IFRS Implementation Challenges

IFRS

The international Accounting Standards Board (IASB) presented the International Reporting Standard (IFRS) in 2002 and advised that countries around the world should use these accounting standards. The European Union (EU), including the United Kingdom, were first to adopt these accounting standards and had completely incorporated IFRS by 2005 via the enactment Regulation (EC) Number 1606/2002. The transformation from GAAP to IFRS aimed to improve the quality of accounting ideals, which was thought to lead to transparency, accountability, and efficacy. However, the perceived advantages of the adoption of IFRS is still a subject of debate among the practitioners of accounting, stakeholders, and academicians. Various studies have documented that that IFRS enhances financial reporting and at the same time this system has various challenges that hinder the efficacy of IFRS and its implementation. Aschfalk-Evertz and Oliver (2013) stated that the efficacy of IFRS implementation majorly relays on the incentives of the prepares (for example companies, accountants, and managers) to be transparent and the implementors like auditors, and governmental regulatory bodies to enforce the implementation of these guidelines. The inefficacy of the implementation process of the IFRS system reduces information asymmetry in terms of some companies deciding not to expose all their financial earning, and ultimately disadvantaging the investors. Such a situation creates a conflict of interest between the company and the shareholding in respect to the fact that companies should work in the best interest of their bondholders and not withhold any information, yet at the same time, companies would not wish to disclose their real financial value not avoid taxation.

Corporate Tax avoidance (CTA) has developed to a major issue both in practical and academic study. The commonly used mechanisms of tax avoidance include transfer pricing, re-invoicing, undecided charitable trusts majorly through Corporate Social Responsibility (CSR), corporate inversions and offshore purpose vehicles among other tax means of tax abuse. Tax avoidance is among the mechanism that allows companies, managers, and accountants to avert payment from stakeholders to themselves, to fulfil their individualistic interests. Tax avoidance is reticent and needs manipulation of financial dealings to assure some tax reimbursements while protecting it from the system. The same act renders it challenging for stockholders to determine their definite tax commitments and evaluate the actions of the managers. The fact that shareholders cannot ascertain their actual tax obligation leaves various gaps that can be subjugated by the company to track various self-seeking purposes and manage the company’s earning (Brochet, Jagolinzer, and Riedl 2013, p. 1373). Through this type of manipulations, companies demean the value of their financial documentation. In this regard, this paper will analyse the subjects in IFRS sustainability, and the harmonisation of accounting ideals.

Theme 1: Selected Issues in IFRS sustainability

This section will look at the various issues that have led to arguments on whether IFRS is sustainable or not. For some scholars, the issues discussed are the fundamental pillars of IFRS that make these guidelines favourable as compared to other accounting principles, while for other scholars these elements have contributed to various challenges in IFRS implementation.

Corporate Social Responsibility (CSR)

Brochet et al. (2013) stated that the revelation of a true and fair earning is important for Corporate Social Responsibility (CSR) due to the fact that it forms the foundation of outsiders’ trust and assurance in a company’s claims and operation and that high standards of CSR are positively linked with high accounting quality of the company. An increase in CSR presentation and revelation majorly enhances the value of monetary reports leading to improved monetary accountability. Contrary, Joos, and Leung (2012, p. 611) stated that managers acting in pursuit of their own interests by distorting the financial information will be capable of entrenching themselves by partaking CSR and determined on the constructive link between the level of earning management and CSR. Companies that stress on CSR incline to incline towards the notion that they are decent commercial citizens and at the same time they draw attention away from the probable suggestion that they are involved in earning management.

As per the arguments of Finningham (2010) corporate tax avoidance is among the incentives for managing earnings. Daske, Hail, Leuz, and Verdi (2008, p. 1091) stated that corporate tax avoidance (CTA) offers a value improving advantage to stockholders henceforth directors are reinvigorated to use their best knowledge to minimise levies. Though tax avoidance technique provides opportunities for unscrupulous companies to self-seek goals and manages their earning in a manner that provides advantages to directors and manages their earnings in a way that provides paybacks to the company the same benefits are not transferred to the shareholders. Therefore, companies who are managing earning are expected to shield themselves by evading more levies as this type of evasion gives buffers them from investor scrutiny. Reduced tax payment verdures extra after tax cash flow that can be spread as extra dividends or invested in high-return plans. Regardless of the value-enhancing outcome of avoidance, the non-payment or rejection of corporation to pay their reasonable share of taxes has been perceived as socially negligent, therefore market will have an adverse response to equity prices of avoidance firms. Grossi, Biondi, and Lapsley (2014) stated that a company’s equity prices are likely to decline when there is news about their participation in duty shelters. Though, they observed that the response is small comparative to the response to other business transgressions like the company’s managing earning, business inspected by the security and exchange commission for anomalies in their reporting books, company’s indicted by their shareholders for indecorous accounting and firms that regurgitated their financial statements (Le Billon 2011). If the social pressure and response is relatively low with new of CTA in reference to EM, and harmonising systems for both CTA and EM such that organisation that evade taxes can also use those avoidance technique to manipulate earnings to stem some individual advantages, then such organisations managing earnings can recourse to CTA to protect themselves from the social response to EM. Haverals (2007, p. 70) argued that both CTA and CSR have the capability of providing opportunities for managers in a firm to protect their managerial demeanours including manipulating earning. Even so, the relationship between CTA and CST is still being researched, and the results of the concluded studies are inconsistent.

Ho (2012, p. 455) emphasise that a company’s perception towards CSR reasonably effects their choices on the extent of and readiness to reduce their revenue liabilities. It means that where companies justly partake CSR, such organisations are not expected to avoid levies under the IFRS system. That avoidance is perceived to be socially irresponsible as tax payment is seen as the most important way in which businesses can influence the larger society, consequently, tax payment is perceived as an element of CSR. Assuming the balancing link between CTA and EM, then it can be said the decreased evasion might result in a drop in EM. Therefore, morally partaking of CSR is anticipated to reduce both EM and CTA. Contrary where CSR is applied as a reputation organisation tool, the more evasion actions lead to more CSR actions.

Accountability and Governance

The international Accounting Standards Board (IASB) is mandated with the task of overseeing the implementation and execution of the IFRS guideline. The IASB is committed to developing a solitary set of a logical and enforceable accounting standard that would be based on a clear, and equivalent information. In this case, transparency implies that financial reports that are organised in reverence to IFR guidelines (Elmagrhi, Ntim, and Wang 2016 p. 508). Comparability implies that all transactions and records should be accounted for in a similar when they take place. Consequently, IFRS includes some free decisions of various accounting treatment for similar transactions.

IASB proposes that IFRS should be principle oriented; meaning that the standard sets out values that ought to be tracked when making financial reports along with the legal stipulations of the relevant authority. Accountants and managers are required to apply their professionalism when utilising the values to events and situations that rise in the business. The idea of principles-based values implies that the ideals will be grounded on the IASC’s context for preparing and presenting financial declarations; especially when defining various criteria for liabilities, expenditures, and equity.

The IASB works in tandem with the nationwide accounting standard implementors to attain convergence in accounting around the world. It has an official liaison relationship with nation-wide standard implementors in the United Kingdom and is conducting various projects in cooperation with such authorities (Fearnley and Hines (2007, p. 399). Normally, the IASB does not have the legal mandate of enforcing amenability with IFRS. Rather, like the prior IASC, it depends on national bodies that would enforce IFRS and implement its stipulations. The European Union’s IAS regulation is an example of an enforcement body that requires compliance. This regulation is an integration of a long term strategy of the European Union to realise accounting management and 15 years collaboration between IASB and the European commission.

Tax Avoidance

One of the conditions that could establish an association between IFRS and the execution of IFRS and increased cases of tax evasion is the intensification in discretionary and non-discretionary accruals recognised after the implementation of IFRS. Khan, Tanveer, Shah, and Jamil (2015, p. 629) stated that there is an intensification in the aggressiveness of accumulations after adopting IFRS. Meier and Meier (2014, p. 347) contended that more aggressive accruals are linked to augmented cases of revenue avoidance. In respect to growth in accruals that were documented after the implementation of IFRS, and that aggressiveness of accruals is linked to high levels of tax evasion, then IFRS implementation could have circuitously led to revenue avoidance. Kaya and Koch (2015, p. 109) identified an upsurge in profit transfers for the sake of taxation from a country with advanced tax burden to an area with inferior tax liabilites after the implementation of IFRS.

Borker (2013, p. 678) stated that both described incomes and taxable income are a source of additional information for shareholders. Therefore, it is significant for stakeholders and other capital market users to have a clue on whether the taxable income, which offers evidence applied in the process of decision making when allocating resources is manipulated to retract the expenses incurred as tax. Shrives and Brennan (2015, p. 97) argued that both earning management and tax avoidance are like two sides of the same coin, in reference to the fact that managers have incentives for doing both, that is increasing the reported earning and reducing the taxable income. Habbash (2010) revealed a positive relationship between the aggressiveness in the presentation of financial statements and tax avoidance. The authors stated that if a firm has the likelihood of managing its reported earnings upwards and its taxable income downwards in the same period, it is likely to engage in such behaviour. In regard to the fact the adoption of IFRS is related to an increase in the aggressiveness of accruals and that higher levels of aggressiveness of accruals are positively linked with higher levels of tax avoidance, the implementation of IFRS could have led to increased tax avoidance. Another point that should be discussed is the increase in reported earning through accruals after the adoption of IFRS. An increase in reported earnings can lead to tax avoidance, devoid of that there in being an increase in the practises that lead to tax avoidance.

Tax avoidance metrics that include Effective Tax Rate (ETR) generally pre-tax earning as the denominator ; meaning that if these earnings increase and the tax expense is constant, the tax rate will be decreased because of the increase in the denominator and an increase in tax avoidance will be defined, but not because of specific tax reduction behaviours. However, it is clear that an increase in reported earning resulting from an increase in accruals, whether discretionary or non-discretionary, remain in the long run, then the firm is evading corporate tax on the overvalued reporting earning, hence reflecting the practice of tax avoidance.

The adoption of IFRS can also have an impact on the level of tax avoidance of companies because of other factors. Chorafas (2006) confirmed that subsidiary companies in the United Kingdom have developed to become more involved in profit transfer for the sake of tax reasons after adopting IFRS, estimating that averagely the same subsidiaries that mandatorily implemented IFRS transferred 11.5% more profit in relation to subsidiaries in the pre-adoption years and the subsidiaries that did not implement IFRS. Countries in the European Union including the United Kingdom continue to follow the guidelines of the Organisation for Economic Cooperation and Development (OECD) for setting transfer pricing. The preferable means to obtain information on specific contractual guidelines celebrated with or by independent entities for comparable transactions. Because the availability of the same information is limited, the multinational entities generally use reference transfer prices, identifying a set of observables, financially comparable and independent entities, which utilise the same accounting principles to compare profit margins (Agyenim-Boateng 2012). Therefore, the adoption of a single standard such as IFRS by different authority expands the set of entities that can be used as potential references and enable other companies or states to adopt a more favourable reference that supports transfer pricing and has tax advantages.

Theme Two: Harmonisation of IFRS Procedures

Various studies have stated that the national contagions in IFRS arise because the market is becoming more integrated. Therefore, a necessary condition for accounting harmonisation to improve national contagion is that it ought to integrate the capital market and the state corporate environment.

Concept, Context, and Relevance

The harmonisation of IFRS would help in providing a fair ground in the corporate environment. Implementors and auditors will able to receive the same information, facilitating the process of evaluation. In the absence of free trade, international accounting standards such as the IFRS could allow nations’ tariffs quotas and other restraints of trade mechanism ought to be more accurate and less risky for traders. Investors and companies would be capable of making valuable decisions. The recent growth of globalisation in the capital market and the availability of instantaneous communication provide symmetric information across borders (Carmona and Trombetta 2008, p.459). With the absence of harmonisation in accounting standards the extra cost of financial reporting along with challenges that companies face in which they undertake different transactions. It is possible for these transactions to lead to a profit under a harmonised standard whereas it could need a deferral under another standard. Therefore, companies working in the United Kingdom could face a lot of challenges to prepare consolidated financial statements. When a company must report under different financial standards, tit might record some irregularities. For example, in 1998 Daimler Benz a German company secured a stock market listing in the United States, and in the same year reported a net profit of DM 158 million for the first six months based on the German GAAP. However, the US GAAP reconciliatory statements disclosed that the company had incurred a loss of DM 949m. In a similar manner the British Telecom Inc. recorded a net profit of £1767 in 1994 under the UK GAAP, however, under the US GAAP reconciliation the net profit of the company reduced £1476 (Lynn, Seethamraju, and Seetharaman 2008, p. 108).

The process of harmonisation is not an end by itself but is only a mean to an end. The adoption of various accounting standards leads to difficulties in making a relative evaluation of performance of entities. Such an occurrence hampers the valuation and consequently the process of making decision. There are several times in the United Kingdom and other parts of the world where bad accounting practices has led to corporate failures. Another noteworthy benefit that is expected to accrue from a global convergence of accounting standard correlates to cross-boarder mergers and acquisitions. Lastly, the process of harmonisation improves the quality of financial reporting in any jurisdiction.

Implementation and challenges

The main impending factor in the adoption of IFRS in the United Kingdom is not majorly technical, but rather it is a cultural, legal mental, educational and political needs. Fearnley and Hines (2007, p. 405) wrote that the implementation challenges mainly include timely interpretation of standards, constant updates, and amendments of the IFRS system, accounting expertise, regulators and management incentives. As much as IFRS can facilitate international comparability, increase transparency in accounting, reduce information costs, decrease information asymmetry, and ultimately increasing liquidity, efficiency of markets and competition, Deighton, Dix, Graham, and Skinner (2009, p. 542) contended that cultural, corporate, and political variations can impose significant challenges in the progress towards the accounting and governance of the IFRS system. Other challenges that have hindered IFRS governance in the United Kingdom include;

IASB governance structure, funding, and consistency; most business and authorities need the assurance of IASB true independence with a firm source of funding, experienced employees, relevant governance structures to make sure that the process of setting the necessary standards cannot be influenced by political and personal interests. Such a process will improve the legitimacy of the IASB and ensure the confidence of market participation (Bush, Sunder, and Fearnley 2007). This is especially important in the face of the looming threat of developed countries that want to dominate the IASB structure and the process of the setting process to the detriments of the developed countries. Besides, there are strong opposition and lobbying by the same groups to IASB’s standards.

Consistent regulatory review: currently most IFRS regulations have been labelled and have different versions which are not consistent with IASB’s prescription. Besides there lots of uneven application that stem from various IFRS version. Akman (2011, p. 11) indicated that for most motivations and opportunities for various IFRS to persist, there must be a coordinated regulatory review and enforcement mechanisms that facilitate the steady application of this guideline. Besides, there are various uneven applications that stem from the various versions of IFRS. Filatotchev and Boyd (2009, p. 261) noted that for different opportunities and IFRS to continue, there ought to be a coordinated accountability and governance review and an enforcement mechanism that facilitate the consistent application of this policy. The complexity of some IFRS and tax orientation of most countries have been identified as the most substantial impairments to convergence.

Issues in compliance and enforcement mechanisms; there are different levels of compliance with IFRS despite claims by entities that their financial statements follow IFRS, despite sporadic claims by different companies that their financial statements are compliant with IFRS. To make it worse financial auditors have failed to express their opinions in regards to IFRS compliance and non-compliance (Uzma 2016). Another challenge is the enforcement mechanisms of IFRS especially in authority with weak institutions and agencies.

Structural Changes in different companies; there are regulatory and structural challenges among companies and at the same time, these companies demand greater accountability and broader participation when embracing the necessary structural reforms that are faced by companies in adopting IFRS. For a fact embracing globalisation and adopting IFRS at the same time has been proved to be challenging as such changes demand structural and policy change. Besides, there is need for increased training for auditors, shareholders, and accountants on IFRS curriculum. Additionally, the UK legal system ought to be conversant with the new guidelines given by IFRS as it directly influences corporate taxes among other facets of financial law. The adoption of IFRS must then involve the strengthening of several institutions which can improve the efficient implementation.

Social critical perspectives

The IFRS system has been developed in different states under divergent legal, economic, social, and cultural environments. Because of such differences, there is diversity in the accounting standards among different companies and countries around the world. If harmonisation is to be achieved, it is necessary to reach an agreement on what are the main objectives of financial reporting. The IASB standards are focused on serving the needs of investors and capital markets. Companies that had different reporting philosophy are likely to have a difficult time to harmonise their domestic standards with International Financial reporting. Besides the quality of financial reporting majorly relies on the quality of accounting standards and the efficacy of the process by which these standards are implemented. Sufficient regulatory and other supporting structures are required to ensure the right implementation of standards. Regardless of harmonisation, there is no assurance that these policies will be implemented with the same vigour in all companies. Furthermore, the harmonisation of accounting standards is likely to raise more questions of rules versus principles (Wines, Dagwell, and Windsor 2007, p. 873). Currently, IASB standards are principle-based. Therefore, a country like the United Kingdom that has accounting laws, and policies can experience considerable difficulty in adopting harmonisation. Another social challenge is the shortage of skilful employees, especially those who are trained in IFRS, the demand for IFRS accountants are high, and this is likely to lead to a huge gap when it comes to implementation of the harmonised IFRS standards.

A study by Bayerlein and Al Farooque (2012, p. 93) concluded that Small and Medium Enterprises (SMES) might be important for both factual and fair value interpretation and for more comparability of accounting in a global environment. A requirement for such an occurrence will be a broader spread of IFRS for SME familiarity. In general, IFRS for SMES is founded on various concept apart from accounting regulations, therefore, it is not only about the training of new bookkeeping regulations, rather it is about the training if various accounting thoughts and different approach for documenting financial transactions. There is also a need to deliver even information for specialised accountants on the development and variations in IFRS and how these changes can affect SMEs. As a possible limit for the current embracing of IFRS by SMEs could be considered as the lack of motivation as the customers of professional accountant prefer the best solution of accounting operation from a taxation point of view, rather than a true and fair value, because of the close relationship between the national accounting guideline to the regulation of taxes.

In respect to critical view of the accounting standards, Gastón, García, Jarne, and Gadea (2010,p. 311) stated that as much as IFRS was supposed to make business have a common financial language, it has so far failed to unite corporations in the United Kingdom, as much as it has enhanced the value of financial reportage and comparability of financial declarations. In respect to the political and legal system of the country, Soltani and Maupetit (2015, p. 271) purported that the IFRS guideline is seen as a European affair by other countries; this perception is expected to affect the intercontinental standards’ legitimacy in foreign countries. Countries and companies that are more friendly towards European values then IFRS would seem like a natural and ideal system, but for those companies that are aligned to foreign ideologies, IFRS represents an external idea that might not be welcomed. In nations where European establishments are non-native, the acceptance of IFRS could be seen as annulling authority to a Europe based guideline setter. Therefore, it is predicted that nations that are socially closer to Europe are to be expected to approve IFR.

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