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Financial Reporting Regulation Notes

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Financial Reporting Regulation Revision

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Pip Reeve ACHT11W4T4 'In the era of globalisation, should financial reporting be regulated? If so, who should regulate and how? What might be the advantages and disadvantages of the internationally regulated accounting regulations? Demonstrate balanced arguments based on good examples. When answering this question, it is important to consider why International Financial Reporting Standards (IFRS) were established in the first place. Two main points can be used to explain this; firstly there has been a substantial increase in international capital flows and secondly, perhaps interlinked, the number of mergers and acquisitions across national borders increased. Clearly, if a parent company has a subsidiary in a different country, there will be very significant difficulties if two different accounting methods are used. This is similar in the case of international capital flows, for example, when Daimler Benz first got external finance from the US, it had to change its method of accounting from German to US, and subsequently went from a large profit to a negative profit. The reason for this was due to the differences in the methods of measurement between the two accounting models. Different parameters are used in Germany and in the US. Also, the US Generally Accepted Accounting Principles (GAAP's) are rules based as opposed to principles based. Lantto and Sahlstöm suggest that 'the level of capital market orientation of a financial environment explains the differences in accounting systems internationally.' 1 For example, the North American cluster is clearly more capital market orientated than the European cluster. However, Europe 'recently developed from the so-called bank based system towards a market-orientated one,' 2 and consequently the national accounting system developed too. In 2005 all listed firms in the EU started to report their financial statements according to the IFRS. When it comes to mergers and acquisitions (M&A's), the IASB and the FASB have worked on a common convergence project called the 'Business Combinations' project since 2001. The 'most significant change was that it permitted only one method for reporting business combinations.'3 Furthermore, specific standards were put in place such as, 'goodwill acquired in a business combination should not be amortized but should be tested for impairment.' 4 For example, Deutsche Bank went from US GAAP to IFRS in 2007, it consolidated 205 more entities under IFRS, meaning there were €40 billion more total assets and €40 billion more total liabilities on the balance sheet. Some people may argue that the method of accounting used has few real effects. However, it seems clear that this is not true as the method of accounting can affect the economy in a wide variety of different ways. Lantto and Sahlstöm article investigates whether IFRS changes key financial ratios by considering the differences between financial ratios calculated on the basis of domestic accounting standards (DAS) and IFRS for the same reporting period. They use data from Finland whose domestic accounting standards are referred to as FAS. Their results suggest that when moving from FAS to IFRS, a number of changes to the financial ratios took place. Although the current ratio did not change significantly, the profitability ratios increased by 9% to 19% and the potential earnings ratio decreased by 11%. They suggest that these changes can be explained by increases in the income statement profits. In addition, there was a 2.9% increase in the gearing ratio alongside a decrease of 0.7% in equity ratios. Results suggest 'that the removal of the amortisation of purchased goodwill under IFRS 3 is 1 'Impact of international financial reporting standard adoption on key financial ratios' Lantto &Sahlstöm 2009 2 'Impact of international financial reporting standard adoption on key financial ratios' Lantto &Sahlstöm 2009 3 'IFRS and US GAAP convergence in area of mergers and acquisitions' Bohusova and Svoboda 2009 4 'IFRS and US GAAP convergence in area of mergers and acquisitions' Bohusova and Svoboda 2009

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