The Overview of International Accounting Standards

This paper seeks to write about an overview of international accounting standards. The paper will discuss the nature and purpose of these accounting standards, the makers and users. This will also discuss accrual and cash accounting, as way of explaining the importance of these standards. 2. Analysis and Discussions 2. 1 What is the nature and purpose of these international accounting standards? International Accounting Standards (IAS) are guidelines used for the preparation of financial statements.

Financial statements which include the income statement, balance sheet, cash flow statements and the notes to financial statements (Meigs and Meigs, 1995) cannot be said to have complied with the generally accepted accounting principles for the those entities that are required to use these IAS. They are issued by the International Accounting Standards Committee (IASC) 1973to 2000 but from 2001 up to present; these standards have been called International Financial Reporting Standards (IFRS) which have been issue by the International Accounting Standards Board (IASB).

The IASB has in effect replaced the IASC. The IAS or IFRS basically uses the accrual method of accounting as distinguished from the cash accounting, hence the need to understand these two concepts. 2. 2 What entities are covered these standards? These standards are issued not made by government entities hence they are not strictly considered laws or statutes but by there adoption by government they have attain their mandatory use. The European Union (EU) in particular has issue a directive requiring publicly held entities to use IAS and IFRS staring 2005 (Deloitte Touche Tohmatsu, 2008b).

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Since they are guidelines for the preparation of the financial statements, they are also called generally accepted accounting standards (GAAP). The counterparts of these IAS in the US are the statements of Financial accounting Standards (SFAS) issued by the Financial Accounting Standards Board (FASB). The US Securities Exchange Commission requires companies listed in the US Stock exchanges to use US GAAP to convert to US GAAP for their financial statements of companies 2. 3 Accrual basis accounting compared with cash basis accounting

Since IAS prescribes the use of accrual accounting, there is need to distinguish the same from cash accounting for better understanding of the IAS. Microsoft Office Online admitted the use of accrual accounting by “all publicly traded companies and most large businesses” while cash accounting is occasionally used by individuals for simplicity purposes when they file income tax returns. Thus, Ward (n. d. ) agreed that the method of accounting legally required to be used by most business and professionals is the accrual basis of accounting.

To have a deeper understanding of these two concepts, there is a need to know the advantages and disadvantages of each over the other. Before trying to understand the advantages and disadvantages each method, it is proper to understand their distinction. The first distinction lies in the timing of recording of income or expense. Under accrual accounting, income is reported in the period that it is earned, which may or may not correspond with the time of receipt. If income corresponds with receipt it is a cash sale transaction, otherwise the receipt could be explained in many ways as will be explained later.

The same is true with the recording of expenses, where under accrual accounting, an expense must be recognized when the expense is incurred regardless when the payment or actual outflow of cash is made. Compared with cash accounting, the cash receipt is recorded as revenue when it is received, and expenses are deducted in the period when they are paid. State in another way, time of recording of revenues and expenses corresponds with the time of earning or incurring prevails in accrual accounting as against time of collecting or paying in the form of cash that corresponds to income and expense under cash accounting.

The other distinction between the two methods is the absence of other accounts in the other method. Microsoft Office Online (2008) pointed some of the differences between the two methods. One is the fact the there are no receivables or payables in a balance sheet prepared under cash basis accounting. Receivable and payable may also take the forms of accrued revenues and accrued expenses respectively. When revenue is recognized before cash is received the same is know as accrued revenue or account receivable which is part of the current assets.

But it is also possible to have received cash in accrual accounting and yet there is yet no revenue. Such is called deferred revenue or unearned revenue and the same is classified as a current liability. This happens when a customer might pay a deposit for a service but the company needs not recognize the revenues until the company has performed the service. This unearned revenue is not recognized as liability under cash accounting, instead the same would be recognize as revenues upon receipt even before the service is rendered.

On other hand, it is possible to recognize expenses are recognized before cash is paid under accrual accounting the same would be called accrued expense. The same principle could be observed when one pays interest quarterly on a loan from a bank but records the accrued interest on a monthly basis. Another variation is paying cash before incurring the expense which is termed as deferred or prepaid expense in accrual accounting which is not also found in cash accounting since the treatment would outright expense.

The advantages and limitations of cash accounting and accrual accounting could now be derived from their distinctions. Based on their distinctions, it appears that accrual accounting would provide more relevant information as to proper recognition of income and expenses in relation to the accounting period. Since accounting information indispensably deals with the accounting period, the same could not be avoided hence there is need to treat revenues and expenses properly in relation to the same. The method that will match the revenues and expenses with the period would appear to be more accurate.

This analysis could be very evident if there is a large advance collection from the customer which represents a deposit. The same could not be considered as revenue yet since there is not services yet rendered. If the same principle of cash accounting is used for tax purposes, the company would be paying income taxes on cash it has not yet earned. On the other hand, cash accounting has also its advantage over accrual in its capacity to show the proper level of cash at certain points in time. In addition, it is also simple to prepare. Since it is simple to prepare, it could be presumed to have a lower costs in the cost of preparation.

Its limitations are the very advantages of accrual accounting, that is, the cash flows do not reflect the correct revenues in relation to time or earning and incurring. Given the distinctions, advantages and disadvantages of each method, it is not difficult to see the reason for the need to have IAS for many companies around the world. Multinational and global companies need to have uniform financial information for decision making and the presence of international standards would aid them in the computation of their cost of capital and necessarily make them more responsive in making financing and investment decisions.

The fact the under the present, it’s the accrual accounting that is prescribed not only within the EU and the US but also all over the world is proof to the superiority of the accrual method of accounting. Its limitation of not showing which what cash accounting may present as advantage of over accrual accounting is surmounted over by the requirement to prepare cash flow statement, which is now a required basic financial statement. 3. Conclusion Since these IAS and IFRS are required to be used by companies, they are for the benefit and protection of decision makers who will make use of the financial statements.

Since the IAS makes use of accrual accounting over that of cash accounting, it may be concluded that accrual accounting is more objective and more accurate for companies covered. There refusal of companies to comply with there requirements could cause the auditors to issue qualified or adverse or a disclaimer of opinion of these financial statements and which could affect the credibility and use of these financial statements. Since it is the objective of the standard to promote objective and fair reporting in the financial statements companies covered would most like comply than not comply.

Their compliance would have the beneficial effects on the stock price of these companies and their noncompliance could also result in adverse effects. Accrual accounting as followed by the IAS /IFRS has however a limitation as compared to cash accounting, that is, its incapacity to show the correct amount of cash at certain points to help the company make timely decisions. The said problem however is remedied by the requirement to have cash flow statements as part of the basic financial statements.

References

1. Deloitte Touche Tohmatsu (2008a) what is IASB, {www document} URL http://www. iasplus. com/restruct/whatis.htm, Accessed May 31, 2008
2. Deloitte Touche Tohmatsu (2008b), International Reporting Standards in Europe {www document} URL http://www. iasplus. com/restruct/euro2002. htm, Accessed May 31, 2008 Meigs and Meigs (1995)
3. Financial Accounting, McGraw-Hill, New York, USA Microsoft Office Online (2008), About Cash Basis and Accrual Basis Accounting, {www document} URL http://office. microsoft. com/en-us/accounting/HP011731091033. aspx, Accessed May 31, 2008 Ward, S. (n. d)
4. Accrual Basis of Accounting, {www document} URL, http://sbinfocanada. about. com/od/accounting/g/accrualbasis. htm, Accessed May 31, 2008

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