'Economic Integration within the European Union: Have MNEs driven the Commission's decision to adopt the IFRS policy?'

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Amy Archer                EU Integration Studies II

‘Economic Integration within the European Union: Have MNEs driven the Commission’s decision to adopt the IFRS policy?’

“The decision of the Commission of the European Union (EU) to oblige listed European companies…to establish their consolidated financial statements according to IFRS (IAS) represents a preliminary peak in the internationalisation process of financial accounting in Europe” (Haller and Kepler, 2002).

After years of preparation, a EU-wide standard for accounting regulations, named International Financial Reporting Standards (IFRS), came into force in 2005. This essay seeks to investigate into the economic integration process currently occurring amongst EU Member States by examining the adoption of IFRS by the European Commission (EC). It will commence by introducing the IFRS policy and the key areas of financial reporting that it will impact. Then, the advantages and disadvantages of the policy, and previous measures and directives implemented to integrate the EU’s economy will be given. Following on from this, the main body of the essay, being the argument for and against multinational enterprises (MNEs) having driven the Commission to adopt IFRS, will be presented. Finally, the essay will conclude with providing my opinion on whether this argument is valid or not.

According to Anon (2004), “The new rules are aimed at replacing the hodgepodge of national accounting regulations [previously] used across Europe”. The IFRS method of reporting financial statements has been developed by the International Accounting Standards Board (IASB), the “global rule maker” (Flower and Ebbers, 2002), which was established in 2001.

The key areas that IFRS will impact within a multinational’s financial reports include: business consolidations, i.e. the parameters deciding control and ownership stakes of an organisation; financial instruments, such as derivatives; pensions; and executive renumeration. In addition, IFRS will have an impact on certain specific areas such as: intangible assets; provisions for restructuring and for the environment; and revenue recognition.

By having a coherent accounting standards policy across EU Member States, this should allow a number of barriers facing economic integration within the EU to be overcome. Grilli (1989) believes the two most evident barriers to economic integration to be: the different regulatory treatments of domestic and foreign assets thus, limiting cross-border movement of securities; and the discrimination against “nonresident agents and firms” due to the limitations on the activities they are allowed to partake on the national capital markets. Hence, by revising the standard on the treatment of assets and by having one accounting standard to adhere to when applying for a listing on a foreign capital market should overcome both of these barriers, therefore increasing economic integration across the EU.

IFRS is enforced for all listed companies within the EU and is among 90 countries, including, Australia, Canada, China and Russia, to have adopted the new standards wholly or to have based their national standards heavily upon it (Anon, 2004). However, there are still significant differences between IFRS and the United States’ GAAP (Generally Accepted Accounting Principles). Currently, the IASB and the Financial Accounting Standards Board (FASB), who are responsible for the establishment of US GAAP, are working towards convergence, and have been since 2002 (Scholz, 2005). This inevitably means that the EU will be amongst one of the first to implement IFRS and move towards global integration of accounting standards.

Now I will discuss the advantages and disadvantages of adopting uniform standards across the EU. Solomons (1983, cited by Flower and Ebbers, 2002) lists the advantages of the imposition of uniform standards as: creditability; comparability; and the efficiency of communication. Although these advantages were cited before the decision to adopt IFRS was taken, I believe they are still applicable.

In terms of creditability, having more than one set of financial reporting rules means that an enterprise can report quite different results according to the set of standards it chooses to apply (Solomons, 1983 cited by Flower and Ebbers, 2002). For instance, in 1993, Daimler Benz announced profits of DM602 million according to German GAAP, against a loss of DM1,839 million according to US GAAP. According to Solomons (1983, cited by Flower and Ebbers, 2002) this can lead to a loss of confidence by the public, not just in the MNE in question, i.e. Daimler Benz, but also in firms in general.

For the second advantage, comparability, Solomons (1983, cited by Flower and Ebbers, 2002) states that “information provided by an enterprise is more valuable if it can easily be compared with that provided by other enterprises”. Therefore, under IFRS, financial reports can be used to provide an indication of possible weaknesses or inefficiencies. In addition, reports also become increasingly comparable with previous years, although this will not be true until several years of accounts have been produced under IFRS. This should also allow investors to make informed decisions quicker than they previously had been able to (Anon, 2004). Furthermore, firms who have operations in more than one EU Member State will have to conform to one set of regulations now as opposed to the regulations of all those Member States that they have operations in, plus the holding company’s chosen accounting standard (Anon, 2004). Solomons (1983, cited by Flower and Ebbers, 2002) state that in order to assure comparability all enterprises should follow the same rules, which will be partially achieved by the EU’s, plus others, adoption of IFRS. If, eventually, the majority of countries across the globe adopt IFRS, this will further increase comparability.

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Without an agreed set of rules governing financial reporting, it is incredibly difficult for the user to understand and interpret the financial statements of any particular enterprise. It can also be quite costly, as the MNE has to include a lengthy and detailed explanation of the rules that has been followed in their preparation. IFRS will remove the need for this, as the rules will be concise and consistent between countries and MNEs within the EU. Therefore, this should increase the ease of the user to understand and interpret the MNE’s financial reports.

However, according to Anon (2004), ...

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