US GAAP IFRS Convergence - Essay Example

?US GAAP – IFRS Convergence Introduction Over the past 15 years, many accounting controversies and scandals have caused financial turmoil and resulted in the bankruptcy of several major firms. In response to these events, the IASB (International Accounting Standards Board) began developing the IFRS (International Financial Reporting Standards) to provide transparency and comparability for investors across the world. Today, more than 113 countries have adopted the IFRS or are in the process of converging to the standard (Nobes and Parker, 2010). While countries such as Canada adopted the IFRS as early as 2011, the United States has maintained that transition from the US GAAP (Generally Accepted Accounting Principles) to the globally accepted IFRS will require more time. The US GAAP is the accounting standard followed by all companies registered in the United States. Doherty (2008) estimates that the US will not be able to adopt the IFRS completely before 2015. As a result, both the FASB (Federal Accounting Standards Board of the US) and the IASB have been working to achieve convergence between the two standards. However, this convergence exercise has been ongoing for several years as related agencies including the FASB, IASB, SEC and the general industry debate on the pros and cons of specific rules and regulations. This paper provides a critical review on whether the US should abandon the US GAAP and adopt the IFRS with immediate effect. This analysis describes both the pros and cons of this decision and explains the factors, which either encourage or inhibit the early convergence between the two standards. The path to convergence The first step towards achieving convergence between the US GAAP and IFRS was initiated by the Norwalk Agreement in 2002, under which both governing bodies pledged their commitment towards the goal of convergence and agreed to realize it by the year 2008. The boards met once again in 2008 to discuss outstanding milestones and agreed to fulfill them by 2011. Both organizations planned to achieve this through joint projects that would help define and establish a set of principle-based standards (Nobes and Parker, 2010). Achieving these objectives, within the stipulated time period, has however not been possible, owing to a number of bottlenecks and shortcomings on the part of both the IASB and the FASB. For example, both parties realized during 2010 that they would be unable to resolve all outstanding issues by 2011 (Brands, 2011). In response, they decided to prioritize all such projects based on their relative importance. Despite ensuring quicker resolution of these urgent issues, many prioritized projects such as ‘Financial Instruments’ and ‘Revenue Recognition’ are yet to be resolved. As a result, other ‘low-priority’ projects like ‘Income Taxes’, ‘Financial Statement Presentation’ and ‘Liabilities’ are unlikely to be resolved in the near future (Bruce, 2010). Much of the delay can be attributed to the overwhelming and diverse nature of public feedback, received in the form of exposure drafts, which need to be thoroughly examined and analyzed to determine the most appropriate standard. The delay is further exacerbated, as the boards then have to prepare subsequent drafts after taking all public feedback into consideration and re-expose them for further public scrutiny. Most recently, the FASB and IASB announced that they would re-expose their latest drafts on revenue and leases. Based on their expected date of publication and comments from interested parties, the effective date for both standards is unlikely to be set any earlier than 2015 (Jamal, 2010). Thus, it is evident that despite considerable planning it has been impossible to prevent unavoidable delays in the early adoption of a common accounting standard. Hail, Leuz and Wysocki (2010a) blame the IASB and the FASB for ignoring due diligence and instead focusing their efforts towards meeting the deadline. He criticizes both rule-setting bodies for setting highly optimistic targets instead of realizing the enormity of the issues at hand. While one must expect some delay in obtaining a standard that garners wide public acceptance, the problem now concerns the uncertainty that surrounds this delay causing dissatisfaction among companies. This is because companies incur huge expenditures by reconfiguring their accounting systems to conform to changes in the accounting standards. This requires elaborate planning and changes to software systems, implying that firms need to have a credible insight on expected changes to the relevant standard. Additionally, the FASB has also been working alongside on other independent projects such as ‘Goodwill Impairment Assessments’ without engaging the IASB (Ernst & Young, 2011c). This is an alarming development as it may result in an entirely different standard, which may never converge with the impairment model provided by the IFRS. Indulging in independent projects, which may result in divergent accounting frameworks, will further rupture the path towards convergence if not rectified immediately. Reasons to move towards IFRS The primary advantage of adopting IFRS is that it enables companies to compete with one another on an international level. With a common standard, investors would be able to differentiate among good and bad companies by simply analyzing the financial statements and not having to delve deeper to identify differentiating factors. A common accounting standard also facilitates collaboration on a global scale such as in the area of logistics and supply chain management. Companies would be able to compare their books with supplies and customers without requiring intermediate conversions, thereby facilitating a quicker resolution of issues. With major economies such as China, European Union and India moving towards IFRS, it is high time for the US to follow suit if it is to attract foreign investments (Doherty, 2008). According to Nobes and Parker (2010), adopting a common global standard will also prevent companies from exploiting loopholes due to variations in different accounting standards. For instance, Chinese accounting standards do not require firms to report their debt position on the balance sheet. This not only presents an issue in management, but also obscures the solvency of the firm to a foreign investor. With the rapid adoption of IFRS, such firms will be forced to disclose their debt position and therefore provide a true picture of the firm’s overall position (Nobes and Parker, 2010). Today, most firms use ERP (Enterprise Resource Planning) to manage their accounting systems. With rapid globalization and expansion into different markets, it is difficult for firms to maintain accounts under different standards. Changes in the accounting standard of an individual country will result in an expensive and time-consuming restatement of all financial information (Hail, Leuz and Wysocki, 2010b). Thus, companies prefer to operate under a common accounting framework that will allow them to focus on the actual accounting data rather the underlying rules that govern their classification. While the GAAP is based on a strict rule based approach, the principle driven IFRS provides broader flexibility to firms by allowing them to adapt to different scenarios (Dohetry, 2008). For instance, fixed assets (Property, Plant and Equipment) are recorded at historical cost under US GAAP and no further revaluations are allowed under the standard. Such accounting treatment simply ignores the fact that the assets can be sold at prices higher or lower than the current book value in the market. IFRS adopts a different approach by reasoning that the current market value of the asset is the most accurate and fair price. As such, assets under IFRS can be revalued to reflect the true fair value. However, the question remains as to whether fair market prices are available for all assets under consideration, which may not be the case in highly illiquid, uncovered and inaccessible markets (Ernst & Young, 2011b). Nonetheless, migration from US GAAP to the IFRS system comes at a cost. Such transition requires a lot of time, money and effort to make the relevant procedural changes to the accounting systems. Furthermore, such initiatives may not deliver significant advantages beyond compliance with a global accounting standard (Ernst & Young, 2011a). For instance, reporting fixed assets under the new system may not deliver benefits in terms of asset utilization rates or salvage values. It may still prove beneficial to convert gradually towards IFRS in order to realize the fair value of the asset. Transition to IFRS also provides many other advantages as it allows companies to scrutinize their reporting process (Ernst & Young, 2011b). For instance, common reporting allows firms to identify non-performing subsidiaries that have been passive under consolidated group reporting in earlier accounting systems. This also allows firms to develop a common data dictionary that can be used to accommodate new changes to accounting standards, even on an ad-hoc basis. Estimates such as depreciation and amortization will have to follow a single accounting rule and can no longer be hidden under different assumption at successive organizational levels. This also implies that consolidation from local subsidiaries to the main offices will be much quicker and require fewer validations. According to Deloitte (2010a), investors under IFRS will have precise information on ownership structures, despite the existence of numerous subsidiaries. The path towards transition As mentioned previously, shifting from the US GAAP to IFRS requires elaborate planning and preparation. Ernst & Young (2011a) attributes convergence to the costs associated with the accounting areas that needs to be changed to conform to the new standard. Companies will have to carefully assess the bottom-up effects of changing to a new accounting framework and convey their evaluations to all relevant stakeholders. Besides, all related staff will have to undergo sufficient training to attain competency in the new framework. Investors, creditors and suppliers will also have to analyze the implications of the new accounting standard on their outstanding interests in the firm. While this may not impact the company’s ability to clear its obligations, investors and creditors may still need to revise their valuation models to keep in tune with the firm’s revised accounting policies. The practice of accrual and fair value accounting further necessitates this remodeling as it allows creditors to determine the repaying capacity of the company. According to Jamal (2010), there are several ways for the US to adopt the IFRS. The first option is through adoption or conversion to IFRS without any convergence. The second route is to initiate a conversion through a gradual transition from US GAAP to total IFRS. The third option is to accept the latest version of the IFRS even before it becomes mandatory from a legal perspective. Nobes and Parker (2010) refer to the term ‘condorsement’, which has emerged as the SEC’s (Securities and Exchanges Commission) favored option for the transition. Aimed at providing a recognizable role for the FASB, ‘condorsement’ will allow the US standard-setter to reserve the right to endorse any additional topics that have not achieved convergence so far. Simply said, ‘condorsement’ allows the US to retain certain standards under US GAAP despite the move towards a universal accounting framework. Supporters of this option argue that this would eliminate the need for US companies to convert to IFRS and instead facilitate the incorporation of IFRS rules into US GAAP. Doing so, they say, would allow firms to focus on value-added conversion and cut related costs. For example, US firms would not be required to modify any debt covenants according to IFRS guidelines under the ‘condorsement’ feature (Bradshaw, 2010). However, these supporters do not realize that choosing this option would lead to a separate US-defined version of the IFRS that would be different from the standard followed by the rest of the world, thereby defeating the whole purpose of convergence. The goal of using common financial reporting standards would thus be inconsistent should the US prefer to adopt this route. Conversion strategy for firms As the title of this critical review suggests, even if the US were to adopt the IFRS with immediate effect, US companies would require a minimum period of at least one year to make the change. Much of this period would be spent towards defining new accounting policies that can accommodate the new standards and incorporating those changes in the accounting software. PwC (2010a) notes that the conversion process would be much more complicated for US firms. Companies should prepare a transition plan that entails to achieve conversion within a specific timeframe and budget by taking all identifiable risk factors into consideration. Companies must also spend this time training employees, top management and the board of directors on the IFRS framework. The effect of IFRS on important balance sheet items such as leases, goodwill and loan agreements should also be evaluated prior to the conversion. In addition, firms must work in close coordination with their external auditors to prevent any discrepancies. According to Sleigh-Johnson (2012), concerns among US companies in making a shift to IFRS citing widespread disparities are rather unfounded. In fact, both standards enjoy a high degree of overlap on most topics such as components of financial statements, long-lived assets, interest expenses and revenue recognition. While supporting the need to undertake a careful assessment to eliminate fear, Sleigh-Johnson (2012) also stresses that any actual change towards IFRS (through implementations in the IT infrastructure) should be undertaken only after a conversion date is announced. This apprehension is understandable given the constant delays in announcing a final date on the part of the SEC and the accounting boards. The earliest expected date for conversion is 2015, which should provide companies with ample time to prepare for a possible transition. Besides, all public firms in the European Union underwent a similar transition from their local country GAAPs to IFRS in 2005. Analyzing their experiences and the lessons learned during such conversion would prove useful in allowing US companies to develop best practices for eventual conversion in the future. Conclusion The preceding sections demonstrate that the manner in which the FASB, IASB and the SEC have been working towards achieving convergence between the US GAAP and IFRS is indeed questionable. Despite several delays, there appears to be commitment between both sides to achieve a universal accounting framework at the earliest. The 2008 financial crisis and the ensuing Greek debt crisis have raised questions on the complexity and fair value accounting of financial instruments. Analyzing and modifying these standards in a bid to ensure better transparency and risk management is indeed taking more time. The path ahead seems much more complicated than it was before 2008. On the other hand, US companies will require time to adapt to the new IFRS framework as and when they are developed. Besides requiring elaborate planning and budgetary allocation, the main challenge facing companies is to ensure that their employees stay abreast of the latest IFRS guidelines through proper training. The conversion will prove much more challenging for smaller companies, as they will have far less resources, thereby requiring more time to make the transition. A common set of standards is also supported by the major accounting firms, as this will stimulate additional investments and open up new opportunities for international trade. For the regulators’ part, a universal framework would provide for better monitoring of the general industry and reduce the risk of accounting malpractices. The conversion date for US GAAP to IFRS is highly anticipated by all stakeholders and only time will tell whether the convergence has realized its true potential. References Bradshaw, M. et al., 2010. Response to the SEC’s Proposed Rule – Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards (IFRS) by U.S. Issuers. Accounting Horizons [e-journal] 24(1) Available through: Library’s e-journals Brands, K., 2011. Adoption Battle. 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Support grows for keeping US GAAP but basing future standards on IFRS. Ernst & Young, [online] Available at: [Accessed 16 March 2012] Hail, L., Leuz, C., and Wysocki, P., 2010a. Global Accounting Convergence and the Potential Adoption of IFRS by the U.S. (Part I): Conceptual Underpinnings and Economic Analysis. Accounting Horizons [e-journal] 24(3) Available through: Library’s e-journals Hail, L., Leuz, C., and Wysocki, P., 2010b. Global Accounting Convergence and the Potential Adoption of IFRS by the U.S. (Part II): Conceptual Underpinnings and Economic Analysis. Accounting Horizons [e-journal] 24(4) Available through: Library’s e-journals Huber, N., 2010. Rule the world. Accountancymagazine, [online] Availabe at: [Accessed 15 March 2012] Jamal et. al., 2010. A Research-Based Perspective on the SEC’s Proposed Rule – Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards (IFRS) by U.S. Issuers. 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