Motors buying at inflated prices from Daewoo Heavy Industry to show a profit in 1997 while in reality, the company had a loss of 670 million dollars (Connolly, 2007).
The purpose of financial statements is to show the financial status of a company (Barnes et. all, 2019). The financial statements include the financial performance and cash flows of an organization that allows investors and other external parties to know the status of the current situation of a company (Barnes et. all, 2019). By having different accounting standards, it is difficult to compare different financial statements. Thus, it makes it more difficult for stakeholders and creditors to perform a financial analysis of the company if there is no international standard. For example, if the company is located in a country that uses IFRS or another standard while stakeholders are located in the United States, it would be difficult for the stakeholders to understand the financial statements and know exactly the ratios of this firm compared to the other ones in the field or its competitor to make an educated decision. For example, in 2014, Twitter had a loss of 0.96 dollars per share in one measurement while reporting a profit of 0.34 per share in another measurement (Sherman & Young, 2016). This makes it very difficult for investors to know the exact financial status of an organization.
Auditing can be defined as the review and evaluation of the information used to prepare the financial statement of the company (Nickels, McHugh, & McHugh, 2016). If there are standards in place, auditors will be able to use the set of rules provided by the standards and make sure that those rules are followed (Commerce Mates, 2019). In many instances, a company might have its financial statements audited by external parties. This auditing is required by law if the stocks are publicly traded by investors and in this case, a public accountant is the one performing this auditing. If a company in the United States has offices in Europe where another standard is implemented, it will need to hire experts in that standard because of the differences between both systems. Therefore, a trained auditor in GAAP might not do the same job as the one experienced in the IFRS.
Companies that have subsidiaries in different parts of the world are required to follow local regulations for their financial statements (Beke, 2016). Therefore, they need to create multiple financial statements for each of the subsidiaries because they need to follow the local regulations and one of the native countries. For instance, General Motors in Mexico has to prepare financial statements in Mexican pesos and by Mexican rules while General Motors in Japan creates it in yen and using Japanese rules (Beke, 2016). Then, General Motors in the US has to take those financial statements and convert them into US dollars using and using the US GAAP (Beke, 2016). This is a waste of resources because it makes the work redundant and accountants need to work extra to convert those initial financial statements, which could be avoided using an international standard. Something similar applies to accounting information systems because multiple systems need to be developed and maintained during the lifetime of the company to follow different standards. Also, accountants would need to learn different accounting standards to transfer from the US where GAAP is used to another country where IFRS is implemented.
In conclusion, there are a lot of issues related to the diversity of accounting standards across the world. Some of the issues are the lack of transparency that can provide false information to the stakeholders, no able to compare financial statements clearly, it is more difficult to audit different accounting systems, and the redundancy that occurs while trying to maintain two systems that are supposed to do the same job. The good news is that the SEC is committed to requiring companies in the United States to switch from GAAP to IFRS for preparing financial statements in the future (Romney & Steinbart, 2017). Therefore, the United States will also follow the International Financial Reporting Standards which means that we will be a step closer to an international accounting system.
- Connolly, M. B. (2007). International Business Finance. New York, NY: Routledge.
- Daimler Global Media Site. (n.d.). The production network: The worldwide plants.
- Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2015). Accounting Principles (12th ed.). Mississauga, Ont., MA: Wiley.
- IFRS. (n.d.). Why global accounting standards?
- Barnes, J., et. all (2019). International GAAP 2019. Generally Accepted Accounting Practice under International Financial Reporting Standards. Chichester, West
Sussex, UK: Wiley.
- Sherman, H., & Young, S. (2016, August 21). Where Financial Reporting Still FallsShort.
- Nickels, W. G., McHugh, J. M., & McHugh, S. M. (2016). Understanding business (11th ed.). New York, NY: McGraw-Hill Education.
- Commerce Mates. (2019, November 11). Benefits & Limitations of Accounting Standards.
- Beke, J. (2016). International Accounting Harmonization: Adopting Universal Information Methods for a Global Financial System. New York, NY: Palgrave Macmillan
- Romney, M. B., & Steinbart, P. J. (2017). Accounting information systems (14th ed.). Harlow, London: Pearson.