Need for IFRS
Imagine that you have to visit a country and you are not comfortable with its native language. The immediate challenge you see is how you would communicate when you are there. You may require a translator or interpreter who can help you understand the local language. It is likely that without such an interpreter or translator, you are not able to express correctly what you may want to. This would result in confusion and ambiguity.
In the same manner, a company who operates across countries may need to communicate to the users about the financial performance of the company in the language which they understand. IFRS serve the purpose of a translator or interpreter to these users.
Even if the company does not operate in many regions, there is a possibility that the users are from different places. All these users must understand the financial statements in the similar manner. This could only be achieved if the financial statements are prepared on a uniform basis of accounting.
International accounting Standards or IFRS is a single set of high quality, understandable and enforceable global accounting standards. The idea is that these same standards are used across the globe by companies, so financial statements can be prepared on uniform basis.
IFRS are needed for following reasons:
Offer operational simplicity
Imagine a situation where a company is operating in different countries. When the company consolidates its financial results, it would need to convert all the local GAAP information into a financial statement which uses the same accounting principles across regions. Consolidating the financial statements would not require a lot of effort and can be done with ease.
Global market access (low cost funding)
The cost of funds is not the same across the globe. Some countries may have huge cost of funds, while others may offer the funding at relatively lower rate. However, without the understanding of financial statements of an entity, lenders willing to provide funds at a lower rate may not be willing to lent money.
IFRS act as a support to give these lenders the confidence to invest into the company by uniformly communicating about the financial position and financial performance of the company. The company, on the other hand, will gain from access to low-cost funds.
Example: An entity which desires to list its debt instruments on London Stock Exchange (LSE) needs to be IFRS compliant. The LSE offers low-cost funds access against other countries. However, for the investors to understand the financial health of the company, it is required to prepare IFRS financial statements.
Professional judgment through principle based standards rather than rule based accounting
IFRS are essentially principle based accounting standards. They differ from rule based standards since IFRS would require the preparers and the auditors to apply their judgment with regard to a particular accounting situation. Hence, they offer a more quality approach than relying upon some rules. We would deal with examples on the concept at later stage.
Interpretation of financial statements in the same manner
The very basic requirement of IFRS is to ensure that the users interpret the financial statements in the same way, irrespective of their location. The companies would use a common base of preparing their financial statements, no matter where they operate from. This would ensure comparability and uniformity.