Harmonisation Of Accounting Reports- Rolls Royce Essay

Question:

Discuss about the Report for Harmonisation of Accounting Reports- Rolls Royce.

Answer:

Introduction

Harmonisation within accounting parlance refers to the process of increasing the congruity of the accounting practices by putting a limit to the amount of variation. There has greater implication than standardisation even though harmonisation and standardisation is used reciprocally. According to Stenka and Ormrod (2007) harmonisation in accounting practices seeks to bring uniformity by reducing procedural differences. Rolls Royce is one of the most popular and acclaimed engine manufacturing companies all over the globe. The company was established in the year 1906 as a partnership between Charles Stewart Rolls and Sir Frederick Henry Royce. The company has established its operations in different parts of the world. The paper will analyse the process of harmonisation of accounting practices with due emphasis on Rolls Royce. The paper will also focus on International Financial Reporting Standards and their influence on accounting practices at Rolls Royce. IFRS was mooted for promoting compatibility and to promote a common set of accounting standard (Lehman, 2009). The process of harmonisation of accounting standard has become a highly debated issue since it provides unique benefits. The accounting policies used by the company will also be discussed and evaluated against the standards as devised by IFRS.

Reasons for harmonisation

The renewed trade and commerce that is taking place all over the globe has resulted in adopting an accounting standard that is compatible and understandable across international boundaries. Globalisation has meant that companies operate from diverse countries other than their country of origin which necessitates an accounting standard that is readily understandable to individuals from different academic backgrounds. As such harmonisation of accounting practices is useful not only for the entities but also for the regulators, governments and the investors (Askary, 2006). One of the prime advantages of harmonisation is that it will benefit the world economy through sound and educated investment decisions. Such educated economic decisions will eventually lead to economic growth all over the world. Information from financial statements can be interpreted more readily by financial experts thus reducing the risk of investment. Financial analysis incorporates comparability of financial statements or financial information of similar business within a particular industry. Harmonisation of accounting practices will help in making investment decision less dicey. There will be greater intelligence in investment decisions leading to educated investment decision all over the world (Bradshaw and Miller, 2008). One of the prime benefits that will be witnessed can be attributed to multinational companies who have to prepare their accounting information in multiple accounting standards. Empirical studies have proved that the cost involved in converting to US standard of accounting to a multinational company is more than $1 million. Adopting harmonised accounting standards will inevitably lead to cost reduction that can be subsequently passed on to the consumers (Hammermeister and Zimmermann, 2010).

Benefits of harmonisation can also be seen on countries with fewer resources. These countries will not have to invest so as to develop their own accounting standards. Such countries are the ones whose economies are classifies as underdeveloped. Harmonisation of accounting will also do away with the hassles of regulating national accounting agencies. Other benefits also exist related to listing on stock exchanges. For the purpose of getting listed on a reputed stock exchange organisations must adhere to the financial reporting protocol of the exchange it wants to sell securities through. As such stock exchanges all over the globe are expected to profit from harmonisation of accounting reports (Ionas et al, 2007). More and more companies will start to adopt the standard in a bid to be eligible for listing in the eminent stock exchanges. With the number of listing on the stock exchanges on a high there will be increased securities transaction. (Thoma et al, 2010).

Another distinct benefit arising out from the implementation of harmonising accounting standards is that there will be increased audit efficiency. Such internationalisation will mean that they can operate in different countries without any difficulty. As because the US is the biggest economy in the world present practices involve remodelling accounting standards to GAAP so as to augment trade and commerce with the US. Implementation of IAS/ IFRS along with GAAP will slowly pave way for a single accounting standard in the world. Finally there is a concerted effort from the regulatory bodies in favour of a single accounting standard that will augment trade and commerce (Perry and N?lke, 2006). Such a move also enhances the credibility of corporate entity all over the globe and help in the process of comparisons. As such, greater intensity of competition can be witnessed both within the domestic and international arena. One of the major issues that are behind the process of harmonisation is the emergence of multinational companies. Almost one third of world output is shared by the MNCs and therefore the national economy within the globe is influenced directly and indirectly by these MNCs (Krishansing, 2006).

Of late the national boundaries have given way and there is an emergence of unions like European Union, BRICS, and Financial Treaties. Harmonisation within the spheres of political, regional and economic domain has called for a single code of practice within the discipline of accounting. It has to be understood that accounting is a tool for maintaining and disclosing financial transactions. A unified method of reporting will help the different entities and professionals to move towards a globally unified capital market (Devalle et al, 2010). Advantage of harmonisation is also evident since every country will have a single accounting standard that will provide symmetry and equal opportunity. Such symmetry and equity will help in the economic development of the different countries in the long run. Increased need for harmonisation is evident from two of the major issues: The desire of foreign capital by the MNCs; The aspiration of the MNCs to reduce cost of accounting and reporting (Jeanjean and Stolowy, 2008). Mutual needs exist between the countries in the globe as there is an underlying flow of economic resources. In such vein it may b stated that every country should aspire for harmonisation not only in the political field but also in accounting sphere. Aspect of transparency will also get bolstered as a result of implementing harmonisation in the accounting process (Qu and Zhang, 2010).

GAAP is considered to be based on rule whereas IFRS is seen as a standard that sticks to principle. Differences exist between these two standards and both these system has its own intricacy. The approach of IFRS is more dynamic as a result of which this has been adopted in many economies all over the globe. There will be greater consistency in the international markets which will lead to more efficient and more transparent capital markets as a result of harmonisation. Maintenance of a uniform accounting standard will also mean adhering to standard that is accurate, precise, timely and dependable (Cairns et al, 2011). Accountant will be able to evaluate the performances of the companies regardless of the international boundary. Investors will also benefit from harmonisation as it will enable them to evaluate financial statements and make sound investments. Calls for transparency have also become stronger in the wake of collapse of Enron. This was partly because Enron’s unusual methods of accounting in numerous energy markets all over the globe (Koga and Rimmel, 2007). By resorting to spurious tactics the company was able to hide major liabilities. Implementation of spurious tactics by the company kept the investors in dark about the risks involved in investing in 3000 companies that were floated by the company. As a result, the scandal by the company was the largest bankruptcy case to be filed in the US history. After the aftermath of the ENRON crisis the efficacy of uniform accounting standard is being praised from different quarters and experts. Focus has also shifted to promoting standards that eschew ambiguity and scrupulous activities by entities (Morais and Fialho, 2008).

Issues of harmonisation

There are certain issues associated with the process of harmonisation. Issues related to time and costs are the main drawbacks associated with the process. Again control process from an internal perspective will also need to be incorporated since the existing process will become outdated. There will be costs associated with the transition process to a new accounting system (Woods et al, 2008). The training process for the accountants will also likely to be another bottleneck and many individuals may be unwilling to move towards a new accounting system. There is a greater need on investment on matters of accounting and training the numerous employees of an organisation which may not be feasible for small scale companies. It has also been estimated that such a move has the potential to inhibit the growth of numerous small scale industries across the length and breadth of the world. Therefore such a move can become counterproductive to a lesser extent. There are definite gaps between the Anglo-Saxon accounting standards and different other continental standards (Jeanjean and Stolowy, 2008). As such gaps exist that hinders the promotion of universal accounting standards.

Another notable barrier comes from national regulations and a dearth of supranational regulators. (Qu and Zhang, 2010). Other issues related to harmonisation include integration problems, sovereignty issues and licensing and enforcement. Traditionally, the move to harmonise the process has been opposed by the countries of Canada, UK, Japan and the US. Under the present system Modified Accelerated Cost Recovery System is used for the purpose of depreciation which is likely to change when changes are made to IAS accounting standards. Within the US there are state laws apart from the rules that govern the accounting system related to banking and insurance activities. Sovereignty issues may crop up in case IAS accounting model is implemented (Bradshaw and Miller, 2008). Licensing and aspects will also be evident since CPAs and practitioners will have to comply with the new international standard. Moreover issues related to enforcement in case of a breach are also likely to be another significant issue in case of any breach. Prosecutorial authority and its scope have to be made clear that will throw up challenges relating to jurisdictional and constitutional facets. It may be seen that adopting international accounting standard will directly contradict US statute law. As such the implementation of universal accounting codes does have its own share of lacunae that have to be addressed by the authorities (Perry and N?lke, 2006).

Case study to illustrate the success or failure of harmonisation

In light of the above discussion it can be made out that the advantages of harmonising accounting standards far outweigh the disadvantages. The UK has its own accounting system known as UK GAAP. The financial Reporting council in the UK has set out five standards that form the basis of financial reporting and accounting standard within the country (Stenka and Ormrod, 2007). Within UK IFRS has been an important part since 2005 when the EC regulation 1606/2002 came into effect. Financial Reporting Council (FRC) in the UK maintains that IAS regulations apply only to listed companies. Apart from that companies operating within UK have been allowed to use UK GAAP or IFRS. However for charitable companies both individual and group financial statements have to be prepared according to UK GAAP policies. Again the Alternative Investment Market (AIM) is not a regulated one and hence is not required to comply with IFRS standards (Devalle et al, 2010). Thus it may be seen that some amount of flexibility has been rendered within the accounting system by implementing IFRS partially. The law makes it possible to use either IFRS or UK GAAP conventions as per the convenience. In context to Rolls Royce it may be said that the company is a public limited company that has maintained a consistent and fruitful practices over the years. The preparations for a transition to IFRS led standards began as early as 2005 within Rolls Royce. There was indeed some effect on adoption of IFRS at the company as may be seen from stock movements at the corresponding time (Qu and Zhang, 2010).

Traditionally Rolls Royce has prepared its accounts in adherence to UK GAAP conventions. The then EU regulations made it necessary for the company to adhere to IFRS from the year 2005. As a result the different financial statements underwent certain changes. These changes were reported within the profit and loss account, balance sheet and earnings per share. Within the profit and loss statement for the year 2004 profit before accounting for underlying (non-trading) items increased from 345 million pounds to 364 million pounds. Profit before tax also increased from 306 million pounds to 364 million pounds signifying an increase of 58 million pounds (The Free library, 2005). The earnings per share increased from 12.07 pence to 15.56 indicating a growth of 29 percent. Underlying earnings per share increased from 14.5 pence to 15.56 pence indicating a growth of 7 percent. Within the balance sheet there was a reduction in the net assets by 861 million pounds. Net assets decreased from 2307 million pounds to 1446 million. Net debt also increased from 149 million pounds from 80 million pounds signifying an increase of 69 million in net debt. However there were no reported changes in the trading performances o the entity after the implementation of IFRS (Cairns et al, 2011). In other words adopting of IFRS only changes the presentation of accounts at Rolls Royce without affecting business model or any strategy. No changes were also observed in the cash flows by the group and ‘underlying profit’ was retained as the benchmark for measuring operating performance by the company. The market reacted positively as may be made out by increase in the share prices at Rolls Royce by 3.4 % to 256.75 p (The Free library, 2005).

Enforcement of Accounting Standards for Rolls Royce, UK:

Evolution of Accounting in UK has been in accordance with statutory laws and rules. The year of 2005 was water shed moment for UK as it moved from the erstwhile GAAP conventions to IFRS signifying a momentous transition in matters of accounting practices and standards. Alike all other companies Roll Royce has to abide by the existing provisions and statutes. Accounting disclosures in the UK are carried out as per the standards laid out by Accounting Standards Board (ASB) in conjunction with other regulatory frameworks and relevant standards. Since Rolls Royce has been based in UK pounds is used for expressing financial information. The Financial Reporting Council (FRC) exhorts companies to use five accounting standards in UK and these standards are FRS 100 to 104. FRS 105 deals with organisations that are classified as ‘micro entities’. IFRS frameworks influence the areas of Business Combinations, Conceptual Framework, Financial Instruments Accounting and other areas. The method of preparing accounts by Roll Royce is in strict adherence to the standards as may be seen from the relevant discussions (Devalle et al, 2010).

Segment Reporting:

Segment reporting is carried out so as to convey information to different stakeholders of the company about the most significant operating divisions or segments of a company. At Rolls Royce operations have been categorised into five distinct divisions of Civil Aerospace, Defence Aerospace, Power systems, Marine and Nuclear. The underlying revenue mix for Roll Royce for the year 2015 was 52 % for Civil Aerospace, 15 % for Defence Aerospace, 18% for Power systems, 10% for Marines and 5 % for Nuclear. The Civil Aerospace had an underlying revenue of ?6933 million with underlying profit of ?812 million for the year ended 2015. The underlying revenue mix for this sector was 47 % OE revenue and 53 % services revenue. For defence Aerospace the underlying revenue was ?2035 million along with underlying profit of 393 million for the year ended 2015. Power Systems segment of Rolls Royce accumulated underlying revenue of ?2385 million and underlying profit of 194 million for the year of 2015. The marine division of the company had underlying revenue of ?1324 million with underlying profit of ?15 million. Underlying revenue for nuclear business was ?687 million for 2015 with ?70 million underlying profit (Rolls-Royce, 2015).

The process of creating harmonisation at Rolls Royce started from 2002 as revealed by pertinent secondary sources. At the same time it can also be observed that the company has encouraged the use of IFRS. By moving to IFRS standard the company has provided an example of good practices that can be emulated for overall benefit. The implementation of IFRS affected five key areas within Rolls Royce. These five areas are research and development costs, sales of original equipment, Financial risk and revenue-sharing partners, Treatment of hedging for foreign exchange and Pension and other post retirement benefits (The Free library, 2005). Timeline to adopt IFRS by the company was three years as may be seen from the annals. Certain changes as occurred in the wake of implementing IFRS have been illustrated in the section above. The Companies Act, 2006 is the main act that governs the business activities of the different entities in UK. As per the Act, consolidated and individual financial statements have to be presented together. This is also applicable where consolidated and individual financial statements are arranged by different conventions (Koga and Rimmel, 2007). In Rolls Royce, it may be seen that the company has readily coordinated with the local and national authorities to smoothen the process of switching over to IFRS. After the transition from UK GAAP to IFRS the company has seen definite changes in the valuation of intangible assets, leases, contingent liabilities and income tax burden. With the valuable support from the auditors KPMG Audit plc, Rolls Royce has been successful in switching over to IFRS from UK GAAP (Stenka and Ormrod, 2007).

Conclusion

The process of harmonization has gathered momentum in the past decade owing to numerous benefits that it allows. The paper has illustrated the different advantages of harmonising with instances from the company of Rolls Royce. The emergence of the MNCs has meant that the harmonisation has numerous benefits prime among which are augmenting the global trade and commerce with increased transparency. Some of the issues related to the process of harmonisation has also been shown prime among which are time and monetary ones (Woods et al, 2008). Rolls Royce has been able to move over to IFRS seamlessly. The role of the UK Government also deserves special mentioning in implementing IFRS standards in the country.

Skills and Learning Statement

I have conducted the research on the given topic by the help of articles, journals, articles and credible internet sources. At the initial stage I concentrated on collecting credible data from different secondary sources. Thereafter I used my communication skills (both written an oral) so as to prepare the assignment. I have understood that harmonisation of accounting standards will make it easier to attract international investors. This is because of the reason that maintaining universal accounting standard facilitates in decision making and is beneficial from the perspectives of the regulatory authorities as well the different stakeholders. Entities will no longer to have to maintain different sets of accounting for different operating regions making the process of decision making smooth and in conjunction with the needs of the various stakeholders. I have also observed that diversity in accounting practices all over the globe has the potential to destroy the flow of capital globally. Moreover there is pressure from the group of investors who have argued that financial information should be prepared in a manner that is smart as well comparable.

Other direct benefits include high quality of financial reporting as a result of unified and standard accounting practices. There is pressure also from professionals of accounting discipline as harmonisation will pave way to internationalisation of the profession. I can also opine that the global economy will benefit directly as a result of the mergers of two standards: the GAAP and IFRS. The worldwide economy is becoming more and more prevalent in present society and as a result demand for a universal reporting system has increased. Focus of the authorities is on implementing the best practices in the field of accounting that will enhance trade and commerce.

On the other hand there are certain issues related with the process of harmonisation. I have observed that the companies now operate from different countries that have their own accounting standards if not GAAP. Promoting universal accounting standards in these countries will essentially be an arduous task owing to the resources and time that is going to be consumed. For small scale companies the costs associated with training the different employees can have an adverse affect owing to the issues of time and cost. I have observed that national accounting standards are maintained poorly in some countries.

In such a context it may be stated that these economies are less likely to switch over to standards as spelt out by IFRS. Another notable issue in case of implementation of IFRS is the one associated with the language barrier. There are myriad languages in existence across the globe along with different culture and practices which makes the implementation of a single accounting standard a cumbersome process. At the time of preparing this assignment I was not sure whether I will be able to gather all the needed information so as to complete the assignment. Another challenge was in the form of presenting the findings with the allocated timeframe. The role of my mentor and professor went a long way in completing this module successfully.

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