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Audit-Rules Convergence Plays Catch-Up

Settling on a single set of auditing standards worldwide gets a lot less attention than the commingling of accounting standards, but is gaining ground.

Sarah Johnson, | US
April 8, 2008

Limitations of IFRSıs and IASıs ı Differences in Currency (Exchange Rates), Inflation Rates, and Interest Rates

The International Financial Reporting Standards and International Accounting Standards are beneficial for financial statement comparability as common standards of preparation are used. However, there should be several caveats. The preparation is under the particular Countries' currency. Thus, for instance, take Company USA and Company EU. Company USA is located in the United States and it uses the American Dollar as its domestic currency. Company EU is in the European Union and it uses the Euro as its domestic currency. Given the higher value of the Euro relative to the US Dollar, financial statements denominated in Euros of Company EU will have a higher fair value measurement basis than Company USA in American Dollars. There is also the issue of inflation and interest rate nation differences. These too impact relative purchasing power and investment incentives respectively. These economic indicators are not reflected comparatively in financial statements. For instance, in converse, if Company EU is prone to higher inflation than Company USA, then fair value measurements reflected in the financial statements of Company EU will also be higher in Euros than in USD for Company USA. However, the purchasing power will be lower (given the higher inflation in the EU) for Individual human investors in Company EU, for the related stocks, bonds, and derivatives than the USA counterpart investors in Company USA even though the currency EU is worth more than the USD. Thus, fair value at the company level may be higher but the Individual level purchasing power may be lower. These Country, Company, and Individual discrepancies are not accounted for. Interest rate differences are also a factor as they impact the weighted average cost of capital as influenced by the risk free rate. These will differ by Company let alone by Country. The differing prime rates of the European Union and the United States impacts the risk free rate and risk rates of investment in specific Countries however the investment is only measured to the extent of fair value offerings of stocks, bonds, and derivatives. If we assume the Capital Asset Pricing Model is used, the risk free rates differ by country alone and thus, there is limited comparability of equity, debt, and derivative offerings given the varying risk free rates used by Company USA and Company EU in the Capital Asset Pricing Model. Therefore, there will be limited financial statement comparability until there is 1) Integration of foreign currencies into a global standard currency, 2) Common inflationary measurements by complete integration of economies, 3) A Global prime interest rate applicable to all countries that adopt IFRS's and IAS's such that risk free rates are comparable. The nature, extent, and timing when the above occur depend on national politics. The adoption of International Standards on Auditing (ISAıs) should be less contentious save for interpretations of sufficient appropriate audit evidence and related procedures that govern work performed.

Posted by David Newman | April 08, 2008 10:39 pm

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